10-Q


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
þ
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2015
OR
¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                         
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)
 
(I.R.S. 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 Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 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    No   Â
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No   Â
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer
 
þ
Accelerated filer
¨


 
 
 
 
 
Non-accelerated filer
 
¨


Smaller reporting company
¨


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes   Â No  þ
Number of shares outstanding as of October 26, 2015: 80,250,212


 
1
 



PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED BALANCE SHEET
(DOLLARS IN THOUSANDS)
(Unaudited)
 
 
September 30, 2015
 
December 31, 2014
ASSETS
 
 
 
 
Current Assets:
 
 
 
 
Cash and cash equivalents
 
$
272,276

 
$
478,573

Trade receivables (net of allowances of $8,217 and $9,147, respectively)
 
569,608

 
493,768

Inventories: Raw materials
 
284,503

 
275,161

Work in process
 
19,338

 
17,705

Finished goods
 
285,622

 
275,863

Total Inventories
 
589,463

 
568,729

Deferred income taxes
 
12,586

 
27,709

Prepaid expenses and other current assets
 
194,818

 
141,248

Total Current Assets
 
1,638,751

 
1,710,027

Property, plant and equipment, at cost
 
1,779,422

 
1,766,746

Accumulated depreciation
 
(1,070,520
)
 
(1,046,478
)
 
 
708,902

 
720,268

Goodwill
 
932,307

 
675,484

Other intangible assets, net
 
323,054

 
76,557

Deferred income taxes
 
179,447

 
183,047

Other assets
 
129,224

 
129,238

Total Assets
 
$
3,911,685

 
$
3,494,621

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
 
Current Liabilities:
 
 
 
 
Bank borrowings and overdrafts and current portion of long-term debt
 
$
133,056

 
$
8,090

Accounts payable
 
254,344

 
216,038

Accrued payroll and bonus
 
55,228

 
71,264

Dividends payable
 
44,995

 
37,968

Other current liabilities
 
199,697

 
185,448

Total Current Liabilities
 
687,320

 
518,808

Long-term debt
 
1,057,992

 
934,232

Deferred gains
 
44,154

 
46,535

Retirement liabilities
 
354,507

 
354,333

Other liabilities
 
171,563

 
118,024

Total Other Liabilities
 
1,628,216

 
1,453,124

Commitments and Contingencies (Note 13)
 

 

Shareholders’ Equity:
 
 
 
 
Common stock 12 1/2¢ par value; authorized 500,000,000 shares; issued 115,858,190 shares as of September 30, 2015 and December 31, 2014 and outstanding 80,356,014 and 80,777,590 shares as of September 30, 2015 and December 31, 2014
 
14,470

 
14,470

Capital in excess of par value
 
136,786

 
140,008

Retained earnings
 
3,569,911

 
3,350,734

Accumulated other comprehensive loss
 
(611,636
)
 
(540,430
)
Treasury stock, at cost - 35,502,176 shares as of September 30, 2015 and 35,080,600 shares as of December 31, 2014
 
(1,517,659
)
 
(1,446,221
)
Total Shareholders’ Equity
 
1,591,872

 
1,518,561

Noncontrolling interest
 
4,277

 
4,128

Total Shareholders’ Equity including noncontrolling interest
 
1,596,149

 
1,522,689

Total Liabilities and Shareholders’ Equity
 
$
3,911,685

 
$
3,494,621


See Notes to Consolidated Financial Statements

 
2
 



INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED STATEMENT OF COMPREHENSIVE INCOME
(AMOUNT IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
(Unaudited)
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Net sales
 
$
765,092

 
$
773,813

 
$
2,307,540

 
$
2,332,451

Cost of goods sold
 
417,966

 
433,702

 
1,269,097

 
1,298,281

Gross profit
 
347,126

 
340,111

 
1,038,443

 
1,034,170

Research and development expenses
 
62,750

 
63,701

 
188,725

 
191,635

Selling and administrative expenses
 
127,663

 
123,212

 
382,560

 
379,864

Restructuring and other charges, net
 

 
608

 
(170
)
 
912

Operating profit
 
156,713

 
152,590

 
467,328

 
461,759

Interest expense
 
11,855

 
10,968

 
34,357

 
34,048

Other expense (income), net
 
1,959

 
(563
)
 
(3,315
)
 
(3,761
)
Income before taxes
 
142,899

 
142,185

 
436,286

 
431,472

Taxes on income
 
36,452

 
34,770

 
96,206

 
107,064

Net income
 
106,447

 
107,415

 
340,080

 
324,408

Other comprehensive income (loss), after tax:
 
 
 
 
 
 
 
 
Foreign currency translation adjustments
 
(48,368
)
 
(25,046
)
 
(81,326
)
 
(26,872
)
(Losses) gains on derivatives qualifying as hedges
 
(12,498
)
 
5,748

 
(6,381
)
 
7,806

Pension and postretirement net liability
 
5,478

 
3,951

 
16,501

 
12,716

Other comprehensive loss
 
(55,388
)
 
(15,347
)
 
(71,206
)
 
(6,350
)
Total comprehensive income
 
$
51,059

 
$
92,068

 
$
268,874

 
$
318,058

 
 
 
 
 
 
 
 
 
Net income per share - basic
 
$
1.32

 
$
1.32

 
$
4.20

 
$
3.98

Net income per share - diluted
 
$
1.31

 
$
1.31

 
$
4.18

 
$
3.95

Average number of shares outstanding - basic
 
80,330

 
80,942

 
80,602

 
80,981

Average number of shares outstanding - diluted
 
80,737

 
81,508

 
81,052

 
81,556

Dividends declared per share
 
$
0.56

 
$
0.47

 
$
1.50

 
$
1.25

See Notes to Consolidated Financial Statements

 
3
 



INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(DOLLARS IN THOUSANDS)
(Unaudited)
 
 
Nine Months Ended September 30,
 
 
2015
 
2014
Cash flows from operating activities:
 
 
 
 
Net income
 
$
340,080

 
$
324,408

Adjustments to reconcile to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
65,099

 
68,678

Deferred income taxes
 
13,134

 
7,496

Gain on disposal of assets
 
(341
)
 
(2,351
)
Stock-based compensation
 
18,355

 
19,627

Pension contributions
 
(61,125
)
 
(34,493
)
Changes in assets and liabilities, net of acquisitions:
 
 
 
 
Trade receivables
 
(108,563
)
 
(47,929
)
Inventories
 
(31,655
)
 
(21,609
)
Accounts payable
 
54,482

 
(2,459
)
Accruals for incentive compensation
 
(13,781
)
 
(45,482
)
Other current payables and accrued expenses
 
34,585

 
(977
)
Other assets/liabilities, net
 
(15,575
)
 
52,594

Net cash provided by operating activities
 
294,695

 
317,503

Cash flows from investing activities:
 
 
 
 
Cash paid for acquisitions, net of cash received (including $15 million of contingent consideration related to the Aromor acquisition in 2014)
 
(493,469
)
 
(102,500
)
Additions to property, plant and equipment
 
(66,632
)
 
(97,820
)
Proceeds from life insurance contracts
 
868

 
17,750

Maturity of net investment hedges
 
9,735

 
(472
)
Proceeds from disposal of assets
 
3,431

 
2,506

Net cash used in investing activities
 
(546,067
)
 
(180,536
)
Cash flows from financing activities:
 
 
 
 
Cash dividends paid to shareholders
 
(113,875
)
 
(95,113
)
Net change in bank borrowings and overdrafts
 

 
8,926

Deferred financing costs
 

 
(1,023
)
Repayments of debt
 
(30,000
)
 

Proceeds from issuance or drawdown of long-term debt
 
279,998

 
4,100

Proceeds from issuance of stock under stock plans
 
288

 
1,361

Excess tax benefits on stock-based payments
 
11,704

 
6,080

Purchase of treasury stock
 
(81,237
)
 
(52,453
)
Net cash provided by (used in) financing activities
 
66,878

 
(128,122
)
Effect of exchange rate changes on cash and cash equivalents
 
(21,803
)
 
(9,514
)
Net change in cash and cash equivalents
 
(206,297
)
 
