Company Quick10K Filing
Quick10K
International Flavors & Fragrances
Closing Price ($) Shares Out (MM) Market Cap ($MM)
$141.78 107 $15,120
10-Q 2018-09-30 Quarter: 2018-09-30
10-Q 2018-06-30 Quarter: 2018-06-30
10-Q 2018-03-31 Quarter: 2018-03-31
10-K 2017-12-31 Annual: 2017-12-31
10-Q 2017-09-30 Quarter: 2017-09-30
10-Q 2017-06-30 Quarter: 2017-06-30
10-Q 2017-03-31 Quarter: 2017-03-31
10-K 2016-12-31 Annual: 2016-12-31
10-Q 2016-09-30 Quarter: 2016-09-30
10-Q 2016-06-30 Quarter: 2016-06-30
10-Q 2016-03-31 Quarter: 2016-03-31
10-K 2015-12-31 Annual: 2015-12-31
8-K 2019-02-13 Earnings, Exhibits
8-K 2018-11-30 Regulation FD, Exhibits
8-K 2018-11-05 Earnings, Exhibits
8-K 2018-10-03 M&A, Off-BS Arrangement, Regulation FD, Exhibits
8-K 2018-09-24 Enter Agreement, Off-BS Arrangement, Other Events, Exhibits
8-K 2018-09-20 Enter Agreement, Off-BS Arrangement, Other Events, Exhibits
8-K 2018-09-20 Other Events, Exhibits
8-K 2018-09-12 Enter Agreement, Off-BS Arrangement, Other Events, Exhibits
8-K 2018-09-10 Other Events, Exhibits
8-K 2018-09-06 Regulation FD, Exhibits
8-K 2018-08-25 Enter Agreement, Regulation FD, Exhibits
8-K 2018-08-07 Earnings, Exhibits
8-K 2018-08-03 Other Events, Exhibits
8-K 2018-06-06 Enter Agreement, Off-BS Arrangement, Exhibits
8-K 2018-05-21 Enter Agreement, Exhibits
8-K 2018-05-07 Enter Agreement, Regulation FD, Exhibits
8-K 2018-05-02 Amend Bylaw, Shareholder Vote, Exhibits
8-K 2018-02-14 Earnings, Exhibits
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TROX Tronox
FF Futurefuel
RYAM Rayonier Advanced Materials
VNTR Venator Materials
AMRS Amyris
HYGS Hydrogenics
IFF 2018-09-30
Part I. Financial Information
Item 1. Financial Statements.
Note 1. Nature of Operations and Summary of Significant Accounting Policies
Note 2. Net Income per Share
Note 3. Acquisitions
Note 4. Restructuring and Other Charges, Net
Note 5. Goodwill and Other Intangible Assets, Net
Note 6. Tangible Equity Units
Note 7. Debt
Note 8. Income Taxes
Note 9. Stock Compensation Plans
Note 10. Segment Information
Note 11. Employee Benefits
Note 12. Financial Instruments
Note 13. Accumulated Other Comprehensive Income (Loss)
Note 14. Commitments and Contingencies
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
Item 4. Controls and Procedures.
Part II. Other Information
Item 1. Legal Proceedings.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Item 6. Exhibits.
EX-31.1 iff93018exhibit311.htm
EX-31.2 iff93018exhibit312.htm
EX-32 iff93018exhibit32.htm

International Flavors & Fragrances Earnings 2018-09-30

IFF 10Q Quarterly Report

Balance SheetIncome StatementCash Flow

10-Q 1 iff10-q318.htm 10-Q 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 September 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 every Interactive Data File required to be submitted 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 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 October 23, 2018: 106,619,224






PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED BALANCE SHEET
(Unaudited)
(DOLLARS IN THOUSANDS)
September 30, 2018
 
December 31, 2017
ASSETS
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
5,274,459

 
$
368,046

Trade receivables (net of allowances of $13,762 and $13,392, respectively)
701,111

 
663,663

Inventories: Raw materials
372,606

 
326,140

Work in process
26,297

 
16,431

Finished goods
320,605

 
306,877

Total Inventories
719,508

 
649,448

Prepaid expenses and other current assets
251,749

 
215,387

Total Current Assets
6,946,827

 
1,896,544

Property, plant and equipment, at cost
2,124,886

 
2,090,755

Accumulated depreciation
(1,250,069
)
 
(1,210,175
)
 
874,817

 
880,580

Goodwill
1,152,864

 
1,156,288

Other intangible assets, net
385,575

 
415,787

Deferred income taxes
87,481

 
99,777

Other assets
167,978

 
149,950

Total Assets
$
9,615,542

 
$
4,598,926

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current Liabilities:
 
 
 
Short term borrowings
$
45,985

 
$
6,966

Accounts payable
312,236

 
338,188

Accrued payroll and bonus
75,970

 
88,361

Dividends payable
66,901

 
54,420

Other current liabilities
257,364

 
280,833

Total Current Liabilities
758,456

 
768,768

Long-term debt
4,331,242

 
1,632,186

Deferred gains
33,867

 
37,344

Retirement liabilities
218,696

 
228,936

Other liabilities
235,332

 
242,398

Total Other Liabilities
4,819,137

 
2,140,864

Commitments and Contingencies (Note 14)

 

Shareholders’ Equity:
 
 
 
Common stock 12 1/2¢ par value; 500,000,000 shares authorized; 128,526,137 and 115,858,190 shares issued as of September 30, 2018 and December 31, 2017, respectively; and 91,717,377 and 78,947,381 shares outstanding as of September 30, 2018 and December 31, 2017, respectively
16,066

 
14,470

Capital in excess of par value
2,441,530

 
162,827

Retained earnings
4,021,172

 
3,870,621

Accumulated other comprehensive loss
(715,105
)
 
(637,482
)
Treasury stock, at cost (36,808,760 and 36,910,809 shares as of September 30, 2018 and December 31, 2017, respectively)
(1,731,849
)
 
(1,726,234
)
Total Shareholders’ Equity
4,031,814

 
1,684,202

Noncontrolling interest
6,135

 
5,092

Total Shareholders’ Equity including noncontrolling interest
4,037,949

 
1,689,294

Total Liabilities and Shareholders’ Equity
$
9,615,542

 
$
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
 
Nine Months Ended
 
September 30,
 
September 30,
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
2018
 
2017
 
2018
 
2017
Net sales
$
907,548

 
$
872,940

 
$
2,758,492

 
$
2,544,094

Cost of goods sold
506,882

 
492,542

 
1,553,300

 
1,427,630

Gross profit
400,666

 
380,398

 
1,205,192

 
1,116,464

Research and development expenses
75,302

 
73,762

 
228,545

 
218,649

Selling and administrative expenses
157,796

 
145,652

 
457,847

 
428,675

Amortization of acquisition-related intangibles
9,003

 
8,766

 
27,772

 
24,327

Restructuring and other charges, net
927

 
3,249

 
2,830

 
14,183

Gains on sales of fixed assets
(1,630
)
 
(31
)
 
(435
)
 
(120
)
Operating profit
159,268

 
149,000

 
488,633

 
430,750

Interest expense
23,914

 
19,221

 
93,755

 
49,584

Loss on extinguishment of debt
38,810

 

