November 29, 2007
Mr. Rufis Decker
Accounting Branch Chief
Division of Corporate Finance
United States Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549
Re: International Flavors & Fragrances Inc.
File Reference 001-4858
Form 10-K for the year ended December 31, 2006
Form 10-Q for the period ended June 30, 2007
Proxy Statement on Schedule 14A
Dear Mr. Decker:
The Company is furnishing the following supplementary information and comments
with reference to the matters and questions raised in your letter dated October
31, 2007. The items below correspond to the numbered matters raised in your
letter; in each case, the question or comment raised by the Commission has been
repeated and the Company's response immediately follows.
General
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1. Where a comment below requests additional disclosures or other revisions to
be made, please show us in your supplemental response what the revisions
will look like. These revisions should be included in your future filings,
including your interim filings.
Company Response:
---------------
Additional disclosures or other revisions to our future filings are
included, as applicable, in the Company's response; in each instance, such
additional disclosures are identified as such.
Legal Proceedings, page 10
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2. We note your statement that "the Company believes that 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 be material to the Company's financial
condition, results of operations or liquidity." Please supplementally tell
us whether your pending environmental proceedings involve the matters
addressed in Instruction 5 to Item 103 of Regulation S-K. Please also
provide us with the number of pending claims, your potential liability and
the amount of your insurance coverage.
Company Response:
----------------
IFF is currently involved with nine environmental claims. None of the
claims involve administrative or judicial proceedings addressed in
Instruction 5 to Item 103 of Regulation S-K. Current aggregate liability
for these claims is estimated to be less than $5 million prior to
consideration of any potential insurance recovery. IFF is party to a
confidential agreement with insurers concerning coverage of such claims and
the amount of such coverage exceeds current liability estimates.
Management's Discussion and Analysis of Financial Condition and Results of
Operations and Sales Commentary, page 20
3. Please revise to more fully explain the differences between each of your
principal product categories (e.g., ingredients, flavor compounds, fine
fragrance and toiletries, and functional fragrances).
Company Response
----------------
The Company's Form 10-K for the year ended December 31, 2007 will include
expanded disclosures in the Executive Overview, as presented in the
following paragraph.
Effective January 1, 2007, IFF reorganized into two units that reflect its
flavor and fragrance businesses. Approximately 43% of IFF's 2007 net sales
were flavor compounds. Flavor compounds are sold to the food and beverage
industries for use in consumer products such as prepared foods, beverages,
dairy, food and confectionery products. The remaining 57% of sales,
representing the fragrance business unit, were in three fragrance
categories: functional fragrances, including fragrance compounds for
personal care (e.g., soaps) and household products (e.g., detergents and
cleaning agents); fine fragrance and beauty care, including perfumes,
colognes and toiletries; and ingredients, consisting of synthetic
ingredients that can be combined with other materials to create unique
functional and fine fragrance compounds. Major fragrance customers include
the cosmetics industry, including perfume and toiletries manufacturers, and
the household products industry, including manufacturers of soaps,
detergents, household cleaners and air fresheners. Approximately 55% of the
Company's ingredient production is consumed internally; the balance is sold
to third party customers.
Operating Results, page 23
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4. Please revise to provide a more comprehensive analysis of segment
operating results for each segment, including operating profit or
segment profit. In doing so, please also discuss the business reasons
for changes between periods in the Global Expenses column of your
segment footnote. Please also revise to include an analysis of changes
in consolidated operating expenses such as cost of goods sold,
selling, general and administrative expenses, and research and
development expenses.
Company Response:
----------------
Please note that the Company changed its segment reporting beginning
January 1, 2007 into two business units - Flavors and Fragrances. The
Company will include an analysis of operating results for each segment, as
well as a discussion of any material changes between periods in the Global
Expenses caption, as appropriate.
Accordingly, in the Company's Form 10-K for the year ended December 31,
2007, discussion of operating results, including segment disclosure, will
be consistent with the format presented in Appendix I (September 30, 2007
information is included for illustrative purposes); prior year disclosures
will conform to the new format.
