Document


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 June 30, 2018
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    ¨
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    ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
þ
Accelerated filer
¨
Non-accelerated filer
¨
Smaller reporting company
¨
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes    ¨ No  þ
Number of shares outstanding as of July 24, 2018: 79,047,426






PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED BALANCE SHEET
(Unaudited)
(DOLLARS IN THOUSANDS)
June 30, 2018
 
December 31, 2017
ASSETS
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
322,423

 
$
368,046

Trade receivables (net of allowances of $13,622 and $13,392, respectively)
723,855

 
663,663

Inventories: Raw materials
353,220

 
326,140

Work in process
23,671

 
16,431

Finished goods
318,301

 
306,877

Total Inventories
695,192

 
649,448

Prepaid expenses and other current assets
285,110

 
215,387

Total Current Assets
2,026,580

 
1,896,544

Property, plant and equipment, at cost
2,098,513

 
2,090,755

Accumulated depreciation
(1,230,884
)
 
(1,210,175
)
 
867,629

 
880,580

Goodwill
1,148,586

 
1,156,288

Other intangible assets, net
391,426

 
415,787

Deferred income taxes
82,204

 
99,777

Other assets
157,017

 
149,950

Total Assets
$
4,673,442

 
$
4,598,926

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current Liabilities:
 
 
 
Short term borrowings
$
6,500

 
$
6,966

Accounts payable
315,656

 
338,188

Accrued payroll and bonus
59,278

 
88,361

Dividends payable
54,488

 
54,420

Other current liabilities
263,448

 
280,833

Total Current Liabilities
699,370

 
768,768

Long-term debt
1,717,189

 
1,632,186

Deferred gains
35,824

 
37,344

Retirement liabilities
226,221

 
228,936

Other liabilities
238,635

 
242,398

Total Other Liabilities
2,217,869

 
2,140,864

Commitments and Contingencies (Note 13)

 

Shareholders’ Equity:
 
 
 
Common stock 12 1/2¢ par value; 500,000,000 shares authorized; 115,858,190 shares issued as of June 30, 2018 and December 31, 2017; and 79,046,217 and 78,947,381 shares outstanding as of June 30, 2018 and December 31, 2017, respectively
14,470

 
14,470

Capital in excess of par value
167,432

 
162,827

Retained earnings
3,992,452

 
3,870,621

Accumulated other comprehensive loss
(692,498
)
 
(637,482
)
Treasury stock, at cost (36,811,973 and 36,910,809 shares as of June 30, 2018 and December 31, 2017, respectively)
(1,732,001
)
 
(1,726,234
)
Total Shareholders’ Equity
1,749,855

 
1,684,202

Noncontrolling interest
6,348

 
5,092

Total Shareholders’ Equity including noncontrolling interest
1,756,203

 
1,689,294

Total Liabilities and Shareholders’ Equity
$
4,673,442

 
$
4,598,926


See Notes to Consolidated Financial Statements
1



INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
(Unaudited)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
2018
 
2017
 
2018
 
2017
Net sales
$
920,016

 
$
842,861

 
$
1,850,944

 
$
1,671,154

Cost of goods sold
521,299

 
469,877

 
1,046,419

 
935,088

Gross profit
398,717

 
372,984

 
804,525

 
736,066

Research and development expenses
74,767

 
72,761

 
153,244

 
144,887

Selling and administrative expenses
157,407

 
139,319

 
300,051

 
283,023

Amortization of acquisition-related intangibles
9,584

 
8,494

 
18,769

 
15,561

Restructuring and other charges, net
1,186

 
791

 
1,903

 
10,934

Losses (gains) on sales of fixed assets
1,264

 
(68
)
 
1,195

 
(89
)
Operating profit
154,509

 
151,687

 
329,363

 
281,750

Interest expense
53,246

 
17,556

 
69,841

 
30,363

Other (income), net
(20,655
)
 
(7,909
)
 
(21,232
)
 
(29,140
)
Income before taxes
121,918

 
142,040

 
280,754

 
280,527

Taxes on income
22,769

 
32,245

 
52,190

 
54,968

Net income
99,149

 
109,795

 
228,564

 
225,559

Other comprehensive income (loss), after tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(85,264
)
 
13,347

 
(70,461
)
 
10,090

Gains (losses) on derivatives qualifying as hedges
10,455

 
(11,768
)
 
9,926

 
(13,519
)
Pension and postretirement net liability
2,890

 
3,688

 
5,519

 
7,323

Other comprehensive income (loss)
(71,919
)
 
5,267

 
(55,016
)
 
3,894

Total comprehensive income
$
27,230

 
$
115,062

 
$
173,548

 
$
229,453

 
 
 
 
 
 
 
 
Net income per share - basic
$
1.25

 
$
1.39

 
$
2.89

 
$
2.85

Net income per share - diluted
$
1.25

 
$
1.38

 
$
2.87

 
$
2.84

Average number of shares outstanding - basic
79,065

 
79,072

 
79,041

 
79,088

Average number of shares outstanding - diluted
79,303

 
79,305

 
79,347

 
79,360

Dividends declared per share
$
0.69

 
$
0.64

 
$
1.38

 
$
1.28


See Notes to Consolidated Financial Statements
2



INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
 
Six Months Ended June 30,
(DOLLARS IN THOUSANDS)
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
228,564

 
$
225,559

Adjustments to reconcile to net cash provided by operating activities:
 
 
 
Depreciation and amortization
64,968

 
55,805

Deferred income taxes
14,342

 
1,505

Loss (gain) on disposal of assets
1,195

 
(89
)
Stock-based compensation
15,173

 
12,893

Pension contributions
(9,963
)
 
(31,557
)
Litigation settlement

 
(56,000
)
Product recall claim settlement
(12,969
)
 

Foreign currency gain on liquidation of entity

 
(12,214
)
Changes in assets and liabilities, net of acquisitions:
 
 
 
Trade receivables
(99,963
)
 
(77,580
)
Inventories
(67,940
)
 
(4,228
)
Accounts payable
(7,139
)
 
(23,479
)
Accruals for incentive compensation
(25,158
)
 
(12,316
)
Other current payables and accrued expenses
11,028

 
(3,099
)
Other assets
(65,620
)
 
18,007

Other liabilities
8,651

 
(35,286
)
Net cash provided by operating activities
55,169

 
57,921

Cash flows from investing activities:
 
 
 
Cash paid for acquisitions, net of cash received
(22
)
 
(191,304
)
Additions to property, plant and equipment
(67,421
)
 
(46,153
)
Proceeds from life insurance contracts

 
1,941

Maturity of net investment hedges
(2,642
)
 
3,016

Proceeds from disposal of assets
618

 
473

Net cash used in investing activities
(69,467
)
 
(232,027
)
Cash flows from financing activities:
 
 
 
Cash dividends paid to shareholders
(108,824
)
 
(101,184
)
Increase in revolving credit facility borrowings and overdrafts
110,259

 
21,595

Deferred financing costs
(1,401
)
 
(5,373
)
Proceeds from issuance of long-term debt

 
498,250

Loss on pre-issuance hedges

 
(5,310
)
Proceeds from issuance of stock under stock plans

 
329

Employee withholding taxes paid
(9,096
)
 
(11,485
)
Purchase of treasury stock
(15,475
)
 
(53,211
)
Net cash (used in) provided by financing activities
(24,537
)
 
343,611

Effect of exchange rate changes on cash and cash equivalents
(6,788
)
 
(2,111
)
Net change in cash and cash equivalents
(45,623
)
 
167,394

Cash and cash equivalents at beginning of year
368,046

 
323,992

Cash and cash equivalents at end of period
$
322,423

 
$
491,386

Supplemental Disclosures:
 
 
 
Interest paid, net of amounts capitalized
$
74,422

 
$
32,039

Income taxes paid
$
57,809

 
$
50,962

Accrued capital expenditures
$
19,160

 
$
13,589


See Notes to Consolidated Financial Statements
3



INTERNATIONAL FLAVORS & FRAGRANCES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1.    NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
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 2017 Annual Report on Form 10-K (“2017 Form 10-K”). These interim statements are unaudited. The year-end balance sheet data included in this Form 10-Q 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, June 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 2018 and 2017 quarters, the actual closing dates were June 29 and June 30, 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.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Reclassifications and Revisions
Certain prior year amounts have been reclassified and revised to conform to current year presentation.
As discussed below and in conformity with the Financial Accounting Standards Board's ("FASB") amendments to the Compensation - Retirement Benefits guidance, the Company has reclassified certain components of net periodic benefit expense (income) to Other income (expense), net.
U.S. Tax Reform
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”) that significantly revised the U.S. tax code effective January 1, 2018 by, among other things, lowering the corporate income tax rate from a top marginal rate of 35% to a flat 21%, limiting deductibility of interest expense and performance based incentive compensation, transitioning to a territorial system and creating new taxes associated with global operations.
In the fourth quarter of 2017, the Company recorded approximately $139.2 million in charges related to the impact of the Tax Act. Given the significant complexity of the Tax Act, anticipated guidance from the U.S. Treasury about implementing the Tax Act and the potential for additional guidance from the SEC or the FASB, the amount recorded by the Company in the fourth quarter of 2017 was provisional and will continue to be adjusted during 2018. The impact of the Tax Act is expected to be finalized no later than the fourth quarter of 2018. The aforementioned guidance and additional information regarding the Tax Act may also impact the Company's 2018 effective income tax rate, exclusive of any adjustment to the provisional charge. Any material revisions in our computations could adversely affect our cash flows and results of operations.
During the six months ended June 30, 2018, the Company recorded an additional charge of $0.6 million to adjust an accrual related to withholding taxes on planned repatriations.
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 provided by operations from participating in these programs decreased approximately $25.5 million for the six months ended June 30, 2018 compared to a decrease of approximately $4.7 million for the six months ended June 30, 2017. The cost of participating in these programs was immaterial to our results in all periods.