(669
)
Cash and cash equivalents at beginning of year
 
478,573

 
405,505

Cash and cash equivalents at end of period
 
$
272,276

 
$
404,836

Interest paid, net of amounts capitalized
 
$
42,871

 
$
26,407

Income taxes paid
 
$
71,167

 
$
63,007

See Notes to Consolidated Financial Statements

 
4
 



Notes to Consolidated Financial Statements
Note 1. Consolidated Financial Statements:
Basis of Presentation
These interim statements and related management’s discussion and analysis should be read in conjunction with the Consolidated Financial Statements and the related notes and management’s discussion and analysis of results of operations, liquidity and capital resources included in our 2014 Annual Report on Form 10-K (“2014 Form 10-K”). These interim statements are unaudited. The year-end balance sheet data included in this Form 10-Q filing was derived from audited financial statements, but does not include all disclosures required by generally accepted accounting principles in the United States of America. We have historically operated and continue to operate on a 52/53 week fiscal year ending on the Friday closest to the last day of the quarter. For ease of presentation, September 30 and December 31 are used consistently throughout this Form 10-Q and these interim financial statements and related notes to represent the period-end dates. For the 2015 and 2014 quarters, the actual closing dates were October 2, and September 26, respectively. The unaudited interim financial statements include all adjustments (consisting only of normal recurring adjustments) and accruals necessary in the judgment of management for a fair statement of the results for the periods presented. When used herein, the terms “IFF,” the “Company,” “we,” “us” and “our” mean International Flavors & Fragrances Inc. and its consolidated subsidiaries.
Reclassifications and Revisions
Certain prior year amounts have been reclassified to conform with current year presentation. Additionally, an adjustment has been made to accounts payable and accrued liabilities to correct the classification of certain amounts included in the accompanying December 31, 2014 consolidated balance sheet and a corresponding adjustment has been made to the September 30, 2014 consolidated statement of cash flows. These revisions are not considered material to the previously issued financial statements.
Recent Accounting Pronouncements
In September 2015, the Financial Accounting Standards Board ("FASB") issued authoritative guidance relating to the adjustments made during the measurement period for items in a business combination. Specifically, the new guidance would require adjustments related to the finalization of estimates to be recorded in the period when they are determined and to provide certain additional disclosures. This guidance is effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. The Company has determined that the adoption of this guidance will not have a significant impact on its consolidated financial statements.
In July 2015, the FASB issued authoritative guidance relating to the measurement of inventory costs, which more closely aligns the measurement of inventory in Generally Accepted Accounting Principles with the measurement of inventory in International Financial Reporting Standards. This guidance is effective for years beginning after December 15, 2016, including interim periods within those fiscal years. The Company does not expect that the adoption of this guidance will have a significant impact on its consolidated financial statements.
In April 2015, the FASB issued authoritative guidance which provides a practical expedient related to the measurement date of defined benefit plan assets and obligations. This guidance is effective for annual and interim periods beginning after December 15, 2015. The Company does not expect that the adoption of this guidance will have a significant impact on its consolidated financial statements.
In April 2015, the FASB issued authoritative guidance which requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability. This guidance is effective for annual and interim periods beginning after December 15, 2015. The Company has determined that the adoption of this guidance will not have a significant impact on its consolidated financial statements.
In February 2015, the FASB issued authoritative guidance related to accounting for consolidation of certain legal entities. The guidance will change the analysis that a reporting entity must perform to determine the criteria for consolidating certain types of entities. This guidance is effective for annual and interim periods beginning after December 15, 2015. The Company has determined that the adoption of this guidance will not have a significant impact on its consolidated financial statements.
In May 2014, the FASB issued authoritative guidance to clarify the principles to be used to recognize revenue and, in August 2015, issued authoritative guidance delaying the effective adoption date of that guidance by one year. The guidance is applicable to all entities and, based on the revised adoption date, is effective for annual and interim periods beginning after

 
5
 



December 15, 2017. Adoption as of the original effective date is permitted. The Company is currently evaluating the impact that this new standard will have on its consolidated financial statements.
Accounts Receivable
The Company sells certain accounts receivable on a non-recourse basis to unrelated financial institutions under “factoring” agreements that are sponsored, solely and individually, by certain customers. The Company accounts for these transactions as sales of receivables, removes the receivables sold from its financial statements, and records cash proceeds when received by the Company. The beneficial impact on cash from operations from participating in these programs increased approximately $0.2 million for the nine months ended September 30, 2015 compared to an increase of approximately $19.4 million for the nine months ended September 30, 2014. The cost of participating in these programs was immaterial to our results in all periods.

Note 2. 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)
2015
 
2014
 
2015
 
2014
Basic
80,330

 
80,942

 
80,602

 
80,981

Assumed dilution under stock plans
407

 
566

 
450

 
575

Diluted
80,737

 
81,508

 
81,052

 
81,556

There were no stock options or stock-settled appreciation rights (“SSARs”) excluded from the computation of diluted net income per share for the three and nine months ended September 30, 2015 and 2014.
The Company has issued shares of purchased restricted common stock (“PRS”) which contain rights to nonforfeitable dividends while these shares are outstanding and thus are considered participating securities. Such securities are required to be included in the computation of basic and diluted earnings per share pursuant to the two-class method. The Company did not present the two-class method since the difference between basic and diluted net income per share for both unrestricted common shareholders and PRS shareholders was less than $0.01 per share for each period presented, and the number of PRS outstanding as of September 30, 2015 and 2014 was immaterial. Net income allocated to such PRS was $0.5 million and $0.6 million during the three months ended September 30, 2015 and 2014, respectively and $1.6 million and $1.9 million during the nine months ended September 30, 2015 and 2014, respectively.
Note 3. Acquisitions:
2015 Activity
Lucas Meyer
During the third quarter of 2015, the Company completed the acquisition of 100% of the outstanding shares of Lucas Meyer Cosmetics, a business of Unipex Group ("Lucas Meyer"). (The total shares acquired include shares effectively acquired pursuant to put and call option agreements). Lucas Meyer was acquired in order to strengthen and expand Fragrance Ingredients. Total consideration was approximately Euro 284 million ($312 million), including approximately $4.8 million of cash acquired. The Company paid Euro 282 million (approximately $310 million) for this acquisition, which was funded from existing resources, and recorded a liability of approximately Euro 2 million (approximately $2 million). The purchase price exceeded the fair value of existing net assets by approximately $289 million. The excess was allocated principally to identifiable intangible assets (approximately $169 million), goodwill (approximately $174 million) and approximately $54 million to deferred taxes. Separately identifiable intangible assets are principally related to customer relationships and proprietary technology. The intangible assets are being amortized using lives ranging from 10-20 years. The purchase price allocation is preliminary pending final valuations and is expected to be completed by the fourth quarter of 2015, with the assignment of final values and applicable useful lives of intangible assets. No pro forma financial information for 2015 is presented as the impact of the acquisition was immaterial to the Consolidated Statement of Comprehensive Income.
Ottens Flavors
During the second quarter of 2015, the Company completed the acquisition of 100% of the outstanding shares of Henry H. Ottens Manufacturing Co., Inc. ("Ottens Flavors"). Ottens Flavors was acquired in order to strengthen the IFF Flavors business in North America. The Company paid approximately $198.9 million (including approximately $10.4 million of cash acquired)

 
6
 



for this acquisition, which was funded from existing resources. The purchase price exceeded the fair value of existing net assets by approximately $162 million. The excess was allocated principally to identifiable intangible assets (approximately $85 million) and goodwill (approximately $78 million). Separately identifiable intangible assets are principally related to customer relationships and proprietary flavors technology. The intangible assets are being amortized using lives ranging from 5-17 years. The purchase price allocation is preliminary pending finalization of the purchase price and is expected to be completed by the fourth quarter of 2015. No pro forma financial information for 2015 is presented as the impact of the acquisition is immaterial.
2014 Activity
Aromor
During the first quarter of 2014, the Company completed the acquisition of 100% of the equity of Aromor Flavors and Fragrances Ltd. ("Aromor"). Aromor is part of the IFF Fragrances Ingredients business. The Company paid $102.6 million (including $0.1 million of cash acquired) for this acquisition, which was funded from existing resources. The purchase price exceeded the carrying value of existing net assets by approximately $56 million. The excess was allocated principally to identifiable intangible assets (approximately $53 million), goodwill (approximately $10 million) and approximately $9 million to deferred tax liabilities. Separately identifiable intangible assets are principally related to technological know-how. The intangible assets are being amortized using lives ranging from 13-19 years. Additionally, the consideration included $15 million related to post-combination contingent consideration, held in escrow, which is being expensed by the Company as it is earned by the selling shareholders.
Note 4. Restructuring and Other Charges, Net:
In 2014, the Company closed its fragrance ingredients manufacturing facility in Augusta, Georgia and consolidated production into other Company facilities. In connection with this closure, during 2014, the Company recorded total charges of $13.8 million, consisting of $2.2 million related to severance, $10.3 million related to accelerated depreciation, and $1.3 million in plant shutdown and other related costs. During the nine months ended September 30, 2015, the Company recorded a net credit of $0.2 million principally related to the reversal of severance accruals.
Changes in employee-related restructuring liabilities during the nine months ended September 30, 2015, were as follows:
 
(DOLLARS IN THOUSANDS)
Employee-Related Costs
 
Other
 
Total
December 31, 2014
$
759

 
$

 
$
759

Additional charges (reversals), net
(357
)
 
187

 
(170
)
Payments and other costs
(282
)
 
(187
)
 
(469
)
September 30, 2015
$
120

 
$

 
$
120

Note 5. Other Intangible Assets, Net:
Other intangible assets, net consist of the following amounts: 
 
September 30,
 
December 31,
(DOLLARS IN THOUSANDS)
2015
 
2014
Gross carrying value (1)
$
475,473

 
$
218,676

Accumulated amortization
(152,419
)
 
(142,119
)
Total
$
323,054

 
$
76,557

 
(1) 
Includes patents, trademarks, technological know-how and other intellectual property, valued at acquisition.
The increase in intangible assets for the nine months ended September 30, 2015 relates to the acquisitions of Ottens Flavors and Lucas Meyer, as discussed in Note 3.
Amortization
Amortization expense was $5.4 million and $1.9 million for the three months ended September 30, 2015 and 2014, respectively and $10.3 million and $5.9 million for the nine months ended September 30, 2015 and 2014, respectively. Annual amortization is expected to be $15.9 million for the full year 2015, $23.9 million for the years 2016 through 2018, and $23.2 million for the years 2019 through 2020.