5. As noted in a previous comment letter we sent to you on October 28,
2004, the sum of the segment profit (loss) of all of your segments is
not the same as operating profit (loss) determined under US GAAP due
to your exclusion of certain unallocated expenses, amortization of
goodwill and the effect of restructuring and other charges. The
combined amount represents a non-GAAP measure when it is presented or
discussed outside of your SFAS 131 footnote. You should either:
(a) Remove the non-GAAP measure and your discussions of it, or
(b) Present the disclosures required by Item 10(e) of Regulation S-K,
including:
o Identifying this amount as a non-GAAP performance measure;
o Explaining why your management believes that this measure
provides useful information to investors;
o Stating how your management uses the non-GAAP measure;
o Providing cautionary disclosure that the non-GAAP measure
presented may not be comparable to similarly titled measures
used by other entities; and
o Stating that this non-GAAP measure should not be considered
as an alternative to operating income (loss) or net income
(loss), which are determined in accordance with GAAP.
See also Question 21 of our FAQ Regarding the Use of Non-GAAP Financial
Measures dated June 13, 2003.
Company Response:
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Beginning with the Company's Form 10-K for the year ended December 31,
2007, the Company will exclude the measure and related discussion of
segment profit.
Quantitative and Qualitative Disclosures About Market Risk, page 34
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6. Please supplementally provide us with the potential loss in fair value,
earnings, or cash flows of a 10% change in the value of the foreign
exchange rates denominating your exchange hedging instruments as well as
the loss attributable to a similar hypothetical change in interest rates.
Please also provide us supplementally with a brief analysis discussing your
conclusion that these changes would not result in a material potential
change in fair value, earnings, or cash flows.
Company Response:
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The Company's Form 10-K for the year ended December 31, 2007 will include a
discussion regarding market risk, as presented in the following paragraphs.
At December 31, 2006, the Company had Japanese Yen 15.15 billion aggregate
notional value interest rate swaps that mature in 2008 and 2011, a $50
million notional value cross-currency interest rate swap (JPY/USD) that
matures in 2013 and a $300 million notional value cross-currency interest
rate swap (Euro/USD) that matures in 2008. At December 31, 2006, these
swaps were all effective as hedges under SFAS 133.
The Company has established a centralized reporting system to evaluate the
effects of changes in interest rates, currency exchange rates and other
relevant market risks. The Company regularly determines the potential loss
from market risk by evaluating a value-at-risk computation. Value-at-risk
analysis is a statistical model that utilizes historic currency exchange
and interest rate data to measure the potential impact on future earnings
of the Company's existing portfolio of derivative financial instruments.
The value-at-risk analysis that the Company evaluated on December 31, 2006
for the portfolio of derivative financial instruments indicated that the
risk of loss resulting from a 10% change in the applicable currency
exchange rate or the interest rate, as applicable was immaterial.
The foreign currency and interest rate swap contracts existing during the
years ended December 31, 2006 and 2005 were entered into for the purpose of
seeking to mitigate the risk of certain specific adverse currency and
interest rate risks. As a result of these financial instruments, the
Company reduced financial risk in exchange for foregoing any gain (reward)
that might have occurred if the markets moved favorably. In using these
contracts, management exchanged the risks of the financial markets for
counterparty risk.
Counterparty risk arises from the inability of a counterparty to meet its
obligations. To mitigate counterparty risk, the Company entered into
derivative contracts with major leading financial institutions that have
credit ratings equal to or better than the Company's credit rating.
Consolidated Financial Statements
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Note 1 -Nature of Operations and Summary of Significant Accounting Policies
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General
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7. Please revise your filing to explain the nature of other receivables, how
they arise, and how you evaluate the collectibility of such amounts.
Company Response:
----------------
The Company's Form 10-K for the year ended December 31, 2007 will include
disclosures regarding other receivables in the discussion of significant
accounting policies, as presented in the following paragraph.
