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| IFF > SEC Filings for IFF > Form 10-K on 26-Feb-2009 | All Recent SEC Filings |
26-Feb-2009
Annual Report
(Unless indicated otherwise, dollars in millions except per share amounts)
Organization of Information
Management's Discussion and Analysis provides a narrative on our operating performance, financial condition and liquidity and should be read in conjunction with the accompanying financial statements. It includes the following sections:
• Executive Overview
• Sales Commentary
• Consolidated Operating Results
• Goodwill and Intangible Assets
• Restructuring and Other Charges
• Income Taxes
• Postretirement Benefits
• Financial Condition
• Critical Accounting Policies and Use of Estimates
• New Accounting Standards
• Non-GAAP Financial Measures
• Cautionary Statement Under the Private Securities Litigation Reform Act of 1995
Executive Overview
We are a leading creator and manufacturer of flavor and fragrance compounds used to impart or improve the flavor or fragrance in a wide variety of consumer products. The precise size of the global market for flavors and fragrances is difficult to determine because the industry is highly fragmented, both geographically and along product lines; there are a limited number of publicly traded companies in the industry; certain customers maintain in-house capabilities fulfilling a portion of their flavor or fragrance needs; and the quality and depth of market information in developing regions of the world is limited. Analysts generally estimate the global market to be $14 billion of which IFF represents 16%; the largest competitor in the industry has approximately a 25% market share. IFF is one of the top four companies, which together represent 70% of the flavors and fragrances industry.
IFF is organized into two units that reflect our flavor and fragrance businesses. Approximately 46% of our 2008 net sales were flavor compounds. Flavor compounds are sold to the food and beverage industries for use in consumer products such as prepared foods, beverages, dairy, food and confectionery products. The remaining 54% of sales, representing the fragrance business unit, were in three fragrance categories: functional fragrances, including fragrance compounds for personal care (e.g., soaps) and household products (e.g., detergents and cleaning agents); fine fragrance and beauty care, including perfumes, colognes and toiletries; and ingredients, consisting of natural and synthetic ingredients that can be combined with other materials to create unique functional and fine fragrance compounds. Major fragrance customers include the cosmetics industry, including perfume and toiletries manufacturers, and the household products industry, including manufacturers of soaps, detergents, fabric care, household cleaners and air fresheners. Approximately 55% of our ingredient production is consumed internally; the balance is sold to third party customers.
Changing social habits resulting from such factors as increases in personal income, leisure time, health concerns, urbanization and population growth stimulate demand for consumer products utilizing flavors and fragrances. These developments expand the market for products with finer fragrance quality, as well as the market for colognes and toiletries. Such developments also stimulate demand for convenience foods, soft drinks and low-
fat and organic food products that must conform to expected tastes. These developments necessitate the creation and development of flavors and fragrances and ingredients that are compatible with newly introduced materials and methods of application used in consumer products.
Flavors and fragrances are generally:
• created for the exclusive use by a specific customer;
• sold in powder or liquid form, in amounts ranging from a few pounds to several tons depending on the nature of the end product in which they are used;
• a small percentage of the volume and cost of the end product sold to the consumer; and
• a major factor in consumer selection and acceptance of the product.
The flavors and fragrances industry is impacted by macroeconomic factors in all product categories and geographic regions. Such factors include the impact of currency on the price of raw materials and operating costs as well as on translation of reported results. In addition, IFF is susceptible to margin pressures due to customers' cost improvement programs and input cost increases. However, these pressures can often be mitigated through a combination of product reformulation, sourcing strategies and material substitution plus internal cost containment efforts, and the development of innovative and streamlined solutions and processes.
We produce more than 33,000 unique compounds, of which approximately 60% are flavors and 40% fragrances. We continually create new compounds to meet the changing characteristics and needs of our customers' end products. No single compound represents more than 2% of net sales. Development of flavors and fragrances is a complex artistic and technical process calling upon the combined knowledge and talents of creative perfumers and flavorists, and application and research chemists. An important element of creation is the development of new ingredients. We bear essentially all costs incurred in connection with the creation and development of new flavors and fragrances and such formulae are generally protected under trade secrecy. We are not materially dependent on any patents, trademarks or licenses.
