International Flavors & Fragrances - 10-Q quarterly report FY

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 þ Noo

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements, an amendment of ARB No. 51” (“FAS 160”).  FAS 160 establishes accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary.  It also amends certain of ARB No. 51’s consolidation procedures for consistency with the requirements of FAS 141(R).  This statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008.  The statement shall be applied prospectively as of the beginning of the year in which the statement is adopted.  We are in the process of evaluating the impact of FAS 160 on our Consolidated Financial Statements.

This hierarchy requires us to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.

FAS 157 requires that we take into account our own credit risk when measuring the fair value. The adoption of FAS 157 has also resulted in some other changes to the valuation techniques we use when determining fair value, most notably changes to the way that the probability of default of a counterparty is factored in. The change in the fair value of these liabilities due to such changes in our own credit risk (or instrument-specific credit risk) was immaterial.

Certain reclassifications have been made to the prior period’s financial statements to conform to 2008 classifications. In addition, Operating cash flows in 2007 were revised to $3 million from the $8 million reported in 2007 to properly reflect the inclusion of the purchase of investments of $5 million offset by proceeds of $9 million from investments in investing activities.

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:

Stock options to purchase 331,593 and 120,000 shares were outstanding for the first quarter of 2008 and 2007, respectively, but were not included in the computation of diluted net income per share for the respective periods since the impact was anti-dilutive.

Movements in restructuring liabilities, included in Restructuring and other charges in the accompanying Consolidated Balance Sheet, were (in millions):

Goodwill by operating segment at March 31, 2008 and December 31, 2007 is as follows:

Trademark and other intangible assets consist of the following amounts:

Amortization expense for the quarter ended March 31, 2008 was $1.5 million, compared to $3.6 million in the 2007 quarter; estimated annual amortization is $6 million in 2008 and $6 million in each year 2009 through 2012.

When available, we generally use quoted market prices to determine fair value, and classify such items in Level 1. In some cases where a market price is available, we will make use of acceptable practical expedients (such as matrix pricing) to calculate fair value in which case the items are classified in Level 2.

The following section describes the valuation methodologies used by us to measure different financial instruments at fair value, including an indication of the level in the fair value hierarchy in which each instrument is generally classified. Where appropriate, the description includes details of the valuation models, the key inputs to those models as well as any significant assumptions.

As of March 31, 2008, we had $87 million of gross unrecognized tax benefits recorded in other liabilities.  If recognized, $86 million, net of federal benefits, would be recorded as a component of income tax expense and affect the effective tax rate.

We have consistently recognized interest and penalties related to unrecognized tax benefits as a component of income tax expense.  At March 31, 2008, we had accrued $10 million of interest and penalties.

We conduct business globally and remain open to examination in several tax jurisdictions for various years from 2000-2007. We are under examination in several significant tax jurisdictions for various years from 2001 to 2007. As a result of the expiry of various statutes of limitation and the completion of examinations during the next twelve months, it is possible that a decrease in certain unrecognized tax benefits may occur in the range of $5 - $8 million.

We have various plans under which our officers, senior management, other key employees and directors may be granted equity-based awards including restricted stock, restricted stock units (“RSUs”), stock settled appreciation rights (“SSARs”) or stock options to purchase our common stock.

 We offer a Long Term Incentive Plan (“LTIP”) for executive officers and other Company executives.  LTIP plan awards are based on meeting certain targeted financial and/or strategic goals established by the Compensation Committee of the Board of Directors at the start of each cycle.  The targeted payout of the LTIP 2007 - 2009 cycle and thereafter is 50% cash and 50% IFF stock.  The number of shares for the 50% stock portion will be determined by the closing share price on the first trading day at the beginning of the cycle.  The executive generally must remain employed with IFF during the cycle to receive the award.

Restricted stock and RSU activity for the quarter ended March 31, 2008 was as follows:

We are organized 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 described in Note 1 of the Notes to the Consolidated Financial Statements included in our 2007 Annual Report.

