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EX-32 - EXHIBIT 32 - INTERNATIONAL FLAVORS & FRAGRANCES INCiff33118exhibit32.htm
EX-31.2 - EXHIBIT 31.2 - INTERNATIONAL FLAVORS & FRAGRANCES INCiff33118exhibit312.htm
EX-31.1 - EXHIBIT 31.1 - INTERNATIONAL FLAVORS & FRAGRANCES INCiff33118exhibit311.htm
EX-12 - EXHIBIT 12 - INTERNATIONAL FLAVORS & FRAGRANCES INCiff33118exhibit12.htm


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 March 31, 2018
OR
¨

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                         
Commission file number 1-4858
 INTERNATIONAL FLAVORS &
FRAGRANCES INC.
(Exact name of registrant as specified in its charter)
 
 
 
New York
 
13-1432060
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
521 West 57th Street, New York, N.Y. 10019-2960
(Address of principal executive offices) (Zip Code)
Registrant’s telephone number, including area code (212) 765-5500
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  þ    No    ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  þ    No    ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
þ
Accelerated filer
¨
Non-accelerated filer
¨
Smaller reporting company
¨
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).     Yes    ¨ No  þ
Number of shares outstanding as of April 24, 2018: 78,943,811






PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS.
INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED BALANCE SHEET
(Unaudited)
(DOLLARS IN THOUSANDS)
March 31, 2018
 
December 31, 2017
ASSETS
 
 
 
Current Assets:
 
 
 
Cash and cash equivalents
$
305,276

 
$
368,046

Trade receivables (net of allowances of $13,484 and $13,392, respectively)
734,378

 
663,663

Inventories: Raw materials
346,948

 
326,140

Work in process
22,357

 
16,431

Finished goods
318,512

 
306,877

Total Inventories
687,817

 
649,448

Prepaid expenses and other current assets
242,870

 
215,387

Total Current Assets
1,970,341

 
1,896,544

Property, plant and equipment, at cost
2,139,372

 
2,090,755

Accumulated depreciation
(1,251,889
)
 
(1,210,175
)
 
887,483

 
880,580

Goodwill
1,166,022

 
1,156,288

Other intangible assets, net
414,055

 
415,787

Deferred income taxes
88,231

 
99,777

Other assets
155,144

 
149,950

Total Assets
$
4,681,276

 
$
4,598,926

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current Liabilities:
 
 
 
Short term borrowings
$
36,819

 
$
6,966

Accounts payable
324,262

 
338,188

Accrued payroll and bonus
51,194

 
88,361

Dividends payable
54,404

 
54,420

Other current liabilities
250,073

 
280,833

Total Current Liabilities
716,752

 
768,768

Long-term debt
1,676,211

 
1,632,186

Deferred gains
36,930

 
37,344

Retirement liabilities
226,937

 
228,936

Other liabilities
245,484

 
242,398

Total Other Liabilities
2,185,562

 
2,140,864

Commitments and Contingencies (Note 13)

 

Shareholders’ Equity:
 
 
 
Common stock 12 1/2¢ par value; 500,000,000 shares authorized; 115,858,190 shares issued as of March 31, 2018 and December 31, 2017; and 78,920,199 and 78,947,381 shares outstanding as of March 31, 2018 and December 31, 2017, respectively
14,470

 
14,470

Capital in excess of par value
166,517

 
162,827

Retained earnings
3,947,791

 
3,870,621

Accumulated other comprehensive loss
(620,579
)
 
(637,482
)
Treasury stock, at cost (36,937,991 and 36,910,809 shares as of March 31, 2018 and December 31, 2017, respectively)
(1,735,049
)
 
(1,726,234
)
Total Shareholders’ Equity
1,773,150

 
1,684,202

Noncontrolling interest
5,812

 
5,092

Total Shareholders’ Equity including noncontrolling interest
1,778,962

 
1,689,294

Total Liabilities and Shareholders’ Equity
$
4,681,276

 
$
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 March 31,
(AMOUNTS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
2018
 
2017
Net sales
$
930,928

 
$
828,293

Cost of goods sold
525,119

 
465,210

Gross profit
405,809

 
363,083

Research and development expenses
78,476

 
72,126

Selling and administrative expenses
142,644

 
143,704

Amortization of acquisition-related intangibles
9,185

 
7,066

Restructuring and other charges, net
717

 
10,143

Gain on sales of fixed assets
(69
)
 
(21
)
Operating profit
174,856

 
130,065

Interest expense
16,595

 
12,807

Other (income), net
(576
)
 
(21,229
)
Income before taxes
158,837

 
138,487

Taxes on income
29,421

 
22,723

Net income
129,416

 
115,764

Other comprehensive income (loss), after tax:
 
 
 
Foreign currency translation adjustments
14,803

 
(3,257
)
(Losses) on derivatives qualifying as hedges
(529
)
 
(1,751
)
Pension and postretirement net liability
2,629

 
3,635

Other comprehensive income (loss)
16,903

 
(1,373
)
Total comprehensive income
$
146,319

 
$
114,391

 
 
 
 
Net income per share - basic
$
1.63

 
$
1.46

Net income per share - diluted
$
1.63

 
$
1.45

Average number of shares outstanding - basic
79,018

 
79,098

Average number of shares outstanding - diluted
79,393

 
79,409

Dividends declared per share
$
0.69

 
$
0.64


See Notes to Consolidated Financial Statements
2



INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
(Unaudited)
 
Three Months Ended March 31,
(DOLLARS IN THOUSANDS)
2018
 
2017
Cash flows from operating activities:
 
 
 
Net income
$
129,416

 
$
115,764

Adjustments to reconcile to net cash provided by operating activities:
 
 
 
Depreciation and amortization
33,384

 
26,802

Deferred income taxes
18,404

 
(3,766
)
Gain on disposal of assets
(69
)
 
(21
)
Stock-based compensation
7,620

 
5,819

Pension contributions
(4,387
)
 
(25,263
)
Product recall claim settlement
(12,969
)
 

Foreign currency gain on liquidation of entity

 
(12,214
)
Changes in assets and liabilities, net of acquisitions:
 
 
 
Trade receivables
(61,301
)
 
(60,858
)
Inventories
(30,185
)
 
(109
)
Accounts payable
(8,435
)
 
(1,978
)
Accruals for incentive compensation
(36,583
)
 
(23,485
)
Other current payables and accrued expenses
(18,540
)
 
(7,586
)
Other assets
(26,035
)
 
30,284

Other liabilities
(1,715
)
 
(24,894
)
Net cash (used in) provided by operating activities
(11,395
)
 
18,495

Cash flows from investing activities:
 
 
 
Cash paid for acquisitions, net of cash received
(22
)
 
(138,093
)
Additions to property, plant and equipment
(33,105
)
 
(26,662
)
Maturity of net investment hedges
(2,405
)
 
1,948

Proceeds from disposal of assets
293

 
619

Net cash used in investing activities
(35,239
)
 
(162,188
)
Cash flows from financing activities:
 
 
 
Cash dividends paid to shareholders
(54,420
)
 
(50,677
)
Increase in revolving credit facility borrowings and overdrafts
23,762

 
100,481

Increase in commercial paper
29,926

 
107,441

Loss on pre-issuance hedges

 
300

Employee withholding taxes paid
(3,266
)
 
(3,000
)
Purchase of treasury stock
(10,617
)
 
(37,612
)
Net cash (used in) provided by financing activities
(14,615
)
 
116,933

Effect of exchange rate changes on cash and cash equivalents
(1,521
)
 
2,835

Net change in cash and cash equivalents
(62,770
)
 
(23,925
)
Cash and cash equivalents at beginning of year
368,046

 
323,992

Cash and cash equivalents at end of period
$
305,276

 
$
300,067

Cash paid for:
 
 
 
Interest paid, net of amounts capitalized
$
20,236

 
$
25,590

Income taxes paid
$
24,939

 
$
20,043

Noncash investing activities:
 
 
 
Accrued capital expenditures
$
18,868

 
$
5,433


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, March 31 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 March 30 and March 31, respectively. The unaudited interim financial statements include all adjustments (consisting only of normal recurring adjustments) and accruals necessary in the judgment of management for a fair statement of the results for the periods presented. When used herein, the terms “IFF,” the “Company,” “we,” “us” and “our” mean International Flavors & Fragrances Inc. and its consolidated subsidiaries.
Use of Estimates
The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Reclassifications and Revisions
Certain prior year amounts have been reclassified and revised to conform to current year presentation.
As discussed below and in conformity with the Financial Accounting Standards Board's ("FASB") amendments to the Compensation - Retirement Benefits guidance, the Company has reclassified certain components of net periodic benefit expense (income) to Other income (expense), net.
Additionally, approximately $5.4 million of expense was recorded during the first quarter of 2017 for a tax assessment relating to prior periods. The Consolidated Statement of Cash Flows for the three months ended March 31, 2017 has been revised to properly reclassify $3.2 million from Net cash used in financing activities to reduce Net cash provided by operating activities, and has also been revised to correctly state the amount of Cash paid for interest, net of amounts capitalized, for the three months ended March 31, 2017. These adjustments were not material to the current or previously-issued financial statements.
U.S. Tax Reform
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”) that significantly revised the U.S. tax code effective January 1, 2018 by, among other things, lowering the corporate income tax rate from a top marginal rate of 35% to a flat 21%, limiting deductibility of interest expense and performance based incentive compensation, transitioning to a territorial system and creating new taxes associated with global operations.
In the fourth quarter of 2017, the Company recorded approximately $139.2 million in charges related to the impact of the Tax Act. Given the significant complexity of the Tax Act, anticipated guidance from the U.S. Treasury about implementing the Tax Act and the potential for additional guidance from the SEC or the FASB, the amount recorded by the Company in the fourth quarter of 2017 was provisional and will continue to be adjusted during 2018. The impact of the Tax Act is expected to be finalized no later than the fourth quarter of 2018. The aforementioned guidance and additional information regarding the Tax Act may also impact the Company's 2018 effective income tax rate, exclusive of any adjustment to the provisional charge. Any material revisions in our computations could adversely affect our cash flows and results of operations.
During the 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.