4



Recent Accounting Pronouncements
In June 2018, the FASB issued Accounting Standards Update ("ASU") 2018-07, "Compensation—Stock Compensation (Topic 718)" intended to reduce cost and complexity and to improve financial reporting for nonemployee share-based payments. This guidance expands the scope of Topic 718, Compensation-Stock Compensation which currently only includes share-based payments to employees to include share-based payments issued to nonemployees for goods or services. This guidance is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The Company is currently evaluating the impact this guidance will have on its Consolidated Financial Statements, but does not expect this guidance to have a material impact on its Consolidated Financial Statements.
In February 2018, FASB issued ASU 2018-02, "Income Statement—Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income" which allows for a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act, in addition to requiring certain disclosures about stranded tax effects. This guidance is effective for periods beginning after December 15, 2018, with an election to adopt early. The Company is currently evaluating the impact this guidance may have on its Consolidated Financial Statements.
In August 2017, FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities" which eliminates the requirement to separately measure and present hedge ineffectiveness and aligns the presentation of hedge gains and losses with the underlying hedge item. This guidance is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted. The amended presentation and disclosure requirements are to be applied prospectively while the amendments to cash flow and net investment hedge relationships are to be applied on a modified retrospective basis. The Company is currently evaluating the impact this guidance will have on its Consolidated Financial Statements, but does not expect this guidance to have a material impact on its Consolidated Financial Statements.
In May 2017, the FASB issued 2017-09, "Compensation—Stock Compensation (Topic 718): Scope of Modification Accounting" which clarifies changes to the terms or conditions of a share-based payment award that require an entity to apply modification accounting. This guidance is effective for the current year. The Company has determined that this guidance does not have an impact on its Consolidated Financial Statements as it is not the Company's practice to modify the terms or conditions of a share-based payment award after it has been granted.
In March 2017, the FASB issued 2017-07, "Compensation—Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost" which requires employers who present a measure of operating income in their statement of income to include only the service cost component of net periodic pension cost and postretirement costs in operating expenses. This guidance is effective, and as required, has been applied on a full retrospective basis. The impact of the adoption of this standard on January 1, 2018 was a decrease in operating profit by approximately $7.4 million in the three months ended June 30, 2017 and by approximately $14.9 million in the six months ended June 30, 2017, and a corresponding increase in Other (income) expense, net as presented in the Company's Consolidated Statement of Income and Comprehensive Income. There was no impact to Net income or Net Income per share in either period. See Note 10 of the Consolidated Financial Statements for further details.
The new guidance also limits the amount of net periodic benefit cost eligible for capitalization to assets. The new guidance permits only the service cost component of net periodic benefit cost to be eligible for capitalization. The Company applied the practical expedient that permits the use of amounts previously disclosed as the basis for retrospective application and, as provided under the practical expedient, has not presented the income statement impact based on the capitalization of the applicable costs.
In August 2016, the FASB issued 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments" which requires changes to the classification of certain activities within the statement of cash flows. This guidance is effective for the current year, and the Company has determined that this adoption does not have an impact on its Consolidated Statement of Cash Flows.
In June 2016, the FASB issued 2016-13, "Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments" which requires issuers to measure expected credit losses for financial assets based on historical experience, current conditions and reasonable and supportable forecasts. As such, an entity will use forward-looking information to estimate credit losses. The guidance is effective for financial statements issued for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption is permitted for the fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company is currently evaluating the impact this guidance may have on its consolidated financial statements, but does not expect this guidance to have a material impact on its Consolidated Financial Statements.

5



In February 2016, the FASB issued 2016-02, "Leases (Topic 842)", with subsequent amendments, which requires changes to the accounting for leases. The new guidance establishes a new lease accounting model that requires entities to record assets and liabilities related to leases on the balance sheet for certain types of leases. The guidance will be effective for annual and interim periods beginning after December 15, 2018. The Company expects to adopt this guidance effective December 29, 2018, the first day of the Company’s 2019 fiscal year, and that the adoption of this guidance will result in significant increases to assets and liabilities on its Consolidated Balance Sheet. The Company is still evaluating the impact of this guidance on its Consolidated Statement of Income and Comprehensive Income and Consolidated Statement of Cash Flows. The Company has begun to evaluate the nature of its leases and has compiled a preliminary analysis of the type and location of its leases. The Company expects that the significant portion of its lease liabilities and right of use assets will relate to property, with additional lease and corresponding right of use assets in existence that relate to vehicles and machinery.
Adoption of ASC Topic 606, Revenue from Contracts with Customers
In May 2014, the FASB issued 2014-09, "Revenue from Contracts with Customers", with subsequent amendments, that provides for a comprehensive model to be used in accounting for revenue arising from contracts with customers (ASC Topic 606, Revenue from Contracts with Customers) (the “Revenue Standard”). Under the Revenue Standard, revenue is recognized to reflect the transfer of goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. Companies have the option to apply the new guidance under a retrospective approach to each prior reporting period presented or a modified retrospective approach with the cumulative effect of initially applying the new guidance recognized at the date of initial application within the Consolidated Balance Sheet. The new Revenue Standard became effective for annual reporting periods beginning after December 15, 2017, and the Company has adopted the new revenue standard using the modified retrospective approach on December 30, 2017, the first day of the Company’s 2018 fiscal year.
The Company creates and manufactures flavors and fragrances. Approximately 90% of its products, principally Flavors compounds and Fragrances compounds, are customized to customer specifications and have no alternative use other than the sale to the specific customer (“Compounds products”). The remaining revenue is derived largely from Fragrance Ingredients products that, generally, are commodity products with alternative uses and not customized (“Ingredients products”).
With respect to the vast majority of the Company’s contracts for Compounds products, the Company currently recognizes revenue on the transfer of control of the product at a point in time as the Company does not have an “enforceable right to payment for performance to date” (as set out in the Revenue Standard). With respect to a small number of contracts for the sale of Compounds, the Company has an “enforceable right to payment for performance to date” and as the products do not have an alternative use, the Company recognizes revenue for these contracts over time and records a contract asset using the output method. The output method recognizes revenue on the basis of direct measurements of the value to the customer of the goods or services transferred to date relative to the remaining goods or services promised under the contract.
With respect to the Company’s contracts related to Ingredients products, the Company currently recognizes revenue on the transfer of control of the product at a point in time as such products generally have alternative uses and the Company does not have an “enforceable right to payment for performance to date.”
As the Company adopted the Revenue Standard using the modified retrospective method effective the first day of its 2018 fiscal year, results for its 2018 fiscal year are presented under the Revenue Standard while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under ASC Topic 605, which required that revenue was accounted for when the earnings process was complete.
The Company recorded a net increase to retained earnings of $2.1 million as of the first day of its 2018 fiscal year due to the cumulative impact of adopting the Revenue Standard. In connection with the adjustment to retained earnings, the Company also recorded an increase of $4.4 million in contract assets (which are included in Prepaid expenses and other assets), a decrease of $1.7 million in inventory, and an increase in taxes payable of $0.6 million.
The impact to revenues, gross profit and net income for the three months ended June 30, 2018 were reductions of $1.9 million, $1.2 million and $0.9 million, respectively, and for the six months ended June 30, 2018 were reductions of $2.5 million, $1.6 million and $1.2 million, respectively, as a result of applying the Revenue Standard as compared to the amounts that would have been recognized under ASC Topic 605.
Revenue Recognition
The Company recognizes revenue when control of the promised goods is transferred to its customers in an amount that reflects the consideration it expects to be entitled to in exchange for those goods. Sales, value add, and other taxes the Company collects are excluded from revenues. The Company receives payment in accordance with standard customer terms.

6



The following table presents the Company's revenues disaggregated by business unit:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(DOLLARS IN THOUSANDS)
2018

2017(a)
 
2018

2017(a)
Flavor Compounds
$
450,540

 
$
414,323

 
$
899,559

 
$
820,487

Fragrance Compounds
 
 
 
 
 
 
 
Consumer Fragrances
274,586

 
253,258

 
554,849

 
505,891

Fine Fragrances
97,448

 
91,432

 
195,817

 
179,199

Fragrance Ingredients
97,442

 
83,848

 
200,719

 
165,577

Total revenues
$
920,016

 
$
842,861

 
$
1,850,944

 
$
1,671,154

_______________________ 
(a)
Prior period amounts have not been adjusted based on the modified retrospective method.
The following table presents our revenues disaggregated by region, based on the region of our customers:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(DOLLARS IN THOUSANDS)
2018
 
2017(a)
 
2018
 
2017(a)
Europe, Africa and Middle East
$
292,848

 
$
259,292

 
$
602,161

 
$
516,976

Greater Asia
242,221

 
224,703

 
485,779

 
447,523

North America
249,054

 
230,529

 
490,199

 
449,357

Latin America
135,893

 
128,337

 
272,805

 
257,298

Total revenues
$
920,016

 
$
842,861

 
$
1,850,944

 
$
1,671,154

_______________________ 
(a)
Prior period amounts have not been adjusted based on the modified retrospective method.
Flavors and Fragrances Compounds Revenues
The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties and payment terms (which vary by customer) are identified, the contract has commercial substance, and collectability of consideration is probable. Consistent with our past practice, the amount of revenue recognized is adjusted at the time of sale for expected discounts and rebates (“Variable Consideration”).
The Company generates revenues primarily by manufacturing customized Flavor compounds and Fragrance compounds for the exclusive use of our customers. The Company combines the shipment of goods with their manufacture to account for both shipment and manufacture as the sole performance obligation.
With respect to the vast majority of the Company’s contracts for Compounds products, the Company recognizes a sale at the point in time when it ships the product from its manufacturing facility to its customer, as this is the time when control of the goods has transferred to the customer. The amount of consideration received and revenue recognized is impacted by the Variable Consideration the Company has agreed with its customers. The Company estimates Variable Consideration amounts for each customer based on the specific agreement, an analysis of historical volumes and the current activity with that customer. The Company reassesses its estimates of Variable Consideration at each reporting date throughout the contract period and updates the estimate until the uncertainty is resolved. During the current period, changes to estimates of Variable Consideration have been immaterial.
With respect to a small number of contracts for the sale of Compounds products, the Company recognizes revenue over time as it manufactures customized compounds that do not have an alternative use and for which the contracts provide the Company with an enforceable right to payment, including a reasonable profit, at all times during the contract term commencing with the manufacturing of the goods. When revenue is recognized over time, the amount of revenue recognized is based on the extent of progress towards completion of the promised goods. The Company generally uses the output method to measure progress for its contracts as this method reflects the transfer of goods to the customer. Once customization begins, the manufacturing process is generally completed within a two week period. Due to the short time frame for production, there is little estimation uncertainty in the process. In addition, due to the customized nature of our products, our returns are not material.