IFF's success in the flavors and fragrances industry is driven by our ability to create unique sensory experiences that meet evolving consumer needs and expectations. These solutions are delivered in a cost-efficient manner in conjunction with world-class customer service.
STRATEGIC DRIVERS
We are well positioned to increase shareholder value by executing the following key drivers: targeting strategically important global and regional customers in both developed and emerging markets; attracting, developing and retaining top talent; and fostering a culture of innovation and continuous improvement. Our goal is to deliver differentiated solutions that enable our customers' brands to win in the marketplace.
Customers
We believe there is a great deal of opportunity to grow sales by earning a greater share of our customers' business across multiple categories, both in the developed and emerging markets. We use our proprietary tools of consumer insight to understand the connections between the consumer, the product, and the brand. This enables us to create flavors and fragrances that resonate with consumers and drive brand loyalty.
People
As a leading creator of flavors and fragrances, our ability to succeed is highly dependent on our greatest asset - our people. We continue to invest considerable time and resources in developing our leaders to build IFF for the long-term.
Innovation
IFF continues to focus on creating innovative processes, technologies and delivery systems, which includes a significant financial commitment to research and development. We see potential to gain market share by providing
unique solutions to our customers that enable their brands to win in the marketplace. In addition, by streamlining internal processes, we are better able to allocate resources to appropriate initiatives.
As implementation of our strategy progresses, setting strategic initiatives requires regular establishment and reassessment of priorities and necessitates choices in order to provide the best opportunity for continuous improvement in shareholder value.
Sales Commentary
A breakdown of sales by principal product category is depicted in the graph below.
2008 Sales by Category
Our five largest customers comprise 32% of consolidated sales and our top 30 customers 56%; these percentages have remained fairly constant for several years, although sales to larger customers are trending higher. We have one customer that accounts for 11% of our sales. A key factor for commercial success is inclusion on the strategic customers' core supplier lists, opening opportunities to win new business. We are on the core supplier lists of a majority of our strategic customers.
Net sales by business unit for 2008, 2007 and 2006 were as follows:
Percent Percent
Net Sales 2008 Change 2007 Change 2006
Flavors $ 1,092 9 % $ 1,006 12 % $ 895
Fragrances 1,297 2 % 1,271 6 % 1,200
Total net sales $ 2,389 5 % $ 2,277 9 % $ 2,095
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2008 Sales by Destination
We currently manage our operations by business unit but consider destination sales a supplemental performance measure. Although reported sales and earnings are affected by the weakening or strengthening of the U.S. dollar, this has not had a long-term effect on the underlying strength of our business.
[[Image Removed: GRAPH]]
Net sales by destination for 2008, 2007 and 2006 were as follows:
Percent Percent
Sales by Destination 2008 Change 2007 Change 2006
EAME(1) $ 898 6 % $ 850 12 % $ 758
North America 601 -4 % 630 3 % 612
Greater Asia 556 13 % 491 12 % 439
Latin America 334 9 % 306 7 % 286
Total net sales, as reported $ 2,389 5 % $ 2,277 9 % $ 2,095
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(1) Europe, Africa and Middle East
2008 in Comparison to 2007
Sales totaled $2,389 million for 2008, up 5% from 2007; Flavor and Fragrance sales increased 9% and 2%, respectively. 2008 sales benefited from the generally weaker U.S. dollar and at comparable exchange rates would have increased 2% over the prior year.
Flavors Business Unit
Flavor sales increased 9% for 2008 based on new wins across all regions, particularly in the beverage category, led by a 21% increase in Latin America. Excluding the impact of currencies, sales growth for the Flavors business was 6%.