Other receivables consist primarily of Value Added Tax (VAT) receivable in
the various countries in which the Company operates, and insurance
recoveries receivable. VAT receivables are recorded when goods are received
and are normally recoverable within 30 days. Insurance recoveries
receivable are recorded, on an undiscounted basis, when it is probable that
a recovery will be realized; such recoveries are accounted for as a
component of the income statement caption in which the original expense was
recognized.
8. Please revise to disclose the amount of advertising expenses incurred
during each period presented and the line item of the income statement in
which these expenses are recorded. Refer to paragraph 49(c) of SOP 93-7.
Company Response:
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The Company incurred advertising expense of approximately $500 thousand and
$400 thousand for the full year 2006 and the first nine months of 2007,
respectively, representing less than .2% of operating income for these time
periods. The Company considers such expenditures to be immaterial to the
consolidated financial statements and does not believe disclosure is
required
The Company will continue to monitor its advertising expenditures and will
provide additional disclosure under applicable accounting standards, if
appropriate.
Principles of Consolidation, page 46
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9. Please tell us the amount of minority interest included other liabilities
and applicable income (expense) attributable to minority interest that is
included in other (income) expense, net for each period presented. Please
also revise your filing to present minority interest on your balance sheets
and income statements as separate line items. Refer to Rules 5-02(27) and 5
03(12) of Regulation S-X.
Company Response:
----------------
Minority interest balances of $11.3 million and $10.9 million were included
as a component of Other liabilities in the Company's consolidated balance
sheet at September 30, 2007 and December 31, 2006, respectively; balances
represent 0.7 % and 1.0% of other liabilities at those dates, respectively.
Minority interest expense of $1.6 million for the year ended December 31,
2006 and $1.4 million for the nine months ended September 30, 2007 is
included in other (income) expense; minority interest expense represents
0.5% of consolidated pretax income for the respective periods. The Company
believes the minority interest to be immaterial to the financial statements
and therefore does not merit separate disclosure.
Note 2 - Restructuring and Other Charges, page 49
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10. Please revise to disclose, for each reportable segment, the total amount of
costs expected to be incurred in connection with your exit/disposal
activities, and the total cumulative amount incurred to date. Refer to
paragraph 20(d) of SFAS 146.
Company Response:
----------------
In accordance with SFAS 146 paragraph 20 (d), the Company disclosed in Note
13 - Segment Information, page 59 the total amount of costs incurred to
date for each reportable segment. The amount of the liability recognized at
inception of the restructuring was equal to the total costs expected to be
incurred. All such costs qualified for accrual under SFAS 146 at inception
of the related plan; the Company does not expect to incur any additional
charges relating to these plans. Disclosure to this effect will be made in
future filings beginning with the Company's Annual Report on Form 10K for
the year December 31, 2007.
All such charges were reported by geographic segment in the Company's 2006
Annual Report. As previously noted, the Company reorganized into two
business units - Flavors and Fragrances - effective January 1, 2007.
Restructuring and other charges previously reported on a geographic basis
will henceforth be reported on a business unit basis; prior year
disclosures will conform to the new format.
Note 7 - Other Current Liabilities, page 51
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11. We note that you have an accrual for rebates and incentives. Please
disclose, if true, that all rebates and incentives are treated as a
reduction of revenues when recorded. Please also revise your accounting
policy footnote to clarify when you record rebates and incentives in your
financial statements.
Company Response:
----------------
The Company's Form 10-K for the year ended December 31, 2007 will include
expanded disclosures regarding revenue recognition in significant
accounting policies, as presented in the following paragraph:
Revenue Recognition Revenue is recognized when the earnings process is
complete, generally when (i) products are shipped to the customer in
accordance with the terms of sale, (ii) title and risk of loss have been
transferred and (iii) collectibility is reasonably assured. Net sales are
reduced, at the time revenue is recognized, by accrual for applicable
discounts, rebates and sales allowances based on historical experience.
Related accruals are included in accrued liabilities.