4



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 $11.0 million for the three months ended March 31, 2018 compared to a decrease of approximately $27.1 million for the three months ended March 31, 2017. The cost of participating in these programs was immaterial to our results in all periods.
Recent Accounting Pronouncements
In February 2018, FASB issued amendments to the Income Statement - Reporting Comprehensive Income guidance 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 amendments to the Derivatives and Hedging guidance which eliminates the requirement to separately measure and present hedge ineffectiveness and aligns the presentation of hedge gains and losses with the underlying hedge item. This guidance is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted. The amended presentation and disclosure requirements are to be applied prospectively while the amendments to cash flow and net investment hedge relationships are to be applied on a modified retrospective basis. The Company is currently evaluating the impact this guidance will have on its Consolidated Financial Statements, but does not expect this guidance to have a material impact on its Consolidated Financial Statements.
In May 2017, the FASB issued amendments to the Compensation - Stock Compensation guidance 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 amendments to the Compensation - Retirement Benefits guidance which requires employers who present a measure of operating income in their statement of income to include only the service cost component of net periodic pension cost and postretirement costs in operating expenses. This guidance is effective, and as required, has been applied on a full retrospective basis. The impact of the adoption of this standard on January 1, 2018, was a decrease in operating profit of $7.3 million for the three months ended March 31, 2017, and an increase in income within Other (income) expense, net, as presented in the Company's Consolidated Statement of Income and Comprehensive Income. There was no impact to Net income or Net Income per share in either period. See Note 10 of the Consolidated Financial Statements for further details.
The new guidance also limits the amount of net periodic benefit cost eligible for capitalization to assets. The new guidance permits only the service cost component of net periodic benefit cost to be eligible for capitalization. The Company applied the practical expedient that permits the use of amounts previously disclosed as the basis for retrospective application and, as provided under the practical expedient, has not presented the income statement impact based on the capitalization of the applicable costs.
In August 2016, the FASB issued authoritative guidance 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 a significant impact on its Consolidated Statement of Cash Flows.
In June 2016, the FASB issued authoritative guidance 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 authoritative guidance 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

5



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 30, 2018, the first day of the Company’s 2019 fiscal year, and that the adoption of this guidance will result in significant increases to assets and liabilities on its Consolidated Balance Sheet. The Company is still evaluating the impact of this guidance on its Consolidated Statement of Income and Comprehensive Income and Consolidated Statement of Cash Flows. The Company has begun to evaluate the nature of its leases and has compiled a preliminary analysis of the type and location of its leases. The Company expects that the significant portion of its lease liabilities will relate to property, with additional lease and corresponding right of use assets in existence that relate to vehicles and machinery.
Adoption of ASC Topic 606, Revenue from Contracts with Customers
In May 2014, the FASB issued authoritative guidance that provides for a comprehensive model to be used in accounting for revenue arising from contracts with customers (ASC Topic 606, Revenue from Contracts with Customers) (the “Revenue Standard”). Under the Revenue Standard, revenue is recognized to reflect the transfer of goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. Companies have the option to apply the new guidance under a retrospective approach to each prior reporting period presented or a modified retrospective approach with the cumulative effect of initially applying the new guidance recognized at the date of initial application within the Consolidated Balance Sheet. The new Revenue Standard became effective for annual reporting periods beginning after December 15, 2017, and the Company has adopted the new revenue standard using the modified retrospective approach on December 30, 2017, the first day of the Company’s 2018 fiscal year.
The Company creates and manufactures flavors and fragrances. Approximately 90% of its products, principally Flavors compounds and Fragrances compounds, are customized to customer specifications and have no alternative use other than the sale to the specific customer (“Compounds products”). The remaining revenue is derived largely from Fragrance Ingredients products that, generally, are commodity products with alternative uses and not customized (“Ingredients products”).
With respect to the vast majority of the Company’s contracts for Compounds products, the Company currently recognizes revenue on the transfer of control of the product at a point in time as the Company does not have an “enforceable right to payment for performance to date” (as set out in the Revenue Standard). With respect to a small number of contracts for the sale of Compounds, the Company has an “enforceable right to payment for performance to date” and as the products do not have an alternative use, the Company recognizes revenue for these contracts over time and records a contract asset using the output method. The output method recognizes revenue on the basis of direct measurements of the value to the customer of the goods or services transferred to date relative to the remaining goods or services promised under the contract.
With respect to the Company’s contracts related to Ingredients products, the Company currently recognizes revenue on the transfer of control of the product at a point in time as such products generally have alternative uses and the Company does not have an “enforceable right to payment for performance to date.”
As the Company adopted the Revenue Standard using the modified retrospective method effective the first day of its 2018 fiscal year, results for its 2018 fiscal year are presented under the Revenue Standard while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under ASC Topic 605, which required that revenue was accounted for when the earnings process was complete.
The Company recorded a net increase to retained earnings of $2.1 million as of the first day of its 2018 fiscal year due to the cumulative impact of adopting the Revenue Standard. In connection with the adjustment to retained earnings, the Company also recorded an increase of $4.4 million in contract assets (which are included in Prepaid expenses and other assets), a decrease of $1.7 million in inventory, and an increase in taxes payable of $0.6 million.
The impact to revenues, gross profit and net income for three months ended March 31, 2018 were reductions of $0.6 million, $0.4 million and $0.3 million, respectively, as a result of applying the Revenue Standard as compared to the amounts that would have been recognized under ASC Topic 605.
Revenue Recognition
The Company recognizes revenue when control of the promised goods is transferred to its customers in an amount that reflects the consideration it expects to be entitled to in exchange for those goods. Sales, value add, and other taxes the Company collects are excluded from revenues. The Company receives payment in accordance with standard customer terms.

6



The following table presents the Company's revenues disaggregated by business unit:
 
Three Months Ended March 31,
(DOLLARS IN THOUSANDS)
2018
 
2017(a)
Flavor Compounds
449,019

 
406,164

Fragrance Compounds
 
 
 
Consumer Fragrances
280,238

 
252,695

Fine Fragrances
98,395

 
87,705

Fragrance Ingredients
103,276

 
81,729

Total revenues
930,928

 
828,293

_______________________ 
(a)
Prior period amounts have not been adjusted based on the modified retrospective method.
The following table presents our revenues disaggregated by region, based on the region of our customers:
 
Three Months Ended March 31,
(DOLLARS IN THOUSANDS)
2018
 
2017(a)
Europe, Africa and Middle East
309,312

 
257,684

Greater Asia
243,557

 
222,820

North America
241,146

 
218,828

Latin America
136,913

 
128,961

Total revenues
930,928

 
828,293

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

7



Fragrance Ingredients Revenues
The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties and payment terms (which vary by customer) are identified, the contract has commercial substance, and collectability of consideration is probable.
The Company generates revenues primarily by manufacturing Ingredients products for the use of our customers. The Company combines the shipment of goods with their manufacture to account for both shipment and manufacture as the sole performance obligation.
Generally, the Company recognizes a sale at the time when it ships the product from their manufacturing facility to their customer, as this is the point when control of the goods or services has transferred to the customer. The amount of consideration received and revenue recognized is impacted by discounts offered to its customers. The Company estimates discounts based on an analysis of historical experience and current activity. The Company assesses its estimates of discounts at each reporting date throughout the contract period and updates its estimates until the uncertainty has been resolved. During the current period, changes to estimates of discounts have been immaterial.
Contract Asset and Accounts Receivable
The following table reflects the changes in our contract assets and accounts receivable for the three months ended March 31, 2018 and December 31, 2017:
(DOLLARS IN THOUSANDS)
March 31, 2018
 
At adoption
Receivables (included in Trade receivables)
747,862

 
677,055

Contract asset - Short term
3,839

 
4,449

NOTE 2. NET INCOME PER SHARE
Net income per share is based on the weighted average number of shares outstanding. A reconciliation of the shares used in the computation of basic and diluted net income per share is as follows: 
 
Three Months Ended March 31,
(SHARES IN THOUSANDS)
2018
 
2017
Basic
79,018

 
79,098

Assumed dilution under stock plans
375

 
311

Diluted
79,393

 
79,409

There were no stock options or stock-settled appreciation rights (“SSARs”) excluded from the computation of diluted net income per share for the three months ended March 31, 2018 and 2017.
The Company has issued shares of purchased restricted common stock and purchased restricted common stock units (collectively “PRSUs”) which contain rights to nonforfeitable dividends while these shares are outstanding and thus are considered participating securities. Such securities are required to be included in the computation of basic and diluted earnings per share pursuant to the two-class method. The Company did not present the two-class method since the difference between basic and diluted net income per share for both unrestricted common shareholders and PRSU shareholders was less than $0.01 per share for each period presented, and the number of PRSUs outstanding as of March 31, 2018 and 2017 was immaterial. Net income allocated to such PRSUs was $0.3 million for both the three months ended March 31, 2018 and 2017.
NOTE 3.    ACQUISITIONS
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).

8



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 revised during the first quarter of 2018 and resulted in a decrease in administrative expense of approximately $0.6 million.
No pro forma financial information for 2017 is presented as the acquisition was not material to the consolidated financial statements.
Fragrance Resources
On January 17, 2017, the Company completed the acquisition of 100% of the outstanding shares of Fragrance Resources, Inc., Fragrance Resources GmbH, and Fragrance Resources SAS (collectively "Fragrance Resources"), a privately-held fragrance company with facilities in Germany, North America, France, and China. The acquisition was accounted for under the purchase method. Fragrance Resources was acquired to strengthen the North American and German Fragrances business.
The Company paid approximately €143.4 million (approximately $151.9 million) including approximately €13.7 million (approximately $14.4 million) of cash acquired for this acquisition, which was funded from existing resources including use of its revolving credit facility. Of the total paid, approximately €142.0 million (approximately $150.5 million) was paid at closing and an additional €1.4 million (approximately $1.5 million) was paid in connection with the finalization of the working capital adjustment. The purchase price exceeded the fair value of existing net assets by approximately $122.0 million. The excess was allocated principally to identifiable intangible assets including approximately $51.7 million related to customer relationships, approximately$13.6 million related to proprietary technology and trade name, and approximately $72.0 million of goodwill (which is not deductible for tax purposes) and approximately $15.3 million of net deferred tax liability. Goodwill is the excess of the purchase price over the fair value of net assets acquired and represents synergies from the addition of Fragrance Resources to the Company's existing Fragrances business. The intangible assets are being amortized over the following estimated useful lives: trade name, 2 years; proprietary technology, 5 years; and customer relationships, 12 - 16 years.
The purchase price allocation was finalized in the fourth quarter of 2017. Certain measurement period adjustments were made subsequent to the initial purchase price allocation including adjustments related to the finalization of the purchase price, the allocation of certain intangibles and the calculation of applicable deferred taxes. The additional amortization of intangibles required as a result of the measurement period adjustments was not material.
No pro forma financial information for 2016 is presented as the acquisition was not material to the consolidated financial statements.
NOTE 4.    RESTRUCTURING AND OTHER CHARGES, NET
Restructuring and other charges primarily consist of separation costs for employees including severance, outplacement and other benefit costs.
2017 Productivity Program
On February 15, 2017, the Company announced that it was adopting a multi-year productivity program designed to improve overall financial performance, provide flexibility to invest in growth opportunities and drive long-term value creation. In connection with this program, the Company expects to optimize its global footprint and simplify its organizational structures globally. In connection with this initiative, the Company expects to incur cumulative, pre-tax cash charges of between $30-$35 million, consisting primarily of $24-$26 million in personnel-related costs and an estimated $6 million in facility-related costs, such as lease termination, and integration-related costs.
The Company recorded $21.3 million of charges related to personnel costs and lease termination costs through the first 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 $0.7 million and $10.1 million of charges related to personnel costs and lease termination costs during the three months ended March 31, 2018 and 2017, respectively.