Fragrances Business Unit
Fragrance sales increased 2%. Excluding the impact of currencies, Fragrance sales declined 1% as strong growth in emerging markets was offset by weakness in the U.S. market. New product introductions of fragrance compounds were offset by volume declines primarily in the U.S. and EAME. Ingredient sales benefited from price increases, partially offset by volume declines as part of a product rationalization initiative and weaker economies in the U.S. and EAME.
Sales By Region and Category
Regional and product category sales performance for 2008 compared to the prior
year, in reported dollars and local currency, was as follows:
2008 vs. 2007
Percent Change in Sales by Region of Destination
Fine & Total
Beauty Care Functional Ingredients Frag. Flavors Total
North America Reported -14 % -10 % -2 % -10 % 2 % -4 %
EAME Reported 2 % 8 % 6 % 5 % 7 % 6 %
Local Currency -4 % 2 % -1 % -1 % 2 % 0 %
Latin America Reported 7 % -2 % 17 % 3 % 21 % 9 %
Greater Asia Reported 19 % 13 % 11 % 14 % 13 % 13 %
Local Currency 17 % 12 % 7 % 12 % 10 % 11 %
Total Reported 0 % 3 % 5 % 2 % 9 % 5 %
Local Currency -3 % 0 % 1 % -1 % 6 % 2 %
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• North America flavors new product introductions of $22 million and some benefit from price increases were largely offset by volume declines. Weak economic conditions and significant slowdown in customer order activity led to volume declines in fine and functional fragrance compounds and ingredients. Fine fragrance sales were also negatively impacted by customer inventory corrections in the first half of the year.
• Flavors sales in EAME were up as new product introductions of $22 million were partially offset by volume declines. Fine and functional fragrance new product introductions of $18 million and $15 million were offset by volume declines. Price increases in ingredients were offset by volume declines.
• Latin America flavors sales were strong throughout the region, driven mainly by new product introductions of $19 million. Fragrance sales growth was driven by new product introductions of $10 million offset by volume decreases, primarily in functional. Ingredients sales benefited from higher volumes coupled with price increases.
• Greater Asia sales growth in Flavors was driven by new product introductions of $16 million plus volume and price increases. Fragrance sales benefited from new product introductions of $25 million, partially offset by volume declines.
2007 in Comparison to 2006
Sales totaled $2,277 million, up 9% from 2006; flavor and fragrance sales increased 12% and 6%, respectively. 2007 sales benefited from the generally weaker U.S. dollar and at comparable exchange rates would have increased 5% over the prior year.
Flavors Business Unit
Flavors delivered strong sales performance across all regions - most notably in Latin America, Greater Asia and Europe - and in virtually all categories, particularly beverages and savory.
Fragrance Business Unit
Total Fragrance sales increased by 6% for the year and were driven by continued growth in Fine and Beauty Care of 8% and Ingredients of 9%, despite a decline in Ingredients pricing. Foreign exchange accounted for 4% of the sales increase.
Sales By Region and Category
Regional and product category sales performance for 2007 compared to the prior
year, in reported dollars and local currency, was as follows:
2007 vs. 2006
Percent Change in Sales by Region of Destination
Fine & Total
Beauty Care Functional Ingredients Frag. Flavors Total
North America Reported 4 % -1 % 1 % 2 % 4 % 3 %
EAME Reported 8 % 12 % 17 % 12 % 13 % 12 %
Local Currency 0 % 4 % 8 % 3 % 5 % 4 %
Latin America Reported 11 % -7 % 3 % -1 % 27 % 7 %
Greater Asia Reported 16 % 2 % 4 % 6 % 16 % 12 %
Local Currency 13 % 1 % 4 % 4 % 12 % 9 %
Total Reported 8 % 3 % 9 % 6 % 12 % 9 %
Local Currency 4 % 0 % 5 % 2 % 9 % 5 %
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• North America fine fragrance growth was driven by new product introductions of $20 million partially offset by volume declines. Ingredients volume growth was partially offset by pricing declines. The decline in Functional fragrances was mainly volume related. Flavors sales growth was driven by new product introductions of $20 million mainly in the beverage and savory categories.