 
7
 



Note 6. Borrowings:
Debt consists of the following:
(DOLLARS IN THOUSANDS)
Rate
 
Maturities
 
September 30, 2015
 
December 31, 2014
Senior notes - 2007
6.40
%
 
2017-27
 
$
500,000

 
$
500,000

Senior notes - 2006
6.14
%
 
2016
 
125,000

 
125,000

Senior notes - 2013
3.20
%
 
2023
 
299,802

 
299,782

Credit facility
1.31
%
 
2019
 
247,655

 

Bank overdrafts and other
 
 
 
 
14,866

 
12,335

Deferred realized gains on interest rate swaps
 
 
 
 
3,725

 
5,205

 
 
 
 
 
1,191,048

 
942,322

Less: Current portion of long-term debt
 
 
 
 
(133,056
)
 
(8,090
)
 
 
 
 
 
$
1,057,992

 
$
934,232

Note 7. Income Taxes:
Uncertain Tax Positions
At September 30, 2015, the Company had $15.5 million of unrecognized tax benefits recorded in Other liabilities and $0.5 million recorded in Other current liabilities. If these unrecognized tax benefits were recognized, the effective tax rate would be affected.
At September 30, 2015, the Company had accrued interest and penalties of $0.7 million classified in Other liabilities.
As of September 30, 2015, the Company’s aggregate provisions for uncertain tax positions, including interest and penalties, was $16.7 million associated with various tax positions asserted in foreign jurisdictions, none of which is individually material.
The Company regularly repatriates a portion of current year earnings from select non–U.S. subsidiaries. No provision is made for additional taxes on undistributed earnings of subsidiary companies that are intended and planned to be indefinitely invested in such subsidiaries. We intend to, and have plans to, reinvest these earnings indefinitely in our foreign subsidiaries to fund local operations and/or capital projects.
The Company has ongoing income tax audits and legal proceedings which are at various stages of administrative or judicial review, of which the most significant items are discussed below. In addition, the Company has open tax years with various taxing jurisdictions that range primarily from 2005 to 2014. Based on currently available information, we do not believe the ultimate outcome of any of these tax audits and other tax positions related to open tax years, when finalized, will have a material impact on our financial position.
The Company also has other ongoing tax audits and legal proceedings that relate to indirect taxes, such as value-added taxes, capital tax, sales and use taxes and property taxes, which are discussed in Note 13.
Spanish Tax
As of December 31, 2014, the Company had one outstanding income tax case in Spain relating to fiscal year 2002, which had been previously appealed by the Company. As of December 31, 2014, the Company had fully reserved the original assessment asserted by the Spanish Tax Authority. During the first quarter of 2015, the Company received a favorable ruling on this appeal and accordingly, reversed the total reserve related to the 2002 fiscal year (with a value of Euro 1.9 million or $2.3 million).
As of September 30, 2015, the three dividend withholding tax controversies in Spain have now been resolved. The Company made total payments of Euro 4.5 million ($4.9 million) during the second quarter of 2015 related to the resolution of these three controversies.
Effective Tax Rate
The effective tax rate for the three months ended September 30, 2015 was 25.5% compared with 24.5% for the three months ended September 30, 2014. The quarter-over-quarter increase is largely due to mix of earnings partially offset by lower loss provisions and lower expected repatriation costs in 2015. The effective tax rate for the nine months ended September 30, 2015 was 22.1% compared with 24.8% for the nine months ended September 30, 2014. The year-over-year decrease is

 
8
 



primarily due to a benefit of $10.5 million recorded in the first quarter of 2015, as a result of favorable tax rulings in Spain and another jurisdiction for which reserves were previously recorded.

Note 8. Stock Compensation Plans:
The Company has various plans under which its officers, senior management, other key employees and directors may be granted equity-based awards. Equity awards outstanding under the plans include PRS, purchased restricted stock units, restricted stock units ("RSUs"), stock options, SSARs and Long-Term Incentive Plan awards; liability-based awards outstanding under the plans are cash-settled RSUs.
Stock-based compensation expense and related tax benefits were as follows: 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(DOLLARS IN THOUSANDS)
2015
 
2014
 
2015
 
2014
Equity-based awards
$
5,495

 
$
5,593

 
$
18,355

 
$
19,627

Liability-based awards
782

 
452

 
3,355

 
3,216

Total stock-based compensation expense
6,277

 
6,045

 
21,710

 
22,843

Less: tax benefit
(1,914
)
 
(1,899
)
 
(6,326
)
 
(6,970
)
Total stock-based compensation expense, after tax
$
4,363

 
$
4,146

 
$
15,384

 
$
15,873

On May 6, 2015, the shareholders of the Company approved the 2015 Stock Award and Incentive Plan (the "2015 Plan"). The 2015 Plan replaces the 2010 Stock Award and Incentive Plan (the “2010 Plan”). The total number of shares authorized for issuance under the Plan is 1,500,000 shares plus shares that remained available for issuance under the 2010 Plan as of May 6, 2015 and any shares subject to outstanding awards under the 2010 Plan that are cancelled, forfeited or expire.
Note 9. Segment Information:
The Company is organized into two operating segments: Flavors and Fragrances. These segments align with the internal structure of the Company used to manage these businesses. Performance of these operating segments is evaluated based on segment profit which is defined as operating profit before Restructuring and other charges, net, Global expenses (as discussed below) and certain non-recurring items, Interest expense, Other income (expense), net and Taxes on income.
The Global expenses caption below represents corporate and headquarters-related expenses which include legal, finance, human resources, certain incentive compensation expenses and other R&D and administrative expenses that are not allocated to individual operating segments.
Reportable segment information is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(DOLLARS IN THOUSANDS)
2015
 
2014
 
2015
 
2014
Net sales:
 
 
 
 
 
 
 
Flavors
$
359,103

 
$
358,708

 
$
1,108,689

 
$
1,100,726

Fragrances
405,989

 
415,105

 
1,198,851

 
1,231,725

Consolidated
$
765,092

 
$
773,813

 
$
2,307,540

 
$
2,332,451

Segment profit:
 
 
 
 
 
 
 
Flavors
$
79,803

 
$
79,747

 
$
256,546

 
$
258,614

Fragrances
90,893

 
86,615

 
252,416

 
259,253

Global expenses
(6,874
)
 
(12,882
)
 
(27,067
)
 
(49,182
)
Restructuring and other charges, net

 
(608
)
 
170

 
(912
)
Acquisition and related costs (1)
(6,830
)
 

 
(13,896
)
 

Operational improvement initiative costs (2)
(279
)
 
(282
)
 
(841
)
 
(6,014
)
Operating profit
156,713

 
152,590

 
467,328

 
461,759

Interest expense
(11,855
)
 
(10,968
)
 
(34,357
)
 
(34,048
)
Other (expense) income, net
(1,959
)
 
563

 
3,315

 
3,761

Income before taxes
$
142,899

 
$
142,185

 
$
436,286

 
$
431,472

 

 
9
 



(1)
Acquisition and related costs are associated with the acquisitions of Ottens Flavors and Lucas Meyer as discussed in Note 3, including inventory step-up charges related to the inventory acquired.
(2)
Operational improvement initiative costs relate to the closing of a smaller facility in Europe in the 2014 period and certain manufacturing activities in Asia in both the 2015 and 2014 periods, while transferring production to larger facilities in each respective region.
Net sales are attributed to individual regions based upon the destination of product delivery. Net sales related to the U.S. for the three months ended September 30, 2015 and 2014 were $182 million and $162 million, respectively and for the nine months ended September 30, 2015 and 2014 were $520 million and $495 million, respectively. Net sales attributed to all foreign countries in total for the three months ended September 30, 2015 and 2014 were $583 million and $612 million, respectively and for the nine months ended September 30, 2015 and 2014 were $1,788 million and $1,837 million, respectively. No country other than the U.S. had net sales in any period presented greater than 9.0% of total consolidated net sales.

Note 10. Employee Benefits:

Pension and other defined contribution retirement plan expenses included the following components:
U.S. Plans
Three Months Ended September 30,
 
Nine Months Ended September 30,
(DOLLARS IN THOUSANDS)
2015
 
2014
 
2015
 
2014
Service cost for benefits earned
$
984

 
$
530

 
$
2,952

 
$
2,299

Interest cost on projected benefit obligation
5,954

 
6,349

 
17,860

 
18,812

Expected return on plan assets
(8,083
)
 
(6,906
)
 
(24,248
)
 
(20,732
)
Net amortization and deferrals
5,203

 
4,720

 
15,607

 
13,229

Net periodic benefit cost
4,058

 
4,693

 
12,171

 
13,608

Defined contribution and other retirement plans
1,847

 
1,964

 
6,075

 
5,866

Total expense
$
5,905

 
$
6,657

 
$
18,246

 
$
19,474

 
 
 
 
 
 
 
 
Non-U.S. Plans
Three Months Ended September 30,
 
Nine Months Ended September 30,
(DOLLARS IN THOUSANDS)
2015
 
2014
 
2015
 
2014
Service cost for benefits earned
$
4,220

 
$
2,772

 
$
12,659

 
$
10,722

Interest cost on projected benefit obligation
6,283

 
8,298

 
18,848

 
25,250

Expected return on plan assets
(12,712
)
 
(12,576
)
 
(38,137
)
 
(37,731
)
Net amortization and deferrals
3,397

 
2,058

 
10,189

 
8,012

Loss due to settlements and special terminations

 
32

 

 
32

Net periodic benefit cost
1,188

 
584

 
3,559

 
6,285

Defined contribution and other retirement plans
1,923

 
1,886

 
5,211

 
4,508

Total expense
$
3,111

 
$
2,470

 
$
8,770

 
$
10,793

The Company expects to contribute a total of approximately $30 million to its non-U.S. pension plans during 2015. During the three months ended September 30, 2015, there were no contributions made to the qualified U.S. pension plans, but during the nine months ended September 30, 2015, $35.0 million of contributions were made. In the three and nine months ended September 30, 2015, $3.6 million and $26.1 million of contributions were made to the non-U.S. plans, respectively. In the three and nine months ended September 30, 2015, $1.1 million and $3.2 million of benefit payments were made with respect to the Company’s non-qualified U.S. pension plan, respectively.
Expense recognized for postretirement benefits other than pensions included the following components: 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(DOLLARS IN THOUSANDS)
2015
 
2014
 
2015
 
2014
Service cost for benefits earned
$
301

 
$
326

 
$
901

 
$
971

Interest cost on projected benefit obligation
1,082

 
1,197

 
3,246

 
3,672

Net amortization and deferrals
(712
)
 
(1,124
)
 
(2,134
)
 
(3,082
)
Total postretirement benefit expense
$
671

 
$
399

 
$
2,013

 
$
1,561


 
10
 



The Company expects to contribute approximately $5 million to its postretirement benefits other than pension plans during 2015. In the three and nine months ended September 30, 2015, $1.4 million and $4.8 million of contributions were made.