9



The Company made payments of $1.7 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 employee-related restructuring liabilities during the three months ended March 31, 2018, were as follows:
(DOLLARS IN THOUSANDS)
Employee-Related Costs
 
Other
 
Total
Balance at December 31, 2017
$
7,539

 
$
418

 
$
7,957

Additional charges (reversals), net
717

 

 
717

Non-cash charges

 

 

Payments
(1,696
)
 

 
(1,696
)
Balance at March 31, 2018
$
6,560

 
$
418

 
$
6,978

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
9,712

Balance at March 31, 2018
$
1,166,022

Other Intangible Assets
Other intangible assets, net consisted of the following amounts: 
 
March 31,
 
December 31,
(DOLLARS IN THOUSANDS)
2018
 
2017
Asset Type
 
 
 
Customer relationships
$
414,684

 
$
407,636

Trade names & patents
39,556

 
38,771

Technological know-how
162,515

 
161,856

Other
24,909

 
24,814

Total carrying value
641,664

 
633,077

Accumulated Amortization
 
 
 
Customer relationships
(111,796
)
 
(104,800
)
Trade names & patents
(16,175
)
 
(15,241
)
Technological know-how
(79,929
)
 
(76,766
)
Other
(19,709
)
 
(20,483
)
Total accumulated amortization
(227,609
)
 
(217,290
)
Other intangible assets, net
$
414,055

 
$
415,787

 
Amortization
Amortization expense was $9.2 million and $7.1 million for the three months ended March 31, 2018 and 2017, respectively. Annual amortization is expected to be $36.7 million for the full year 2018, $35.2 million for the year 2019, $34.5 million for the year 2020, $29.7 million for the year 2021, $25.5 million for the year 2022 and $25.4 million for the year 2023.

10



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

 
$
249,800

 
$
249,765

Senior notes - 2013 (1)
3.39
%
 
298,747

 
298,670

Euro Senior notes - 2016 (1)
1.99
%
 
611,030

 
589,848

Senior notes - 2017 (1)
4.50
%
 
492,880

 
492,819

Credit facility
LIBOR + 1.125%

(2)
24,617

 

Commercial paper
%
(3)
29,926

 

Bank overdrafts and other
 
 
5,973

 
7,993

Deferred realized gains on interest rate swaps
 
 
57

 
57

 
 
 
1,713,030

 
1,639,152

Less: Short term borrowings (4)
 
 
(36,819
)
 
(6,966
)
 
 
 
$
1,676,211

 
$
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)
The effective interest rate of commercial paper issuances fluctuate as short term interest rates and demand fluctuate, and deferred debt issuance costs are immaterial. Additionally, the effective interest rate of commercial paper is not meaningful as issuances do not materially differ from short term interest rates.
(4)
Includes bank borrowings, commercial paper, overdrafts and current portion of long-term debt.
Commercial Paper
Commercial paper issued by the Company generally has terms of 90 days or less. As of March 31, 2018, there was $29.9 million of commercial paper outstanding and no commercial paper outstanding as of December 31, 2017. The revolving credit facility is used as a backstop for the Company's commercial paper program. The maximum amount of commercial paper outstanding for the three months ended March 31, 2018 and 2017 was $40.0 million and $107.5 million, respectively.
NOTE 7. INCOME TAXES
U.S. Tax Reform
In the fourth quarter of 2017, the Company recorded approximately $139.2 million in charges related to the impact of the Tax Act. Given the significant complexity of the Tax Act, anticipated guidance from the U.S. Treasury about implementing the Tax Act and the potential for additional guidance from the SEC or the FASB, the amount recorded by the Company in the fourth quarter of 2017 was provisional and will continue to be adjusted during 2018. The impact of the Tax Act is expected to be finalized no later than the fourth quarter of 2018. The aforementioned guidance and additional information regarding the Tax Act may also impact the Company's 2018 effective income tax rate, exclusive of any adjustment to the provisional charge. Any material revisions in our computations could adversely affect our cash flows and results of operations.
During the first quarter of 2018, the Company recorded an additional charge of $0.6 million to adjust an accrual related to withholding taxes on planned repatriations.
Uncertain Tax Positions
At March 31, 2018, the Company had $28.5 million of unrecognized tax benefits recorded in Other liabilities and $5 million in Other current liabilities. If these unrecognized tax benefits were recognized, the effective tax rate would be affected.
At March 31, 2018, the Company had accrued interest and penalties of $2.3 million classified in Other liabilities and $0.5 million in Other current liabilities.

11



As of March 31, 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 taxes on undistributed earnings of subsidiary companies that are intended and planned to be indefinitely invested in such subsidiaries. We intend to, and have plans to, reinvest these earnings indefinitely in our foreign subsidiaries to fund local operations and/or capital projects.
The Company has ongoing income tax audits and legal proceedings which are at various stages of administrative or judicial review. In addition, the Company has open tax years with various taxing jurisdictions that range primarily from 2008 to 2017. Based on currently available information, we do not believe the ultimate outcome of any of these tax audits and other tax positions related to open tax years, when finalized, will have a material impact on our financial position.
The Company also has other ongoing tax audits and legal proceedings that relate to indirect taxes, such as value-added taxes, sales and use taxes and property taxes, which are discussed in Note 13.
Effective Tax Rate
The effective tax rate for the three months ended March 31, 2018 was 18.5% compared with 16.4% for the three months ended March 31, 2017. The year-over-year increase was largely due to the impact of U.S. tax reform and increased loss provisions, partially offset by mix of earnings, a lower cost of repatriation (principally due to tax reform) and the release of a State valuation allowance that related to prior years.
NOTE 8.    STOCK COMPENSATION PLANS
The Company has various plans under which its officers, senior management, other key employees and directors may be granted equity-based awards. Equity awards outstanding under the plans include PRSUs, restricted stock units (RSUs), SSARs and Long-Term Incentive Plan awards. Liability-based awards outstanding under the plans are cash-settled RSUs.
Stock-based compensation expense and related tax benefits were as follows: 
 
Three Months Ended March 31,
(DOLLARS IN THOUSANDS)
2018
 
2017
Equity-based awards
$
7,620

 
$
5,819

Liability-based awards
155

 
1,753

Total stock-based compensation expense
7,775

 
7,572

Less: tax benefit
(1,563
)
 
(2,213
)
Total stock-based compensation expense, after tax
$
6,212

 
$
5,359

NOTE 9. SEGMENT INFORMATION
The Company is organized into two operating segments: Flavors and Fragrances. These segments align with the internal structure of the Company used to manage these businesses. Performance of these operating segments is evaluated based on segment profit which is defined as operating profit before Restructuring and other charges, net; Global expenses and certain non-recurring items; Interest expense; Other income (expense), net; and Taxes on income.
The Global expenses caption below represents corporate and headquarters-related expenses which include legal, finance, human resources, certain incentive compensation expenses and other R&D and administrative expenses that are not allocated to individual operating segments.

12



Reportable segment information is as follows:
 
Three Months Ended March 31,
(DOLLARS IN THOUSANDS)
2018
 
2017
Net sales:
 
 
 
Flavors
$
449,019

 
$
406,164

Fragrances
481,909

 
422,129

Consolidated
$
930,928

 
$
828,293

Segment profit:
 
 
 
Flavors
$
111,564

 
$
94,556

Fragrances
93,277

 
77,875

Global expenses
(23,825
)
 
(16,293
)
Operational Improvement Initiatives (a)
(1,026
)
 
(621
)
Acquisition Related Costs (b)
514

 
(8,788
)
Integration Related Costs (c)

 
(1,192
)
Tax Assessment (d)

 
(5,350
)
Restructuring and Other Charges, net (e)
(717
)
 
(10,143
)
Gain on Sale of Assets
69

 
21

FDA Mandated Product Recall (f)
(5,000
)
 

Operating profit
174,856

 
130,065

Interest expense
(16,595
)
 
(12,807
)
Other income (expense)
576

 
21,229

Income before taxes
$
158,837

 
$
138,487

(a)
For 2018, represents accelerated depreciation related to a plant relocation in India and a lab closure in Taiwan. 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 and Fragrance Resources, 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)
Represents costs related to the integration of the David Michael and Fragrance Resources acquisitions.
(d)
Represents the reserve for payment of a tax assessment related to commercial rent for prior periods.
(e)
Represents severance costs related to the 2017 Productivity Program and Taiwan lab closure.
(f)
Represents management's best estimate of losses related to the previously disclosed FDA mandated recall.
Net sales are attributed to individual regions based upon the destination of product delivery. Net sales related to the U.S. for the three months ended March 31, 2018 and 2017 were $230.2 million and $227.6 million, respectively. Net sales attributed to all foreign countries in total for the three months ended March 31, 2018 and 2017 were $700.7 million and $600.7 million, respectively. No country other than the U.S. had net sales in any period presented greater than 6% of total consolidated net sales.

13



NOTE 10. EMPLOYEE BENEFITS
Pension and other defined contribution retirement plan expenses included the following components:
(DOLLARS IN THOUSANDS)
U.S. Plans
 
Location of Pension Benefit (Income)
Three Months Ended March 31,
 
2018
 
2017
 
Service cost for benefits earned
$
596

 
$
698

 
Included as a component of Operating Profit
Interest cost on projected benefit obligation
4,790

 
4,560

 
Included as a component of Other Income (Expense), net
Expected return on plan assets
(7,739
)
 
(9,246
)
 
Included as a component of Other Income (Expense), net
Net amortization and deferrals
1,549

 
1,793

 
Included as a component of Other Income (Expense), net
Net periodic benefit income
(804
)
 
(2,195
)
 
 
Defined contribution and other retirement plans
2,690

 
2,255

 
Included as a component of Operating Profit
Total expense
$
1,886

 
$
60

 
 
(DOLLARS IN THOUSANDS)
Non-U.S. Plans
 
Location of Pension Benefit (Income)
Three Months Ended March 31,
 
2018
 
2017
 
Service cost for benefits earned
$
4,470

 
$
5,514

 
Included as a component of Operating Profit
Interest cost on projected benefit obligation
4,338

 
3,848

 
Included as a component of Other Income (Expense), net
Expected return on plan assets
(12,032
)
 
(12,133
)
 
Included as a component of Other Income (Expense), net
Net amortization and deferrals
2,972

 
3,923

 
Included as a component of Other Income (Expense), net
Net periodic benefit (income) cost
(252
)
 
1,152

 
 
Defined contribution and other retirement plans
1,551

 
1,297

 
Included as a component of Operating Profit
Total expense
$
1,299

 
$
2,449

 
 
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 three months ended March 31, 2018, no contributions were made to the qualified U.S. pension plans, $3.3 million of contributions were made to the non-U.S. pension plans, and $1.1 million of benefit payments were made with respect to the Company's non-qualified U.S. pension plan.
Expense recognized for postretirement benefits other than pensions included the following components: 
 
Three Months Ended March 31,
(DOLLARS IN THOUSANDS)
2018
 
2017
Service cost for benefits earned
$
195

 
$
221

Interest cost on projected benefit obligation
654

 
588

Net amortization and deferrals
(1,189
)
 
(1,046
)
Total postretirement benefit income
$
(340
)
 
$
(237
)
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, 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 $6.1 million and $7.3 million in the three months ended March 31, 2018 and 2017, respectively, compared to what the Other (income) expense, net would have been under the previous method. The retroactive $7.3 million reduction in operating profit for the three months ended March 31, 2017 was reflected as a $1.6 million increase in cost of goods sold, a $2.4 million increase in research and development expenses, and a $3.3 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 three months ended March 31, 2018, $0.9 million of contributions were made.