7



Fragrance Ingredients Revenues
The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties and payment terms (which vary by customer) are identified, the contract has commercial substance, and collectability of consideration is probable.
The Company generates revenues primarily by manufacturing Ingredients products for the use of our customers. The Company combines the shipment of goods with their manufacture to account for both shipment and manufacture as the sole performance obligation.
Generally, the Company recognizes a sale at the time when it ships the product from their manufacturing facility to their customer, as this is the point when control of the goods or services has transferred to the customer. The amount of consideration received and revenue recognized is impacted by discounts offered to its customers. The Company estimates discounts based on an analysis of historical experience and current activity. The Company assesses its estimates of discounts at each reporting date throughout the contract period and updates its estimates until the uncertainty has been resolved. During the current period, changes to estimates of discounts have been immaterial.
Contract Asset and Accounts Receivable
The following table reflects the balances in our contract assets and accounts receivable for the six months ended June 30, 2018 and December 31, 2017:
(DOLLARS IN THOUSANDS)
June 30, 2018
 
At adoption
Receivables (included in Trade receivables)
$
737,477

 
$
677,055

Contract asset - Short term
1,903

 
4,449

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 June 30,
 
Six Months Ended June 30,
(SHARES IN THOUSANDS)
2018
 
2017
 
2018
 
2017
Basic
79,065

 
79,072

 
79,041

 
79,088

Assumed dilution under stock plans
238

 
233

 
306

 
272

Diluted
79,303

 
79,305

 
79,347

 
79,360

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 six months ended June 30, 2018 and 2017.
The Company has issued shares of purchased restricted common stock and purchased restricted common stock units (collectively “PRSUs”) 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 PRSU shareholders was less than $0.01 per share for each period presented, and the number of PRSUs outstanding as of June 30, 2018 and 2017 was immaterial. Net income allocated to such PRSUs was $0.2 million for each of the three months ended June 30, 2018 and 2017, respectively, and $0.5 million during each of the six months ended June 30, 2018 and 2017.
NOTE 3.    ACQUISITIONS
Pending Acquisition of Frutarom
On May 7, 2018, the Company entered into a definitive agreement and plan of merger to acquire Frutarom Industries Ltd. (“Frutarom”). Frutarom is an Israeli company that, through its subsidiaries, develops, produces and markets flavors and fine ingredients used in manufacturing food, beverages, flavors and fragrances, pharma/nutraceuticals, cosmetics and personal care products. The proposed merger was unanimously approved by the Boards of Directors of both companies and was approved by Frutarom shareholders on August 6, 2018. Closing is dependent upon clearance by the relevant regulatory authorities and other customary closing conditions and is currently expected to occur in the fourth quarter of 2018.

8



Under the terms of the merger agreement, for each share of outstanding stock, Frutarom shareholders will receive $71.19 in cash and 0.2490 of a share of the Company's common stock. The transaction was valued, based on the Company's stock price as of May 7, 2018, at approximately $7.1 billion, including the assumption of approximately $681 million of Frutarom's net debt, which the Company intends to refinance or repay concurrent with the closing of the transaction.
The Company expects to fund the cash portion of the merger consideration through up to $3.1 billion of debt financing, cash on hand and the issuance of up to $2.2 billion in new equity securities. In connection with these financings, the Company also expects to pay its outstanding $250 million of its Senior Notes 2007 and the associated make-whole payments of approximately $35 million.
Based on the exchange ratio of 0.2490 of a share of the Company’s common stock for each ordinary share of Frutarom issued and outstanding at closing, the estimated number of shares of the Company’s common stock issuable as a portion of the merger consideration is approximately 14.88 million shares, which will result in former Frutarom shareholders holding approximately 15.8% of the outstanding fully diluted IFF common stock, based on the number of outstanding shares of common stock and outstanding stock-based awards of IFF and the number of outstanding ordinary shares and share-based awards of Frutarom as of May 4, 2018, the last trading day for IFF common stock prior to the announcement of the acquisition and without taking into account the issuance by IFF of equity securities in connection with the financing of the acquisition.
On May 7, 2018, the Company entered into a bridge facility commitment letter pursuant to which Morgan Stanley Senior Funding, Inc. committed, subject to customary conditions, to provide up to $5.45 billion under a 364-day senior unsecured bridge term loan credit facility to finance the cash portion of the merger consideration if the Company has not completed its anticipated financing transactions prior to the consummation of the acquisition.
PowderPure
On April 7, 2017, the Company completed the acquisition of 100% of the outstanding shares of Columbia PhytoTechnology, LLC d/b/a PowderPure ("PowderPure"), a privately-held flavors company with facilities in North America. The acquisition was accounted for under the purchase method. PowderPure was acquired to expand expertise in, and product offerings of, clean label solutions within the Flavors business. The Company paid approximately $54.6 million, including $0.4 million of cash acquired for this acquisition, which was funded from existing resources. Additionally, the Company recorded an accrual of approximately $1.4 million representing the estimate at acquisition of additional contingent consideration payable to the former owners of PowderPure (the maximum earnout payable is $10 million upon satisfaction of certain performance metrics).
The purchase price exceeded the preliminary fair value of existing net assets by approximately $48.0 million. The excess was allocated principally to identifiable intangible assets including approximately $27.5 million to proprietary technology, approximately $4.5 million to trade name, approximately $0.8 million to customer relationships, and approximately $15.2 million of goodwill which is deductible for tax purposes. Goodwill is the excess of the purchase price over the fair value of net assets acquired and represents the value the Company expects to achieve from its increased exposure to clean label products within the existing Flavors business. The intangible assets are being amortized over the following estimated useful lives: proprietary technology, 14 years; trade name, 14 years; and customer relationships, 2 years.
The purchase price allocation was completed in the first quarter of 2018. No material adjustments have been made to the purchase price allocation since the preliminary valuation performed in the second quarter of 2017. The estimated amount of the contingent consideration payable was adjusted during the first quarter of 2018 and resulted in a decrease in administrative expense of approximately $0.6 million.
No pro forma financial information for 2017 is presented as the acquisition was not material to the consolidated financial statements.
Fragrance Resources
On January 17, 2017, the Company completed the acquisition of 100% of the outstanding shares of Fragrance Resources, Inc., Fragrance Resources GmbH, and Fragrance Resources SAS (collectively "Fragrance Resources"), a privately-held fragrance company with facilities in Germany, North America, France, and China. The acquisition was accounted for under the purchase method. Fragrance Resources was acquired to strengthen the North American and German Fragrances business.
The Company paid approximately €143.4 million (approximately $151.9 million) including approximately €13.7 million (approximately $14.4 million) of cash acquired for this acquisition, which was funded from existing resources including use of its revolving credit facility. Of the total paid, approximately €142.0 million (approximately $150.5 million) was paid at closing and an additional €1.4 million (approximately $1.5 million) was paid in connection with the finalization of the working capital adjustment. The purchase price exceeded the fair value of existing net assets by approximately $122.0 million. The excess was

9



allocated principally to identifiable intangible assets including approximately $51.7 million related to customer relationships, approximately$13.6 million related to proprietary technology and trade name, and approximately $72.0 million of goodwill (which is not deductible for tax purposes) and approximately $15.3 million of net deferred tax liability. Goodwill is the excess of the purchase price over the fair value of net assets acquired and represents synergies from the addition of Fragrance Resources to the Company's existing Fragrances business. The intangible assets are being amortized over the following estimated useful lives: trade name, 2 years; proprietary technology, 5 years; and customer relationships, 12 - 16 years.
The purchase price allocation was finalized in the fourth quarter of 2017. Certain measurement period adjustments were made subsequent to the initial purchase price allocation including adjustments related to the finalization of the purchase price, the allocation of certain intangibles and the calculation of applicable deferred taxes. The additional amortization of intangibles required as a result of the measurement period adjustments was not material.
No pro forma financial information for 2016 is presented as the acquisition was not material to the consolidated financial statements.
NOTE 4.    RESTRUCTURING AND OTHER CHARGES, NET
Restructuring and other charges primarily consist of separation costs for employees including severance, outplacement and other benefit costs.
2017 Productivity Program
On February 15, 2017, the Company announced that it was adopting a multi-year productivity program designed to improve overall financial performance, provide flexibility to invest in growth opportunities and drive long-term value creation. In connection with this program, the Company expects to optimize its global footprint and simplify its organizational structures globally. In connection with this initiative, the Company expects to incur cumulative, pre-tax cash charges of between $30-$35 million, consisting primarily of $24-$26 million in personnel-related costs and an estimated $6 million in facility-related costs, such as lease termination, and integration-related costs.
The Company recorded $22.5 million of charges related to personnel costs and lease termination costs through the second quarter of 2018, with the remainder of the personnel related and other costs expected to be recognized by the end of 2018. The Company recorded $1.2 million and $3.1 million of charges related to personnel costs and lease termination costs during the three months ended June 30, 2018 and 2017, respectively, and $1.9 million and $13.2 million of charges related to personnel costs and lease termination costs during the six months ended June 30, 2018 and 2017, respectively.
The Company made payments of $4.5 million related to severance in 2018. The overall charges were split approximately evenly between Flavors and Fragrances. This initiative is expected to result in the reduction of approximately 370 members of the Company’s global workforce, including acquired entities, in various parts of the organization.
Changes in restructuring liabilities during the six months ended June 30, 2018, were as follows:
(DOLLARS IN THOUSANDS)
Employee-Related Costs
 
Other
 
Total
Balance at December 31, 2017
$
7,539

 
$
418

 
$
7,957

Additional charges (reversals), net
1,903

 

 
1,903

Payments
(4,581
)
 

 
(4,581
)
Balance at June 30, 2018
$
4,861

 
$
418

 
$
5,279


10



NOTE 5. GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Goodwill
Movements in goodwill during 2018 were as follows:
(DOLLARS IN THOUSANDS)
Goodwill
Balance at December 31, 2017
$
1,156,288

Acquisitions
22

Foreign exchange
(7,724
)
Balance at June 30, 2018
$
1,148,586

Other Intangible Assets
Other intangible assets, net consisted of the following amounts: 
 
June 30,
 
December 31,
(DOLLARS IN THOUSANDS)
2018
 
2017
Asset Type
 
 
 
Customer relationships
$
402,032

 
$
407,636

Trade names & patents
38,146

 
38,771

Technological know-how
161,331

 
161,856

Other
24,734

 
24,814

Total carrying value
626,243

 
633,077

Accumulated Amortization
 
 
 
Customer relationships
(116,519
)
 
(104,800
)
Trade names & patents
(16,998
)
 
(15,241
)
Technological know-how
(81,580
)
 
(76,766
)
Other
(19,720
)
 
(20,483
)
Total accumulated amortization
(234,817
)
 
(217,290
)
Other intangible assets, net
$
391,426

 
$
415,787

 
Amortization
Amortization expense was $9,584 and $8,494 for the three months ended June 30, 2018 and 2017, respectively and $18,769 and $15,561 for the six months ended June 30, 2018 and 2017, respectively. Annual amortization is expected to be $36.0 million for the full year 2018, $34.6 million for the year 2019, $33.9 million for the year 2020, $29.0 million for the year 2021, $25.0 million for the year 2022 and $24.9 million for the year 2023.