Note 11. Financial Instruments:
Fair Value
Accounting guidance on fair value measurements specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. These two types of inputs create the following fair value hierarchy:
Level 1–Quoted prices for identical instruments in active markets.
Level 2–Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
Level 3–Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
This hierarchy requires us to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. We determine the fair value of structured liabilities (where performance is linked to structured interest rates, inflation or currency risks) using the LIBOR swap curve and forward interest and exchange rates at period end. Such instruments are classified as Level 2 based on the observability of significant inputs to the model. We do not have any instruments classified as Level 1 or Level 3, other than those included in pension asset trusts as discussed in Note 13 of our 2014 Form 10-K.
These valuations take into consideration our credit risk and our counterparties’ credit risk. The estimated change in the fair value of these instruments due to such changes in our own credit risk (or instrument-specific credit risk) was immaterial as of September 30, 2015.

The amounts recorded in the balance sheet (carrying amount) and the estimated fair values of financial instruments at September 30, 2015 and December 31, 2014 consisted of the following: 
 
September 30, 2015
 
December 31, 2014
 
Carrying
Amount
 
Fair
Value
 
Carrying
Amount
 
Fair
Value
(DOLLARS IN THOUSANDS)
 
 
 
 
 
 
 
Cash and cash equivalents (1)
$
272,276

 
$
272,276

 
$
478,573

 
$
478,573

Credit facilities and bank overdrafts (2)
262,521

 
262,521

 
12,335

 
12,335

Long-term debt: (3)
 
 
 
 
 
 
 
Senior notes - 2007
500,000

 
576,155

 
500,000

 
587,650

Senior notes - 2006
125,000

 
129,110

 
125,000

 
133,137

Senior notes - 2013
299,802

 
299,577

 
299,782

 
296,290

 
(1)
The carrying amount of cash and cash equivalents approximates fair value due to the short maturity of those instruments.
(2)
The carrying amount of our credit facilities and bank overdrafts approximates fair value as the interest rate is reset frequently based on current market rates as well as the short maturity of those instruments.
(3)
The fair value of our long-term debt was calculated using discounted cash flows applying current interest rates and current credit spreads based on our own credit risk.
Derivatives
The Company periodically enters into foreign currency forward contracts with the objective of reducing exposure to cash flow volatility associated with our intercompany loans, foreign currency receivables and payables, and anticipated purchases of certain raw materials used in operations. These contracts generally involve the exchange of one currency for a second currency at a future date, have maturities not exceeding twelve months and are with counterparties which are major international financial institutions.


 
11
 



During the nine months ended September 30, 2015 and the year ended December 31, 2014, the Company entered into several forward currency contracts which qualified as net investment hedges, in order to mitigate a portion of our net European investments from foreign currency risk. The effective portions of net investment hedges are recorded in Other comprehensive income (“OCI”) as a component of Foreign currency translation adjustments in the accompanying Consolidated Statement of Comprehensive Income. Realized gains (losses) are deferred in accumulated other comprehensive income ("AOCI") where they will remain until the net investments in our European subsidiaries are divested. The outstanding forward currency contracts have remaining maturities of approximately one year. Four of these forward currency contracts matured during the nine months ended September 30, 2015.

During the nine months ended September 30, 2015 and the year ended December 31, 2014, the Company entered into several forward currency contracts which qualified as cash flow hedges. The objective of these hedges is to protect against the currency risk associated with forecasted U.S. dollar (USD) denominated raw material purchases made by Euro (EUR) functional currency entities which result from changes in the EUR/USD exchange rate. The effective portions of cash flow hedges are recorded in OCI as a component of Gains/(losses) on derivatives qualifying as hedges in the accompanying Consolidated Statement of Comprehensive Income. Realized gains/(losses) in AOCI related to cash flow hedges of raw material purchases are recognized as a component of Cost of goods sold in the accompanying Consolidated Statement of Comprehensive Income in the same period as the related costs are recognized.
During 2015 and 2014, the Company entered into interest rate swap agreements that effectively converted the fixed rate on a portion of our long-term borrowings to a variable short-term rate based on the LIBOR plus an interest markup. These swaps are designated as fair value hedges. Amounts recognized in Interest expense were immaterial for the three and nine months ended September 30, 2015.
The following table shows the notional amount of the Company’s derivative instruments outstanding as of September 30, 2015 and December 31, 2014: 
(DOLLARS IN THOUSANDS)
September 30, 2015
 
December 31, 2014
Foreign currency contracts
$
283,550

 
$
191,150

Interest rate swaps
$
775,000

 
$
425,000


The following tables show the Company’s derivative instruments measured at fair value (Level 2 of the fair value hierarchy), as reflected in the Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014: 
 
September 30, 2015
(DOLLARS IN THOUSANDS)
Fair Value of
Derivatives
Designated as
Hedging
Instruments
 
Fair Value of
Derivatives Not
Designated as
Hedging
Instruments
 
Total Fair
Value
Derivative assets (a)
 
 
 
 
 
Foreign currency contracts
$
6,690

 
$
2,149

 
$
8,839

Interest rate swaps
4,409

 

 
4,409

 
$
11,099

 
$
2,149

 
$
13,248

Derivative liabilities (b)
 
 
 
 
 
Foreign currency contracts
$
3,725

 
$
2,263

 
$
5,988

Interest rate swaps
4,772

 

 
4,772

 
$
8,497

 
$
2,263

 
$
10,760


 
12
 



 
December 31, 2014
(DOLLARS IN THOUSANDS)
Fair Value of
Derivatives
Designated as
Hedging
Instruments
 
Fair Value of
Derivatives Not
Designated as
Hedging
Instruments
 
Total Fair
Value
Derivative assets (a)
 
 
 
 
 
Foreign currency contracts
$
16,637

 
$
4,398

 
$
21,035

Interest rate swaps
683

 

 
683

 
$
17,320

 
$
4,398

 
$
21,718

Derivative liabilities (b)
 
 
 
 
 
Foreign currency contracts
$
6

 
$
1,055

 
$
1,061

 
(a)
Derivative assets are recorded to Prepaid expenses and other current assets in the Consolidated Balance Sheet.
(b)
Derivative liabilities are recorded as Other current liabilities in the Consolidated Balance Sheet.

The following table shows the effect of the Company’s derivative instruments which were not designated as hedging instruments in the Consolidated Statement of Comprehensive Income for the three and nine months ended September 30, 2015 and 2014 (in thousands): 

Derivatives Not Designated as Hedging Instruments
Amount of Gain (Loss)
Recognized in Income on
Derivative
 
Location of Gain (Loss)
Recognized in Income
on Derivative
 
Three Months Ended September 30,
 
 
 
2015
 
2014
 
 
Foreign currency contracts
$
(1,979
)
 
$
17,517

 
Other expense (income), net
Derivatives Not Designated as Hedging Instruments
Amount of Gain (Loss)
Recognized in Income on
Derivative
 
Location of Gain (Loss)
Recognized in Income
on Derivative
 
Nine Months Ended September 30,
 
 
 
2015
 
2014
 
 
Foreign currency contracts
$
8,097

 
$
18,942

 
Other expense (income), net
Most of these net gains (losses) offset any recognized gains (losses) arising from the revaluation of the related intercompany loans during the same respective periods.
The following table shows the effect of the Company’s derivative instruments designated as cash flow and net investment hedging instruments in the Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2015 and 2014 (in thousands): 

 
13
 



 
Amount of (Loss) Gain
Recognized in OCI on
Derivative (Effective
Portion)
 
Location of (Loss) Gain
Reclassified from AOCI into
Income (Effective Portion)
 
Amount of (Loss) Gain
Reclassified from
Accumulated OCI into
Income (Effective
Portion)
 
Three Months Ended September 30,
 
 
 
Three Months Ended September 30,
 
2015
 
2014
 
 
 
2015
 
2014
Derivatives in Cash Flow Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts
(7,794
)
 
5,680

 
Cost of goods sold
 
6,956

 
(1,221
)
Interest rate swaps (1)
(4,703
)
 
69

 
Interest expense
 
(69
)
 
(69
)
Derivatives in Net Investment Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts
(547
)
 
5,097

 
N/A
 

 

Total
$
(13,044
)
 
$
10,846

 
 
 
$
6,887

 
$
(1,290
)
 
 
 
 
 
 
 
 
 
 
 
Amount of (Loss) Gain
Recognized in OCI on
Derivative (Effective
Portion)
 
Location of (Loss) Gain
Reclassified from AOCI into
Income (Effective Portion)
 
Amount of (Loss) Gain
Reclassified from
Accumulated OCI into
Income (Effective
Portion)
 
Nine Months Ended September 30,
 
 
 
Nine Months Ended September 30,
 
2015
 
2014
 
 
 
2015
 
2014
Derivatives in Cash Flow Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts
(1,815
)
 
7,601

 
Cost of goods sold
 
11,540

 
(2,699
)
Interest rate swaps (1)
(4,565
)
 
207

 
Interest expense
 
(207
)
 
$
(207
)
Derivatives in Net Investment Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts
2,984

 
5,395

 
N/A
 

 

Total
$
(3,396
)
 
$
13,203

 
 
 
$
11,333

 
$
(2,906
)
 
(1) Interest rate swaps were entered into as pre-issuance hedges.