14



NOTE 11. FINANCIAL INSTRUMENTS
Fair Value
Accounting guidance on fair value measurements specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. These two types of inputs create the following fair value hierarchy:
Level 1 — Quoted prices for identical instruments in active markets.
Level 2 — Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
Level 3 — Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. The Company determines the fair value of structured liabilities (where performance is linked to structured interest rates, inflation or currency risks) using the London Interbank Offer Rate ("LIBOR") swap curve and forward interest and exchange rates at period end. Such instruments are classified as Level 2 based on the observability of significant inputs to the model. The Company does not have any instruments classified as Level 1 or Level 3, other than those included in pension asset trusts as discussed in Note 14 of our 2017 Form 10-K.
These valuations take into consideration the Company's credit risk and its counterparties’ credit risk. The estimated change in the fair value of these instruments due to such changes in its own credit risk (or instrument-specific credit risk) was immaterial as of March 31, 2018.
The principal amounts and the estimated fair values of financial instruments at March 31, 2018 and December 31, 2017 consisted of the following: 
 
March 31, 2018
 
December 31, 2017
(DOLLARS IN THOUSANDS)
Principal
 
Fair
Value
 
Principal
 
Fair
Value
Cash and cash equivalents(1)
$
305,276

 
$
305,276

 
$
368,046

 
$
368,046

Credit facilities and bank overdrafts(2)
30,589

 
30,589

 
7,993

 
7,993

Commercial paper (2)
29,926

 
29,926

 

 

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

 
285,062

 
250,000

 
293,232

Senior notes - 2013
300,000

 
297,535

 
300,000

 
304,219

Euro Senior notes - 2016
615,400

 
642,921

 
594,400

 
627,782

Senior notes - 2017
500,000

 
497,689

 
500,000

 
525,906

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

15



During the three months ended March 31, 2018 and the year ended December 31, 2017, the Company entered into several forward currency contracts which qualified as net investment hedges, in order to mitigate a portion of its net European investments from foreign currency risk. The effective portions of net investment hedges are recorded in other comprehensive income (“OCI”) as a component of Foreign currency translation adjustments in the accompanying Consolidated Statement of Income and Comprehensive Income. Realized gains/(losses) are deferred in accumulated other comprehensive income (loss) ("AOCI") where they will remain until the net investments in the Company's European subsidiaries are divested. The outstanding forward currency contracts have remaining maturities of less than one year. Three of these forward currency contracts matured during the three months ended March 31, 2018.
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 three months ended March 31, 2018 and the year ended December 31, 2017, the Company entered into several forward currency contracts which qualified as cash flow hedges. The objective of these hedges is to protect against the currency risk associated with forecasted U.S. dollar ("USD") denominated raw material purchases made by Euro ("EUR") functional currency entities which result from changes in the EUR/USD exchange rate. The effective portions of cash flow hedges are recorded in OCI as a component of Gains/(Losses) on derivatives qualifying as hedges in the accompanying Consolidated Statement of Income and Comprehensive Income. Realized gains/(losses) in AOCI related to cash flow hedges of raw material purchases are recognized as a component of Cost of goods sold in the accompanying Consolidated Statement of Income and Comprehensive Income in the same period as the related costs are recognized.
The Company maintains various interest rate swap agreements that effectively convert the fixed rate on a portion of its long-term borrowings to a variable short-term rate based on the LIBOR plus an interest markup. These swaps are designated as fair value hedges. Amounts recognized in Interest expense were immaterial for the three months ended March 31, 2018 and 2017.
The Company has previously entered into interest rate swap agreements to hedge the anticipated issuance of fixed-rate debt, which are designated as cash flow hedges. The amount of gains and losses realized upon termination of these agreements is amortized over the life of the corresponding debt issuance.
The following table shows the notional amount of the Company’s derivative instruments outstanding as of March 31, 2018 and December 31, 2017: 
(DOLLARS IN THOUSANDS)
March 31, 2018
 
December 31, 2017
Forward currency contracts
$
777,134

 
$
896,947

Interest rate swaps
$
150,000

 
$
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 March 31, 2018 and December 31, 2017: 
 
March 31, 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
$
1,053

 
$
6,307

 
$
7,360

Derivative liabilities (b)
 
 
 
 
 
Foreign currency contracts
$
6,425

 
$
743

 
$
7,168

Interest rate swaps
3,169

 

 
3,169

Total Derivative liabilities
$
9,594

 
$
743

 
$
10,337


16



 
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 months ended March 31, 2018 and 2017 (in thousands): 

 
Amount of Gain (Loss)
 
Location of Gain (Loss)
Recognized in Income
on Derivative
(DOLLARS IN THOUSANDS)
For the Three Months Ended March 31,
 
2018
 
2017
 
Foreign currency contract
$
(3,615
)
 
$
(10,127
)
 
Other (income) expense, net
Most of these net gains (losses) offset any recognized gains (losses) arising from the revaluation of the related intercompany loans during the same respective periods.
The following table shows the effect of the Company’s derivative instruments designated as cash flow and net investment hedging instruments, net of tax, in the Consolidated Statement of Income and Comprehensive Income for the three months ended March 31, 2018 and 2017 (in thousands): 
 
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 March 31,
 
 
Three Months Ended March 31,
 
2018
 
2017
 
 
2018
 
2017
Derivatives in Cash Flow Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts
$
(743
)
 
$
(2,948
)
 
Cost of goods sold
 
$
(2,193
)
 
$
458

Interest rate swaps (1)
216

 
1,213

 
Interest expense
 
$
(216
)
 
(188
)
Derivatives in Net Investment Hedging Relationships:
 
 
 
 
 
 
 
 
 
Foreign currency contracts
(696
)
 
(1,046
)
 
N/A
 

 

Euro Senior notes - 2016
(15,977
)
 
(11,409
)
 
N/A
 

 

Total
$
(17,200
)
 
$
(14,190
)
 
 
 
$
(2,409
)
 
$
270

 _______________________
(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 months ended March 31, 2018 and 2017.

17



The Company expects that approximately $6.4 million (net of tax) of derivative loss included in AOCI at March 31, 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.
NOTE 12.    ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)
The following tables present changes in the accumulated balances for each component of other comprehensive income, including current period other comprehensive income and reclassifications out of accumulated other comprehensive income:
(DOLLARS IN THOUSANDS)
Foreign
Currency
Translation
Adjustments
 
(Losses) Gains on Derivatives
Qualifying as
Hedges
 
Pension and
Postretirement
Liability
Adjustment
 
Total
Accumulated other comprehensive (loss) income, net of tax, as of December 31, 2017
$
(297,416
)
 
$
(10,332
)
 
$
(329,734
)
 
$
(637,482
)
OCI before reclassifications
14,803

 
(2,938
)
 

 
11,865

Amounts reclassified from AOCI

 
2,409

 
2,629

 
5,038

Net current period other comprehensive income (loss)
14,803

 
(529
)
 
2,629

 
16,903

Accumulated other comprehensive (loss) income, net of tax, as of March 31, 2018
$
(282,613
)
 
$
(10,861
)
 
$
(327,105
)
 
$
(620,579
)

(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
8,957

 
(1,481
)
 

 
7,476

Amounts reclassified from AOCI
(12,214
)
(a)
(270
)
 
3,635

 
(8,849
)
Net current period other comprehensive income (loss)
(3,257
)
 
(1,751
)
 
3,635

 
(1,373
)
Accumulated other comprehensive (loss) income, net of tax, as of March 31, 2017
$
(355,282
)
 
$
5,853

 
$
(332,039
)
 
$
(681,468
)
 _______________________
 (a) Represents a foreign currency exchange gain from the release of a currency translation adjustment upon the liquidation of a foreign entity in 2017.

18



The following table provides details about reclassifications out of accumulated other comprehensive income to the Consolidated Statement of Income and Comprehensive Income: 
 
Three Months Ended March 31,
 
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
$
(2,506
)
 
$
524

 
Cost of goods sold
Interest rate swaps
(216
)
 
(188
)
 
Interest expense
Tax
313

 
(66
)
 
Provision for income taxes
Total
$
(2,409
)
 
$
270

 
Total, net of income taxes
(Losses) gains on pension and postretirement liability adjustments
 
 
 
 
 
Prior service cost
$
1,772

 
$
1,753

 
(a)
Actuarial losses
(5,103
)
 
(6,423
)
 
(a)
Tax
702

 
1,035

 
Provision for income taxes
Total
$
(2,629
)
 
$
(3,635
)
 
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.

NOTE 13.    COMMITMENTS AND CONTINGENCIES
Guarantees and Letters of Credit
The Company has various bank guarantees and letters of credit which are available for use to support its ongoing business operations and to satisfy governmental requirements associated with pending litigation in various jurisdictions.
At March 31, 2018, we had total bank guarantees and standby letters of credit of approximately $51.7 million with various financial institutions. Included in the above aggregate amount is a total of $15.7 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 March 31, 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 $15.9 million as of March 31, 2018.
Lines of Credit
The Company has various lines of credit which are available to support its ongoing business operations. As of March 31, 2018, we had available lines of credit of approximately $106.4 million with various financial institutions, in addition to the $950 million of capacity under the Credit Facility discussed in Note 9 of our 2017 Form 10-K. There were no material amounts drawn down pursuant to these lines of credit as of March 31, 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

19



claims experience with its insurance carriers. The liabilities are recorded at management’s best estimate of the probable outcome of the lawsuits and claims, taking into consideration the facts and circumstances of the individual matters as well as past experience on similar matters. At each balance sheet date, the key issues that management assesses are whether it is probable that a loss as to asserted or unasserted claims will be incurred and if so, whether the amount of loss can be reasonably estimated. The Company records the expected liability with respect to claims in Other liabilities and expected recoveries from its insurance carriers in Other assets. The Company recognizes a receivable when it believes that realization of the insurance receivable is probable under the terms of the insurance policies and its payment experience to date.
Environmental
Over the past 20 years, various federal and state authorities and private parties have claimed that we are a Potentially Responsible Party (“PRP”) as a generator of waste materials for alleged pollution at a number of waste sites operated by third parties located principally in New Jersey and have sought to recover costs incurred and to be incurred to clean up the sites.
The Company has been identified as a PRP at eight facilities operated by third parties at which investigation and/or remediation activities may be ongoing. The Company analyzes potential liability on at least a quarterly basis and accrues for environmental liabilities when they are probable and estimable. The Company estimates its share of the total future cost for these sites to be less than $5 million.
While joint and several liability is authorized under federal and state environmental laws, the Company believes the amounts it has paid and anticipates paying in the future for clean-up costs and damages at all sites are not and will not have a material adverse effect on its financial condition, results of operations or liquidity. This assessment is based upon, among other things, the involvement of other PRPs at most of the sites, the status of the proceedings, including various settlement agreements and consent decrees, and the extended time period over which payments will likely be made. There can be no assurance, however, that future events will not require the Company to materially increase the amounts it anticipates paying for clean-up costs and damages at these sites, and that such increased amounts will not have a material adverse effect on its financial condition, results of operations or cash flows.
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 $70 million as of March 31, 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 in the first quarter of 2018.
The net book value of the current plant was approximately $25 million as of March 31, 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 $160 million as of March 31, 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.