11



NOTE 6.    DEBT
Debt consists of the following:
(DOLLARS IN THOUSANDS)
Effective Interest Rate
 
June 30, 2018
 
December 31, 2017
Senior notes - 2007(1)(4)
6.40% - 6.82%

 
$
249,776

 
$
249,765

Senior notes - 2013(1)
3.39
%
 
298,823

 
298,670

Euro Senior notes - 2016(1)
1.99
%
 
573,514

 
589,848

Senior notes - 2017(1)
4.50
%
 
492,941

 
492,819

Credit facility
LIBOR + 1.125%

(2)
103,988

 

Bank overdrafts and other
 
 
4,590

 
7,993

Deferred realized gains on interest rate swaps
 
 
57

 
57

 
 
 
1,723,689

 
1,639,152

Less: Short term borrowings(3)
 
 
(6,500
)
 
(6,966
)
 
 
 
$
1,717,189

 
$
1,632,186

_______________________ 
(1)
Amount is net of unamortized discount and debt issuance costs.
(2)
Represents the rate on drawn down and outstanding balances. Deferred debt issuance costs are immaterial.
(3)
Includes bank borrowings, commercial paper, overdrafts and current portion of long-term debt.
(4)
As discussed in Note 3 above, in connection with the pending acquisition of Frutarom and associated financing, the Company also expects to pay its outstanding $250 million of its Senior Notes 2007 and the associated make-whole payments of approximately $35 million. The amount outstanding continues to be reflected as long term given that the Company has not entered into a contractual commitment to repay.
Commercial Paper
Commercial paper issued by the Company generally has terms of 90 days or less. As of June 30, 2018 and December 31, 2017, there was no commercial paper outstanding. The revolving credit facility is used as a backstop for the Company's commercial paper program. The maximum amount of commercial paper outstanding for the six months ended June 30, 2018 and 2017 was $85 million and $50 million, respectively.
Financing of the Pending Acquisition of Frutarom
Bridge Loan Facility
In connection with entering into the merger agreement with Frutarom, the Company entered into a debt commitment letter for up to a $5.45 billion 364-day unsecured bridge loan facility to the extent the Company has not received $5.45 billion of net cash proceeds (and/or qualified bank commitments) from a combination of (a) the issuance by the Company of a combination of equity securities, equity-linked securities and/or unsecured debt securities and/or (b) unsecured term loans, in each case, at or prior to completion of the acquisition. The bridge loan commitment will be reduced to the extent that the Company obtains certain other debt financing and completes certain equity issuances. On May 21, 2018, the Company, Morgan Stanley Senior Funding, Inc. and certain other financial institutions entered into a bridge joinder agreement to the commitment letter to provide for additional bridge commitment parties. In connection with the bridge loan commitment, the Company incurred $37.0 million of fees which are being amortized over the commitment period and are included in Interest expense in Consolidated Statement of Comprehensive Income.
Term Facility
On June 6, 2018, the Company entered into a term loan credit agreement to replace a portion of the bridge loan facility, reducing the amount of the bridge loan commitments by $350 million. Under the term loan credit agreement, the lenders thereunder have committed to provide, subject to certain conditions, a senior unsecured term loan facility (as amended, "Term Facility") in an original aggregate principal amount of up to $350.0 million, maturing three years after the funding date thereunder. The debt is expected to be issued in the fourth quarter of 2018.

12



The Term Facility will bear interest, at the Company’s option, at a per annum rate equal to either (x) an adjusted LIBOR rate plus an applicable margin varying from 0.75% to 2.00% or (y) a base rate plus an applicable margin varying from 0.00% to 1.00%, in each case depending on the public debt ratings for non-credit enhanced long-term senior unsecured debt issued by the Company. Loans under the Term Facility will amortize quarterly at a per annum rate of 10.0% of the aggregate principal amount of the loans made under the Term Facility on the funding date, commencing at the end of the first full fiscal quarter after funding, with the balance payable on the third anniversary of the funding date. The Company may voluntarily prepay the term loans without premium or penalty. The term loan credit agreement contains various covenants, limitations and events of default customary for similar facilities for similarly rated borrowers, including a maximum ratio of net debt to EBITDA of 4.50x with step-downs over time and a temporary step-up to 6.0x for the first full fiscal quarter after funding if the Company has not issued equity or mandatory convertible securities generating gross proceeds of at least $1.75 billion on or before the closing date of the acquisition.
Amended Credit Facility
On May 21, 2018 and June 6, 2018, the Company and certain of its subsidiaries amended and restated the Company’s existing amended and restated credit agreement with Citibank, N.A., as administrative agent, last amended and restated on December 2, 2016 (as amended, the “Amended Credit Facility”) in connection with the pending acquisition of Frutarom, to, among other things (i) extend the maturity date of the Amended Credit Facility until December 2, 2023, (ii) increase the maximum ratio of net debt to EBITDA on and after the closing date of the acquisition and (iii) increase the drawn down capacity to $1.0 billion, consisting of a $585 million tranche A revolving credit facility (which provides for borrowings available in U.S. dollars, euros, Swiss francs, Japanese yen and/or British pounds sterling, with a sublimit of $25 million for swing line borrowings) (“Tranche A”) and a $415 million tranche B revolving credit facility (which provides for borrowings available in U.S. dollars, euros, Swiss francs, Japanese yen and/or British pounds sterling, with sublimits of €50 million and $25 million for swing line borrowings) (“Tranche B” and, together with Tranche A, the “Revolving Facility”). The interest rate on the Revolving Facility will be, at the applicable borrower’s option, a per annum rate equal to either (x) an adjusted LIBOR rate plus an applicable margin varying from 0.75% to 1.75% or (y) a base rate plus an applicable margin varying from 0.00% to 0.750%, in each case depending on the public debt ratings for non-credit enhanced long-term senior unsecured debt issued by the Company. Other terms and covenants under the Amended Credit Facility remain substantially unchanged.
In connection with the Amended Credit Facility, the Company incurred $0.7 million of debt issuance costs. As of June 30, 2018, total availability under the Amended Credit Facility was $1.6 billion, with no outstanding borrowings.
NOTE 7. INCOME TAXES
U.S. Tax Reform
In the fourth quarter of 2017, the Company recorded approximately $139.2 million in charges related to the impact of the Tax Act. Given the significant complexity of the Tax Act, anticipated guidance from the U.S. Treasury about implementing the Tax Act and the potential for additional guidance from the SEC or the FASB, the amount recorded by the Company in the fourth quarter of 2017 was provisional and will continue to be adjusted during 2018. The impact of the Tax Act is expected to be finalized no later than the fourth quarter of 2018. The aforementioned guidance and additional information regarding the Tax Act may also impact the Company's 2018 effective income tax rate, exclusive of any adjustment to the provisional charge. Any material revisions in our computations could adversely affect our cash flows and results of operations.
During the first quarter of 2018, the Company recorded an additional charge of $0.6 million to adjust an accrual related to withholding taxes on planned repatriations.
Uncertain Tax Positions
At June 30, 2018, the Company had $30.6 million of unrecognized tax benefits recorded in Other liabilities and $1.2 million in Other current liabilities. If these unrecognized tax benefits were recognized, the effective tax rate would be affected.
At June 30, 2018, the Company had accrued interest and penalties of $2.5 million classified in Other liabilities and $0.1 million in Other current liabilities.
As of June 30, 2018, the Company’s aggregate provisions for uncertain tax positions, including interest and penalties, was$34.4 million associated with various tax positions asserted in various 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 withholding taxes on undistributed earnings of subsidiary companies that are intended and planned to be

13



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. In addition, the Company has open tax years with various taxing jurisdictions that range primarily from 2008 to 2017. 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, sales and use taxes and property taxes, which are discussed in Note 13.
Effective Tax Rate
The effective tax rate for the three months ended June 30, 2018 was 18.7% compared with 22.7% for the three months ended June 30, 2017. The quarter-over-quarter decrease was largely due to a more favorable mix of earnings, a lower cost of repatriation and the re-measurement of loss provisions, partially offset by the impact from U.S. tax reform and other items (including the impact of current year transactions costs and certain non-taxable gains on foreign currency in prior year).
The effective tax rate for the six months ended June 30, 2018 was 18.6% compared with 19.6% for the six months ended June 30, 2017. The year-over-year decrease was largely due to a more favorable mix of earnings, a lower cost of repatriation, the re-measurement of loss provisions and the release of a State valuation allowance related to prior years, partially offset by the impact of U.S. tax reform and other items (including the impact of current year transaction costs and certain non-taxable gains on foreign currency in prior year).
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 PRSUs, restricted stock units (RSUs), 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 June 30,
 
Six Months Ended June 30,
(DOLLARS IN THOUSANDS)
2018
 
2017
 
2018
 
2017
Equity-based awards
$
7,554

 
$
7,074

 
$
15,173

 
$
12,893

Liability-based awards
242

 
1,298

 
396

 
3,051

Total stock-based compensation expense
7,796

 
8,372

 
15,569

 
15,944

Less: Tax benefit
(1,335
)
 
(2,336
)
 
(2,897
)
 
(4,549
)
Total stock-based compensation expense, after tax
$
6,461

 
$
6,036

 
$
12,672

 
$
11,395

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 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.