• EAME flavor sales growth resulted mainly from new product introductions of $25 million. Functional fragrance growth was strong primarily due to new product introductions of $23 million partially offset by volume declines and to a lesser extent lower pricing. The growth in fine fragrance related to new product
introductions of $28 million was offset by volume declines. Ingredients sales growth was volume related, partially offset by lower pricing.
• Latin America sales growth reflects strong performances in both flavors and fine fragrances. Flavors growth was driven by new product introductions of $21 million. Fine fragrances sales growth is largely attributable to new product introductions of $9 million. Functional fragrance performance was primarily volume related in the fabric care category; we saw some reversal of this trend in the fourth quarter as a result of new product introductions. Ingredients sales performance was largely due to volume increases partially offset by price declines.
• Greater Asia sales growth was driven by new product introductions of $35 million in flavors. Fragrance sales growth was driven by fine fragrances as a result of new product introductions of $4 million.
Consolidated Operating Results
The percentage relationship of cost of goods sold and other operating expenses
to reported sales is detailed as follows:
2008 2007 2006
Cost of goods sold 59.4% 58.2% 57.8%
Research and development expenses 8.9% 8.7% 8.9%
Selling and administrative expenses 16.0% 16.5% 16.8%
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Cost of goods sold includes the cost of materials and manufacturing expenses; raw materials generally constitute 70% of the total. Research and development expenses are for the development of new and improved products, technical product support, compliance with governmental regulations, and help in maintaining relationships with customers who are often dependent on technological advances. Selling and administrative expenses support our sales and operating levels.
2008 in Comparison to 2007
Cost of goods sold, as a percentage of sales, was 59.4% compared with 58.2% in 2007. This increase was mainly the result of higher input costs and lower absorption of manufacturing expenses, most notably in North America fragrance compounds. These factors were partially offset by internal efficiencies, reformulation and material substitution efforts. Product mix, notably lower sales of fine and beauty care compounds, also impacted cost of goods sold as a percentage of sales.
Research and development expense, as a percentage of sales, was 8.9%. This increase over the prior year period reflects increasing investments in customer applications and basic research.
Selling and administrative expenses, as a percentage of sales, was 16.0% in the current period compared to 16.5% in the prior year period. The 2008 results included the benefit of a $3 million insurance recovery related to a 2005 product contamination matter offset by $3 million of employee separation costs. The 2007 results included $4 million of business transformation costs that enabled us to better leverage our global SAP software platforms. The decline in selling and administrative expenses, as a percentage of sales, is mainly attributable to lower incentive compensation. This was partially offset by $2 million related to the implementation of our global shared service center.
Interest Expense
Interest expense totaled $74 million compared to $42 million in 2007, due to higher borrowings incurred in connection with the 2007 share repurchase activities as well as a wider spread between the LIBOR (London InterBank Offer Rate) and EURIBOR (European InterBank Offer Rate) interest rates applicable to our interest rate swaps. Average cost of debt was 6.1% for 2008 compared to 4.5% in 2007.
Other (Income) Expense, Net
Other income was $3 million in 2008 as compared to $11 million in 2007. Other income in 2007 included $11 million related to gains on asset sales.
Income Taxes
The effective tax rate was 18.1% in 2008 as compared to a rate of 24.8% in the prior year. The lower tax rate in the current year primarily reflects the benefit of higher tax settlements related to prior years and a higher proportion of earnings in lower tax jurisdictions. The 2008 rate includes a $23 million benefit, primarily tax settlements related to prior years; the 2007 rate includes $10 million of similar benefits.
Operating Results by Business Unit
We evaluate the performance of business units based on operating profit before gains/losses on the disposition of assets, interest expense, other income (expense), net and income taxes. See Note 12 to our Consolidated Financial Statements for the reconciliation to Income before taxes.
Flavors Business Unit
In 2008, Flavors operating profit totaled $198 million, or 18.1% as a percentage of sales, compared to $187 million or 18.6% in 2007. The 2008 amount includes $3.5 million of restructuring expenses. Excluding the restructuring charge, profitability was comparable year over year as strong sales growth augmented by lower incentive compensation expense was partially offset by unfavorable product mix.