20



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 $31.6 million. The Brazilian matters take an extended period of time to proceed through the judicial process and there are a limited number of rulings to date.
ZoomEssence
As previously disclosed, in March 2012, ZoomEssence, Inc. filed a complaint against the Company in the U.S. District Court for the District of New Jersey alleging trade secret misappropriation, breach of contract and unjust enrichment in connection with certain spray dry technology disclosed to the Company. ZoomEssence sought an injunction and monetary damages. In November 2014, the Company filed a counterclaim against ZoomEssence alleging trade secret misappropriation, breach of contract, breach of the implied covenant of good faith and fair dealing, unjust enrichment, misappropriation of confidential and proprietary information, common law unfair competition, tortious interference with contractual relations, and conversion. During the second quarter of 2017, the Company and ZoomEssence mutually agreed to settle all claims and counterclaims. The parties agreed to dismiss their claims against one another, with prejudice and without any admission of liability or wrongful conduct, to avoid any further expense and disruption from the litigation. The complaint was dismissed, with prejudice, on July 5, 2017. Under the settlement agreement, the Company made a one-time payment to ZoomEssence of $56 million during the second quarter of 2017 and the parties exchanged full mutual releases. Accordingly, the Company recorded an additional charge of $1.0 million during the second quarter of 2017.
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 March 31, 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 for a total of $16.0 million, of which $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. Separately, the Company expects to pursue reimbursement of all or a portion of costs, once incurred, from its insurance company and/or the supplier; however, the nature, timing and amount of any 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.
NOTE 14.    SUBSEQUENT EVENTS
On May 7, 2018, the Company entered into a definitive agreement and plan of merger to acquire Frutarom Industries Ltd. (“Frutarom”). Frutarom is a flavors, savory solutions and natural ingredients company with production and development centers on six continents, that is traded on the Tel Aviv and London Stock Exchanges. The transaction is targeted to close in six to nine months, has been unanimously approved by the Boards of Directors of both companies and is subject to approval by Frutarom shareholders, clearance by the relevant regulatory authorities and other customary closing conditions.

21



Under the terms of the merger agreement, for each share of outstanding stock, Frutarom shareholders will receive $71.19 in cash and 0.2490 of a share of the Company's common stock, which, based on the 10-day volume weighted average price for the Company's common stock for the period ending May 4, 2018, represents a total value of $106.25 per share. The transaction is valued at approximately $7.1 billion, including the assumption of approximately $681 million of Frutarom's net debt, which the Company intends to refinance or repay concurrent with the closing of the transaction.
The Company expects to fund the cash portion of the merger consideration with cash on hand, new mid-term and long-term bonds, term loans and an issuance of equity. In connection with these financings, the Company also expects to pay its outstanding $250 million of its Senior Notes 2007 and the associated make-whole payments of approximately $35 million. Based on the number of Frutarom shares of common stock outstanding as of May 4, 2018, the Company anticipates issuing approximately 18.9% of its issued and outstanding shares of common stock as the stock portion of merger consideration. On May 7, 2018, the Company entered into a bridge facility commitment letter pursuant to which Morgan Stanley Senior Funding, Inc. committed, subject to customary conditions, to provide up to $5.5 billion under a 364-day senior unsecured bridge term loan credit facility to finance the cash portion of the merger consideration if the Company has not completed its anticipated financing transactions prior to the consummation of the merger.
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
(UNLESS INDICATED OTHERWISE, DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
Overview
Company background
We are a leading innovator of sensory experiences, co-creating unique products that consumers taste, smell, or feel in fine fragrances and cosmetics, detergents and household goods, and food and beverages. We take advantage of our capabilities in consumer insights, research and product development (“R&D”), creative expertise and customer intimacy to partner with our customers in developing innovative and differentiated offerings for consumers. We believe that this collaborative approach will generate market share gains for our customers. Our flavors and fragrance compounds combine a number of ingredients that are blended, mixed or reacted together to produce proprietary formulas created by our flavorists and perfumers.
Flavors are the key building blocks that impart taste experiences in food and beverage products and, as such, play a significant role in determining consumer preference for the end products in which they are used. As a leading creator of flavors, we help our customers deliver on the promise of delicious and healthy foods and drinks that appeal to consumers. While we are a global leader, our flavors business is more regional in nature, with different formulas that reflect local taste preferences. Our flavors compounds are ultimately used by our customers in four end-use categories: (1) Savory, (2) Beverages, (3) Sweet and (4) Dairy.
We are a global leader in the creation of fragrance compounds that are integral elements in the world’s finest perfumes and best-known consumer products, within fabric care, home care, personal wash, hair care and toiletries products. Our Fragrances business consists of Fragrance Compounds and Fragrance Ingredients. Our Fragrance Compounds are defined into two broad categories, (1) Fine Fragrances and (2) Consumer Fragrances. Consumer Fragrances consists of five end-use categories of products: (1) Fabric Care, (2) Home Care, (3) Personal Wash, (4) Hair Care and (5) Toiletries. Fragrance Ingredients consist of cosmetic active and functional ingredients that are used internally and sold to third parties, including customers and competitors, and are included in the Fragrances business unit.
The flavors and fragrances market is part of a larger market which supplies a wide variety of ingredients and compounds that are used in consumer products. The broader market includes large multinational companies and smaller regional and local 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 in partnership 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.

22



On May 7, 2018, we entered into a definitive agreement and plan of merger to acquire Frutarom Industries Ltd. (“Frutarom”). Frutarom is a flavors, savory solutions and natural ingredients company with production and development centers on six continents, that is traded on the Tel Aviv and London Stock Exchanges. The transaction is targeted to close in six to nine months, has been unanimously approved by the Boards of Directors of both companies and is subject to approval by Frutarom shareholders, clearance by the relevant regulatory authorities and other customary closing conditions. The transaction is valued at approximately $7.1 billion, including the assumption of approximately $681 million of Frutarom's net debt, which the Company intends to refinance or repay concurrent with the closing of the transaction. See Note 14 to the Consolidated Financial Statements for further details.
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 Footnote 10 to the Consolidated Financial Statements, the net effect of the change was to decrease operating profit and increase Other income.
Net sales during the first quarter of 2018 increased 12% on a reported basis and 7% on a currency neutral basis (which excludes the effects of changes in currency) versus the 2017 period, with the effect of acquisitions being immaterial to both reported and currency neutral growth rates. Reported and currency neutral sales growth was driven by higher volumes, primarily in Fragrances, and favorable pricing, primarily in Flavors.
Exchange rate variations did not have a material impact on Net income for the first quarter. The effect of exchange rates can vary by business and region, depending upon the mix of sales by destination country as well as the relative percentage of local sales priced in U.S. dollars versus local currencies.
Gross margins decreased to 43.6% in the first quarter of 2018 from 43.8% in the 2017 period, driven primarily by unfavorable price versus input costs, the effect of foreign currency conversion, which were only partially offset by cost savings and productivity initiatives. Included in the first quarter of 2018 were $0.5 million of operational improvement costs and $5.0 million related to an FDA mandated product recall compared to $6.0 million of acquisition-related amortization of inventory "step-up" costs, operational improvement initiative costs and integration-related costs included in the first quarter of 2017. Excluding these items, gross margin decreased 40 bps compared to the prior year period. The raw material cost environment continued its recent upward trend. We believe that in 2018 we will continue to see higher prices on certain categories (such as vanilla and citrus), increases related to turpentine and oil derived materials and higher costs on a key ingredient due to the BASF supply disruption related to one of our key ingredients (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 first quarter of 2018 increased approximately 12% as compared to the 2017 period. We continued to benefit from our diverse portfolio of end-use product categories and geographies and had currency neutral growth in all four regions and all four of our Flavors end-use product categories. Sales growth was driven by new win performance (net of losses) in both Flavors and Fragrances, and price increases in Flavors. Flavors achieved sales growth of 11% on a reported basis and 6% on a currency neutral basis, with the effect of acquisitions contributing approximately 1% to both reported and currency neutral growth rates. Fragrances achieved reported sales growth of 14% and currency neutral sales growth of 8%. Additionally, Fragrance Ingredients sales were up 26% on a reported basis and 18% on a currency neutral basis. Overall, our first quarter 2018 results continued to be driven by our strong emerging market presence that represented 47% of total sales and experienced 10% reported and 6% currency neutral growth in the first quarter 2018. From a geographic perspective, for the first quarter of 2018, North America ("NOAM"), Europe, Africa and the Middle East ("EAME"), Latin America ("LA") and Greater Asia ("GA") all delivered sales growth, led by EAME with 20% reported and 7% currency neutral growth.

23



Operating profit
Operating profit increased $44.8 million to $174.9 million (18.8% of sales) in the 2018 first quarter compared to $130.1 million (15.7% of sales) in the comparable 2017 period. The first quarter of 2018 included $6.2 million of charges related to operational improvement initiatives, acquisition related costs, a gain on sale of assets, restructuring and other charges, net and an FDA mandated product recall as compared to $26.1 million of charges related to operational improvement initiatives, acquisition related costs, integration related costs, a tax assessment and restructuring and other charges, net which were partially offset by a gain on sale of assets in the 2017 period. Excluding these charges, adjusted operating profit was $181.0 million (19.4% of sales) for the first quarter of 2018, an increase from $156.1 million (18.9% of sales) for the first quarter of 2017, principally driven by volume growth, favorable sales mix, and productivity initiatives which more than offset incentive compensation and the impact of the BASF supply chain disruption. Foreign currency changes had a 4% favorable impact on operating profit in the 2018 period compared to a 5% unfavorable impact on operating profit in the 2017 period.
Other (income) expense, net
Other (income) expense, net decreased $20.7 million to $0.6 million of income in the first quarter of 2018 compared to $21.2 million of income in the first quarter of 2017. The year-over-year decrease was primarily driven by foreign exchange losses and the release of a currency translation adjustment ("CTA") upon the liquidation of a foreign entity in 2017.
Net income
Net income increased by $13.7 million quarter-over-quarter to $129.4 million for the first quarter of 2018 from $115.8 million in the 2017 period, driven by the factors discussed above.
Cash flows
Cash flows used from operations for the three months ended March 31, 2018 was $11.4 million or 1.2% of sales, compared to cash flows provided by operations of $18.5 million or 2.2% of sales for the three months ended March 31, 2017. The change in cash flows from operations in 2018 was principally driven by higher core working capital requirements, the effect of a payment for a product claim and the timing of certain other items for the 2018 period as compared to the 2017 period.