 
38,810

 

Other income, net
(4,158
)
 
(11,547
)
 
(25,389
)
 
(40,687
)
Income before taxes
100,702

 
141,326

 
381,457

 
421,853

Taxes on income
4,986

 
31,065

 
57,176

 
86,033

Net income
95,716

 
110,261

 
324,281

 
335,820

Other comprehensive (loss) income, after tax:
 
 
 
 
 
 
 
Foreign currency translation adjustments
(27,587
)
 
19,719

 
(98,048
)
 
29,809

Gains (losses) on derivatives qualifying as hedges
2,421

 
(4,014
)
 
12,347

 
(17,533
)
Pension and postretirement net liability
2,559

 
3,845

 
8,078

 
11,168

Other comprehensive (loss) income
(22,607
)
 
19,550

 
(77,623
)
 
23,444

Total comprehensive income
$
73,109

 
$
129,811

 
$
246,658

 
$
359,264

 
 
 
 
 
 
 
 
Net income per share - basic
$
1.18

 
$
1.39

 
$
4.06

 
$
4.24

Net income per share - diluted
$
1.17

 
$
1.39

 
$
4.04

 
$
4.22

Average number of shares outstanding - basic
81,263

 
79,063

 
79,783

 
79,072

Average number of shares outstanding - diluted
81,647

 
79,362

 
80,115

 
79,353


See Notes to Consolidated Financial Statements
2



INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)
 
Nine Months Ended September 30,
(DOLLARS IN THOUSANDS)
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
324,281

 
$
335,820

Adjustments to reconcile to net cash provided by operating activities:
 
 
 
Depreciation and amortization
95,994

 
85,446

Deferred income taxes
20,623

 
(3,439
)
Gains on sale of assets
(435
)
 
(120
)
Stock-based compensation
22,041

 
20,149

Pension contributions
(15,983
)
 
(36,870
)
Loss on extinguishment of debt
38,810

 

Gain on deal contingent derivatives
(12,505
)
 

Litigation settlement

 
(56,000
)
Product recall claim settlement, net of insurance proceeds received
(3,090
)
 

Foreign currency gain on liquidation of entity

 
(12,214
)
Changes in assets and liabilities, net of acquisitions:
 
 
 
Trade receivables
(93,198
)
 
(94,945
)
Inventories
(92,705
)
 
6,211

Accounts payable
(17,198
)
 
(20,560
)
Accruals for incentive compensation
(10,753
)
 
2,907

Other current payables and accrued expenses
386

 
9,423

Other assets
(61,597
)
 
3,824

Other liabilities
7,287

 
(40,143
)
Net cash provided by operating activities
201,958

 
199,489

Cash flows from investing activities:
 
 
 
Cash paid for acquisitions, net of cash received
(22
)
 
(191,304
)
Additions to property, plant and equipment
(102,421
)
 
(77,318
)
Proceeds from life insurance contracts
1,837

 
1,941

Maturity of net investment hedges
(2,642
)
 
2,226

Proceeds from disposal of assets
961

 
1,275

Net cash used in investing activities
(102,287
)
 
(263,180
)
Cash flows from financing activities:
 
 
 
Cash dividends paid to shareholders
(163,318
)
 
(151,678
)
Increase in revolving credit facility and short term borrowings
112,483

 
35,998

Deferred financing costs
(21,944
)
 
(5,373
)
Repayments on debt
(288,810
)
 
(250,000
)
Proceeds from issuance of long-term debt
2,926,414

 
498,250

Proceeds from sales of equity securities, net of issuance costs
2,268,965

 

Gain (loss) on pre-issuance hedges
12,505

 
(5,310
)
Proceeds from issuance of stock in connection with stock options

 
329

Employee withholding taxes paid
(9,725
)
 
(11,509
)
Purchase of treasury stock
(15,475
)
 
(53,211
)
Net cash provided by financing activities
4,821,095

 
57,496

Effect of exchange rate changes on cash and cash equivalents
(14,353
)
 
(1,795
)
Net change in cash and cash equivalents
4,906,413

 
(7,990
)
Cash and cash equivalents at beginning of year
368,046

 
323,992

Cash and cash equivalents at end of period
$
5,274,459

 
$
316,002

Supplemental Disclosures:
 
 
 
Interest paid, net of amounts capitalized
$
91,874

 
$
48,485

Income taxes paid
$
86,672

 
$
77,356

Accrued capital expenditures
$
18,247

 
$
13,054


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, September 30 and December 31 are used consistently throughout this Form 10-Q and these interim financial statements and related notes to represent the period-end dates. For the 2018 and 2017 quarters, the actual closing dates were September 28 and September 29, 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. generally accepted accounting principles (“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.
Adoption of Highly Inflationary Accounting in Argentina
U.S. GAAP requires the use of highly inflationary accounting for countries whose cumulative three-year inflation rate exceeds 100 percent. In the second quarter of 2018, the Argentine peso rapidly devalued relative to the U.S. dollar, which along with increased inflation, indicated that the three-year cumulative inflation rate in that country exceeded 100 percent as of July 1, 2018. As a result, the Company has elected to adopt highly inflationary accounting as of the beginning of the third quarter of 2018 for its subsidiary in Argentina. Under highly inflationary accounting, the functional currency of the subsidiary in Argentina became the U.S. dollar, and its results for the third quarter have been recorded on that basis. The net effect of the adoption of the U.S. dollar as the functional currency did not result in a material change to the Company's Consolidated Balance Sheet or the Consolidated Statement of Income and Comprehensive Income. For the three months ended September 30, 2018, the Company's Argentina subsidiary represented less than 3% of the Company’s consolidated net sales and less than 1% of its consolidated total assets as of September 30, 2018.
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.

4



During the nine months ended September 30, 2018, the Company recorded an additional benefit of $8.0 million to adjust the provisional “toll charge” required from the transition to the new territorial tax system, and a benefit of $0.2 million to adjust the remeasurement of net deferred tax assets as a result of U.S. tax reform. These benefits were partially offset by 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 $11.4 million for the nine months ended September 30, 2018 compared to an increase of approximately $12.1 million for the nine months ended September 30, 2017. The cost of participating in these programs was immaterial to our results in all periods.
Recent Accounting Pronouncements
In August 2018, the FASB issued Accounting Standards Update ("ASU") 2018-15, “Intangibles – Goodwill and Other – Internal – Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of the FASB Emerging Issues Task Force).” The ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). This guidance is effective for fiscal years beginning after December 15, 2019, and for interim periods within those fiscal years, with early adoption permitted. 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 August 2018, the FASB issued ASU 2018-14, "Compensation – Retirement Benefits – Defined Benefit Plans", which modifies the disclosure requirements on company-sponsored defined benefit plans. The ASU is effective for fiscal years beginning after December 15, 2020 on a retrospective basis to all periods presented. Early adoption is permitted. 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 August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820)", which modifies, removes and adds certain disclosure requirements on fair value measurements. The ASU is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted. 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 June 2018, the FASB issued 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