We evaluate the performance of business units based on operating profit before interest expense, other income (expense), net and income taxes. 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.

 Our reportable segment information was as follows:

For the quarters ended March 31, 2008 and 2007, expense recognized for postretirement benefits other than pensions included the following components:

In the quarter ended March 31, 2008, $1 million of contributions were made; we expect to contribute $4 million to our postretirement benefit plans in 2008.

We are party to a number of lawsuits and claims related primarily to flavoring supplied by us to manufacturers of butter flavor popcorn. At each balance sheet date, or more frequently as conditions warrant, we review the status of each pending claim, as well as our insurance coverage for such claims with due consideration given to potentially applicable deductibles, retentions and reservation of rights under our insurance policies, and the advice of our outside legal counsel with respect to all these matters. While the ultimate outcome of any litigation cannot be predicted, management believes that adequate provision has been made with respect to all known claims. Based on information presently available and in light of the merits of our defenses and the availability of insurance, we do not expect the outcome of the above cases, singly or in the aggregate, to have a material adverse effect on our financial condition, results of operation or liquidity. There can be no assurance that future events will not require us to increase the amount we have accrued for any matter or accrue for a matter that has not been previously accrued.

We have recognized our expected liability with respect to these claims in Other current liabilities and expected recoveries from our insurance carrier group in other receivables recorded in Other current assets in the accompanying Consolidated Balance Sheet. We believe that realization of the insurance receivable is probable due to the terms of the insurance policies and the payment experience to date of the carrier group as it relates to these claims.

We are a leading creator and manufacturer of compounds used to impart or improve the flavor or fragrance in a wide variety of consumer products.

Flavors and fragrances are generally:

The flavor and fragrance industry is impacted by macroeconomic factors in all product categories and geographic regions. Such factors include the impact of currency on the price of raw materials and operating costs as well as on translation of reported results. In addition, pricing pressure placed on our customers by large and powerful retailers and distributors is inevitably passed along to us and our competitors. Leadership in innovation and creativity mitigates the impact of pricing pressure. Success and growth in the industry is dependent upon creativity and innovation in meeting the many and varied needs of the customers' products in a cost-efficient and effective manner, and with a consistently high level of timely service and delivery.

As implementation of our strategy progresses, setting strategic initiatives requires regular establishment and reassessment of priorities and necessitates choices in order to provide the best opportunity for continuous improvement in shareholder value.

First quarter 2008 sales totaled $597 million, increasing 5% over the prior year quarter; flavor sales increased 12% while fragrance sales were flat with the prior year period.  Reported sales for the 2008 quarter benefited from the weaker U.S. dollar, mainly against the Euro, during the quarter; at comparable exchange rates, sales would have increased 1% in comparison to the 2007 quarter. Fragrance sales were strongest in Greater Asia offset by weakness in the U.S. market.  Functional fragrance sales increased 6% on a combination of new wins and improved volumes, most notably in Greater Asia. Fragrance Ingredients sales reflected a planned shift in product mix, which resulted in lower sales, but improved gross margins

Sales performance by region and product category in comparison to the prior year quarter in both reported dollars and local currency, where applicable, was as follows:

The percentage relationship of cost of goods sold and other operating expenses to reported sales is as follows:

Cost of goods sold includes the cost of materials and manufacturing expenses; raw materials generally constitute 70% of the total. Research and development expenses are for the development of new and improved products, technical product support, compliance with governmental regulations, and help in maintaining relationships with customers who are often dependent on technological advances. Selling, general and administrative expenses support our sales and operating levels.

With respect to the restructuring and other charges:

            In the first quarter 2008, as part of our business transformation initiative to enable us to better leverage our global SAP software platform, we implemented a plan to centralize transactions in a global shared service center.  These actions resulted in the elimination of 123 positions, primarily in the finance and accounting around the world. The majority of affected positions involved employee separation. As a result of these actions, we recognized pre-tax charges of $6.2 million in 2008 related to employee separation costs.  Annual savings from these actions is expected to approximate $5 million beginning in 2009.