No ineffectiveness was experienced in the above noted cash flow hedges during the three and nine months ended September 30, 2015 and 2014. The ineffective portion of the net investment hedges was not material during the three and nine months ended September 30, 2015 and 2014.
The Company expects that approximately $8.7 million (net of tax) of derivative gains included in AOCI at September 30, 2015, based on current market rates, will be reclassified into earnings within the next 12 months. The majority of this amount will vary due to fluctuations in foreign currency exchange rates.

 
14
 



Note 12. Accumulated Other Comprehensive Income (Loss):
The following tables present changes in the accumulated balances for each component of other comprehensive income, including current period other comprehensive income and reclassifications out of accumulated other comprehensive income:
 
Foreign
Currency
Translation
Adjustments
 
(Losses) Gains on
Derivatives
Qualifying as
Hedges
 
Pension and
Postretirement
Liability
Adjustment
 
Total
(DOLLARS IN THOUSANDS)
 
 
 
 
 
 
 
Accumulated other comprehensive (loss) income, net of tax, as of December 31, 2014
$
(173,342
)
 
$
12,371

 
$
(379,459
)
 
$
(540,430
)
OCI before reclassifications
(81,326
)
 
4,952

 

 
(76,374
)
Amounts reclassified from AOCI

 
(11,333
)
 
16,501

 
5,168

Net current period other comprehensive income (loss)
(81,326
)
 
(6,381
)
 
16,501

 
(71,206
)
Accumulated other comprehensive (loss) income, net of tax, as of September 30, 2015
$
(254,668
)
 
$
5,990

 
$
(362,958
)
 
$
(611,636
)
 
 
Foreign
Currency
Translation
Adjustments
 
(Losses) Gains on
Derivatives
Qualifying as
Hedges
 
Pension and
Postretirement
Liability
Adjustment
 
Total
(DOLLARS IN THOUSANDS)
 
 
 
 
 
 
 
Accumulated other comprehensive (loss) income, net of tax, as of December 31, 2013
$
(104,278
)
 
$
(4,012
)
 
$
(284,421
)
 
$
(392,711
)
OCI before reclassifications
(26,872
)
 
4,900

 

 
(21,972
)
Amounts reclassified from AOCI

 
2,906

 
12,716

 
15,622

Net current period other comprehensive income (loss)
(26,872
)
 
7,806

 
12,716

 
(6,350
)
Accumulated other comprehensive (loss) income, net of tax, as of September 30, 2014
$
(131,150
)
 
$
3,794

 
$
(271,705
)
 
$
(399,061
)

The following table provides details about reclassifications out of accumulated other comprehensive income to the Consolidated Statement of Comprehensive Income: 
 
Nine Months Ended September 30, 2015
 
Nine Months Ended September 30, 2014
 
Affected Line Item in the
Consolidated Statement
of Comprehensive  Income
(DOLLARS IN THOUSANDS)
 
 
 
 
 
(Losses) gains on derivatives qualifying as hedges
 
 
 
 
 
Foreign currency contracts
13,189

 
(3,723
)
 
Cost of goods sold
Interest rate swaps
(207
)
 
(207
)
 
Interest expense
 
(1,649
)
 
1,024

 
Provision for income taxes
 
$
11,333

 
$
(2,906
)
 
Total, net of income taxes
(Losses) gains on pension and postretirement liability adjustments
 
 
 
 
 
Settlements / Curtailments
$

 
$
(32
)
 
(a) 
Prior service cost
3,472

 
3,489

 
(a) 
Actuarial losses
(27,134
)
 
(21,648
)
 
(a) 
 
7,161

 
5,475

 
Provision for income taxes
 
$
(16,501
)
 
$
(12,716
)
 
Total, net of income taxes
 
(a)
The amortization of prior service cost and actuarial loss is included in the computation of net periodic benefit cost. Refer to Note 13 of our 2014 Form 10-K for additional information regarding net periodic benefit cost.

Note 13. Commitments and Contingencies:
Guarantees and Letters of Credit
The Company has various bank guarantees and letters of credit which are available for use to support its ongoing business operations and to satisfy governmental requirements associated with pending litigation in various jurisdictions.
At September 30, 2015, we had total bank guarantees and standby letters of credit of approximately $31.3 million with various financial institutions. Included in the above aggregate amount is a total of $13.2 million in bank guarantees which the Company has posted for certain assessments in Brazil for other diverse income tax and indirect tax disputes related to fiscal years 1998-2011. There were no material amounts utilized under the standby letters of credit as of September 30, 2015.
In order to challenge the assessments in these cases in Brazil, the Company has been required to, and has separately pledged assets, principally property, plant and equipment, to cover assessments in the amount of approximately $12.0 million as of September 30, 2015.
Lines of Credit
The Company has various lines of credit which are available to support its ongoing business operations. At September 30, 2015, we had available lines of credit (in addition to the Credit Facility discussed in Note 8 of our 2014 Form 10-K) of approximately $68.0 million with various financial institutions. There were no significant amounts drawn down pursuant to these lines of credit as of September 30, 2015.
Litigation
The Company assesses contingencies related to litigation and/or other matters to determine the degree of probability and range of possible loss. A loss contingency is accrued in the Company’s consolidated financial statements if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Because litigation is inherently unpredictable and unfavorable resolutions could occur, assessing contingencies is highly sensitive and requires judgments about future events. On at least a quarterly basis, the Company reviews contingencies related to litigation to determine the adequacy of accruals. The amount of ultimate loss may differ from these estimates and further events may require the Company to increase or decrease the amounts it has accrued on any matter.
Periodically, we assess our insurance coverage for all known claims, where applicable, taking into account aggregate coverage by occurrence, limits of coverage, self-insured retentions and deductibles, historical claims experience and claims experience with our insurance carriers. The liabilities are recorded at management’s best estimate of the probable outcome of the lawsuits and claims, taking into consideration the facts and circumstances of the individual matters as well as past

 
15
 



experience on similar matters. At each balance sheet date, the key issues that management assesses are whether it is probable that a loss as to asserted or unasserted claims has been incurred and if so, whether the amount of loss can be reasonably estimated. We record the expected liability with respect to claims in Other liabilities and expected recoveries from our insurance carriers in Other assets. We recognize a receivable when we believe that realization of the insurance receivable is probable under the terms of the insurance policies and our payment experience to date.
Environmental
Over the past 20 years, various federal and state authorities and private parties have claimed that we are a Potentially Responsible Party (“PRP”) as a generator of waste materials for alleged pollution at a number of waste sites operated by third parties located principally in New Jersey and have sought to recover costs incurred and to be incurred to clean up the sites.
We have been identified as a PRP at eight facilities operated by third parties at which investigation and/or remediation activities may be ongoing. We analyze our potential liability on at least a quarterly basis. We accrue for environmental liabilities when they are probable and estimable. We estimate our share of the total future cost for these sites to be less than $5 million.

While joint and several liability is authorized under federal and state environmental laws, we believe the amounts we have paid and anticipate paying in the future for clean-up costs and damages at all sites are not material and will not have a material adverse effect on our financial condition, results of operations or liquidity. This assessment is based upon, among other things, the involvement of other PRPs at most of the sites, the status of the proceedings, including various settlement agreements and consent decrees, and the extended time period over which payments will likely be made. There can be no assurance, however, that future events will not require us to materially increase the amounts we anticipate paying for clean-up costs and damages at these sites, and that such increased amounts will not have a material adverse effect on our financial condition, results of operations or cash flows.
China Odor Matter
The Company has been notified by Chinese authorities of compliance issues pertaining to the emission of odors from several of its plants in China. The Company has been addressing these issues by making investments in additional odor-abatement equipment.
The Company’s Flavors facility in China was temporarily idled and another facility is currently operating at a reduced workload. The Company has been making and will continue to make additional odor-abatement investments across all of its China facilities while it continues to work with the various authorities in China. To meet production requirements, the Company has moved a portion of its Chinese Flavors production to other IFF and third party facilities. If the Company is required to close a plant, or operate one at significantly reduced production levels on a permanent basis, the Company may be required to record charges that could have a material impact on its consolidated financial results of operations, financial position and cash flows in future periods.
Other Contingencies
The Company has contingencies involving third parties (such as labor, contract, technology or product-related claims or litigation) as well as government-related items in various jurisdictions in which we operate pertaining to such items as value-added taxes, other indirect taxes, customs and duties and sales and use taxes. It is possible that cash flows or results of operations, in any period, could be materially affected by the unfavorable resolution of one or more of these contingencies.
The most significant government-related contingencies exist in Brazil. With regard to the Brazilian matters, we believe we have valid defenses for the underlying positions under dispute; however, in order to pursue these defenses, we are required to, and have provided, bank guarantees and pledged assets in the aggregate amount of $25.2 million. The Brazilian matters take an extended period of time to proceed through the judicial process and there are a limited number of rulings to date.
In March 2012, ZoomEssence, Inc. filed a complaint against the Company in the U.S. District Court of New Jersey alleging trade secret misappropriation, breach of contract and unjust enrichment in connection with certain spray dry technology disclosed to the Company. In connection with the claims, ZoomEssence is seeking an injunction and monetary damages. ZoomEssence initially sought a temporary restraining order and preliminary injunction, but the Court denied these applications in an order entered on September 27, 2013, finding that ZoomEssence had not demonstrated a likelihood of success on the merits of its claims. The Court subsequently referred the matter to mediation, however the private mediation session did not result in a resolution of the dispute. On November 3, 2014, ZoomEssence amended its complaint against the Company to include allegations of breach of the duty of good faith and fair dealing, fraud in the inducement, and misappropriation of confidential and proprietary information.  On November 13, 2014, the Company filed a counterclaim against ZoomEssence alleging trade secret misappropriation, breach of contract, breach of the implied covenant of good faith and fair dealing, unjust enrichment, misappropriation of confidential and proprietary information,  common law unfair competition, tortious interference with contractual relations, and conversion. The case is currently proceeding through

 
16
 



discovery with a trial on the merits anticipated in mid-2016. The Company denies the allegations and will vigorously defend and pursue its position in Court. At this stage of the litigation, based on the information currently available to the Company, management does not believe that this matter represents a material loss contingency.
Based on the information available as of September 30, 2015, we estimate a range of reasonably possible loss related to the matters above, collectively, is $0-$31 million.