14



Reportable segment information is as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(DOLLARS IN THOUSANDS)
2018
 
2017
 
2018
 
2017
Net sales:
 
 
 
 
 
 
 
Flavors
$
450,540

 
$
414,323

 
$
899,559

 
$
820,487

Fragrances
469,476

 
428,538

 
951,385

 
850,667

Consolidated
$
920,016

 
$
842,861

 
$
1,850,944

 
$
1,671,154

Segment profit:
 
 
 
 
 
 
 
Flavors
$
109,605

 
$
96,840

 
$
221,169

 
$
191,395

Fragrances
80,780

 
80,993

 
174,056

 
158,867

Global expenses
(20,572
)
 
(13,488
)
 
(44,398
)
 
(29,781
)
Operational Improvement Initiatives (a)
(403
)
 
(445
)
 
(1,429
)
 
(1,066
)
Acquisition Related Costs (b)
4

 
(6,278
)
 
518

 
(15,066
)
Integration Related Costs (c)
(993
)
 
(731
)
 
(993
)
 
(1,923
)
Legal Charges/Credits, net (d)

 
(1,000
)
 

 
(1,000
)
Tax Assessment (e)

 
19

 

 
(5,331
)
Restructuring and Other Charges, net (f)
(193
)
 
(791
)
 
(910
)
 
(10,934
)
(Losses) Gains on Sale of Assets
(1,264
)
 
68

 
(1,195
)
 
89

FDA Mandated Product Recall (g)

 
(3,500
)
 
(5,000
)
 
(3,500
)
Frutarom Acquisition Related Costs (h)
(12,455
)
 

 
(12,455
)
 

Operating profit
154,509

 
151,687

 
329,363

 
281,750

Interest expense
(53,246
)
 
(17,556
)
 
(69,841
)
 
(30,363
)
Other income (expense)
20,655

 
7,909

 
21,232

 
29,140

Income before taxes
$
121,918

 
$
142,040

 
$
280,754

 
$
280,527

(a)
For 2018, represents accelerated depreciation related to a plant relocation in India. For 2017, represents accelerated depreciation and idle labor costs in Hangzhou, China.
(b)
For 2018, represents adjustments to the contingent consideration payable for PowderPure, and transaction costs related to Fragrance Resources and PowderPure within Selling and administrative expenses. For 2017, represents the amortization of inventory "step-up" related to the acquisitions of David Michael, Fragrance Resources and PowderPure, included in cost of goods sold and transaction costs related to the acquisitions of David Michael, Fragrance Resources and PowderPure, included in Selling and administrative expenses.
(c)
For 2018, represents costs related to the integration of David Michael. For 2017, represents costs related to the integration of David Michael and Fragrance Resources acquisitions.
(d)
Represents additional charge related to litigation settlement.
(e)
Represents the reserve for payment of a tax assessment related to commercial rent for prior periods.
(f)
Represents severance costs related to the 2017 Productivity Program and Taiwan lab closure.
(g)
Represents management's best estimate of losses related to the previously disclosed FDA mandated recall.
(h)
Represents transaction-related costs and expenses related to the pending acquisition of Frutarom.
Net sales are attributed to individual regions based upon the destination of product delivery are as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(DOLLARS IN THOUSANDS)
2018
 
2017
 
2018
 
2017
Net sales related to the U.S.
$
234,118

 
$
243,815

 
$
464,521

 
$
449,325

Net sales attributed to all foreign countries
685,898

 
599,046

 
1,386,423

 
1,221,829

No country other than the U.S. had net sales in any period presented greater than 6% of total consolidated net sales.

15



NOTE 10. EMPLOYEE BENEFITS
Pension and other defined contribution retirement plan expenses included the following components:
(DOLLARS IN THOUSANDS)
U.S. Plans
Three Months Ended June 30,
 
Six Months Ended June 30,
2018
 
2017
 
2018
 
2017
Service cost for benefits earned(1)
$
596

 
$
698

 
$
1,192

 
$
1,395

Interest cost on projected benefit obligation(2)
4,790

 
4,561

 
9,580

 
9,122

Expected return on plan assets(2)
(7,740
)
 
(9,246
)
 
(15,479
)
 
(18,492
)
Net amortization and deferrals(2)
1,549

 
1,793

 
3,098

 
3,585

Net periodic benefit income
(805
)
 
(2,194
)
 
(1,609
)
 
(4,390
)
Defined contribution and other retirement plans(1)
3,081

 
2,524

 
5,771

 
4,779

Total expense
$
2,276

 
$
330

 
$
4,162

 
$
389

(DOLLARS IN THOUSANDS)
Non-U.S. Plans
Three Months Ended June 30,
 
Six Months Ended June 30,
2018
 
2017
 
2018
 
2017
Service cost for benefits earned(1)
$
4,470

 
$
5,610

 
$
8,939

 
$
11,220

Interest cost on projected benefit obligation(2)
4,338

 
3,911

 
8,675

 
7,822

Expected return on plan assets(2)
(12,032
)
 
(12,334
)
 
(24,064
)
 
(24,668
)
Net amortization and deferrals(2)
2,972

 
3,988

 
5,943

 
7,977

Net periodic benefit (income) cost
(252
)
 
1,175

 
(507
)
 
2,351

Defined contribution and other retirement plans(1)
1,706

 
1,616

 
3,258

 
2,913

Total expense
$
1,454

 
$
2,791

 
$
2,751

 
$
5,264

_______________________ 
(1)
Included as a component of Operating Profit.
(2)
Included as a component of Other Income (Expense), net.
The Company expects to contribute a total of approximately $4.1 million to its U.S. pension plans and a total of $17.1 million to its Non-U.S. Plans during 2018. During the six months ended June 30, 2018, no contributions were made to the qualified U.S. pension plans, $7.8 million of contributions were made to the non-U.S. pension plans, and $2.2 million of benefit payments were made with respect to the Company's non-qualified U.S. pension plan.
Expense recognized for postretirement benefits other than pensions included the following components: 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(DOLLARS IN THOUSANDS)
2018
 
2017
 
2018
 
2017
Service cost for benefits earned
$
196

 
$
221

 
$
391

 
$
442

Interest cost on projected benefit obligation
654

 
588

 
1,308

 
1,176

Net amortization and deferrals
(1,189
)
 
(1,046
)
 
(2,378
)
 
(2,092
)
Total postretirement benefit income
$
(339
)
 
$
(237
)
 
$
(679
)
 
$
(474
)
The components of net periodic benefit (income) other than the service cost component are included in Other (income) expense, net in the Consolidated Statement of Income and Comprehensive Income. Beginning in 2018, under the revised FASB guidance adopted in the first quarter of 2018, only the service cost component of net periodic benefit (income) cost is a component of operating profit in the Consolidated Statements of Income and Comprehensive Income and the other components of net periodic benefit cost are now included in Other (income), net. As a result of this change, Other income increased by approximately $6.7 million and $7.4 million in the three months ended June 30, 2018 and 2017, respectively, and by approximately $13.3 million and $14.9 million in the six months ended June 30, 2018 and 2017, respectively, compared to what the Other (income) expense, net would have been under the previous method. The retroactive $7.4 million reduction in

16



operating profit for the three months ended June 30, 2017 was reflected as a $1.6 million increase in cost of goods sold, a $2.4 million increase in research and development expenses, and a $3.4 million increase in selling and administrative expenses. The retroactive $14.9 million reduction in operating profit for the six months ended June 30, 2017 was reflected as a $3.2 million increase in cost of goods sold, a $4.9 million increase in research and development expenses, and a $6.8 million increase in selling and administrative expenses.
The Company expects to contribute approximately $5.0 million to its postretirement benefits other than pension plans during 2018. In the six months ended June 30, 2018 $2.4 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 the Company's 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 the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. The Company determines the fair value of structured liabilities (where performance is linked to structured interest rates, inflation or currency risks) using the London Interbank Offer Rate ("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. The Company does not have any instruments classified as Level 1 or Level 3, other than those included in pension asset trusts as discussed in Note 14 of our 2017 Form 10-K.
These valuations take into consideration the Company's credit risk and its counterparties’ credit risk. The estimated change in the fair value of these instruments due to such changes in its own credit risk (or instrument-specific credit risk) was immaterial as of June 30, 2018.
The principal amounts and the estimated fair values of financial instruments at June 30, 2018 and December 31, 2017 consisted of the following: 
 
June 30, 2018
 
December 31, 2017
(DOLLARS IN THOUSANDS)
Principal
 
Fair Value
 
Principal
 
Fair Value
Cash and cash equivalents(1)
$
322,423

 
$
322,423

 
$
368,046

 
$
368,046

Credit facilities and bank overdrafts(2)
115,078

 
115,078

 
7,993

 
7,993

Long-term debt:(3)
 
 
 
 
 
 
 
Senior notes - 2007
250,000

 
278,720

 
250,000

 
293,232

Senior notes - 2013
300,000

 
294,645

 
300,000

 
304,219

Euro Senior notes - 2016
577,700

 
599,111

 
594,400

 
627,782

Senior notes - 2017
500,000

 
452,689

 
500,000

 
525,906

_______________________

17



(1)
The carrying amount of cash and cash equivalents approximates fair value due to the short maturity of those instruments.
(2)
The carrying amount 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 the Company's long-term debt was calculated using discounted cash flows applying current interest rates and current credit spreads based on its 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 its 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.
During the six months ended June 30, 2018 and the year ended December 31, 2017, the Company entered into several forward currency contracts which qualified as net investment hedges, in order to mitigate a portion of its 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 Income and Comprehensive Income. Realized gains/(losses) are deferred in accumulated other comprehensive income (loss) ("AOCI") where they will remain until the net investments in the Company's European subsidiaries are divested. Four of these forward currency contracts matured during the six months ended June 30, 2018 and as of June 30, 2018, there were no remaining contracts outstanding.
Subsequent to the issuance of the Euro Senior Notes - 2016 during the first quarter of 2016, the Company designated the debt as a hedge of a portion of its net European investments. Accordingly, the change in the value of the debt that is attributable to foreign exchange movements is recorded in OCI as a component of Foreign currency translation adjustments in the accompanying Consolidated Statement of Income and Comprehensive Income.
During the year ended December 31, 2017, 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 Income and 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 Income and Comprehensive Income in the same period as the related costs are recognized.
The Company maintains various interest rate swap agreements that effectively convert the fixed rate on a portion of its 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 six months ended June 30, 2018 and 2017.
In the second quarter of 2018, the Company entered into a foreign currency contract and two interest rate swap agreements, which are contingent upon the closing of the Frutarom acquisition, for a total notional amount of $1.9 billion. As of June 30, 2018, the changes in fair value of the foreign currency contract resulted in an $11.0 million pre-tax gain included in Other income, net and the two interest rate swaps resulted in a $25.0 million pre-tax loss included in Interest expense in the accompanying Consolidated Statement of Income and Comprehensive Income.
The Company has previously entered into interest rate swap agreements to hedge the anticipated issuance of fixed-rate debt, which are designated as cash flow hedges. The amount of gains and losses realized upon termination of these agreements is amortized over the life of the corresponding debt issuance.