Note 13 - Segment Information, page 59
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12. It appears from your disclosures on pages 24 and 49 that you are excluding
gains on the sale of assets from operating income. Please revise your
filing to present the gains as operating expenses or explain why your
current treatment is appropriate. Refer to paragraph 45 of SFAS 144.
Company Response:
----------------
In the future, beginning with the Company's Form 10-K for the year ended
December 31, 2007, operating profit for the individual business units and
on a consolidated basis will include gains and losses on the sale of
assets. Prior year disclosures will conform to the new format.
Note 15 - Financial Instruments, page 66
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13. Please revise your filing to include the disclosures required by paragraph
45 of SFAS 133 for both your fair value and cash flow hedges for each
period presented.
Company Response:
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The Company's Form 10-K for the year ended December 31, 2007 will include
expanded disclosures regarding both the cash flow and fair value hedges as
required by paragraph 45 of SFAS 133 as presented below:
The Company employs various interest rate swaps and debt issuances with the
objective of managing and optimizing its interest rate exposure. In
February 2003, the Company executed a 10-year Yen - U.S. dollar currency
swap related to the monthly sale and purchase of products between the U.S.
and Japan. The annual notional value of this swap is approximately $5
million. As of December 31, 2006, the cash flow hedge experienced no
ineffectiveness and therefore no net gain or loss is recognized in earnings
during the reporting period. In addition, no component of the derivative
instruments' gain or loss is excluded from the assessment of hedge
effectiveness. Interest income on the periodic settlement and the foreign
exchange gain/loss on the closed out portion of the hedge is recorded in
current income. Any gain or loss on the hedge is offset by a corresponding
change in the receivable/revenue exchange rate. The gain or loss in the
change in fair value of the remaining hedge balance outstanding is marked
to market in AOCI as a hedge of forecasted future cash flow and released
month by month through earnings over the ten-year period of the hedge.
In 2002, the Company entered into certain interest rate swap agreements
effectively converting the fixed rate on its long-term Japanese Yen
borrowings to a variable short-term rate based on the Japanese Yen LIBOR
rate plus an interest markup. These swaps are designated as qualified fair
value hedges. During 2003 and 2005, the Company amended the swaps and the
counterparty paid the Company $3 million and $1 million, respectively,
including accrued interest. Such gains have been deferred, classified as a
separate component of debt and are amortized over the remaining term of the
debt. As of December 31, 2006, the fair value hedge experienced no
ineffectiveness; therefore no net gain or loss is recognized in earnings
during the reporting period. In addition, no component of the derivative
instruments' gain or loss is excluded from the assessment of hedge
effectiveness. Interest income on the periodic settlement and reset of the
floating interest rate is recorded in current income and the gain or loss
in the change in fair value of the underlying debt attributable to the
hedge risk adjusts the carrying amount of the hedged debt and is reflected
as a component of income.
14. Please revise you filing to more clearly quantify and describe your various
types of SFAS 133 hedging relationships. For each category of hedged items
(e.g. fixed rate Japanese Yen borrowings), please present the following
information in a tabular format to increase transparency and augment your
disclosures:
o Quantify the notional amount outstanding;
o Describe the specific hedged risk you identify in your hedge
documentation; and
o Disclose the methods used to assess hedge effectiveness and calculate
hedge ineffectiveness.
Company Response:
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The Company's Form 10-K for the year ended December 31, 2007 will quantify
and describe the various types of SFAS 133 hedging relationships, including
a table as presented in Appendix II that:
o Quantifies the notional amount outstanding;
o Describes the specific hedged risk identified in our hedge
documentation; and
o Discloses the methods used to assess hedge effectiveness and calculate
hedge ineffectiveness
Note 17 - Commitments and Contingencies, page 67
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15. We note your disclosures on page 12 regarding claims against you as a
potentially responsible party for alleged pollution at a number of waste
sites. Please revise your financial statement footnotes to provide the
disclosures required by SAB Topic 5:Y. These disclosures should include the
following:
o The extent to which unasserted claims are reflected in your accrual or may
affect the magnitude of the contingency;
o Uncertainties with respect to joint and several liability that may affect
the magnitude of the contingency, including disclosure of the aggregate
expected cost to remediate particular sites that are individually material
if the likelihood of contribution by the other significant parties has not
been established;
o Disclosure of the nature and terms of cost-sharing arrangements with other
potentially responsible parties;
o The time frame over which the accrued or presently unrecognized amounts may
be paid out;
o Material components of the accruals and significant assumptions underlying
estimates; and
o Disaggregated disclosure that describes accrued and reasonably likely
losses with respect to particular environmental sites that are individually
material. Also, if management's investigation of potential liability and
remediation cost is at different stages with respect to individual sites,
the consequences of this with respect to amounts accrued and disclosed.