 
17
 



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Company background
We create, manufacture and supply flavors and fragrances that are used in the food, beverage, personal care and household products industries either in the form of compounds or individual ingredients, including cosmetic active ingredients. Our flavors and fragrance compounds combine a large number of ingredients that are blended, mixed or reacted together to produce proprietary formulas created by our perfumers and flavorists.
Flavors are the key building blocks that impart taste in processed food and beverage products and, as such, play a significant role in determining consumer preference of the end products in which they are used. While we are a global leader, our flavors business is more regional in nature, with different formulas that reflect local tastes and ingredients. As a leading creator of flavors, we help our customers deliver on the promise of delicious and healthy foods and drinks that appeal to consumers. Our flavors compounds are ultimately used by our customers in four end-use categories: (1) Savory, (2) Beverages, (3) Sweet, pharmaceutical and oral care (“Sweet”), and (4) Dairy.
Our fragrances are a key component in the world’s finest perfumes and best-known consumer brands, including beauty care, fabric care, personal wash and home care products. Our Fragrances business consists of Fragrance Compounds and Fragrance Ingredients. Our Fragrance Compounds are defined into broad market categories, (1) Fine Fragrances and (2) Consumer Fragrances. Consumer Fragrances consists of five end-use categories: (1) Fabric Care, (2) Home Care, (3) Personal Wash, (4) Hair Care and (5) Toiletries. In addition, Fragrance Ingredients (which includes Lucas Meyer as of July 31, 2015), that are used internally and sold to third parties, including customers and competitors, for use in preparation of compounds, are included in the Fragrances business unit.
The flavors and fragrances market is part of a larger market which supplies a variety of ingredients and components that consumer products companies utilize in their products. The broader market includes large multinational companies or smaller regional and local participants which supply products such as seasonings, texturizers, spices, enzymes, certain food-related commodities, fortified products and cosmetic ingredients. In 2014, the flavors and fragrances market, in which we compete, was estimated to be at least $18 billion; however the exact size of the global market is not available due to fragmentation of data. We, together with the other top three companies, are estimated to comprise approximately two-thirds of the total estimated sales in the global flavors and fragrances sub-segment of the broader market.
Vision 2020
During the second quarter of 2015, the Company announced its Vision 2020 strategy, which focuses on building differentiation and accelerating profitable growth. The strategy has four pillars:
(1) Win Where We Compete - achieve a #1 or #2 market leadership position in key markets and categories, and with specific customers.
(2) Innovating Firsts - strengthen our position and drive differentiation in priority R&D platforms such as delivery systems, modulation, new molecules and naturals.
(3) Become Our Customers' Partner of Choice - attain commercial excellence by providing our customers with in-depth local consumer understanding, industry-leading innovation, outstanding service and the highest quality products.
(4) Strengthen and Expand the Portfolio - actively pursue value-creation through partnerships, collaborations, and acquisitions within flavors, fragrances and adjacencies.
Talent and Organization, Continuous Improvement, and Sustainability enable the successful execution of Vision 2020.
The Company also announced its long-term financial targets for 2016 to 2020. These include 4-6% currency neutral sales growth, 7-9% currency neutral operating profit growth, and 10% currency neutral EPS growth. In addition to these organic goals, the Company is also targeting $500 million to $1 billion of sales growth through acquisitions by 2020. Leveraging its strong cash flow generation and commitment to Vision 2020, the Company increased its targeted cash return to shareholders to 50-60% of adjusted net income.
2015 Progress
During the third quarter of 2015, we completed the acquisition of 100% of the outstanding shares of Lucas Meyer Cosmetics, a business of Unipex Group, ("Lucas Meyer") for approximately Euro 284 million ($312 million). (The total shares acquired include shares effectively acquired pursuant to put and call option agreements). This acquisition did not have a

 
18
 



material impact on our Consolidated Statement of Comprehensive Income. The acquisition strengthened and expanded Fragrance Ingredients.
During the second quarter of 2015, we completed the acquisition of 100% of the outstanding shares of Henry H. Ottens Manufacturing Co., Inc. ("Ottens Flavors") for approximately $198.9 million. The acquisition did not have a material impact on our consolidated financial statements. The acquisition strengthened our position in the targeted North American market for Flavors.
Net sales during the third quarter of 2015 declined 1% on a reported basis but increased 7% on a currency neutral basis (which excludes the effects of changes in currency), with the effects of acquisitions contributing approximately 3% to both reported and currency neutral basis growth rates. The currency neutral growth of 4%, excluding acquisitions, reflects new win performance (net of losses) in Fragrance Compounds and Flavors and lower volume erosion on existing business, which was partially offset by declines in Fragrance Ingredients.
Exchange rate fluctuations had an 800 basis point (bps) unfavorable impact on net sales for the third quarter, driven mainly by the weakening of the Euro against the U.S. dollar. The effect of exchange rates can vary by business and region, depending upon the mix of sales by destination country as well as the relative percentage of local sales priced in U.S. dollars versus local currencies.
Gross margins increased year-over-year to 45.4% in the third quarter of 2015 from 44.0% in the 2014 period. Included in the third quarter of 2015 was $2.8 million of acquisition-related inventory "step-up" costs and costs associated with operational improvement initiatives, compared to $0.3 million of costs related to operational improvement initiatives included in the 2014 period. Excluding these items, gross margin increased 30 bps compared to the prior year period. The overall raw material cost base is essentially benign. We believe input costs will increase less than 1% in 2015 as higher prices on certain categories, such as naturals, will largely offset benefits associated with oil-based derivatives that are expected to occur later in 2015. We continue to seek improvements in our margins through operational performance, cost reduction efforts and mix enhancement.
FINANCIAL PERFORMANCE OVERVIEW
Sales
Reported sales in the third quarter of 2015 decreased approximately 1%. In currency neutral terms, sales increased 7%, reflecting new win performance in both Fragrance Compounds and Flavors, lower volume erosion on existing business and the effect of acquisitions (which added approximately 3% to both reported and currency neutral basis amounts). We continue to benefit from our diverse portfolio of end-use product categories and geographies and had growth in two of our four regions and currency neutral growth in both Consumer Fragrances and Flavors. Flavors realized currency neutral growth of 8% for the third quarter of 2015, including approximately half of the growth coming from acquisitions. Our Fragrance business achieved currency neutral growth of 6%, with approximately one-third of the growth coming from acquisitions. Fragrances growth principally reflects new win performance in our Consumer Fragrances end-use categories, led by sales in Fabric Care. Growth in Fragrance Ingredients was driven entirely by the inclusion of acquisitions. Overall, our third quarter 2015 results include 4% from developed markets and 3% from emerging markets which each represented 50% of currency neutral sales. From a geographic perspective, for the third quarter, North America (NOAM), Europe, Africa and the Middle East (EAME), Latin America (LA) and Greater Asia (GA) all delivered currency neutral growth in 2015, led by NOAM with 13%.
Operating profit
Operating profit increased $4.1 million to $156.7 million (20.5% of sales) in the 2015 third quarter compared to $152.6 million (19.7% of sales) in the comparable 2014 period. The three months ended September 30, 2015 included operational improvement initiative costs of $0.3 million and $6.8 million of acquisition related costs compared to $0.9 million of restructuring and operational improvement initiative costs in the prior year period. Excluding these charges, adjusted operating profit was $163.8 million (21.4% of sales) for the third quarter of 2015 compared to $153.5 million (19.8% of sales) for the third quarter of 2014. Foreign currency changes had an unfavorable impact on operating profit of approximately 3% in the third quarter of 2015.
Other expense (income), net
Other expense (income), net decreased $2.6 million to $2.0 million of expense in the third quarter of 2015 compared to $0.6 million of income in the third quarter of 2014. The year-over-year decrease is primarily driven by lower foreign exchange gains on working capital and lower mark-to-market adjustments on deferred compensation plan assets during 2015 compared to the 2014 period.