24



Results of Operations
 
Three Months Ended March 31,
 
 
(DOLLARS IN THOUSANDS EXCEPT PER SHARE AMOUNTS)
2018
 
2017
 
Change
Net sales
$
930,928

 
$
828,293

 
12
 %
Cost of goods sold
525,119

 
465,210

 
13
 %
Gross profit
405,809

 
363,083

 
 
Research and development (R&D) expenses
78,476

 
72,126

 
9
 %
Selling and administrative (S&A) expenses
142,644

 
143,704

 
(1
)%
Amortization of acquisition-related intangibles
9,185

 
7,066

 
30
 %
Restructuring and other charges, net
717

 
10,143

 
(93
)%
Gain on sales of fixed assets
(69
)
 
(21
)
 
229
 %
Operating profit
174,856

 
130,065

 
 
Interest expense
16,595

 
12,807

 
30
 %
Other (income) expense, net
(576
)
 
(21,229
)
 
(97
)%
Income before taxes
158,837

 
138,487

 
 
Taxes on income
29,421

 
22,723

 
29
 %
Net income
$
129,416

 
$
115,764

 
12
 %
Diluted EPS
$
1.63

 
$
1.45

 
12
 %
Gross margin
43.6
%
 
43.8
%
 
(20
)
R&D as a percentage of sales
8.4
%
 
8.7
%
 
(30
)
S&A as a percentage of sales
15.3
%
 
17.3
%
 
(200
)
Operating margin
18.8
%
 
15.7
%
 
310

Adjusted operating margin (1)
19.4
%
 
18.9
%
 
50

Effective tax rate
18.5
%
 
16.4
%
 
210

Segment net sales
 
 
 
 
 
Flavors
$
449,019

 
$
406,164

 
11
 %
Fragrances
481,909

 
422,129

 
14
 %
Consolidated
$
930,928

 
$
828,293

 
 
 
(1)
Adjusted operating margin excludes $6.2 million of charges related to operational improvement initiatives, restructuring and other charges, net, acquisition related costs, gain on sale of assets and an FDA mandated product recall for the three months ended March 31, 2018, and excludes $26.1 million of charges related to operational improvement initiatives, acquisition related costs, integration related costs, tax assessment, restructuring and other charges, net and gain on sale of assets for the three months ended March 31, 2017. See "Non-GAAP Financial Measures" below.
Cost of goods sold includes the cost of materials and manufacturing expenses. R&D expenses related to the development of new and improved products, technical product support and compliance with governmental regulations. S&A expenses include expenses necessary to support our commercial activities and administrative expenses supporting our overall operating activities.

FIRST QUARTER 2018 IN COMPARISON TO FIRST QUARTER 2017
Sales
Sales for the first quarter of 2018 totaled $930.9 million, an increase of 12% on a reported basis and 7% on a currency neutral basis as compared to the prior year quarter. Sales growth was driven by new win performance (net of losses) in both Flavors and Fragrances and price increases in Flavors.
Flavors Business Unit
Flavors sales increased 11% on a reported basis and 6% on a currency neutral basis for the first quarter of 2018 compared to the first quarter of 2017. Acquisitions accounted for approximately 1% of the net sales growth on both a reported and a currency neutral basis. Sales growth excluding acquisitions reflected new win performance and favorable price increases,

25



partially offset by lower volume declines on existing business. Overall growth was primarily driven by low to high single-digit growth in all four Flavors end-use categories, led by mid single-digit growth in Dairy and Savory.
Fragrances Business Unit
Fragrances sales increased 14% on a reported basis and 8% on a currency neutral basis for the first quarter of 2018 compared to the first quarter of 2017. Reported sales growth reflected volume growth on existing business and new win performance. Overall growth was primarily driven by double-digit growth in Fragrance Ingredients, and by low single-digit to high single-digit growth in all end-use categories.
Sales Performance by Region and Category
 
 
 
% Change in Sales - First Quarter 2018 vs. First Quarter 2017
 
 
Fine Fragrances
 
Consumer Fragrances
 
Ingredients
 
Total Frag.
 
Flavors
 
Total
NOAM
Reported
10
 %
 
13
%
 
6
%
 
11
%
 
10
 %
 
10
%
EAME
Reported
7
 %
 
19
%
 
28
%
 
17
%
 
24
 %
 
20
%
 
Currency Neutral (1)
-5
 %
 
5
%
 
15
%
 
4
%
 
11
 %
 
7
%
LA
Reported
37
 %
 
3
%
 
26
%
 
11
%
 
-2
 %
 
6
%
 
Currency Neutral (1)
35
 %
 
3
%
 
24
%
 
11
%
 
-2
 %
 
6
%
GA
Reported
-15
 %
 
8
%
 
56
%
 
14
%
 
6
 %
 
9
%
 
Currency Neutral (1)
-17
 %
 
5
%
 
49
%
 
11
%
 
2
 %
 
6
%
Total
Reported
12
 %
 
11
%
 
26
%
 
14
%
 
11
 %
 
12
%
 
Currency Neutral (1)
4
 %
 
6
%
 
18
%
 
8
%
 
6
 %
 
7
%
_______________________
(1)
Currency neutral sales growth is calculated by translating prior year sales at the exchange rates for the corresponding 2018 period.

NOAM Flavors sales growth included the impact of acquisitions and primarily reflected high single-digit growth in Beverage, Sweet and Dairy and low single-digit growth in Savory. Total Fragrances sales growth reflected double-digit gains in Fine Fragrances, Toiletries, Fabric Care and Home Care, as well as high single-digit gains in Hair Care and low single-digit gains in Personal Wash and Fragrance Ingredients.
EAME Flavors sales experienced double-digit gains in Beverage and Dairy, high single-digit gains in Savory, and low single-digit gains in Sweet. Total Fragrances sales growth was driven mainly by double-digit growth in Toiletries, Hair Care, Home Care, and Fragrance Ingredients as well as low single-digit growth in Fabric Care. These gains more than offset low single-digit declines in Personal Wash and mid single-digit declines in Fine Fragrances.
LA Flavors sales included mid single-digit declines in Beverage and Sweet, which were partially offset by double-digit gains in Savory and low single-digit gains in Dairy. Total Fragrances sales growth reflected double-digit gains in Fragrance Ingredients and Fine Fragrances, mid single-digit gains in Hair Care, Personal Wash and Fabric Care, as well as high single-digit gains in Toiletries. These gains more than offset double-digit declines in Home Care.
GA Flavors sales growth included the impact of acquisitions and primarily reflected mid to high single-digit growth in Savory and Sweet, respectively, and low single-digit gains in Dairy, which were only partially offset by mid single-digit declines in Beverage. Total Fragrances sales growth was principally driven by double-digit gains in Fragrance Ingredients and Home Care, high single-digit gains in Fabric care, and mid single-digit gains in Toiletries, which more than offset double-digit declines in Fine Fragrances and low single-digit declines in Personal Wash.

Cost of Goods Sold
Cost of goods sold, as a percentage of sales, increased 20 bps to 56.4% in the first quarter of 2018 compared to 56.2% in the first quarter of 2017, principally driven by unfavorable price versus input costs, the impact of foreign exchange and the effect of the BASF supply chain disruption, which were only partially offset by cost savings and productivity initiatives and a favorable product sales mix.
Included in cost of goods sold were $5.0 million related to an FDA mandated product recall and a $0.5 million adjustment to the contingent consideration payable for PowderPure in the first quarter of 2018, as compared to $6.0 million of acquisition-related amortization of inventory "step-up" costs, operational improvement initiative costs and integration-related costs in 2017.

26



Research and Development (R&D) Expenses
Overall R&D expenses, as a percentage of sales, decreased slightly to 8.4% in the first quarter of 2018 versus 8.7% in the first quarter of 2017. The slight increase in 2018 was principally driven by the effect of foreign currency, and, to a lesser extent, incentive compensation.
Selling and Administrative (S&A) Expenses
S&A expenses decreased $1.1 million to $142.6 million, or 15.3% as a percentage of sales, in the first quarter of 2018 compared to $143.7 million, or 17.3% as a percentage of sales, in the first quarter of 2017. The $1.1 million decrease from the comparable quarter of the prior year was principally due to the effect of approximately $9.8 million in tax assessment and transaction costs in the prior year offset by unfavorable foreign currency effects and increased incentive compensation expenses in the current year. Included in 2018 was approximately $0.5 million of acquisition related costs, and included in 2017 was approximately $9.8 million of expense related to a tax assessment from prior year and acquisition-related costs. Excluding these costs, adjusted S&A expense increased by $9.2 million and was 15.4% of sales in 2018 compared to 16.2% of sales in 2017, principally due to the previously mentioned items.
Restructuring and Other Charges
2017 Productivity Program
On February 15, 2017, we announced that we were 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, we expect to optimize our global footprint and simplify our organizational structure globally. We expect 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.
We recorded $21.3 million of charges related to personnel costs and lease termination costs through the first quarter of 2018, with the remainder of the personnel related and other costs expected to be recognized by the end of 2018. We recorded $.7 million of charges related to personnel costs and lease termination costs three months ended March 31, 2018.
We made payments of $1.7 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 our global workforce, including acquired entities, in various parts of the organization.
Amortization of Acquisition-Related Intangibles
Amortization expenses increased to $9.2 million in the first quarter of 2018 compared to $7.1 million in the first quarter of 2017. The increase was principally driven by the impact of acquisitions.
Operating Results by Business Unit
We evaluate the performance of business units based on segment profit which is defined as operating profit before Restructuring and other charges, net; Global expenses (as discussed in Note 9 to the Consolidated Financial Statements) and certain non-recurring items, net; Interest expense; Other (expense) income, net; and Taxes on income. See Note 9 to the Consolidated Financial Statements for the reconciliation to Income before taxes. 