Refer to Questions 2 and 3 of SAB Topic 5:Y.
Company Response:
----------------
The Company has been identified as a Potentially Responsible Party ("PRP")
at nine facilities operated by third parties where investigation and/or
remediation activities are ongoing. The Company analyzes its liability at
active waste sites on a regular basis and accrues for environmental
liabilities when they are probable and estimable. Currently, the Company
estimates its share of the total future costs for these sites to be less
than $5 million, on an undiscounted basis, prior to consideration of any
potential insurance recovery. The Company believes the related accrual for
the probable liability is not material and does not warrant separate
disclosure.
Notwithstanding, the Company will include a discussion of the environmental
liabilities in the Commitments and Contingencies the footnote to financial
statements beginning with the Company's Form 10-K for the year ended
December 31, 2007 as presented in the following paragraphs.
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 nine facilities operated by
third parties at which investigation and/or remediation activities may be
ongoing. The Company analyzes its liability on a regular basis. The Company
accrues for environmental liabilities when they are probable and estimable.
At December 31, 2006, the Company estimated its share of the total future
costs 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 that 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 be material to the Company's financial
condition, results of operations or liquidity. This conclusion is based
upon, among other things, the involvement of other PRP's at most sites, the
status of the proceedings, including various settlement agreements and
consent decrees, the extended time period over which payment will likely be
made and an agreement reached in July 1994 with three of the Company's
liability insurers pursuant to which defense costs and indemnity amounts
payable by the Company in respect of the sites will be shared by the
insurers up to an agreed amount.
In addition, the Company will continue to evaluate its estimated liability
with respect to environmental liabilities and if any change or development
requires any additional disclosure under applicable SEC standards, such
disclosure will be made.
FORM 10-Q FOR THE PERIOD ENDED JUNE 30, 2007 Exhibits to Form 10-Q
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16. Please revise future filings so that exhibits are filed as separate exhibit
documents on EDGAR instead of being included as part of the main body of
the Form 10-Q.
Company Response:
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In the future, the Company will file exhibits as separate documents on
EDGAR and not part of the main body of the Form 10-Q.
PROXY STATEMENT ON SCHEDULE 14A, FILED MARCH 23, 2007 Executive Compensation
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Discussion & Analysis, page 36
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17. We note that your performance criteria for the Annual Incentive Plan are
sales growth and operating profit as a percent of sales, while your
strategic goals relate to targeted increases in your established local
currency sales, operating margins, and earnings per share as specific
targets for each criterion. Please supplementally tell us how you
calculated whether target performance satisfied these criteria, as well as
whether earnings per share was viewed as influencing sales growth or
operating margin.
Company Response:
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Our strategic goals relate to local currency sales growth, operating margin
improvement and earnings per share. The use of local currency sales growth
allows the measurement of achievement exclusive of currency fluctuations -
thereby ensuring that we are rewarding real incremental achievement. The
use of operating margins and earnings per share is the means by which we
ensure that sales growth is accretive in terms of business operations. Use
of these three measures for our strategic goals ensures there is a strong
connection between shareholder interests, business performance, and
rewards. It should be noted that earnings per share is not viewed as
influencing sales growth or operating margin; rather, it is an outcome of
the two. In the course of constructing our strategic plan, mid- to
long-term targets for each were developed. Performance criteria for the
Annual Incentive Plan were established on the basis of taking the long term
strategic plan and developing the annual milestones for each criterion
necessary for achievement of the strategic plan. Achievement of targets
annually will result in achievement of our strategic goals.