 
19
 



Net income
Net income decreased by $1.0 million quarter-over-quarter to $106.4 million for the third quarter of 2015.
Cash flows
Cash flows from operations for the nine months ended September 30, 2015 were $294.7 million or 12.8% of sales, compared to cash inflow from operations of $317.5 million or 13.6% of sales for the nine months ended September 30, 2014. The decrease in cash flow from operations in 2015 reflects higher cash outflows from core working capital (trade receivables, inventories and accounts payable) and higher pension contributions in the 2015 period, which were only partially offset by higher net income and lower payments for incentive compensation.
Results of Operations  
 
Three Months Ended September 30,
 
 
 
Nine Months Ended September 30,
 
 
(DOLLARS IN THOUSANDS
EXCEPT PER SHARE AMOUNTS)
2015
 
2014
 
Change
 
2015
 
2014
 
Change
Net sales
$
765,092

 
$
773,813

 
(1
)%
 
$
2,307,540

 
$
2,332,451

 
(1
)%
Cost of goods sold
417,966

 
433,702

 
(4
)%
 
1,269,097

 
1,298,281

 
(2
)%
Gross profit
347,126

 
340,111

 
 
 
1,038,443

 
1,034,170

 
 
Research and development (R&D) expenses
62,750

 
63,701

 
(1
)%
 
188,725

 
191,635

 
(2
)%
Selling and administrative (S&A) expenses
127,663

 
123,212

 
4
 %
 
382,560

 
379,864

 
1
 %
Restructuring and other charges, net

 
608

 
(100
)%
 
(170
)
 
912

 
(119
)%
Operating profit
156,713

 
152,590

 
 
 
467,328

 
461,759

 
 
Interest expense
11,855

 
10,968

 
8
 %
 
34,357

 
34,048

 
1
 %
Other expense (income), net
1,959

 
(563
)
 
(448
)%
 
(3,315
)
 
(3,761
)
 
(12
)%
Income before taxes
142,899

 
142,185

 
 
 
436,286

 
431,472

 
 
Taxes on income
36,452

 
34,770

 
5
 %
 
96,206

 
107,064

 
(10
)%
Net income
$
106,447

 
$
107,415

 
(1
)%
 
$
340,080

 
$
324,408

 
5
 %
Diluted EPS
$
1.31

 
$
1.31

 
 %
 
$
4.18

 
$
3.95

 
6
 %
Gross margin
45.4
%
 
44.0
%
 
140

 
45.0
%
 
44.3
%
 
70

R&D as a percentage of sales
8.2
%
 
8.2
%
 

 
8.2
%
 
8.2
%
 

S&A as a percentage of sales
16.7
%
 
15.9
%
 
80

 
16.6
%
 
16.3
%
 
30

Operating margin
20.5
%
 
19.7
%
 
80

 
20.3
%
 
19.8
%
 
50

Adjusted operating margin (1)
21.4
%
 
19.8
%
 
160

 
20.9
%
 
20.1
%
 
80

Effective tax rate
25.5
%
 
24.5
%
 
100

 
22.1
%
 
24.8
%
 
(270
)
Segment net sales
 
 
 
 
 
 
 
 
 
 
 
Flavors
$
359,103

 
$
358,708

 
0
 %
 
$
1,108,689

 
$
1,100,726

 
1
 %
Fragrances
405,989

 
415,105

 
(2
)%
 
1,198,851

 
1,231,725

 
(3
)%
Consolidated
$
765,092

 
$
773,813

 
 
 
$
2,307,540

 
$
2,332,451

 
 
 
(1)
Adjusted operating margin excludes operational improvement initiative costs of $0.3 million and acquisition and related costs of $6.8 million for the three months ended September 30, 2015 and excludes $0.9 million of restructuring and operational improvement initiative costs for the three months ended September 30, 2014. For the nine months ended September 30, 2015, adjusted operating margin excludes the benefit from Restructuring and other charges, net of $0.2 million, operational improvement initiative costs of $0.8 million and acquisition related costs of $13.9 million compared to the exclusion of $6.9 million of Restructuring and other charges, net and operational improvement initiative costs during the comparable 2014 period.
Cost of goods sold includes the cost of materials and manufacturing expenses. R&D expenses relate to the development of new and improved products, technical product support and compliance with governmental regulations. S&A expenses

 
20
 



include expenses necessary to support our commercial activities and administrative expenses supporting our overall operating activities.

THIRD QUARTER 2015 IN COMPARISON TO THIRD QUARTER 2014
Sales
Sales for the third quarter of 2015 totaled $765.1 million, a decrease of 1% from the prior year quarter. Excluding the impact of foreign currency, currency neutral sales increased 7%, as a result of new win performance in both Fragrance Compounds and Flavors, lower volume erosion on existing business and the effect of acquisitions. On both a reported and currency neutral basis, the effect of acquisitions was approximately 3% to net sales amounts. Overall organic currency neutral growth includes 4% from developed markets and 3% from emerging markets.
Flavors Business Unit
Flavors reported sales were essentially flat with the prior year period while currency neutral sales growth was 8% during the third quarter of 2015 compared to the 2014 period. Acquisitions accounted for approximately 4.5% of the growth in both reported and currency neutral basis amounts. In addition, the overall performance reflects lower volume erosion on existing business and new win performance. The currency neutral increase was due to mid to high single-digit growth in Beverage and Dairy. The Flavors business delivered currency neutral growth in NOAM, EAME and LA, led by LA. Sales in LA were driven by double-digit gains in Beverage and Savory. Sales in EAME were driven by high single-digit gains in Beverage. NOAM sales were led by double-digit gains in Dairy and mid single-digit gains in Beverage.
Fragrances Business Unit
The Fragrances business experienced a decline of 2% in reported sales and a 6% increase in currency neutral sales for the third quarter of 2015 compared to the third quarter of 2014. Acquisitions accounted for approximately one-third of the growth in both reported and currency neutral basis amounts. The overall currency neutral increase was primarily driven by double-digit gains in our Fabric Care category and mid to high single-digit gains in our Hair Care, Home Care and Personal Wash categories in addition to mid single-digit growth in Fragrance Ingredients, which included the acquisition of Lucas Meyer. Our Fragrance Compounds and Fragrance Ingredients, which includes Lucas Meyer, both saw currency neutral sales growth of 6% over the prior year period. Excluding the effects of acquisitions, Fragrance Ingredients sales declined mid single-digits on a currency neutral basis.
Sales Performance by Region and Category
 
 
 
% Change in Sales-Third Quarter 2015 vs. Third Quarter 2014
 
 
Fine Fragrances
 
Consumer Fragrances
 
Ingredients
 
Total Frag.
 
Flavors
 
Total
NOAM
Reported
4
 %
 
8
 %
 
4
 %
 
6
 %
 
19
 %
 
13
 %
EAME
Reported
-11
 %
 
-12
 %
 
-9
 %
 
-11
 %
 
-12
 %
 
-11
 %
 
Currency Neutral (1)
5
 %
 
5
 %
 
6
 %
 
5
 %
 
4
 %
 
5
 %
LA
Reported
-13
 %
 
9
 %
 
-5
 %
 
2
 %
 
9
 %
 
4
 %
 
Currency Neutral (1)
-8
 %
 
13
 %
 
9
 %
 
7
 %
 
20
 %
 
11
 %
GA
Reported
-23
 %
 
2
 %
 
6
 %
 
2
 %
 
-6
 %
 
-3
 %
 
Currency Neutral (1)
-22
 %
 
5
 %
 
7
 %
 
4
 %
 
0
 %
 
2
 %
Total
Reported
-9
 %
 
0
 %
 
-3
 %
 
-2
 %
 
0
 %
 
-1
 %
 
Currency Neutral (1)
1
 %
 
7
 %
 
6
 %
 
6
 %
 
8
 %
 
7
 %
(1)
Currency neutral sales growth is calculated by translating prior year sales at the exchange rates for the corresponding 2015 period.

NOAM Flavors sales increased 19%, which included the impact of acquisitions, and high double-digit growth in Dairy. NOAM Fragrance sales increased 6% in the third quarter of 2015, principally due to double-digit gains in Home Care and Hair Care as well as high single-digit gains in Fabric Care and Personal Wash and low single-digit gains in Fine Fragrances and Fragrance Ingredients, which included the impact of acquisitions.
EAME Flavors currency neutral sales growth of 4% was led by high single-digit growth in Beverage. EAME Fragrance currency neutral sales increased 5% overall, driven mainly by double-digit growth in Fabric Care and mid

 
21
 



single-digit growth in Fine Fragrance and Fragrance Ingredients, which included the impact of acquisitions, that more than offset low single-digit declines in Toiletries and Hair Care.
LA Flavors currency neutral sales were up 20% driven by double-digit gains in the Savory and Beverage categories as well as high single-digit growth in Sweet. LA Fragrances currency neutral sales increased 7% overall, principally led by double-digit gains in Hair Care, Fabric Care and Toiletries, as well as high single-digit gains in Fragrance Ingredients, which more than offset high single-digit declines in Fine Fragrances.
GA Flavors currency neutral sales remained consistent with the prior year period. GA Fragrances currency neutral sales growth of 4% was principally driven by double-digit gains in Fabric Care and high single-digit gains in Personal Wash, with mid single-digit gains in Fragrance Ingredients, which included the impact of acquisitions, that more than offset double-digit declines in Fine Fragrances.

Cost of Goods Sold
Cost of goods sold, as a percentage of sales, decreased 140 bps to 54.6% in the third quarter of 2015 compared to 56.0% in the third quarter of 2014. Included in cost of goods sold was $2.8 million of charges related principally to acquisition-related inventory "step-up" costs as well as operational improvement initiative costs in 2015 compared to $0.3 million of restructuring and operational improvement initiative related costs in 2014.
Research and Development (R&D) Expenses
Overall R&D expenses, as a percentage of sales, was essentially flat compared to the prior year period at 8.2% in the third quarter of 2015 versus 8.2% in the third quarter of 2014.
Selling and Administrative (S&A) Expenses
S&A expenses increased $4.5 million to $127.7 million or 16.7%, as a percentage of sales, in the third quarter of 2015 compared to 15.9% in the third quarter of 2014. The $4.5 million increase is principally due to spending to support the future growth of the Company, including acquisition related expenses, partially offset by the impact of currency and lower incentive compensation expense.
Operating Results by Business Unit
We evaluate the performance of business units based on segment profit which is defined as operating profit before Restructuring and other charges, net, Global expenses (as discussed in Note 9 to the Consolidated Financial Statements) and certain non-recurring items, net, Interest expense, Other (expense) income, net and Taxes on income. See Note 9 to the Consolidated Financial Statements for the reconciliation to Income before taxes. 
 