5



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 ASU 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 ASU 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 for 2018, 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 $8.7 million in the three months ended September 30, 2017 and by approximately $23.6 million in the nine months ended September 30, 2017, and corresponding increases in Other (income) expense, net as presented in the Company's Consolidated Statement of Income and Comprehensive Income for the respective periods. There was no impact to Net income or Net Income per share in either period. See Note 11 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 ASU 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 ASU 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.
In February 2016, the FASB issued ASU 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 is evaluating 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 real estate, 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 ASU 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

6



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 September 30, 2018 were reductions of $0.8 million, $0.6 million and $0.5 million, respectively, and for the nine months ended September 30, 2018 were reductions of $3.3 million, $2.2 million and $1.6 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.
The following table presents the Company's revenues disaggregated by business unit:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(DOLLARS IN THOUSANDS)
2018

2017(a)
 
2018

2017(a)
Flavor Compounds
$
436,214

 
$
409,800

 
$
1,335,773

 
$
1,230,286

Fragrance Compounds
 
 
 
 
 
 
 
Consumer Fragrances
286,078

 
280,018

 
840,532

 
786,412

Fine Fragrances
93,281

 
96,045

 
289,496

 
274,740

Fragrance Ingredients
91,975

 
87,077

 
292,691

 
252,656

Total revenues
$
907,548

 
$
872,940

 
$
2,758,492

 
$
2,544,094

_______________________ 
(a)
Prior period amounts have not been adjusted based on the modified retrospective method.

7



The following table presents our revenues disaggregated by region, based on the region of our customers:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(DOLLARS IN THOUSANDS)
2018
 
2017(a)
 
2018
 
2017(a)
Europe, Africa and Middle East
$
285,519

 
$
276,713

 
$
887,680

 
$
793,590

Greater Asia
237,415

 
224,850

 
723,194

 
672,470

North America
248,661

 
233,083

 
738,857

 
682,438

Latin America
135,953

 
138,294

 
408,761

 
395,596

Total revenues
$
907,548

 
$
872,940

 
$
2,758,492

 
$
2,544,094

_______________________ 
(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.
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

8



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 nine months ended September 30, 2018 and December 31, 2017:
(DOLLARS IN THOUSANDS)
September 30, 2018
 
At adoption
Receivables (included in Trade receivables)
$
714,873

 
$
677,055

Contract asset - Short term
1,126

 
4,449

NOTE 2. NET INCOME PER SHARE
A reconciliation of the shares used in the computation of basic and diluted net income per share is as follows: 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(SHARES IN THOUSANDS)
2018
 
2017
 
2018
 
2017
Basic(1)
81,263

 
79,063

 
79,783

 
79,072

Effect of dilutive securities(2)
384

 
299

 
332

 
281

Diluted
81,647

 
79,362

 
80,115

 
79,353

_______________________ 
(1)
For the three and nine months ended September 30, 2018, the tangible equity units (“TEUs”) were assumed to be outstanding at the minimum settlement amount for weighted-average shares for basic earnings per share. See below for details.
(2)
Effect of dilutive securities includes dilution under stock plans and incremental impact of TEUs. See below for details.
On September 17, 2018, the Company issued and sold 12,667,947 shares of its common stock in an underwritten public offering for net proceeds of approximately $1.6 billion.
The Company declared a quarterly dividend to its shareholders of $0.73 and $0.69 for the three months ended September 30, 2018 and 2017, respectively. For the nine months ended September 30, 2018 and 2017, the Company declared a quarterly dividend to its shareholders of $2.11 and $1.97, respectively.
There were no stock options or stock-settled appreciation rights (“SSARs”) excluded from the computation of diluted net income per share for the three and nine months ended September 30, 2018 and 2017.
As discussed in Note 6, the Company issued 16,500,000 TEUs, consisting of a prepaid stock purchase contract ("SPC") and a senior amortizing note, for net proceeds of approximately $799.0 million on September 17, 2018. For the periods outstanding, the SPC portion of the TEUs were assumed to be settled at the minimum settlement amount of 0.3134 shares per SPC for weighted-average shares for basic earnings per share. For diluted earnings per share, the shares were assumed to be settled at a conversion factor based on the 20 day volume-weighted average price (“VWAP”) per share of the Company’s common stock not to exceed 0.3720 shares per SPC.
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 September 30, 2018 and 2017 was immaterial. Net income allocated to such PRSUs was $0.1 million for the three months ended September 30, 2018 and $0.2 million for the three months ended September 30, 2017, and $0.6 million for the nine months ended September 30, 2018 and $0.8 million for the nine months ended September 30, 2017.

9



NOTE 3.    ACQUISITIONS
Frutarom
On October 4, 2018, the Company completed its acquisition of Frutarom Industries Ltd. (“Frutarom”). IFF acquired 100% of the equity of Frutarom pursuant to a definitive agreement and plan of merger entered into on May 7, 2018. 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, including natural products. The acquisition was made in order to strengthen IFFs customer base, its capabilities and geographic reach, and is expected to result in more exposure to end markets, including those with a focus on naturals and health and wellness.
The acquisition will be accounted for using the purchase method of accounting, and Frutarom's assets, liabilities and results of operations will be included in the Company’s financial statements from the acquisition date.
The Company completed the following financing transactions related to the acquisition:
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 $350.0 million. The term loan credit agreement was funded on October 3, 2018. See Note 7 for further details.
On September 17, 2018, the Company issued and sold 12,667,947 shares of its common stock in an underwritten public offering for net proceeds of approximately $1.6 billion.
On September 17, 2018, the Company issued 16,500,000 TEUs in an underwritten public offering for net proceeds of approximately $799.0 million. See Note 6 for further details.
On September 17, 2018, the Company repaid the $250 million outstanding principal amount of the Senior notes - 2007, plus accrued and unpaid interest of $7.7 million and a make whole payment of $34.9 million. Additionally, the Company incurred a loss of $3.9 million on the termination of a fair value hedge. See Note 7 for further details.
On September 25, 2018, the Company issued €1.1 billion ($1.3 billion in USD) aggregate principal amount of senior unsecured notes for €1,092 million ($1,282 million in USD) net of underwriting discounts and offering costs (the "2018 Euro Senior Notes"). These notes were issued with stated interest rates ranging from 0.50% to 1.80%. These notes mature between September 25, 2021 and September 25, 2026. See Note 7 for further details.
On September 26, 2018, the Company issued $1.5 billion aggregate principal amount of senior unsecured notes for $1,483 million net underwriting discounts and offering costs (the "2018 USD Senior Notes"). These notes were issued with stated interest rates ranging from 3.40% to 5.00%. These notes mature between September 25, 2020 and September 26, 2048. See Note 7 for further details.
In May 2018, the Company entered into a bridge term loan credit facility. On September 26, 2018, upon completion of various equity and debt raising activities, the Company terminated the facility. See Note 7 for further details.
Under the terms of the merger agreement, for each issued and outstanding Frutarom ordinary share, Frutarom shareholders received $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 October 4, 2018, at approximately $7.1 billion, including the assumption of approximately $797 million of Frutarom's net debt, which the Company repaid concurrent with the closing of the transaction.
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 number of shares of the Company’s common stock issued as a portion of the merger consideration was 14.9 million shares, which resulted in former Frutarom shareholders holding approximately 14.0% of the Company's outstanding common stock as of the closing on October 4, 2018.
Due to the limited time since the closing of the transaction, the Company has not yet completed a preliminary purchase price allocation. The purchase price allocation is expected to be completed during 2019.
During the nine months ended September 30, 2018, the Company incurred $38.8 million of deal related interest expense, a $12.5 million realized gain on a deal contingent foreign currency contract, $38.8 million related to the loss on extinguishment of the Senior notes - 2007, and $26.8 million in administrative expenses related to the Frutarom acquisition.