27



 
Three Months Ended March 31,
(DOLLARS IN THOUSANDS)
2018
 
2017
Segment profit:
 
 
 
Flavors
$
111,564

 
$
94,556

Fragrances
93,277

 
77,875

Global expenses
(23,825
)
 
(16,293
)
Operational Improvement Initiatives
(1,026
)
 
(621
)
Acquisition Related Costs
514

 
(8,788
)
Integration Related Costs

 
(1,192
)
Tax Assessment

 
(5,350
)
Restructuring and Other Charges, net
(717
)
 
(10,143
)
Gain on Sale of Assets
69

 
21

FDA Mandated Product Recall
(5,000
)
 

Operating profit
174,856

 
130,065

Profit margin:
 
 
 
Flavors
24.8
%
 
23.3
%
Fragrances
19.4
%
 
18.4
%
Consolidated
18.8
%
 
15.7
%

Flavors Segment Profit
Flavors segment profit increased $17.0 million to $111.6 million in the first quarter of 2018 (24.8% of segment sales) from $94.6 million (23.3% of sales) in the comparable 2017 period. The increase principally reflected new win performance and favorable price increases, partially offset by lower volume declines on existing business.
Fragrances Segment Profit
Fragrances segment profit increased $15.4 million to $93.3 million in the first quarter of 2018 (19.4% of segment sales) from $77.9 million (18.4% of sales) in the comparable 2017 period. The increase in segment profit was primarily due to higher volumes, favorable sales mix, and cost savings and productivity initiatives, which more than offset unfavorable price versus input costs primarily due to the impact of the BASF supply chain disruption.
Global Expenses
Global expenses represent corporate and headquarters-related expenses which include legal, finance, human resources and R&D and other administrative expenses that are not allocated to an individual business unit. In the first quarter of 2018, Global expenses were $23.8 million compared to $16.3 million during the first quarter of 2017. The increase was principally driven by higher incentive compensation expense and the effect of lower gains from our currency hedging program.
Interest Expense
Interest expense increased to $16.6 million in the first quarter of 2018 compared to $12.8 million in the 2017 period reflecting the issuance of the Senior Notes - 2017. Average cost of debt was 3.9% for the 2018 period compared to 3.7% for the 2017 period.
Other (Income) Expense, Net
Other (income) expense, net decreased by approximately $20.7 million to $0.6 million of income in the first quarter of 2018 versus $21.2 million of income in the comparable 2017 period. The year-over-year decrease was primarily driven by lower foreign exchange gains and the release of a currency translation adjustment ("CTA") upon the liquidation of a foreign entity in 2017.

28



Income Taxes
The effective tax rate for the three months ended March 31, 2018 was 18.5% compared with 16.4% for the three months ended March 31, 2017. The year-over-year increase was largely due to the impact of U.S. tax reform and increased loss provisions, partially offset by mix of earnings, a lower cost of repatriation (principally due to tax reform) and the release of a State valuation allowance that related to prior years. Excluding the $0.9 million tax benefit associated with the pre-tax restructuring, and operational improvement initiative costs which were partially offset by the tax charge associated with gains on sales of fixed assets, acquisition-related costs, and the impact of the U.S. tax reform in the current quarter, the adjusted effective tax rate for three months ended March 31, 2018 was 18.4%. For the first quarter of 2017, the adjusted tax rate was 20.5% excluding the $8.5 million tax benefit associated with the pre-tax restructuring, acquisition-related, tax assessment, integration-related and operational improvement initiative costs partially offset by the tax charge associated with gains on sales of fixed assets and the non-taxable gains on foreign currency. The year-over-year decrease was largely due to mix of earnings a lower cost of repatriation (principally due to tax reform) and the release of a State valuation allowance that related to prior years.
U.S. Tax Reform
On December 22, 2017, the U.S. government enacted comprehensive tax legislation commonly referred to as the Tax Cuts and Jobs Act (the “Tax Act”) that significantly revised the U.S. tax code effective January 1, 2018 by, among other things, lowering the corporate income tax rate from a top marginal rate of 35% to a flat 21%, limiting deductibility of interest expense and performance based incentive compensation, transitioning to a territorial system and creating new taxes associated with global operations.
In the fourth quarter of 2017, the Company recorded approximately $139.2 million in charges related to the impact of the Tax Act. Given the significant complexity of the Tax Act, anticipated guidance from the U.S. Treasury about implementing the Tax Act and the potential for additional guidance from the SEC or the FASB, the amount recorded by the Company in the fourth quarter of 2017 was provisional and will continue to be adjusted during 2018. The impact of the Tax Act is expected to be finalized no later than the fourth quarter of 2018. The aforementioned guidance and additional information regarding the Tax Act may also impact the Company's 2018 effective income tax rate, exclusive of any adjustment to the provisional charge. Any material revisions in our computations could adversely affect our cash flows and results of operations.
During the first quarter of 2018, we recorded an additional charge of $0.6 million to adjust an accrual related to withholding taxes on planned repatriations.
Liquidity and Capital Resources
Cash and Cash Equivalents
We had cash and cash equivalents of $305.3 million at March 31, 2018 compared to $368.0 million at December 31, 2017, of which $243.0 million of the balance at March 31, 2018 was held outside the United States. Cash balances held in foreign jurisdictions are, in most circumstances, available to be repatriated to the United States.
The Company regularly repatriates, in the form of dividends from its non-U.S. subsidiaries, a portion of its current year earnings to fund financial obligations in the U.S.
Cash Flows (Used In) Provided By Operating Activities
Net cash used in operating activities in the first three months of 2018 was $11.4 million compared to net cash provided by operating activities of $18.5 million in the first three months of 2017. The decrease in cash from operating activities for the first three months of 2018 compared to 2017 was principally driven by higher core working capital requirements, the effect of a payment for a product claim and the timing of certain other items, for the 2018 period as compared to 2017 period.
Working capital (current assets less current liabilities) totaled $1,253.6 million at March 31, 2018, compared to $1,127.8 million at December 31, 2017.
The Company sold certain accounts receivable on a non-recourse basis to unrelated financial institutions under “factoring” agreements that are sponsored, solely and individually, by certain customers. We believe that participating in the factoring programs strengthens our relationships with these customers and provides operational efficiencies. The beneficial impact on cash provided by operations from participating in these programs decreased approximately $11.0 million for the three months ended March 31, 2018 compared to a decrease of approximately $27.1 million for the three months ended March 31, 2017. The cost of participating in these programs was immaterial to our results in all periods.

29



Cash Flows Used In Investing Activities
Net investing activities during the first three months of 2018 used $35.2 million compared to $162.2 million in the prior year period. The decrease in cash used in investing activities principally reflected the acquisition of Fragrance Resources and PowderPure in 2017 for approximately $137.5 million (net of cash acquired) and $54.2 million (net of cash acquired), respectively. Additions to property, plant and equipment were $33.1 million during the first three months of 2018 compared to $26.7 million in the first three months of 2017. In light of our requirement to begin relocating our Fragrance facility in China and the ongoing construction of a new facility in India, we expect that capital spending in 2018 will be about 4.5-5% of sales (net of potential grants and other reimbursements from government authorities).
Cash Flows (Used In) Provided By Financing Activities
Net financing activities in the first three months of 2018 decreased to $14.6 million compared to $116.9 million of cash inflows in the first three months of 2017, principally driven by decreased utilization of our revolving credit facility and issuance of commercial paper, partially offset by higher dividend payments in the 2018 period compared to the 2017 period.
At March 31, 2018, we had $1,713.0 million of debt outstanding compared to $1,639.2 million outstanding at December 31, 2017.
We paid dividends totaling $54.4 million in the 2018 period. We declared a cash dividend per share of $0.69 in the first quarter of 2018 that was paid on April 6, 2018 to all shareholders of record as of March 26, 2018.
In December 2012, the Board of Directors authorized a $250.0 million share repurchase program, which commenced in the first quarter of 2013. In August 2015, the Board of Directors approved an additional $250 million share repurchase authorization and extension through December 31, 2017. Based on the total remaining amount of $56.1 million available under the amended repurchase program as of October 31, 2017, the Board of Directors re-approved on January 1, 2018 a $250.0 million share repurchase authorization and extension for a total value of $300.0 million available under the program. Based on the total remaining amount of $284.2 million available under the amended repurchase program, approximately 2.1 million shares, or 2.6% of shares outstanding (based on the market price and shares outstanding as of March 31, 2018) were remaining for repurchase under the program as of March 31, 2018. The purchases are authorized to be made from time to time on the open market or through private transactions as market and business conditions warrant, with the repurchased shares to be placed into treasury stock. On May 7, 2018, we announced plans to suspend share repurchases until our deleveraging target is met following our planned acquisition of Frutarom.
Capital Resources
Operating cash flow provides the primary source of funds for capital investment needs, dividends paid to shareholders and debt repayments. We anticipate that cash flows from operations and availability under our existing credit facilities are sufficient to meet our investing and financing needs for at least the next eighteen months. We regularly assess our capital structure, including both current and long-term debt instruments, as compared to our cash generation and investment needs in order to provide ample flexibility and to optimize our leverage ratios. We believe our existing cash balances are sufficient to meet our debt service requirements.
We supplement short-term liquidity with access to capital markets, mainly through bank credit facilities and issuance of commercial paper. Commercial paper issued by the Company generally has terms of 90 days or less. As of March 31, 2018, there was $29.9 million of commercial paper outstanding and no commercial paper outstanding as of December 31, 2017. The revolving credit facility is used as a backstop for the Company's commercial paper program. The maximum amount of commercial paper outstanding for the three months ended March 31, 2018 and 2017 was $40.0 million and $107.5 million, respectively.
We expect to contribute a total of approximately $4.1 million to its U.S. pension plans and a total of $17.1 million to our Non-U.S. Plans during 2018. During the three months ended March 31, 2018, no contributions were made to the qualified U.S. pension plans, $3.3 million of contributions were made to the non-U.S. pension plans, and $1.1 million of benefit payments were made with respect to the Company's non-qualified U.S. pension plan. We also expect to contribute approximately $5.0 million to our postretirement benefits other than pension plans during 2018.
As of March 31, 2018, we had $24.6 million outstanding under our revolving credit facility. The amount which we are able to draw down on under the facility is limited by financial covenants as described in more detail below. Our draw down capacity on the facility was $950.0 million at March 31, 2018.

30



Under our revolving credit facility, we are required to maintain, at the end of each fiscal quarter, a ratio of net debt for borrowed money to adjusted EBITDA in respect of the previous 12-month period of not more than 3.5 to 1. Based on this ratio, at March 31, 2018 our covenant compliance provided overall borrowing capacity of $1,481 million.
At March 31, 2018, we were in compliance with all financial and other covenants, including the net debt to adjusted EBITDA ratio. At March 31, 2018, our Net Debt/adjusted EBITDA (1) ratio, as defined by the debt agreements, was 1.71 to 1, well below the financial covenants of existing outstanding debt. Failure to comply with the financial and other covenants under our debt agreements would constitute default and would allow the lenders to accelerate the maturity of all indebtedness under the related agreement. If such acceleration were to occur, we would not have sufficient liquidity available to repay the indebtedness. We would likely have to seek amendments under the agreements for relief from the financial covenants or repay the debt with proceeds from the issuance of new debt or equity, and/or asset sales, if necessary. We may be unable to amend the agreements or raise sufficient capital to repay such obligations in the event the maturities are accelerated.