Three Months Ended September 30,
(DOLLARS IN THOUSANDS)
2015
 
2014
Segment profit:
 
 
 
Flavors
$
79,803

 
$
79,747

Fragrances
90,893

 
86,615

Global expenses
(6,874
)
 
(12,882
)
Restructuring and other charges, net

 
(608
)
Acquisition and related costs
(6,830
)
 

Operational improvement initiative costs
(279
)
 
(282
)
Operating profit
$
156,713

 
$
152,590

Profit margin
 
 
 
Flavors
22.2
%
 
22.2
%
Fragrances
22.4
%
 
20.9
%
Consolidated
20.5
%
 
19.7
%

Flavors Segment Profit
Flavors segment profit remained consistent at $79.8 million in the third quarter of 2015, or 22.2% as a percentage of sales, with $79.7 million, or 22.2% as a percentage of sales, in the comparable 2014 period. Solid growth and the addition of Ottens Flavors along with productivity initiatives and sales mix were offset by unfavorable currency impacts and incremental operating costs associated with the China Flavors facility.

 
22
 



Fragrances Segment Profit
Fragrances segment profit increased approximately 5% to $90.9 million in the third quarter of 2015, or 22.4% as a percentage of sales, compared to $86.6 million, or 20.9% as a percentage of sales, in the comparable 2014 period. The increase in segment profit and profit margin was primarily due to strong growth in Consumer Fragrances, ongoing cost savings initiatives, lower incentive compensation expense and a slight impact from the addition of Lucas Meyer.
Global Expenses
Global expenses represent corporate and headquarters-related expenses which include legal, finance, human resources and R&D and other administrative expenses that are not allocated to an individual business unit. In the third quarter of 2015, Global expenses were $6.9 million compared to $12.9 million during the third quarter of 2014. The decrease was principally driven by the favorable impact of our cash flow hedging program and lower incentive compensation expense.
Interest Expense
Interest expense increased $0.9 million to $11.9 million in the third quarter of 2015 compared to $11.0 million in the 2014 period. Average cost of debt was 4.3% for the 2015 three month period compared to 4.7% for the 2014 three month period.
Other Expense (Income), Net
Other expense (income), net decreased by approximately $2.6 million to $2.0 million of expense in the third quarter of 2015 versus $0.6 million of income in the comparable 2014 period. The year-over-year decrease was primarily driven by lower foreign exchange gains and lower amounts of income related to lower mark-to-market adjustments on deferred compensation plan assets during 2015 compared to the 2014 period.
Income Taxes
The effective tax rate for the three months ended September 30, 2015 was 25.5% compared with 24.5% for the three months ended September 30, 2014. Excluding the impact of items affecting comparability in the current quarter, the third quarter 2015 adjusted effective tax rate was 24.9%, or 40 bps higher than the third quarter 2014 adjusted effective tax rate of 24.5%, largely due to mix of earnings partially offset by lower loss provisions and lower expected repatriation costs in 2015.

FIRST NINE MONTHS OF 2015 IN COMPARISON TO FIRST NINE MONTHS OF 2014
Sales
Sales for the first nine months of 2015 totaled $2.3 billion, a decrease of 1% from the prior year period. Excluding the impact of foreign currency, currency neutral sales increased 6%. Acquisitions accounted for approximately one-third and one-sixth of the growth in reported and currency neutral net sales amounts, respectively. The overall increase on a currency neutral basis of 6% was primarily due to new win performance in both Flavors and Fragrance Compounds and lower volume erosion on existing business. Overall currency neutral growth was driven by 6% growth in emerging markets.
Flavors Business Unit
Flavors reported sales growth was 1%, and currency neutral sales growth was 8% during the first nine months of 2015 compared to the 2014 period. Acquisitions accounted for less than half of the net sales growth on a currency neutral basis. The overall currency neutral increase of 8% primarily reflects new wins and volume growth. The increase was due to high single-digit growth in Beverage and Dairy as well as low single-digit growth in Savory. The Flavors business delivered currency neutral growth in all regions, led by LA. Sales in LA were driven by double-digit gains in Beverage and Savory categories. Sales in EAME were led by mid to high single-digit growth in Savory and Beverage. GA sales were led by mid single-digit gains in Savory and Beverage and sales in NOAM were led by double-digit gains in Dairy and mid single-digit gains in Sweet.
Fragrances Business Unit
The Fragrances business experienced a decline of 3% in reported sales but a 5% increase in currency neutral sales for the first nine months of 2015 compared to the 2014 period. Acquisitions accounted for approximately one-fifth of the growth in net sales on a currency neutral basis. The overall increase on a currency neutral basis was primarily driven by double-digit gains in our Fabric Care and Home Care categories and high single-digit gains in Hair Care, which more than offset low single-digit declines in Toiletries. Our Fragrance Compounds saw currency neutral sales growth of 6%, while Fragrance Ingredients, which included the impact of acquisitions, remained consistent with the prior year period. Excluding the effects of acquisitions, Fragrance Ingredients sales declined low to mid single-digits on a currency neutral basis.

 
23
 



Sales Performance by Region and Category
 
 
 
% Change in Sales-First Nine Months 2015 vs. First Nine Months 2014
 
 
Fine Fragrances
 
Consumer Fragrances
 
Ingredients
 
Total Frag.
 
Flavors
 
Total
NOAM
Reported
-5
 %
 
4
 %
 
-11
 %
 
-2
 %
 
11
 %
 
5
 %
EAME
Reported
-10
 %
 
-7
 %
 
-9
 %
 
-8
 %
 
-9
 %
 
-9
 %
 
Currency Neutral (1)
7
 %
 
10
 %
 
2
 %
 
7
 %
 
6
 %
 
7
 %
LA
Reported
-11
 %
 
12
 %
 
-1
 %
 
5
 %
 
10
 %
 
7
 %
 
Currency Neutral (1)
-7
 %
 
15
 %
 
2
 %
 
8
 %
 
18
 %
 
11
 %
GA
Reported
2
 %
 
0
 %
 
1
 %
 
0
 %
 
-1
 %
 
-1
 %
 
Currency Neutral (1)
3
 %
 
2
 %
 
7
 %
 
3
 %
 
3
 %
 
3
 %
Total
Reported
-9
 %
 
1
 %
 
-7
 %
 
-3
 %
 
1
 %
 
-1
 %
 
Currency Neutral (1)
0
 %
 
8
 %
 
0
 %
 
5
 %
 
8
 %
 
6
 %
(1)
Currency neutral sales growth is calculated by translating prior year sales at the exchange rates for the corresponding 2015 period.

NOAM Flavors sales increased 11%, which included the impact of acquisitions, and had double-digit gains in Dairy and low to mid single-digit gains in Beverage and Sweet. NOAM Fragrance sales decreased 2% in the first nine months of 2015, principally due to double-digit declines in Fragrance Ingredients and Toiletries and mid single-digit declines in Fine Fragrances, that were only partially offset by double-digit growth in Fabric Care and high single-digit growth in Home Care categories.
EAME Flavors currency neutral sales growth of 6% was led by high single-digit growth in Beverage and mid single-digit growth in Savory. EAME Fragrance currency neutral sales increased 7% overall, driven mainly by double-digit growth in Fabric Care and Home Care categories as well as mid single-digit gains in Fine Fragrance and low single-digit gains in Fragrance Ingredients, which included the impact of acquisitions.
LA Flavors currency neutral sales were up 18% driven by double-digit gains in the Beverage and Savory and high single-digit growth in Sweet. LA Fragrances currency neutral sales increased 8% overall, principally led by double-digit gains in Fabric Care, Home Care and Hair Care as well as low single-digit gains in Fragrance Ingredients, which more than offset high single-digit declines in Fine Fragrances and mid single-digit declines in Toiletries.
GA Flavors had currency neutral sales growth of 3% principally from low to mid single-digit gains in Beverage and Savory. GA Fragrances had currency neutral sales growth of 3%, principally driven by high single-digit growth in Fragrance Ingredients, which included the impact of acquisitions, as well as mid single-digit growth in Toiletries and Fine Fragrances and low single-digit growth in Fabric Care and Hair Care.

Cost of Goods Sold
Cost of goods sold, as a percentage of sales, decreased 70 bps to 55.0% in the first nine months of 2015 compared to 55.7% in the 2014 period. Included in cost of goods sold was $4.1 million of charges related to operational improvement initiative costs and acquisition-related inventory "step-up" costs in 2015 compared to $6.0 million of restructuring and operational improvement initiative costs in 2014.
Research and Development (R&D) Expenses
Overall R&D expenses, as a percentage of sales, remained essentially flat with the prior year period at 8.2% for the first nine months of 2015 compared to 8.2% in the 2014 period.
Selling and Administrative (S&A) Expenses
S&A expenses increased slightly to $382.6 million or 16.6%, as a percentage of sales, in the first nine months of 2015 compared to 16.3% in the 2014 period. The increase in S&A expenses was due to acquisition-related expenses which were partially offset by lower incentive compensation expense.



 
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Operating Results by Business Unit
We evaluate the performance of business units based on segment profit which is defined as operating profit before Restructuring and other charges, net, Global expenses (as discussed in Note 9 to the Consolidated Financial Statements) and certain non-recurring items, net, Interest expense, Other (expense) income, net and Taxes on income. See Note 9 to the Consolidated Financial Statements for the reconciliation to Income before taxes.