10



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.
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 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.
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.

11



The Company recorded $23.4 million of charges related to personnel costs and lease termination costs through the third 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 $0.9 million and $3.2 million of charges related to personnel costs and lease termination costs during the three months ended September 30, 2018 and 2017, respectively, and $2.8 million and $14.2 million of charges related to personnel costs and lease termination costs during the nine months ended September 30, 2018 and 2017, respectively.
The Company made payments of $6.4 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 nine months ended September 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, net
2,830

 

 
2,830

Payments
(6,396
)
 

 
(6,396
)
Balance at September 30, 2018
$
3,973

 
$
418

 
$
4,391

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
(3,446
)
Balance at September 30, 2018
$
1,152,864

Other Intangible Assets
Other intangible assets, net consisted of the following amounts: 
 
September 30,
 
December 31,
(DOLLARS IN THOUSANDS)
2018
 
2017
Asset Type
 
 
 
Customer relationships
$
405,136

 
$
407,636

Trade names & patents
38,492

 
38,771

Technological know-how
161,622

 
161,856

Other
24,776

 
24,814

Total carrying value
630,026

 
633,077

Accumulated Amortization
 
 
 
Customer relationships
(122,001
)
 
(104,800
)
Trade names & patents
(17,558
)
 
(15,241
)
Technological know-how
(83,633
)
 
(76,766
)
Other
(21,259
)
 
(20,483
)
Total accumulated amortization
(244,451
)
 
(217,290
)
Other intangible assets, net
$
385,575

 
$
415,787

 
Amortization
Amortization expense was $9,003 and $8,766 for the three months ended September 30, 2018 and 2017, respectively and $27,772 and $24,327 for the nine months ended September 30, 2018 and 2017, respectively. Annual amortization, excluding the impact of the Frutarom acquisition, is expected to be $36.2 million for the full year 2018, $34.8 million for the year 2019,

12



$34.1 million for the year 2020, $29.3 million for the year 2021, $25.2 million for the year 2022 and $25.1 million for the year 2023.
NOTE 6.    TANGIBLE EQUITY UNITS
On September 17, 2018, the Company issued and sold 16,500,0006.00% TEUs at $50 per unit and received proceeds of $799.0 million, net of discounts and issuance costs of $26.0 million. Each TEU is comprised of: (i) a prepaid stock purchase contract (“SPC”) to be settled by delivery of a specified number of shares of the Company's common stock, and (ii) a senior amortizing note (“Amortizing Note”), with an initial principal amount of $8.4529 and a final installment payment date of September 15, 2021. The Company will pay equal quarterly cash installments of $0.75 per Amortizing Note on March 15, June 15, September 15, and December 15 of each year, with the exception of the first installment payment of $0.7333 per Amortizing Note due on December 15, 2018. In the aggregate, the annual quarterly cash installments will be equivalent to 6.00% per year. Each installment payment constitutes a payment of interest and a partial repayment of principal, computed at an annual rate of 3.79%. Each TEU may be separated by a holder into its constituent SPC and Amortizing Note after the initial issuance date of the TEUs, and the separate components may be combined to create a TEU after the initial issuance date, in accordance with the terms of the SPC. The TEUs are listed on the New York Stock Exchange under the symbol “IFFT”.
The proceeds from the issuance of the TEUs were allocated to equity and debt based on the relative fair value of the respective components of each TEU as follows:
(IN MILLIONS, EXCEPT FAIR VALUE PER TEU)
 
SPC
 
Amortizing Note
 
Total
Fair Value per TEU
 
$
41.5

 
$
8.5

 
$
50.0

 
 
 
 
 
 
 
Gross Proceeds
 
$
685.5

 
$
139.5

 
$
825.0

Less: Issuance costs
 
21.6

 
4.4

 
26.0

Net Proceeds
 
$
663.9

 
$
135.1

 
$
799.0

The net proceeds of the SPCs were recorded as additional paid in capital, net of issuance costs. The net proceeds of the Amortizing Notes were recorded as debt, with deferred financing costs recorded as a reduction of the carrying amount of the debt in our unaudited consolidated balance sheet. Deferred financing costs related to the Amortizing Notes will be amortized through the maturity date using the effective interest rate method.
Unless settled early at the holder’s or the Company's election, each SPC will automatically settle on September 15, 2021 for a number of shares of common stock per SPC based on the 20 day volume-weighted average price (“VWAP”) of our common stock as follows:
VWAP of IFF Common Stock
 
Common Stock Issued
Equal to or greater than $159.54
 
0.3134 shares (minimum settlement rate)
Less than $159.54, but greater than $130.25
 
$50 divided by VWAP
Less than or equal to $130.25
 
0.3839 shares (maximum settlement rate)
At any time prior to the second scheduled trading day immediately preceding September 15, 2021, any holder of an SPC may settle any or all of its SPCs early, and the Company will deliver 0.3134 shares of its common stock for each SPC, subject to adjustment. Additionally, the SPCs may be redeemed in the event of a fundamental change as defined in the SPC.

13



NOTE 7.    DEBT
Debt consists of the following:
(DOLLARS IN THOUSANDS)
Effective Interest Rate
 
September 30, 2018
 
December 31, 2017
Senior notes - 2007(1)(4)
6.40% - 6.82%

 
$

 
$
249,765

Senior notes - 2013(1)
3.30
%
 
299,057

 
298,670

Euro Senior notes - 2016(1)
1.88
%
 
583,049

 
589,848

Senior notes - 2017(1)
4.44
%
 
493,046

 
492,819

2020 Notes(1)
3.73
%
 
297,995

 

2021 Euro Notes(1)
0.78
%
 
348,804

 

2026 Euro Notes(1)
1.93
%
 
930,142

 

2028 Notes(1)
4.57
%
 
395,940

 

2048 Notes(1)
5.12
%
 
785,012

 

Amortizing Notes(1)
5.83
%
 
133,096

 

Credit facility
LIBOR + 1.125%

(2)
105,653

 

Bank overdrafts and other
 
 
5,376

 
7,993

Deferred realized gains on interest rate swaps
 
 
57

 
57

 
 
 
4,377,227

 
1,639,152

Less: Short term borrowings(3)
 
 
(45,985
)
 
(6,966
)
 
 
 