Fragrance Business Unit
In 2008, Fragrance operating profit of $199 million, or 15.3% as a percentage of sales, declined from the $210 million or 16.5% reported in 2007. The 2008 amount includes $4.4 million of restructuring expenses. The decline in profit was driven by unfavorable absorption of manufacturing expenses from the shortfall in sales in North America, as well as unfavorable mix, with declining fine fragrance sales, partially offset by lower incentive compensation expense.
Global Expenses
Global expenses represent corporate and headquarters-related expenses which include legal, finance, human resources and other administrative expenses that are not allocated to an individual business unit, as well as gains on asset sales and a pension curtailment charge. In 2008, Global expenses were $45 million as compared to $27 million in 2007. In 2008, Global expenses included approximately $10 million of restructuring charges, $3 million of employee separation costs and $2 million of implementation costs related to our global shared service center, partially offset by a $3 million insurance recovery related to a 2005 product contamination. Global expenses in 2007 included a $6 million curtailment loss related to changes to the U.S. defined benefit pension plan and $11 million related to the gains on asset sales.
2007 in Comparison to 2006
Cost of goods sold, as a percentage of sales, was 58.2% compared with 57.8% in 2006. This increase was mainly as a result of product mix, notably higher sales of fragrance ingredients and flavor compounds. Lower selling prices for fragrance ingredients, some impact of higher material costs and under absorption of manufacturing costs at a new fragrance ingredient facility in China, which scaled up production in 2007, also contributed to the increase. The average cost of raw materials increased 2-3% over the prior year.
Research and Development expense, as a percentage of sales, was 8.7%, comparable to the prior year levels.
Selling and administrative expenses, as a percentage of sales, was 16.5% in the period compared to 16.8% in the prior year period, reflecting good cost control and the benefit of headcount reductions that occurred in the first half of 2006. Selling and administrative expenses in 2007 include $4 million of business transformation costs to
enable us to better leverage our global SAP software platform. The 2006 results also included the benefit of a $3 million insurance recovery related to a 2005 product contamination matter; excluding the insurance recovery, 2006 Selling and administrative expenses would have been 16.9% of sales for the year.
Interest Expense
In 2007, interest expense totaled $42 million, increasing 63% compared to 2006, due to higher borrowings incurred in connection with share repurchase activities. See Note 10 to the Consolidated Financial Statements for further discussion of the share repurchase activities. Average cost of debt was 4.5% for 2007 compared to 3.3% in 2006.
Other (Income) Expense, Net
Other (income) expense, net in 2007 increased $1 million over the prior year, mainly due to favorable exchange results and higher interest income as a result of higher interest rates. Other income included $11 million and $15 million, in 2007 and 2006, respectively, primarily related to gains on asset sales.
Income Taxes
The effective tax rate was 24.8% in 2007 as compared to a rate of 27.7% in the prior year. Both the 2007 and 2006 rates benefited from favorable tax rulings with respect to prior years; excluding the benefit of these rulings from both years, the 2007 effective tax rate would have been 27.8% compared to a rate of 28.8% for 2006. The lower effective tax rate for the current year was largely the result of a greater percentage of consolidated pre-tax earnings in lower tax jurisdictions.
Operating Results by Business Unit
We evaluate the performance of business units based on operating profit before gains/losses on the disposition of assets, interest expense, other income (expense), net and income taxes. See Note 12 to our Consolidated Financial Statements for the reconciliation to Income before taxes.
Flavors Business Unit
In 2007, Flavors operating profit of $187 million, or 18.6% as a percentage of sales, increased as compared to $153 million or 17.1% in 2006. The amount reported in 2006 benefited from a $3 million insurance recovery related to a 2005 product contamination matter; excluding the insurance recovery from the prior year comparative, Flavors profitability would have increased an additional 30 basis points over 2006. This profitability improvement was primarily driven by margin improvement enabled by strong sales growth, favorable product mix, . . .
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