Positions eliminated and charges by business segment in 2008 are detailed in the table below; there were no such actions undertaken in 2007.

In the first quarter 2008, interest expense totaled $18 million as compared to $8 million in 2007, due to higher borrowings incurred in connection with the 2007 share repurchase activities.  Average cost of debt was 5.9% for 2008 compared to 4.1% in 2007.

Other expense in 2008 of $2 million was mainly exchange losses as a result of our U.S. dollar positions in Europe and Great Britain weakening in comparison to the Euro and Pound Sterling.

The effective tax rate was 25.4% as compared to a rate of 28.0% in the prior year quarter.  The 2008 quarter benefited from favorable tax rulings with respect to prior periods; excluding the benefit of these rulings of $2.1 million, the effective tax rate for the 2008 quarter would have been 28.2%.

Fragrance operating profit for the first quarter of 2008 was $47 million or 14.5%, as a percentage of sales, declining from $59 million or 18.2% reported in 2007.  The 2008 amount includes $2 million of restructuring expenses, which had an 80 basis point negative impact on operating margin. The decline in profit was driven by unfavorable absorption of manufacturing expenses from the shortfall in sales in North America, as well as unfavorable mix, with declining fine fragrance sales.

 Global expenses represent corporate and headquarters-related expenses which include legal, finance, human resources and other administrative expenses that are not allocated to an individual business unit as well as a benefit from insurance recovery in 2008.  In 2008, Global expenses were $8 million, comparable to first quarter 2007.  In 2008, Global expenses included approximately $3 million of restructuring charges.  Excluding the restructuring charges, Global expense decreased almost $3 million, primarily from lower incentive compensation expense.

Cash, cash equivalents and short-term investments totaled $61 million at March 31, 2008 compared to $84 million at March 31, 2007.  Working capital of $662 million at March 31, 2008 was comparable to the $652 million at December 31, 2007.  Additions to property, plant and equipment were $12 million for the quarter ended March 31, 2008. Gross additions to property, plant and equipment are expected to approximate $90 million in 2008.

Operating cash flows in the first quarter 2008 were $8 million comparable to the prior year quarter. Operating cash flows in the 2008 quarter benefited from receipt of $18 million on termination of an interest rate swap, which has been deferred and will be amortized as a reduction to interest expense over the remaining term of the related debt.

At March 31, 2008, we had $1,224 million of debt outstanding, increasing approximately $412 million from the first quarter of 2007, but substantially unchanged from December 31, 2007.  The increase over the prior year quarter is related to debt issued to fund an accelerated purchase of IFF stock in 2007.

In January 2008, we paid a quarterly cash dividend of $.23 per share to shareholders, a 10% increase from the prior year quarter dividend payment. On March 4, 2008, we announced our quarterly dividend of $.23 per share payable in April 2008.

In July 2007, our Board authorized us to repurchase up to 15% or $750 million worth of our outstanding common stock, whichever is less (the “July 2007 Plan”). In September 2007, under the July 2007 Plan, we entered into two agreements to purchase shares of our common stock under a $450 million accelerated share repurchase (“ASR”) program. Subsequently, we 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 prior closing price of our stock. 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 and was reflected in the accompanying Consolidated Balance Sheet as a reduction to Capital in excess of par value.

On completion of the ASR, which is expected by the end of the second quarter of 2008, we may receive additional shares or may be required to pay cash or additional shares at our option, based on the volume-weighted average price (“VWAP”) of the common stock during the agreement term.

In the quarter ended March 31, 2008, we purchased 0.7 million shares at a cost of $30 million. In the quarter ended March 31, 2007, we purchased 0.7 million shares at a cost of $31 million.