18



The following table shows the notional amount of the Company’s derivative instruments outstanding as of June 30, 2018 and December 31, 2017: 
(DOLLARS IN THOUSANDS)
June 30, 2018
 
December 31, 2017
Non-Deal Contingent Swaps
 
 
 
Foreign currency contracts
$
531,092

 
$
896,947

Interest rate swaps
150,000

 
150,000

Deal Contingent Swaps
 
 
 
Foreign currency contract
1,000,000

 

Interest rate swaps
898,513

 

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 Sheet as of June 30, 2018 and December 31, 2017: 
 
June 30, 2018
(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
$
5,525

 
$
17,172

 
$
22,697

Derivative liabilities (b)
 
 
 
 
 
Foreign currency contract
250

 
5,901

 
6,151

Interest rate swaps
3,799

 
24,937

 
28,736

Total derivative liabilities
$
4,049

 
$
30,838

 
$
34,887

 
December 31, 2017
(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
$
1,159

 
$
3,978

 
$
5,137

Derivative liabilities (b)
 
 
 
 
 
Foreign currency contracts
7,842

 
4,344

 
12,186

Interest rate swaps
1,369

 

 
1,369

Total derivative liabilities
$
9,211

 
$
4,344

 
$
13,555

 _______________________
(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 Income and Comprehensive Income for the three and six months ended June 30, 2018 and 2017 (in thousands): 

19




 
Amount of Gain (Loss)
 
Location of Gain (Loss) Recognized in Income on Derivative
(DOLLARS IN THOUSANDS)
Three Months Ended June 30,
 
2018
 
2017
 
Foreign currency contracts
$
4,685

 
$
(3,054
)
 
Other (income), net
Deal contingent swaps
 
 
 
 
 
Foreign currency contracts
10,979

 

 
Other (income), net
Interest rate swaps
(24,937
)
 

 
Interest expense
 
$
(9,273
)
 
$
(3,054
)
 
 
 
Amount of Gain (Loss)
 
Location of Gain (Loss) Recognized in Income on Derivative
 
Six Months Ended June 30,
 
(DOLLARS IN THOUSANDS)
2018
 
2017
 
Foreign currency contracts (1)
$
1,070

 
$
(13,181
)
 
Other (income), net
Deal contingent swaps
 
 
 
 
 
Foreign currency contracts
10,979

 

 
Other (income), net
Interest rate swaps
(24,937
)
 

 
Interest expense
 
$
(12,888
)
 
$
(13,181
)
 
 
 _______________________
(1)
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, net of tax, in the Consolidated Statement of Income and Comprehensive Income for the three and six months ended June 30, 2018 and 2017 (in thousands): 

20



 
Amount of Gain (Loss) 
Recognized in OCI on
Derivative (Effective
Portion)
 
Location of Gain
(Loss) Reclassified
from AOCI into Income
(Effective Portion)
 
Amount of Gain (Loss) 
Reclassified from
Accumulated OCI into
Income (Effective
Portion)
 
Three Months Ended June 30,
 
 
 
Three Months Ended June 30,
 
2018
 
2017
 
 
 
2018
 
2017
Derivatives in Cash Flow Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts
$
10,241

 
$
(6,328
)
 
Cost of goods sold
 
$
(2,330
)
 
$
1,789

Interest rate swaps (1)
216

 
(5,439
)
 
Interest expense
 
(216
)
 
(186
)
Derivatives in Net Investment Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts
178

 
(2,082
)
 
N/A
 

 

Euro Senior notes - 2016
28,682

 
(19,780
)
 
N/A
 

 

Total
$
39,317

 
$
(33,629
)
 
 
 
$
(2,546
)
 
$
1,603

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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)
 
Six Months Ended June 30,
 
 
 
Six Months Ended June 30,
 
2018
 
2017
 
 
 
2018
 
2017
Derivatives in Cash Flow Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts
$
9,498

 
$
(9,276
)
 
Cost of goods sold
 
$
(4,523
)
 
$
2,247

Interest rate swaps (1)
432

 
(4,243
)
 
Interest expense
 
(432
)
 
(357
)
 
 
 
 
 
 
 
 
 
 
Derivatives in Net Investment Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts
(518
)
 
(3,128
)
 
N/A
 

 

Euro Senior notes - 2016
12,705

 
(31,189
)
 
N/A
 

 

Total
$
22,117

 
$
(47,836
)
 
 
 
$
(4,955
)
 
$
1,890

 _______________________
(1)
Interest rate swaps were entered into as pre-issuance hedges for bond offerings.
The ineffective portion of the above noted cash flow hedges and net investment hedges were not material during the three and six months ended June 30, 2018 and 2017.
The Company expects that approximately $2.4 million (net of tax) of derivative loss included in AOCI at June 30, 2018, 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.

21



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:
(DOLLARS IN THOUSANDS)
Foreign
Currency
Translation
Adjustments
 
(Losses) Gains on Derivatives
Qualifying as
Hedges
 
Pension and
Postretirement
Liability
Adjustment
 
Total
Accumulated other comprehensive (loss) income, net of tax, as of December 31, 2017
$
(297,416
)
 
$
(10,332
)
 
$
(329,734
)
 
$
(637,482
)
OCI before reclassifications
(70,461
)
 
4,971

 
186

 
(65,304
)
Amounts reclassified from AOCI

 
4,955

 
5,333

 
10,288

Net current period other comprehensive income (loss)
(70,461
)
 
9,926

 
5,519

 
(55,016
)
Accumulated other comprehensive (loss) income, net of tax, as of June 30, 2018
$
(367,877
)
 
$
(406
)
 
$
(324,215
)
 
$
(692,498
)

(DOLLARS IN THOUSANDS)
Foreign
Currency
Translation
Adjustments
 
(Losses) Gains on
Derivatives
Qualifying as
Hedges
 
Pension and
Postretirement
Liability
Adjustment
 
Total
Accumulated other comprehensive (loss) income, net of tax, as of December 31, 2016
$
(352,025
)
 
$
7,604

 
$
(335,674
)
 
$
(680,095
)
OCI before reclassifications
22,304

 
(11,629
)
 

 
10,675

Amounts reclassified from AOCI
(12,214
)
(a)
(1,890
)
 
7,323

 
(6,781
)
Net current period other comprehensive income (loss)
10,090

 
(13,519
)
 
7,323

 
3,894

Accumulated other comprehensive (loss) income, net of tax, as of June 30, 2017
$
(341,935
)
 
$
(5,915
)
 
$
(328,351
)
 
$
(676,201
)
 _______________________
 (a) Represents a foreign currency exchange gain from the release of a currency translation adjustment upon the liquidation of a foreign entity in 2017.
The following table provides details about reclassifications out of accumulated other comprehensive income to the Consolidated Statement of Income and Comprehensive Income: 
 
Six Months Ended June 30,
 
Affected Line Item in the
Consolidated Statement
of Income and Comprehensive Income
(DOLLARS IN THOUSANDS)
2018
 
2017
 
(Losses) gains on derivatives qualifying as hedges
 
 
 
 
 
Foreign currency contracts
$
(5,169
)
 
$
2,568

 
Cost of goods sold
Interest rate swaps
(432
)
 
(357
)
 
Interest expense
Tax
646

 
(321
)
 
Provision for income taxes
Total
$
(4,955
)
 
$
1,890

 
Total, net of income taxes
(Losses) gains on pension and postretirement liability adjustments
 
 
 
 
 
Prior service cost
$
3,543

 
$
3,512

 
(a)
Actuarial losses
(10,206
)
 
(12,982
)
 
(a)
Tax
1,330

 
2,147

 
Provision for income taxes
Total
$
(5,333
)
 
$
(7,323
)
 
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 14 of our 2017 Form 10-K for additional information regarding net periodic benefit cost.


22



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 June 30, 2018, we had total bank guarantees and standby letters of credit of approximately $49.4 million with various financial institutions. Included in the above aggregate amount is a total of $13.5 million for other assessments in Brazil for various 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 June 30, 2018.
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 $11.2 million as of June 30, 2018.
Lines of Credit
The Company has various lines of credit which are available to support its ongoing business operations. As of June 30, 2018, we had available lines of credit of approximately $102.3 million with various financial institutions, in addition to the $1.0 billion of capacity under the Amended Credit Facility discussed in Note 6 of the Consolidated Financial Statements. There were no material amounts drawn down pursuant to these lines of credit as of June 30, 2018.
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 will be 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, the Company assesses its 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 its 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 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 will be incurred and if so, whether the amount of loss can be reasonably estimated. The Company records the expected liability with respect to claims in Other liabilities and expected recoveries from its insurance carriers in Other assets. The Company recognizes a receivable when it believes that realization of the insurance receivable is probable under the terms of the insurance policies and its 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.
The Company has been identified as a PRP at eight facilities operated by third parties at which investigation and/or remediation activities may be ongoing. The Company analyzes potential liability on at least a quarterly basis and accrues for environmental liabilities when they are probable and estimable. The Company estimates its 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, the Company believes the amounts it has paid and anticipates paying in the future for clean-up costs and damages at all sites are not and will not have a material adverse effect on its 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 the Company to materially increase the amounts it anticipates paying for clean-up costs and damages at these sites, and that such increased amounts will not have a material adverse effect on its financial condition, results of operations or cash flows.