18. Please supplementally tell us your basis for allocating long-term
compensation between your Long-Term Incentive Plan and Equity Choice
Program, as well as the respective compensation policies each program is
designed to award. Refer to Item 402(b)(2)(iii), (v) of Regulation S-K.
Company Response:
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The Long Term Incentive Program (LTIP) and the Equity Choice Program (ECP)
are designed to reward achievement of particular strategic objectives over
the mid- to long-term, as well as aligning executives' interests with those
of our shareholders. In particular, because of the substantial equity
component, awards under the two programs promote Company stock ownership by
executives and help to align each individual executive's interests with
those of the shareholders. Each program promotes executive retention while
at the same time involves substantial variable "at risk" compensation. In
addition, because LTIP payouts are based on achievement against 3-year
performance goals, the LTIP program enables the Compensation Committee of
the Board of Directors ("the Committee") to align this element of incentive
compensation with the Company's success in meeting long-term financial
goals against our strategic plan.
The basis for assigning long-term compensation, consisting of LTIP and ECP,
is a market analysis; the allocation between LTIP and ECP is affected by
both responsibility level and base salary. The Company uses a global
grading structure for its executives, with direct compensation ranges for
each executive grade. Executives are placed in a particular grade based on
internal factors (including scope of responsibilities and job complexity)
and an external market evaluation based on published survey data and review
of like positions within the peer groups identified in our CD&A. The LTIP
target award is specified as a percentage of base pay consistent across
salary grade level, whereas the ECP is determined to be a dollar value
awarded by grade.
As discussed in our CD&A, the Committee used benchmarking against the
indicated peer groups to help determine the appropriate pay mix among (i)
base salary, (ii) annual incentive compensation, and (iii) long-term
incentive compensation consisting of our LTIP and our ECP. The Committee,
taking into consideration the review and advice provided by its independent
compensation consultant, W.T. Haigh & Co., structured individual LTIP and
ECP grants so as to ensure that the overall compensation, including the mix
of LTIP and ECP, was appropriate. As a result of each executive's grade
level and base salary within a grade level, total long-term compensation
targets between LTIP/ECP fell within a range of approximately 40/60 to
60/40. The target percentages for LTIP and the flat dollar value for ECP
are reviewed annually by the Committee's independent compensation
consultant to ensure continued alignment with market practice.
**********************
If you require additional clarification on any of the foregoing responses
or have any additional comments, please contact me at 212-708-7145.
In connection with responding to your comments, the Company acknowledges
that:
o the Company is responsible for the adequacy and accuracy of the
disclosure in its filings;
o staff comments or changes to disclosure in response to staff comments
do not foreclose the Commission from taking any action with respect to
the filing; and
o the Company may not assert staff comments as a defense in any
proceeding initiated by the Commission or any person under the federal
securities laws of the United States.
Yours very truly,
Douglas J. Wetmore
Senior Vice President and
Chief Financial Officer
Appendix I
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Item 2. Management's Discussion and Analysis of Results of Operations and
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Financial Condition Nine months ended September 30, 2007 in Comparison to nine
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months ended September 30, 2006
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Operating Results
The Company evaluates the performance and allocates resources to its
business segments based on segment profit which is Income before taxes on
income, excluding interest expense, other income (expense),net,
gains/losses on the disposition of assets, pension curtailment charges and
the effects of Restructuring and other charges and Accounting changes.
Segment profit is equal to Operating profit in periods where restructuring
and other charges were not incurred. See Note 11 to our Financial
Statements for the reconciliation to Income before taxes on income. Flavors
Flavors operating profit of $146 million or 19.3%, as a percentage of
sales, increased as compared to $122 million or 18.1% for the first nine
months of 2006. The amount reported in 2006 was affected by the $3 million
insurance recovery related to the product contamination matter; excluding
the insurance recovery from the prior year comparative, Flavors
profitability would have increased 170 basis points over the 2006 period.