Cash flows from operations and availability under our existing credit facilities are expected to be sufficient to fund our currently anticipated normal capital spending and other expected cash requirements for at least the next eighteen months.

The discussion of our historical results include and, where indicated, exclude the effects of exchange rate fluctuations, a restructuring charge in the 2008 first quarter, and the 2008 first quarter benefit of tax rulings relating to prior years. Such information is supplemental to information presented in accordance with GAAP and is not intended to represent a presentation in accordance with GAAP. In discussing our historical and expected future results and financial condition, we believe it is meaningful for investors to be made aware of and to be assisted in a better understanding of, on a period-to-period comparative basis, of financial amounts both including and excluding these identified items, as well as the impact of exchange rate fluctuations on operating results and financial condition. We believe such additional non-GAAP information provides investors with an overall perspective of the period-to-period performance of our core business.  In addition, management internally reviews each of these non-GAAP measures to evaluate performance on a comparative period-to-period basis in terms of absolute performance, trends and expected future performance with respect to our core continuing business.  A material limitation of these non-GAAP measures is that such measures do not reflect actual GAAP amounts, restructuring charges include actual cash outlays, and benefits from favorable tax rulings reflect actual accounting and cash benefits realized; and we compensate for such limitations by presenting the accompanying reconciliation to the most directly comparable GAAP measure. These non-GAAP measures may not be comparable to similarly titled measures used by other companies.

There are no material changes in market risk from the information provided in the Company’s 2007 Annual Report on Form 10-K.

Our Chief Executive Officer and Chief Financial Officer, with the assistance of other members of our management, have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q.  Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective as of the end of the period covered by this Quarterly Report on Form 10-Q.

We have established controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions’ rules and forms and is accumulated and communicated to management, including the principal executive officer and the principal financial officer, to allow timely decisions regarding required disclosure.

Our Chief Executive Officer and Chief Financial Officer have also concluded that there have not been any changes in our internal control over financial reporting during the quarter ended March 31, 2008 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

The Company is subject to various claims and legal actions in the ordinary course of its business.

In September 2001, the Company was named as a defendant in a purported class action brought against it in the Circuit Court of Jasper County, Missouri, on behalf of employees of a plant owned and operated by Gilster-Mary Lee Corp. in Jasper, Missouri (“Benavides case”). The plaintiffs alleged that they sustained respiratory injuries in the workplace due to the use by Gilster-Mary Lee of a Bush Boake Allen (“BBA”) and/or IFF flavor. For purposes of reporting these actions, BBA, a wholly owned subsidiary of IFF, and/or IFF are referred to as the “Company”.

In January 2004, the Court ruled that class action status was not warranted. As a result of this decision, each of the 47 plaintiff cases was to be tried separately. Subsequently, 8 cases were tried to a verdict, 4 verdicts resulted for the plaintiffs and 4 verdicts resulted for the Company, all of which were appealed by the losing party. Subsequently, all plaintiff cases related to theBenavides case, including those on appeal, were settled.

Eighteen actions based on similar claims of alleged respiratory illness due to workplace exposure to flavor ingredients are currently pending against the Company and other flavor suppliers and related companies.