23



China Facilities
Guangzhou Flavors plant
During the fourth quarter of 2016, the Company was notified that certain governmental authorities have begun to evaluate a change in the zoning of the Guangzhou Flavors plant. The zoning, if changed, would prevent the Company from continuing to manufacture product at the existing plant. The ultimate outcome of any change that the governmental authorities may propose, the timing of such a change, and the nature of any compensation arrangements that might be provided to the Company are uncertain.
The net book value of the existing plant was approximately $71 million as of June 30, 2018.
Zhejiang Ingredients plant
In the fourth quarter of 2017, the Company concluded discussions with the government regarding the relocation of its Fragrance Ingredients plant in Zhejiang and, based on the agreements reached, expects to receive total compensation payments up to approximately $50 million. The relocation compensation will be paid to the Company over the period of the relocation which is expected to be through the end of 2020. The Company received the first payment of $15 million in the fourth quarter of 2017. No additional amounts have been received since the fourth quarter of 2017.
The net book value of the current plant was approximately $23 million as of June 30, 2018. The Company expects to relocate approximately half of production capacity of the facility by the middle of 2019 and the remainder of the production capacity of the facility by the middle of 2020.
Total China Operations
The total net book value of all five plants in China (one of which is currently under construction) was approximately $161 million as of June 30, 2018.
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 it operates 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, the Company believes it has valid defenses for the underlying positions under dispute; however, in order to pursue these defenses, the Company is required to, and has provided, bank guarantees and pledged assets in the aggregate amount of $24.7 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.
ZoomEssence
As previously disclosed, in March 2012, ZoomEssence, Inc. filed a complaint against the Company in the U.S. District Court for the District of New Jersey alleging trade secret misappropriation, breach of contract and unjust enrichment in connection with certain spray dry technology disclosed to the Company. ZoomEssence sought an injunction and monetary damages. In November 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. During the second quarter of 2017, the Company and ZoomEssence mutually agreed to settle all claims and counterclaims. The parties agreed to dismiss their claims against one another, with prejudice and without any admission of liability or wrongful conduct, to avoid any further expense and disruption from the litigation. The complaint was dismissed, with prejudice, on July 5, 2017. Under the settlement agreement, the Company made a one-time payment to ZoomEssence of $56 million during the second quarter of 2017 and the parties exchanged full mutual releases. Accordingly, the Company recorded an additional charge of $1.0 million during the second quarter of 2017.

24



FDA-Mandated Product Recall
The Company periodically incurs product liability claims based on product that is sold to customers that may be defective or otherwise not in accordance with the customer’s requirements. In the first quarter of 2017, the Company was made aware of a claim for product that was subject to an FDA-mandated product recall. As of June 30, 2018, the Company had recorded total charges of approximately $17.5 million with respect to this claim, of which $5.0 million was recorded in the three months ended March 31, 2018. The Company settled the claim with the customer in the first quarter of 2018 for a total of $16.0 million, of which $3.0 million was paid in the fourth quarter of 2017 and $13.0 million was paid during the three months ended March 31, 2018. The remaining accrual of approximately $1.5 million represents management's best estimate of losses related to claims from other affected parties. The Company does not believe that the ultimate settlement of the claim will have a material impact on its financial condition.
Subsequent to the end of the second quarter of 2018, the Company finalized an agreement with the supplier of the effected product for reimbursement of $9.8 million, in full and final settlement from the supplier. The Company continues to pursue reimbursement of all or a portion of costs, once incurred, from other parties including its insurance company; however, the nature, timing and amount of any additional such reimbursement cannot be determined at this time.
Other
The Company determines estimates of reasonably possible losses or ranges of reasonably possible losses in excess of related accrued liabilities, if any, when it has determined that either a loss is reasonably possible or a loss in excess of accrued amounts is reasonably possible and the amount of losses or range of losses is determinable. For all third party contingencies (including labor, contract, technology, tax, product-related claims and business litigation), the Company currently estimates that the aggregate range of reasonably possible losses in excess of any accrued liabilities is $0 to approximately $12 million. The estimates included in this amount are based on the Company’s analysis of currently available information and, as new information is obtained, these estimates may change. Due to the inherent subjectivity of the assessments and the unpredictability of outcomes of legal proceedings, any amounts accrued or included in this aggregate amount may not represent the ultimate loss to the Company from the matters in question. Thus, the Company’s exposure and ultimate losses may be higher or lower, and possibly significantly so, than the amounts accrued or the range disclosed above.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
(UNLESS INDICATED OTHERWISE, DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
Overview
Company background
We are a leading innovator of sensory experiences, co-creating unique products that consumers taste, smell, or feel in fine fragrances and cosmetics, detergents and household goods, and food and beverages. We take advantage of our capabilities in consumer insights, research and product development (“R&D”), creative expertise and customer intimacy to partner with our customers in developing innovative and differentiated offerings for consumers. We believe that this collaborative approach will generate market share gains for our customers. Our flavors and fragrance compounds combine a number of ingredients that are blended, mixed or reacted together to produce proprietary formulas created by our flavorists and perfumers.
Flavors are the key building blocks that impart taste experiences in food and beverage products and, as such, play a significant role in determining consumer preference for the end products in which they are used. 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. While we are a global leader, our flavors business is more regional in nature, with different formulas that reflect local taste preferences. Our flavors compounds are ultimately used by our customers in four end-use categories: (1) Savory, (2) Beverages, (3) Sweet and (4) Dairy.
We are a global leader in the creation of fragrance compounds that are integral elements in the world’s finest perfumes and best-known consumer products, within fabric care, home care, personal wash, hair care and toiletries products. Our Fragrances business consists of Fragrance Compounds and Fragrance Ingredients. Our Fragrance Compounds are defined into two broad categories, (1) Fine Fragrances and (2) Consumer Fragrances. Consumer Fragrances consists of five end-use categories of products: (1) Fabric Care, (2) Home Care, (3) Personal Wash, (4) Hair Care and (5) Toiletries. Fragrance Ingredients consist of cosmetic active and functional ingredients that are used internally and sold to third parties, including customers and competitors, and are included in the Fragrances business unit.
The flavors and fragrances market is part of a larger market which supplies a wide variety of ingredients and compounds that are used in consumer products. The broader market includes large multinational companies and smaller regional and local

25



participants which supply products such as seasonings, texturizers, spices, enzymes, certain food-related commodities, fortified products and active cosmetic ingredients. The global market for flavors and fragrances has expanded consistently, primarily as a result of an increase in demand for, as well as an increase in the variety of, consumer products containing flavors and fragrances. In 2017, the flavors and fragrances market was estimated by management to be approximately $24.8 billion and is forecasted to grow approximately 2-3% by 2021, primarily driven by expected growth in emerging markets.
Development of new flavors and fragrance compounds is driven by a variety of sources, including requests from our customers who are in need of a specific flavor or fragrance for use in a new or modified consumer product, or as a result of internal initiatives stemming from our consumer insights program. Our product development team works with our scientists and researchers to optimize the consumer appeal of the flavor or fragrance. It then becomes a collaborative process among our researchers, our product development team and our customers to perfect the flavor or fragrance so that it is ready to be included in the final consumer product.
On May 7, 2018, we entered into a definitive agreement and plan of merger to acquire Frutarom Industries Ltd. (“Frutarom”). Frutarom is a flavors, savory solutions and natural ingredients company with production and development centers on six continents, that is traded on the Tel Aviv and London Stock Exchanges. The transaction is targeted to close in the fourth quarter of 2018, has been unanimously approved by the Boards of Directors of both companies and by the Frutarom shareholders, and is subject to clearance by the relevant regulatory authorities and other customary closing conditions. The transaction was valued, based on our stock price as of May 7, 2018, at approximately $7.1 billion, including the assumption of approximately $681 million of Frutarom's net debt, which the Company intends to refinance or repay concurrent with the closing of the transaction. See Note 3 to the Consolidated Financial Statements for additional information on the pending transaction.
2018 Overview
Effective the first quarter of 2018, we adopted new accounting guidance related to revenue recognition and the presentation of pension costs. The revenue recognition guidance was adopted effective the first day of fiscal 2018 and prior period amounts were not revised to conform to the new guidance. The adoption of the new revenue guidance did not have a material impact on our results of operations. The guidance related to the presentation of pension costs was applied retroactively and prior period amounts have been adjusted to conform to the new guidance. As noted in Note 10 to the Consolidated Financial Statements, the net effect of the change was to decrease operating profit and increase Other income.
Net sales during the second quarter of 2018 increased 9% on a reported basis and 5% on a currency neutral basis (which excludes the effects of changes in currency) versus the 2017 period. Reported and currency neutral sales growth were driven by new win performance (net of losses) and price increases (principally due to increases in raw material input costs) in both Flavors and Fragrances.
Exchange rate variations had a 400 bps favorable impact on net sales for the second quarter of 2018. The effect of exchange rates can vary by business and region, depending upon the mix of sales priced in U.S. dollars as compared to other currencies, as well as the relative percentage of local sales priced in U.S. dollars versus local currencies.
Gross margins decreased to 43.3% in the second quarter of 2018 from 44.3% in the 2017 period, driven primarily by unfavorable price versus input costs (including the impact of the BASF supply disruption) which was only partially offset by cost savings and productivity initiatives. Included in the second quarter of 2018 were $0.4 million of operational improvement costs compared to $6.1 million of acquisition-related amortization of inventory "step-up" costs, operational improvement initiative costs and integration-related costs included in the second quarter of 2017. Excluding these items, gross margin decreased 202 bps compared to the prior year period. We believe that, in 2018, we will continue to see higher costs of raw materials across a range of categories (including turpentine, citrus and petro-derived products). Raw material costs incurred by our Fragrance segment continue to be impacted by the BASF supply disruption (as discussed in our 2017 Form 10-K).
We continue to seek improvements in our margins through operational performance, cost reduction efforts and mix enhancement.