$
4,331,242

 
$
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)
In connection with the acquisition of Frutarom and associated financing, the Company repaid the outstanding $250 million of its Senior Notes - 2007 on September 17, 2018, including accrued and unpaid interest of $7.7 million and the associated make whole payment of $34.9 million. Additionally, the Company incurred a loss of $3.9 million on the termination of a fair value hedge which was recognized in earnings for the three and nine months ended September 30, 2018.
Commercial Paper
Commercial paper issued by the Company generally has terms of 90 days or less. As of September 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. There was no issuances or repayments of commercial paper for the nine months ended September 30, 2018. The maximum amount of commercial paper outstanding for the nine months ended September 30, 2017 was $40 million.
Financing of the Acquisition of Frutarom
Bridge Loan Facility
In connection with entering into the merger agreement with Frutarom in May 2018, 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. 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. As a result of the Company's entering into the debt and equity financing as discussed in Note 3, the bridge loan facility was terminated on September 26, 2018. In connection with the bridge loan commitment, the Company incurred $28.8 million and $39.4 million of fees which are included in Interest expense in the

14



Consolidated Statement of Income and Comprehensive Income in the three and nine months ended September 30, 2018, respectively.
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 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 was funded on October 3, 2018.
The Term Facility bears 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 December 31, 2018, with the balance payable on October 3, 2021. 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.
Amended Credit Facility
On May 21, 2018, June 6, 2018 and July 13, 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 (as amended, the “Amended Credit Facility”) in connection with the 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 September 30, 2018, total availability under the Amended Credit Facility was $1.0 billion, with no outstanding borrowings.
Senior Unsecured Notes
On September 25, 2018 the Company issued €300 million aggregate principal amount of senior unsecured notes that mature on September 25, 2021 (the “2021 Euro Notes”). The 2021 Notes bear interest at a rate of 0.5% per year, payable annually on September 25 of each year, beginning September 25, 2019. Total proceeds from the issuance of the 2021 Notes, net of underwriting discounts and offering costs, were €297.7 million ($349.5 million in USD).
On September 25, 2018, the Company issued €800 million aggregate principal amount of senior unsecured notes that mature on September 25, 2026 (the “2026 Euro Notes”). The 2026 Notes bear interest at a rate of 1.8% per year, payable annually on September 25 of each year, beginning September 25, 2019. Total proceeds from the issuance of the 2026 Notes, net of underwriting discounts and offering costs, were €794.1 million ($932.2 million in USD).
On September 26, 2018, the Company issued $300 million aggregate principal amount of senior unsecured notes that mature on September 25, 2020 (the “2020 Notes”). The 2020 Notes bear interest at a rate of 3.4% per year, payable semi-annually on March 25 and September 25 of each year, beginning March 25, 2019. Total proceeds from the issuance of the 2020 Notes, net of underwriting discounts and offering costs, were $298.9 million.
On September 26, 2018, the Company issued $400 million aggregate principal amount of senior unsecured notes that mature on September 26, 2028 (the “2028 Notes”). The 2028 Notes bear interest at a rate of 4.45% per year, payable semi-

15



annually on March 26 and September 26 of each year, beginning March 26, 2019. Total proceeds from the issuance of the 2028 Notes, net of underwriting discounts and offering costs, were $397.0 million.
On September 26, 2018, the Company issued $800 million aggregate principal amount of senior unsecured notes that mature on September 26, 2048 (the “2048 Notes” and collectively with the 2021 Euro Notes, 2026 Euro Notes, 2020 Notes, 2028 Notes, the "2018 Senior Unsecured Notes"). The 2048 Notes bear interest at a rate of 5.0% per year, payable semi-annually on March 26 and September 26 of each year, beginning March 26, 2019. Total proceeds from the issuance of the 2048 Notes, net of underwriting discounts and offering costs, were $787.2 million.
Tangible Equity Units - Senior Unsecured Amortizing Notes
On September 17, 2018, in connection with the issuance of the TEUs, the Company issued $139.5 million aggregate principal amount of Amortizing Notes. The Amortizing Notes mature on September 15, 2021. Each quarterly cash installment payment of $0.75 (or, in the case of the installment payment due on December 15, 2018, $0.73333) per Amortizing Note will constitute a partial repayment of principal and a payment of interest, computed at an annual rate of 3.79%. Interest will be calculated on the basis of a 360 day year consisting of twelve 30 day months. Payments will be applied first to the interest due and payable and then to the reduction of the unpaid principal amount, allocated as set forth in the amortization schedule in the indenture governing the Amortizing Notes. See Note 6 for further information on the TEUs.
There are no covenants or provisions in the indenture related to the TEUs that would afford the holders of the amortizing notes protection in the event of a highly leveraged transaction, reorganization, restructuring, merger or similar transaction involving the Company that may adversely affect such holders. If a fundamental change occurs, or if the Company elects to settle the SPCs early, then the holders of the Amortizing Notes will have the right to require the Company to repurchase the Amortizing Notes at a repurchase price equal to the principal amount of the Amortizing Notes as of the repurchase date plus accrued and unpaid interest. The indenture also contains customary events of default which would permit the holders of the Amortizing Notes to declare the notes to be immediately due and payable if not cured within applicable grace periods, including the failure to make timely installment payments on the notes or other material indebtedness, failure to give notice of a fundamental change and specified events of bankruptcy and insolvency.
NOTE 8. 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. During the third quarter of 2018, the Company recorded a benefit of $8.0 million to adjust the provisional “toll charge” required from the transition to the new territorial tax system, and a benefit of $0.2 million to adjust the remeasurement of net deferred tax assets as a result of U.S. tax reform.
Uncertain Tax Positions
At September 30, 2018, the Company had $32.2 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 September 30, 2018, the Company had accrued interest and penalties of $2.8 million classified in Other liabilities and $0.1 million in Other current liabilities.
As of September 30, 2018, the Company’s aggregate provisions for uncertain tax positions, including interest and penalties, was $36.3 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

16



indefinitely invested in such subsidiaries. The Company intends to, and has plans to, reinvest these earnings indefinitely in its 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, the Company does 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 its 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 14.
Effective Tax Rate
The effective tax rate for the three months ended September 30, 2018 was 5.0% compared with 22.0% for the three months ended September 30, 2017. The quarter-over-quarter decrease was largely due to the benefit recorded to reduce amounts accrued in connection with U.S. tax reform, lower cost of repatriation of earnings, the release of valuation allowances on certain State credits and a more favorable mix of earnings, and other items (including the impact of current year transaction costs).
The effective tax rate for the nine months ended September 30, 2018 was 15.0% compared with 20.4% for the nine months ended September 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, the release of State valuation allowances and the impact of U.S. tax reform, partially offset by other items (including the impact of certain non-taxable gains on foreign currency in the prior year).
NOTE 9.    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 September 30,
 
Nine Months Ended September 30,
(DOLLARS IN THOUSANDS)
2018
 
2017
 
2018
 
2017
Equity-based awards
$
6,867

 
$
7,256

 
$
22,041

 
$
20,149

Liability-based awards
1,545

 
1,396

 
1,942

 
4,447

Total stock-based compensation expense
8,412

 
8,652

 
23,983

 
24,596

Less: Tax benefit
(1,422
)
 
(2,574
)
 
(4,320
)
 
(7,123
)
Total stock-based compensation expense, after tax
$
6,990

 
$
6,078

 
$
19,663

 
$
17,473

NOTE 10. 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.