This profitability improvement was primarily the result of increased sales
volume leading to better absorption of manufacturing expenses, and
favorable product mix. Good cost control also contributed to the increased
profitability.
Fragrances
Fragrance operating profit of $173 million increased from the $165 million
reported in the first nine months of 2006. However, operating profit, as a
percentage of sales, declined to 17.8% in the 2007 period as compared to
18.1% for the first nine months of 2006. Profitability was impacted by
lower fragrance ingredient selling prices, some impact of higher raw
material costs and lower functional fragrance volumes, partially offset by
favorable product mix.
Global Expenses
The Global expense caption represents corporate and headquarters-related
expenses which include legal, finance, human resources and other
administrative expenses that are not allocated to individual business unit,
as well as gain on sale of businesses and other assets and pension
curtailment charges. For the nine-month period ended September 30, 2007,
Global expenses increased $11 million from the prior year period, primarily
due to gains on asset dispositions of approximately $11 million in 2006. In
the 2007 nine-month period, Global expenses contained gains on asset
dispositions of $5 million offset by a curtailment charge of $6 million.
Consolidated Operating Results The percentage relationship of cost of goods
sold and other operating expenses to sales for the nine-month period ended
September 30, 2007 and 2006 are detailed below.
Cost of Goods Sold, as a percentage of sales, was 58.1% compared with 57.5%
in the prior year quarter; the increase as a percentage of sales was mainly
due to a combination of price erosion on fragrance ingredient sales and
some impact of higher raw material costs, which was partially offset by
favorable product mix.
Research and Development ("R&D") spending, as a percentage of sales,
essentially remained at the prior year level, which reflects the Company's
strategy of investing approximately 9% of sales in R&D efforts.
Selling and Administrative ("S&A") expenses, as a percentage of sales, were
16.2% in the current quarter compared to 16.3% in 2006, reflecting good
cost control. The 2006 results included the benefit of a $3 million
insurance recovery related to the 2005 product contamination matter.
Interest expense increased by $2 million from the prior year, primarily due
to higher average interest rates on borrowings; the average interest rate
for the third quarter was 4.4% compared to 3.2% for the 2006 quarter.
The Company's third quarter effective tax rate was 27.0% compared to 29.8%
in the prior year quarter. The lower effective tax rate for the three
months ended September 30, 2007 was the result of a greater percentage of
consolidated pre-tax earnings in lower tax jurisdictions.
Appendix II
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Notional Amount 300,000,000 15,150,000,000 50,000,000
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Currency USD JPY USD
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Description Cross Currency Interest Rate Interest Rate Swap 10 year Cross Currency Swap
Swap (USD/EUR) (JPY/USD) (JPY/USD)
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Hedged risk Foreign Exchange Risk The risk of changes in fair The variablility of cash flows
value attributable to interest attributable to foreign exchange
rate risk. risk.
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Effectiveness Method Quarterly hedge effectiveness is Because the critical terms of the In accordance with DIG G9,
tested using spot-to-spot methodology. Interest Rate Swap and the hedged because the critical terms of
The Company uses a hyphothetical debt match (i.e., the currency, the Cross Currency Swap and the
derivative on an after-tax basis, and notional amount, timing and date forecasted transaction match
ensures that the hedged amount is less of interest payments), changes in (i.e., the currency, notional
then the designated Euro net investment. fair value attributable to the amount and timing), changes in
The Company ensures that the terms of risk being hedged are expected to cash flow attributable to the
the hedging instrument have not changed be completely offset by the hedging risk being hedged are expected
and performs a review of counterparty derivative. Quarterly hedge to be completely offset by the
creditworthiness. effectiveness testing includes hedging derivative. Quarterly
ensuring the terms of the hedging hedge effectiveness testing
instrument and the debt have not includes reviewing counter-
changed and reviewing counterparty party creditworthiness, ensuring
creditworthiness. the probability of hedged fore-
casted transactions has not
changed and ensuring the terms
of the hedging instrument have
not changed.
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