(1)
Adjusted EBITDA and Net Debt, which are non-GAAP measures used for these covenants, are calculated in accordance with the definition in the debt agreements. In this context, these measures are used solely to provide information on the extent to which we are in compliance with debt covenants and may not be comparable to adjusted EBITDA and Net Debt used by other companies. Reconciliations of adjusted EBITDA to net income and net debt to total debt are as follows:
(DOLLARS IN MILLIONS)
Twelve Months Ended March 31, 2018
Net income
$
309.3

Interest expense
69.2

Income taxes
248.1

Depreciation and amortization
124.6

Specified items (1)
46.3

Non-cash items (2)
28.2

Adjusted EBITDA
$
825.7

 
(1)
Specified items for the 12 months ended March 31, 2018 of $46.3 million consisted of legal charges/credits, acquisition-related costs, costs associated with product recalls, operational improvement initiative costs, restructuring and other charges, gains on sales of fixed assets, integration-related costs, tax assessment and CTA realization.
(2)
Non-cash items represent all other adjustments to reconcile net income to net cash provided by operations as presented on the Statement of Cash Flows, including gain on disposal of assets and stock-based compensation.
(DOLLARS IN MILLIONS)
March 31, 2018
Total debt
$
1,713.0

Adjustments:
 
Deferred gain on interest rate swaps
1.1

Cash and cash equivalents
(305.3
)
Net debt
$
1,408.8

As discussed in Note 13 to the Consolidated Financial Statements, at March 31, 2018, we had entered into various guarantees and had undrawn outstanding letters of credit from financial institutions. These arrangements reflect ongoing business operations, including commercial commitments, and governmental requirements associated with audits or litigation that are in process with various jurisdictions. Based on the current facts and circumstances, these arrangements are not reasonably likely to have a material impact on our consolidated financial condition, results of operations, or cash flows.
As discussed above under Recent Developments and in Note 14 to the Consolidated Financial Statements, in connection with our planned acquisition of Frutarom, we intend to finance the cash portion of the transaction consideration through a combination of existing cash on hand, significant new debt and equity. We have secured a bridge facility commitment letter to finance the cash portion of the merger consideration in the event we have not completed our anticipated financing transactions prior to the consummation of the merger.

31



New Accounting Standards
In February 2018, FASB issued amendments to the Income Statement - Reporting Comprehensive Income guidance 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 amendments to the Derivatives and Hedging guidance which eliminates the requirement to separately measure and present hedge ineffectiveness and aligns the presentation of hedge gains and losses with the underlying hedge item. This guidance is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted. The amended presentation and disclosure requirements are to be applied prospectively while the amendments to cash flow and net investment hedge relationships are to be applied on a modified retrospective basis. The Company is currently evaluating the impact this guidance will have on its Consolidated Financial Statements, but does not expect this guidance to have a material impact on its Consolidated Financial Statements.
In May 2017, the FASB issued amendments to the Compensation - Stock Compensation guidance 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 amendments to the Compensation - Retirement Benefits guidance which requires employers who present a measure of operating income in their statement of income to include only the service cost component of net periodic pension cost and postretirement costs in operating expenses. This guidance is effective, and as required, has been applied on a full retrospective basis. The impact of the adoption of this standard on January 1, 2018, was an increase in operating expenses of $7.3 million for the three months ended March 31, 2017, and an increase in income within Other (income) expense, net, as presented in the Company's Consolidated Statement of Income and Comprehensive Income. There was no impact to Net income or Net Income per share in either period.
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 authoritative guidance which requires changes to the classification of certain activities within the statement of cash flows. This guidance is effective, and the Company has determined that this adoption does not have a significant impact on its Consolidated Statement of Cash Flows.
In February 2016, the FASB issued authoritative guidance 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 30, 2018, the first day of the Company’s 2018 fiscal year, and that the adoption of this guidance will result in significant increases to assets and liabilities on its Consolidated Balance Sheet. The Company is still evaluating the impact of this guidance on its Consolidated Statement of Income and Comprehensive Income and Consolidated Statement of Cash Flows. The Company has begun to evaluate the nature of its leases and has compiled a preliminary analysis of the type and location of its leases. The Company expects that the significant portion of its lease liabilities will relate to property, with additional lease and corresponding right of use assets in existence that relate to vehicles and machinery.
Adoption of ASC Topic 606, Revenue from Contracts with Customers
In May 2014, the FASB issued authoritative guidance 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 (i) when control of the promised goods is transferred to customers and (ii) in an amount that reflects the consideration to which we expect to be entitled in exchange for those goods or services. Companies have the option to apply the new guidance under a retrospective approach to each prior reporting period presented or a modified retrospective approach with the cumulative effect of initially applying the new guidance recognized at the date of initial application within the Consolidated Balance Sheet. The new Revenue Standard became effective for annual

32



reporting periods beginning after December 15, 2017, and we have adopted the new revenue standard using the modified retrospective approach on December 30, 2017, the first day of our 2018 fiscal year.
We create and manufacture flavors and fragrances. Approximately 90% of 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 our contracts for Compounds products, we currently recognize revenue on the transfer of control of the product at a point in time as we do not have an “enforceable right to payment for performance to date” (as set out in Section 606-10-25-27(c) of the Revenue Standard). With respect to a small number of contracts for the sale of Compounds, we have an “enforceable right to payment for performance to date” and as the products do not have an alternative use and, we recognize revenue for these contracts over time and record 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 our contracts related to Ingredients products, we currently recognize revenue on the transfer of control of the product at a point in time as such products generally have alternative uses and we do not have an “enforceable right to payment for performance to date.”
As we adopted the Revenue Standard using the modified retrospective method effective the first day of our 2018 fiscal year, results for reporting periods beginning after December 31, 2017 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.
We recorded a net increase to retained earnings of $2.2 million as of December 30, 2017 due to the cumulative impact of adopting the Revenue Standard. As of the date of adoption, we also recorded an increase of $4.1 million in contract assets (which are included in Prepaid expenses and other assets), a decrease of $1.3 million in inventory, and an increase in taxes payable of $0.7 million.
The impact to revenues, gross profit and net income for three months ended March 31, 2018 were reductions of $0.5 million, $0.3 million and $0.2 million, respectively as a result of applying the Revenue Standard as compared to the amounts that would be been presented prior to adoption.
Non-GAAP Financial Measures
The Company uses non-GAAP financial operating measures in this Form 10-Q, including: (i) currency neutral sales (which eliminates the effects that result from translating its international sales in U.S. dollars), (ii) adjusted gross margin (which excludes operational improvement initiatives, acquisition related costs, integration related costs and FDA mandated product recall), (iii) adjusted operating profit and adjusted operating margin (which excludes operational improvement initiatives, acquisition related costs, integration related costs, tax assessment, restructuring and other charges, net, gain on sale of assets and FDA mandated product recall), (iv) adjusted selling and administrative expenses (which excludes acquisition related costs, integration related costs, tax assessment and restructuring and other charges, net) and (v) adjusted effective tax rate (which excludes operational improvement initiatives, acquisition related costs, integration related costs, tax assessment, restructuring and other charges, net, gain on sale of assets, CTA realization, FDA mandated product recall and U.S. tax reform). The Company also provides the non-GAAP measures adjusted EBITDA (which excludes certain specified items and non-cash items as set forth in the Company’s debt agreements) and net debt (which is adjusted for deferred gain on interest rate swaps and cash and cash equivalents) solely for the purpose of providing information on the extent to which the Company is in compliance with debt covenants contained in its debt agreements.
We provide these metrics because they are used by management as one means by which we assess our financial and operational performance and are also frequently used by analysts, investors and other interested parties in providing period to period comparisons of our operational performance. In addition, we believe that these measures, when used as supplements to GAAP measures of performance, are helpful to management and investors in evaluating the effectiveness of our business strategies and to compare our performance relative to our peers. Such information is supplemental to information presented in accordance with GAAP and is not intended to represent a presentation in accordance with GAAP. Currency neutral sales, adjusted gross margin, adjusted operating profit, adjusted operating margin, adjusted selling and administrative expenses and adjusted effective tax rate should not be considered in isolation or as substitutes for analysis of our results under GAAP and may not be comparable to other companies’ calculation of such metrics.


33



A. Reconciliation of Non-GAAP Metrics
Reconciliation of Gross Profit
 
Three Months Ended March 31,
(DOLLARS IN THOUSANDS)
2018
 
2017
Reported (GAAP)
$
405,809

 
$
363,083

Operational Improvement Initiatives (a)
453

 
621

Acquisition Related Costs (b)

 
5,301

Integration Related Costs (c)

 
88

FDA Mandated Product Recall (g)
5,000

 

Adjusted (Non-GAAP)
$
411,262

 
$
369,093

Reconciliation of Selling and Administrative Expenses
 
Three Months Ended March 31,
(DOLLARS IN THOUSANDS)
2018
 
2017
Reported (GAAP)
$
142,644

 
$
143,704

Acquisition Related Costs (b)
514

 
(3,487
)
Integration Related Costs (c)

 
(943
)
Tax Assessment (d)

 
(5,350
)
Adjusted (Non-GAAP)
$
143,158

 
$
133,924

Reconciliation of Operating Profit
 
Three Months Ended March 31,
(DOLLARS IN THOUSANDS)
2018
 
2017
Reported (GAAP)
$
174,856

 
$
130,065

Operational Improvement Initiatives (a)
1,026

 
621

Acquisition Related Costs (b)
(514
)
 
8,788

Integration Related Costs (c)

 
1,192

Tax Assessment (d)

 
5,350

Restructuring and Other Charges, net (e)
717

 
10,143

Gain on Sale of Assets
(69
)
 
(21
)
FDA Mandated Product Recall (g)
5,000

 

Adjusted (Non-GAAP)
$
181,016

 
$
156,138


34



Reconciliation of Net Income
 
Three Months Ended March 31,
 
2018
 
2017
(DOLLARS IN THOUSANDS)
Income before taxes
 
Taxes on income (i)
 
Net income
 
EPS (j)
 
Income before taxes
 
Taxes on income (i)
 
Net income
 
EPS
Reported (GAAP)
$
158,837

 
$
29,421

 
$
129,416

 
1.63

 
$
138,487

 
$
22,723

 
$
115,764

 
$
1.45

Operational Improvement Initiatives (a)
1,026

 
294

 
732

 
0.01

 
621

 
155

 
466

 
0.01

Acquisition Related Costs (b)
(514
)
 
(134
)
 
(380
)
 

 
8,788

 
3,138

 
5,650

 
0.07

Integration Related Costs (c)

 

 

 

 
1,191

 
362

 
829

 
0.01

Tax Assessment (d)

 

 

 

 
5,350

 
1,892

 
3,458

 
0.04

Restructuring and Other Charges, net (e)
717

 
169

 
548

 
0.01

 
10,143

 
2,967

 
7,176

 
0.09

Gain on Sale of Assets
(69
)
 
(17
)
 
(52
)
 

 
(21
)
 
(7
)
 
(14
)
 

CTA Realization (f)

 

 

 

 
(12,214
)
 

 
(12,214
)
 
(0.15
)
FDA Mandated Product Recall (g)
5,000

 
1,196

 
3,804

 
0.05

 

 

 

 

U.S. Tax Reform (h)

 
(649
)
 
649

 
0.01

 

 

 

 

Adjusted (Non-GAAP)
$
164,997

 
$
30,280

 
$
134,717