17



Reportable segment information is as follows:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(DOLLARS IN THOUSANDS)
2018
 
2017
 
2018
 
2017
Net sales:
 
 
 
 
 
 
 
Flavors
$
436,214

 
$
409,800

 
$
1,335,773

 
$
1,230,286

Fragrances
471,334

 
463,140

 
1,422,719

 
1,313,808

Consolidated
$
907,548

 
$
872,940

 
$
2,758,492

 
$
2,544,094

Segment profit:
 
 
 
 
 
 
 
Flavors
$
96,497

 
$
87,375

 
$
317,666

 
$
278,768

Fragrances
87,488

 
88,959

 
261,545

 
247,824

Global expenses
(19,578
)
 
(17,693
)
 
(63,975
)
 
(47,472
)
Operational Improvement Initiatives (a)
(344
)
 
(407
)
 
(1,773
)
 
(1,473
)
Acquisition Related Costs (b)
1

 
(5,436
)
 
519

 
(20,502
)
Integration Related Costs (c)
(958
)
 
(580
)
 
(1,951
)
 
(2,501
)
Legal Charges/Credits, net (d)

 

 

 
(1,000
)
Tax Assessment (e)

 

 

 
(5,331
)
Restructuring and Other Charges, net (f)
(927
)
 
(3,249
)
 
(1,837
)
 
(14,183
)
Gains on Sale of Assets
1,630

 
31

 
435

 
120

FDA Mandated Product Recall (g)
9,800

 

 
4,800

 
(3,500
)
Frutarom Acquisition Related Costs (h)
(14,341
)
 

 
(26,796
)
 

Operating profit
159,268

 
149,000

 
488,633

 
430,750

Interest expense
(23,914
)
 
(19,221
)
 
(93,755
)
 
(49,584
)
Loss on extinguishment of debt
(38,810
)
 

 
(38,810
)
 

Other income (expense)
4,158

 
11,547

 
25,389

 
40,687

Income before taxes
$
100,702

 
$
141,326

 
$
381,457

 
$
421,853

(a)
For 2018, represents accelerated depreciation related to a plant relocation in India and Taiwan asset write off. 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 and Frutarom. 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)
For 2018, represents severance costs related to the 2017 Productivity Program. For 2017, represents severance costs related to the 2017 Productivity Program which were partially offset by the reversal of 2015 severance charges that were no longer needed.
(g)
For 2018, represents recoveries from the supplier for the third quarter, partially offset by final payments to the customer made for the effected product in the first quarter. For 2017, represents management's best estimate of losses related to the previously disclosed FDA mandated recall.
(h)
Represents transaction-related administrative costs and expenses related to the acquisition of Frutarom.

18



Net sales are attributed to individual regions based upon the destination of product delivery are as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(DOLLARS IN THOUSANDS)
2018
 
2017
 
2018
 
2017
Net sales related to the U.S.
$
238,342

 
$
223,750

 
$
703,272

 
$
654,235

Net sales attributed to all foreign countries
669,206

 
649,190

 
2,055,220

 
1,889,859

No country other than the U.S. had net sales in any period presented greater than 6% of total consolidated net sales.
NOTE 11. EMPLOYEE BENEFITS
Pension and other defined contribution retirement plan expenses included the following components:
(DOLLARS IN THOUSANDS)
U.S. Plans
Three Months Ended September 30,
 
Nine Months Ended September 30,
2018
 
2017
 
2018
 
2017
Service cost for benefits earned(1)
$
596

 
$
698

 
$
1,788

 
$
2,094

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

 
4,561

 
14,370

 
13,682

Expected return on plan assets(2)
(7,740
)
 
(9,246
)
 
(23,219
)
 
(27,738
)
Net amortization and deferrals(2)
1,549

 
1,793

 
4,647

 
5,379

Net periodic benefit income
(805
)
 
(2,194
)
 
(2,414
)
 
(6,583
)
Defined contribution and other retirement plans(1)
2,396

 
1,939

 
8,167

 
6,718

Total expense
$
1,591

 
$
(255
)
 
$
5,753

 
$
135

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

 
$
5,956

 
$
13,410

 
$
17,080

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

 
4,066

 
13,014

 
11,825

Expected return on plan assets(2)
(12,032
)
 
(12,873
)
 
(36,096
)
 
(37,340
)
Net amortization and deferrals(2)
2,972

 
4,185

 
8,916

 
12,096

Net periodic benefit (income) cost
(252
)
 
1,334

 
(756
)
 
3,661

Defined contribution and other retirement plans(1)
1,644

 
1,470

 
4,901

 
4,383

Total expense
$
1,392

 
$
2,804

 
$
4,145

 
$
8,044

_______________________ 
(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 nine months ended September 30, 2018, no contributions were made to the qualified U.S. pension plans, $12.7 million of contributions were made to the non-U.S. pension plans, and $3.3 million of benefit payments were made with respect to the Company's non-qualified U.S. pension plan.

19



Expense recognized for postretirement benefits other than pensions included the following components: 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
(DOLLARS IN THOUSANDS)
2018
 
2017
 
2018
 
2017
Service cost for benefits earned
$
196

 
$
221

 
$
587

 
$
663

Interest cost on projected benefit obligation
654

 
588

 
1,962

 
1,764

Net amortization and deferrals
(1,189
)
 
(1,046
)
 
(3,567
)
 
(3,138
)
Total postretirement benefit income
$
(339
)
 
$
(237
)
 
$
(1,018
)
 
$
(711
)
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 $8.7 million in the three months ended September 30, 2018 and 2017, respectively, and by approximately $20.0 million and $23.6 million in the nine months ended September 30, 2018 and 2017, respectively, compared to what the Other (income) expense, net would have been under the previous method. The retroactive $8.7 million reduction in operating profit for the three months ended September 30, 2017 was reflected as a $1.7 million increase in cost of goods sold, a $2.8 million increase in research and development expenses, and a $4.2 million increase in selling and administrative expenses. The retroactive $23.6 million reduction in operating profit for the nine months ended September 30, 2017 was reflected as a $4.8 million increase in cost of goods sold, a $7.7 million increase in research and development expenses, and a $11.0 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 nine months ended September 30, 2018 $3.1 million of contributions were made.
NOTE 12. 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 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 September 30, 2018.
The principal amounts and the estimated fair values of financial instruments at September 30, 2018 and December 31, 2017 consisted of the following: 

20



 
September 30, 2018
 
December 31, 2017
(DOLLARS IN THOUSANDS)
Principal(4)
 
Fair Value
 
Principal(4)
 
Fair Value
LEVEL 1
 
 
 
 
 
 
 
TEUs
$
825,000

 
$
948,750

 
$

 
$

Cash and cash equivalents(1)
$
5,274,459

 
$
5,274,459

 
$
368,046

 
$
368,046

LEVEL 2
 
 
 
 
 
 
 
Credit facilities and bank overdrafts(2)
111,029

 
111,029

 
7,993

 
7,993

Commercial paper (2)

 

 

 

Long-term debt:(3)
 
 
 
 
 
 
 
Senior notes - 2007

 