In May 2004, the Company and another flavor supplier were named defendants, and subsequently a number of third party defendants were added, in a lawsuit by 4 former workers and their spouses at a Ridgeway, Illinois factory in an action brought in the Circuit Court for the Second Judicial Circuit, Gallatin County, Illinois (Barker case) and another concerning 8 other workers and 5 spouses at this same plant was filed in July 2004 and is pending in this same Court against the same defendants (Batteesecase).  In June 2004, the Company and 2 other flavor suppliers were named defendants in a lawsuit by 1 former worker and spouse at a Northlake, Illinois facility in an action brought in the Circuit Court of Cook County, Illinois. 9 third party defendants were added (Lopez case). This case was settled by confidential agreement in March 2008. In July 2005, the Company and 11 other flavor and chemical suppliers were named defendants in a lawsuit by 1 former worker and spouse of Brach's Confections, Inc. in an action brought in the Circuit Court of Cook County, Illinois.  Brach’s has been added as a third party defendant (Campbellcase).  In August 2005, the Company and 16 other companies were named defendants in a lawsuit by 3 former employees of the Gilster-Mary Lee facility in McBride, Missouri in the Missouri Circuit Court, 32nd Judicial Circuit (Fults case). In August 2006, the Company and 3 other flavor and chemical suppliers were named defendants in a lawsuit by 34 current and former employees and/or a neighbor of the Gilster-Mary Lee facility in Jasper, Missouri in the Missouri Circuit Court of Jasper County (Arles case) and 5 other current and former employees in the same Court (Bowan case). A similar case involving 5 former employees, originally plaintiffs in the Arles case, was filed in the same Court in August 2006 and then removed to the U.S. District Court, Western District of Missouri, Southwest Division (Parker case). In November 2006, the Company, 15 other flavor and chemical suppliers, a trade association and a third party defendant company were named defendants in a lawsuit filed in the Circuit Court of Cook County, Illinois by 1 plaintiff allegedly injured by exposure to butter flavor and other substances at various facilities in which he worked (Solis case). In January 2007, the Company and another flavor supplier were named defendants in a lawsuit filed in Hamilton County, Ohio Court of Common Pleas by approximately 245 current and former employees of two separate Marion, Ohio factories and 92 spouses of such employees (Aldrich case). In June 2007, the Company and another flavor supplier were named defendants in a lawsuit filed in Hamilton County, Ohio Court of Common Pleas by 58 current and former employees of a Marion, Ohio facility and 18 spouses of such employees (Arnold case). In May 2007, the Company and 13 other companies were named defendants in a lawsuit filed in Circuit Court of Cook County, Illinois by 5 former employees of Brach’s Confections, Inc. in Chicago, Illinois (Williams case). In June 2007, the Company and 22 other companies were named defendants in a lawsuit in the Missouri Circuit Court, 32ndJudicial Circuit by 7 former employees of a McBride, Missouri facility (Geile case). In July 2007, the Company and another flavor manufacturer were named defendants in a lawsuit filed in Hamilton County, Ohio Court of Common Pleas by 128 current and former workers of two Marion, Ohio facilities and 52 spouses of such employees (Adamson case). In July 2007, the Company was joined as a defendant in a case filed in June 2005 against 7 companies and a trade association in the 8thJudicial District Court of Montana by the widow of the former owner/operator of a popcorn business in Montana (Yatsko case). In October 2007, the Company and 23 other companies were named defendants in a lawsuit in the Missouri Circuit Court, 32ndJudicial Circuit by the widow and daughter of a former worker at a McBride, Missouri facility (Wibbenmeyer case). In March 2008, the Company and another flavor supplier were named defendants in two lawsuits in the Hamilton County, Ohio Court of Common Pleas, one by 16 current and former employees and spouses of such employees of a popcorn plant in Marion, Ohio (Fergusoncase) and the other by 20 current and former employees and spouses of such employees of the same plant (Brown case). In April 2008, the Company and 7 other flavor suppliers, a trade association and a trade association management company were named defendants in a lawsuit in the Circuit Court for Milwaukee County, Wisconsin by one former employee of a Company facility and his spouse (Smeadcase).

The Company believes that all IFF and BBA flavors at issue in these matters meet the requirements of the U.S. Food and Drug Administration and are safe for handling and use by workers in food manufacturing plants when used according to specified safety procedures.  These procedures are detailed in instructions that IFF and BBA provided to all their customers for the safe handling and use of their flavors.  It is the responsibility of IFF’s customers to ensure that these instructions, which include the use of appropriate engineering controls, such as adequate ventilation, prior handling procedures and respiratory protection for workers, are followed in the workplace.