26



FINANCIAL PERFORMANCE OVERVIEW
Sales
Reported sales in the second quarter of 2018 increased approximately 9% as compared to the 2017 period. We continued to benefit from our diverse portfolio of end-use product categories and geographies and achieved currency neutral growth in all four regions. Sales growth was driven by new win performance (net of losses) and price increases (principally due to increases in raw material input costs) in both Flavors and Fragrances. Flavors achieved sales growth of 9% on a reported basis and 6% on a currency neutral basis. Fragrances achieved reported sales growth of 10% and currency neutral sales growth of 5%. Additionally, Fragrance Ingredients sales were up 16% on a reported basis and 10% on a currency neutral basis. Overall, our second quarter 2018 results continued to be driven by our strong emerging market presence that represented 47% of total sales and experienced 14% reported and 7% currency neutral growth in the second quarter 2018. From a geographic perspective, for the second quarter of 2018, North America ("NOAM"), Europe, Africa and the Middle East ("EAME"), Latin America ("LA") and Greater Asia ("GA") all delivered sales growth.
Operating profit
Operating profit increased $2.8 million to $154.5 million in the 2018 second quarter compared to $151.7 million in the comparable 2017 period while operating profit as a percentage of sales decreased to 16.8% in the 2018 second quarter compared to 18.0% in the comparable 2017 period. The second quarter of 2018 included $15.3 million of charges related to operational improvement initiatives, losses on sale of assets, the pending Frutarom acquisition related costs, restructuring and other charges, net and acquisition related costs as compared to $12.7 million of charges related to operational improvement initiatives, acquisition related costs, integration related costs, legal charges/credits, net and restructuring and other charges, net which were partially offset by gains on sale of assets and a favorable tax assessment in the 2017 period. Excluding these charges, adjusted operating profit was $169.8 million for the second quarter of 2018, an increase from $156.1 million for the second quarter of 2017, principally driven by volume growth, the impact of foreign exchange, and cost and productivity initiatives which more than offset price to input costs (including the impact of the BASF supply chain disruption). Foreign currency had a 6% favorable impact on operating profit in the 2018 period compared to a 3% unfavorable impact on operating profit in the 2017 period. Operating profit as a percentage of sales, excluding the above charges, decreased from 18.5% for the second quarter of 2018 compared to 19.5% for the second quarter of 2017, principally driven by lower margins as a result of price to input costs (including the impact of the BASF supply chain disruption), partially offset by the impact of foreign exchange, cost and productivity initiatives and volume growth.
Interest Expense
Interest expense increased to $53.2 million in the second quarter of 2018 compared to $17.6 million in the 2017 period driven by $10.7 million of fees incurred in connection with the bridge loan commitment and $25.0 million mark-to-market adjustments on deal-contingent interest rate derivatives entered into in connection with the pending acquisition with Frutarom.
Other (income) expense, net
Other (income), net increased $12.6 million to $20.7 million of income in the second quarter of 2018 compared to $7.9 million of income in the second quarter of 2017. The year-over-year increase was primarily driven by an $11.0 million mark-to-market adjustment on a foreign currency derivative entered into in connection with the pending acquisition with Frutarom.
Net income
Net income decreased by $10.6 million quarter-over-quarter to $99.1 million for the second quarter of 2018 from $109.8 million in the 2017 period, reflecting a small increase in operating profit, an increase in Other (income) primarily driven by the impact of foreign currency (including a foreign currency derivative related to the pending Frutarom acquisition), and offset by a large increase in interest expense.
Cash flows
Cash flows provided by operations for the six months ended June 30, 2018 was $55.2 million or 3.0% of sales, compared to cash flows provided by operations of $57.9 million or 3.5% of sales for the six months ended June 30, 2017. The change in cash flows from operations in 2018 was principally driven by fees incurred in connection with the bridge loan commitment, higher working capital (principally related to inventories) and FDA mandated product recall costs, partially offset by the impact of the litigation settlement and pension contributions in 2017.

27



Results of Operations
 
Three Months Ended
 
 
 
Six Months Ended
 
 
 
June 30,
 
 
 
June 30,
 
 
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
2018
 
2017
 
Change
 
2018
 
2017
 
Change
Net sales
$
920,016

 
$
842,861

 
9
 %
 
$
1,850,944

 
$
1,671,154

 
11
 %
Cost of goods sold
521,299

 
469,877

 
11
 %
 
1,046,419

 
935,088

 
12
 %
Gross profit
398,717

 
372,984

 
 
 
804,525

 
736,066

 
 
Research and development (R&D) expenses
74,767

 
72,761

 
3
 %
 
153,244

 
144,887

 
6
 %
Selling and administrative (S&A) expenses
157,407

 
139,319

 
13
 %
 
300,051

 
283,023

 
6
 %
Amortization of acquisition-related intangibles
9,584

 
8,494

 
13
 %
 
18,769

 
15,561

 
21
 %
Restructuring and other charges, net
1,186

 
791

 
50
 %
 
1,903

 
10,934

 
(83
)%
Losses (gains) on sales of fixed assets
1,264

 
(68
)
 
(1,959
)%
 
1,195

 
(89
)
 
(1,443
)%
Operating profit
154,509

 
151,687

 
 
 
329,363

 
281,750

 
 
Interest expense
53,246

 
17,556

 
203
 %
 
69,841

 
30,363

 
130
 %
Other (income), net
(20,655
)
 
(7,909
)
 
161
 %
 
(21,232
)
 
(29,140
)
 
(27
)%
Income before taxes
121,918

 
142,040

 
 
 
280,754

 
280,527

 
 
Taxes on income
22,769

 
32,245

 
(29
)%
 
52,190

 
54,968

 
(5
)%
Net income
$
99,149

 
$
109,795

 
(10
)%
 
$
228,564

 
$
225,559

 
1
 %
Diluted EPS
$
1.25

 
$
1.38

 
(9
)%
 
$
2.87

 
$
2.84

 
1
 %
Gross margin
43.3
%
 
44.3
%
 
(91
)
 
43.5
%
 
44.0
%
 
(58
)
R&D as a percentage of sales
8.1
%
 
8.6
%
 
(51
)
 
8.3
%
 
8.7
%
 
(39
)
S&A as a percentage of sales
17.1
%
 
16.5
%
 
58

 
16.2
%
 
16.9
%
 
(73
)
Operating margin
16.8
%
 
18.0
%
 
(120
)
 
17.8
%
 
16.9
%
 
93

Adjusted operating margin (1)
18.5
%
 
19.5
%
 
(104
)
 
19.0
%
 
19.2
%
 
(22
)
Effective tax rate
18.7
%
 
22.7
%
 
(403
)
 
18.6
%
 
19.6
%
 
(101
)
Segment net sales
 
 
 
 
 
 
 
 
 
 
 
Flavors
$
450,540

 
$
414,323

 
9
 %
 
$
899,559

 
$
820,487

 
10
 %
Fragrances
469,476

 
428,538

 
10
 %
 
951,385

 
850,667

 
12
 %
Consolidated
$
920,016

 
$
842,861

 
 
 
$
1,850,944

 
$
1,671,154

 
 
 
(1)
Adjusted operating margin excludes $15.3 million of charges related to operational improvement initiatives, integration related costs, restructuring and other charges, net, losses on sale of assets and costs related to the pending acquisition of Frutarom which were partially offset by acquisition related costs for the three months ended June 30, 2018, and excludes $12.7 million of charges related to operational improvement initiatives, acquisition related costs, integration related costs, legal charges/credits, net, restructuring and other charges, net and FDA mandated product recall which were partially offset by gains on sales of fixed assets and a favorable legal settlement for the three months ended June 30, 2017. For the six months ended June 30, 2018, adjusted operating margin excludes $21.5 million of charges related to operational improvement initiatives, integration related costs, restructuring and other charges, net, gains on sale of assets, FDA mandated product recall and costs related to the pending acquisition of Frutarom which were partially offset by acquisition related costs, compared to the six months ended June 30, 2017 adjusted operating margin which excludes $38.7 million consisting of acquisition-related costs, costs associated with product recalls, tax assessment, legal charges, restructuring, integration-related and operational improvement initiative costs as well as gains on sales of fixed assets See "Non-GAAP Financial Measures" below.
Cost of goods sold includes the cost of materials and manufacturing expenses. R&D includes expenses related to the development of new and improved products and technical product support. S&A expenses include expenses necessary to support our commercial activities and administrative expenses supporting our overall operating activities including compliance with governmental regulations.


28



SECOND QUARTER 2018 IN COMPARISON TO SECOND QUARTER 2017
Sales
Sales for the second quarter of 2018 totaled $920.0 million, an increase of 9% on a reported basis and 5% on a currency neutral basis as compared to the prior year quarter. Sales growth was driven by new win performance (net of losses) and price increases (principally due to increases in raw material input costs) in both Flavors and Fragrances.
Flavors Business Unit
Flavors sales increased 9% on a reported basis and 6% on a currency neutral basis for the second quarter of 2018 compared to the second quarter of 2017. Sales growth reflected new win performance (net of losses) and price increases (principally due to increases in raw material input costs). Overall growth was driven by growth in all four Flavors regions and all end-use categories.
Fragrances Business Unit
Fragrances sales increased 10% on a reported basis and 5% on a currency neutral basis for the second quarter of 2018 compared to the second quarter of 2017. Sales growth reflected new win performance (net of losses) and price increases (principally due to increases in raw material input costs), which were slightly offset by volume reductions on existing business. Overall growth was driven by double-digit growth in Fragrance Ingredients, and by broad based growth in all end-use categories.
Sales Performance by Region and Category
 
 
 
% Change in Sales - Second Quarter 2018 vs. Second Quarter 2017
 
 
Fine Fragrances
 
Consumer Fragrances
 
Ingredients
 
Total 
Fragrances
 
Flavors
 
Total
NOAM
Reported