 
250,000

 
293,232

Senior notes - 2013
300,000

 
292,870

 
300,000

 
304,219

Euro Senior notes - 2016
586,950

 
603,989

 
594,400

 
627,782

Senior notes - 2017
500,000

 
455,060

 
500,000

 
525,906

2020 Notes
300,000

 
301,634

 

 

2021 Euro Notes
352,170

 
352,691

 

 

2026 Euro Notes
939,120

 
940,360

 

 

2028 Notes
400,000

 
401,405

 

 

2048 Notes
800,000

 
799,208

 

 

_______________________
(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.
(4)
See Note 7 for carrying amounts.
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 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 nine months ended September 30, 2018 and as of September 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

21



of goods sold in the accompanying Consolidated Statement of Income and Comprehensive Income in the same period as the related costs are recognized.
In the second quarter of 2018, the Company entered into a foreign currency contract and two interest rate swap agreements (collectively, the "Deal Contingent Swaps"), which were contingent upon the closing of the Frutarom acquisition, for a total notional amount of $1.9 billion. In the third quarter of 2018, the Company completed the offering and sale of the 2018 Senior Unsecured Notes (see Note 7 for additional information) and settled the Deal Contingent Swaps. The Company received $12.2 million for the foreign currency contract and $0.4 million for the two interest rate swap agreements which is included in Other income, net and Interest Expense, respectively, in the accompanying Consolidated Statement of Income and Comprehensive Income for the nine months ended September 30, 2018.
In prior years, the Company has 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.
The following table shows the notional amount of the Company’s derivative instruments outstanding as of September 30, 2018 and December 31, 2017: 
(DOLLARS IN THOUSANDS)
September 30, 2018
 
December 31, 2017
Foreign currency contracts
$
411,788

 
$
896,947

Interest rate swaps

 
150,000

The following tables show the Company’s derivative instruments measured at fair value (Level 2 of the fair value hierarchy), as reflected in the Consolidated Balance Sheet as of September 30, 2018 and December 31, 2017: 
 
September 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
$
2,644

 
$
7,689

 
$
10,333

Derivative liabilities (b)
 
 
 
 
 
Foreign currency contract
371

 
4,400

 
4,771

 
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 nine months ended September 30, 2018 and 2017 (in thousands): 

22




 
Amount of Gain (Loss)
 
Location of Gain (Loss) Recognized in Income on Derivative
(DOLLARS IN THOUSANDS)
Three Months Ended September 30,
 
2018
 
2017
 
Foreign currency contracts
$
8,277

 
$
4,024

 
Other income, net
Deal contingent swaps
 
 
 
 
 
Foreign currency contract
1,175

 

 
Other income, net
Interest rate swaps
25,289

 

 
Interest expense
 
$
34,741

 
$
4,024

 
 
 
Amount of Gain (Loss)
 
Location of Gain (Loss) Recognized in Income on Derivative
 
Nine Months Ended September 30,
 
(DOLLARS IN THOUSANDS)
2018
 
2017
 
Foreign currency contracts (1)
$
9,347

 
$
(9,157
)
 
Other income, net
Deal contingent swaps
 
 
 
 
 
Foreign currency contract
12,154

 

 
Other income, net
Interest rate swaps
352

 

 
Interest expense
 
$
21,853

 
$
(9,157
)
 
 
 _______________________
(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 nine months ended September 30, 2018 and 2017 (in thousands): 

23



 
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 September 30,
 
 
Three Months Ended September 30,
 
2018
 
2017
 
 
2018
 
2017
Derivatives in Cash Flow Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts
$
2,206

 
$
(4,229
)
 
Cost of goods sold
 
$
(2,848
)
 
$
1,815

Interest rate swaps (1)
216

 
216

 
Interest expense
 
(216
)
 
(216
)
Derivatives in Net Investment Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts


 
(1,130
)
 
N/A
 

 

Euro Senior notes - 2016
(7,104
)
 
(11,861
)
 
N/A
 

 

2021 Euro Notes & 2026 Euro Notes
705

 

 
N/A
 

 

Total
$
(3,977
)
 
$
(17,004
)
 
 
 
$
(3,064
)
 
$
1,599

 
 
 
 
 
 
 
 
 
 
 
Amount of (Loss) Gain
Recognized in OCI on
Derivative (Effective
Portion)
 
Location of (Loss) Gain
Reclassified from AOCI into Income (Effective Portion)
 
Amount of (Loss) Gain
Reclassified from
Accumulated OCI into
Income (Effective
Portion)
 
Nine Months Ended September 30,
 
 
Nine Months Ended September 30,
 
2018
 
2017
 
 
2018
 
2017
Derivatives in Cash Flow Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts
$
11,704

 
$
(13,505
)
 
Cost of goods sold
 
$
(7,371
)
 
$
4,062

Interest rate swaps (1)
648

 
(4,027
)
 
Interest expense
 
(648
)
 
(573
)
 
 
 
 
 
 
 
 
 
 
Derivatives in Net Investment Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts
(518
)
 
(4,258
)
 
N/A
 

 

Euro Senior notes - 2016
5,601

 
(43,050
)
 
N/A
 

 

2021 Euro Notes & 2026 Euro Notes
705

 

 
N/A
 

 

Total
$
18,140

 
$
(64,840
)
 
 
 
$
(8,019
)
 
$
3,489

 _______________________
(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 nine months ended September 30, 2018 and 2017.
The Company expects that approximately $6.9 million (net of tax) of derivative loss included in AOCI at September 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.

24



NOTE 13.    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
(98,048
)
 
4,328

 
185

 
(93,535
)
Amounts reclassified from AOCI

 
8,019

 
7,893

 
15,912

Net current period other comprehensive income (loss)
(98,048
)
 
12,347

 
8,078

 
(77,623
)
Accumulated other comprehensive (loss) income, net of tax, as of September 30, 2018
$
(395,464
)
 
$
2,015

 
$
(321,656
)
 
$
(715,105
)

(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
42,023

 
(14,044
)
 

 
27,979

Amounts reclassified from AOCI
(12,214
)
(a)
(3,489
)
 
11,168

 
(4,535
)
Net current period other comprehensive income (loss)
29,809

 
(17,533
)
 
11,168

 
23,444

Accumulated other comprehensive (loss) income, net of tax, as of September 30, 2017
$
(322,216
)
 
$
(9,929
)
 
$
(324,506
)
 
$
(656,651
)
 _______________________
 (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: 
 
Nine Months Ended September 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
$
(8,424
)
 
$
4,642

 
Cost of goods sold
Interest rate swaps
(648
)
 
(573
)
 
Interest expense
Tax
1,053

 
(580
)
 
Provision for income taxes
Total
$
(8,019
)
 
$
3,489

 
Total, net of income taxes
(Losses) gains on pension and postretirement liability adjustments
 
 
 
 
 
Prior service cost
$
5,315

 
$
5,304

 
(a)
Actuarial losses
(15,309
)
 
(20,097
)
 
(a)
Tax
2,101

 
3,625

 
Provision for income taxes
Total
$
(7,893
)
 
$
(11,168
)
 
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.


25



NOTE 14.    COMMITMENTS AND CONTINGENCIES
Guarantees and Letters of Credit
The Company has various bank guarantees and letters of credit which are available for use to support its ongoing business operations and to satisfy governmental requirements associated with pending litigation in various jurisdictions.
At September 30, 2018, the Company had total bank guarantees and standby letters of credit of approximately $49.6 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 September 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 $10.5 million as of September 30, 2018.
Lines of Credit
The Company has various lines of credit which are available to support its ongoing business operations. As of September 30, 2018, the Company had available lines of credit of approximately $102.8 million with various financial institutions, in addition to the $1.0 billion of capacity under the Amended Credit Facility discussed in Note 7 of the Consolidated Financial Statements. There were no material amounts drawn down pursuant to these lines of credit as of September 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 the Company is 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

26



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.
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 $67 million as of September 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 $21 million as of September 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 $162 million as of September 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 $24.0 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. During 2018, the Company received an unfavorable ruling with respect to a claim related to potentially unpaid excise taxes from 1993. Based on the revised ruling, the Company has determined that it is now probable that it will have to pay the original claim in addition to penalties and interest. The total amount of the claim that has been recorded is $4.8 million.
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,

27



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.
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 September 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.
In the third quarter of 2018, the Company received $9.8 million in full and final settlement of its claim from the supplier for the affected product, which has been recorded as a reduction of cost of sales on the Consolidated Statement of Income and Comprehensive Income. 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

28



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 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.
Frutarom acquisition
On October 4, 2018, we completed our acquisition of Frutarom Industries Ltd. (“Frutarom”). We acquired 100% of the equity of Frutarom pursuant to a definitive agreement and plan of merger entered into on May 7, 2018. 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, primarily focused on natural products. The acquisition was made in order to strengthen our customer base, capabilities and geographic reach, and is expected to result in exposure to more end markets, including those with a focus on naturals and health and wellness.
A portion of the cash consideration paid to Frutarom shareholders was funded with (i) borrowings under our term loan credit agreement, (ii) amounts received from our offering of common stock that closed in September 2018, (iii) amounts received from our offering of 16,500,000 6.00% TEUs that closed in September 2018, (iv) amounts received from our offering of €1.1 billion aggregate principal amount of senior unsecured euro-denominated notes that closed in September 2018, and (e) amounts received from our offering of $1.5 billion aggregate principal amount of senior unsecured U.S. dollar-denominated notes that closed in September 2018.
The transaction was valued, based on our stock price as of October 4, 2018, at approximately $7.1 billion, including the assumption of approximately $797 million of Frutarom's net debt, which we repaid concurrent with the closing of the transaction. We issued approximately 14.9 million shares of our common stock in the transaction, which resulted in former Frutarom shareholders holding approximately 14.0% of our outstanding common stock at closing.
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 11 to the Consolidated Financial Statements, the net effect of the change was to decrease operating profit and increase Other income.
Net sales during the third quarter of 2018 increased 4% on a reported and 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 did not have a material impact on net sales for the third 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 increased to 44.1% in the third quarter of 2018 from 43.6% in the 2017 period, driven primarily by insurance recoveries related to an FDA mandated product recall and cost savings and productivity initiatives, which were only partially offset by unfavorable price versus input costs (including the net impact of the BASF supply disruption). Included in the third quarter of 2018 was $9.8 million in income from insurance recoveries from the previously disclosed FDA mandated

29



product recall compared to $5.7 million of expense related to acquisition-related amortization of inventory "step-up" costs, operational improvement initiative costs and integration-related costs included in the third quarter of 2017. Excluding these items, gross margin decreased 111 bps compared to the prior year period. We believe that, for the next several quarters, 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.
FINANCIAL PERFORMANCE OVERVIEW
Sales
Reported sales in the third quarter of 2018 increased approximately 4% 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 6% on a reported basis and 7% on a currency neutral basis. Fragrances achieved reported and currency neutral sales growth of 2%. Additionally, Fragrance Ingredients sales were up 6% on a reported basis and 5% on a currency neutral basis. Overall, our third quarter 2018 results continued to be driven by our strong emerging market presence that represented 47% of total sales and experienced 3% growth on a reported basis for the third quarter of 2018 and was flat on a currency neutral basis. From a geographic perspective, for the third quarter of 2018, North America ("NOAM"), Europe, Africa and the Middle East ("EAME"), Latin America ("LA") and Greater Asia ("GA") all delivered currency neutral sales growth.
Operating profit
Operating profit increased $10.3 million to $159.3 million (17.5% of sales) in the 2018 third quarter compared to $149.0 million (17.1% of sales) in the comparable 2017 period. The third quarter of 2018 included $5.1 million of charges related to operational improvement initiatives, integration related costs, restructuring and other charges, net, and Frutarom acquisition related costs which were partially offset by gains on sale of assets, acquisition related costs and insurance recoveries from an FDA mandated product recall as compared to $9.6 million of charges related to operational improvement initiatives, acquisition related costs, integration related costs, and restructuring and other charges, net which were partially offset by gains on sale of assets in the 2017 period. Excluding these charges, adjusted operating profit was $164.4 million for the third quarter of 2018, an increase from $158.6 million for the third quarter of 2017, principally driven by volume growth, the impact of foreign exchange, and cost and productivity initiatives which was partially offset by price to input costs (including the impact of the BASF supply chain disruption). Foreign currency did not have a material impact on operating profit in the 2018 period compared to a 4% favorable impact on operating profit in the 2017 period. Operating profit as a percentage of sales, excluding the above charges, decreased slightly from 18.1% for the third quarter of 2018 compared to 18.2% for the third quarter of 2017, principally driven by lower margins as a result of price to input costs (including the net impact of the BASF supply chain disruption) and increases in Selling and administrative expenses, offset by cost and productivity initiatives and volume growth.
Interest Expense
Interest expense increased to $23.9 million in the third quarter of 2018 compared to $19.2 million in the 2017 period driven by $28.8 million of fees incurred in connection with the bridge loan commitment, partially offset by the net mark-to-market gains on deal-contingent interest rate derivatives of $25.3 million, all of which was in connection with the acquisition of Frutarom.
Loss on extinguishment of debt
Loss on extinguishment of debt was $38.8 million in the third quarter of 2018. The loss on extinguishment of debt is driven by $34.9 million make whole payment on the Senior Notes - 2007 and $3.9 million realized loss on the termination of a fair value hedge.
Net income
Net income decreased by $14.5 million quarter-over-quarter to $95.7 million for the third quarter of 2018 from $110.3 million in the 2017 period, reflecting an increase in operating profit, and a reduction in the effective tax rate from 22.0% to 5.0% for the third quarter 2018, partially offset by increases in interest expense and loss on extinguishment of debt related to the Frutarom acquisition.

30



Cash flows
Cash flows provided by operations for the nine months ended September 30, 2018 was $202.0 million or 7.3% of sales, compared to cash flows provided by operations of $199.5 million or 7.8% of sales for the nine months ended September 30, 2017. The slight increase in cash flows from operations in 2018 was principally driven lower litigation settlement payments and lower pension contributions in the current year, offset by higher working capital related to inventories and Frutarom transaction costs.
Results of Operations
 
Three Months Ended
 
 
 
Nine Months Ended
 
 
 
September 30,
 
 
 
September 30,
 
 
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
2018
 
2017