ITEM 1B.
UNRESOLVED STAFF COMMENTS.
None.
Our principal properties are as follows:
_______________________
(1)
Leased.
(2)
We have a 93.4% interest in the subsidiary company that owns this facility.
(3)
Land is leased and building, machinery and equipment are owned.
(4)
Building is leased and machinery and equipment are owned.
(5)
We have a 90% interest in the subsidiary company that leases the land and owns the buildings and machinery.
Our principal executive offices and New York laboratory facilities are located at 521 West 57th Street, New York City.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS.
We are subject to various claims and legal actions in the ordinary course of our business.
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.
We have been identified as a PRP at seven facilities operated by third parties at which investigation and/or remediation activities may be ongoing. We analyze our potential liability on at least a quarterly basis. We accrue for environmental liabilities when they are probable and estimable. We estimate our share of the total future cost for these sites to be less than $3 million.
While joint and several liability is authorized under federal and state environmental laws, we believe the amounts we have paid and anticipate paying in the future for clean-up costs and damages at all sites are not material and will not have a material adverse effect on our 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 us to materially increase the amounts we anticipate paying for clean-up costs and damages at these sites, and that such increased amounts will not have a material adverse effect on our financial condition, results of operations or cash flows.
Other
We are also a party to other litigations arising in the ordinary course of our business. We do not expect the outcome of these cases, singly or in the aggregate, to have a material effect on our consolidated financial condition.
ITEM 4.
ITEM 4.
MINE SAFETY DISCLOSURES.
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information.
Our common stock is principally traded on the New York Stock Exchange and available on the Tel Aviv Stock Exchange, both under the ticker symbol "IFF".
Approximate Number of Equity Security Holders.
Issuer Purchases of Equity Securities.
None.
Performance Graph.
The following graph compares a shareholder’s cumulative total return for the last five fiscal years as if such amounts had been invested in: (i) our common stock; (ii) the stocks included in the S&P 500 Index; and (iii) a customized Peer Group. The graph is based on historical stock prices and measures total shareholder return, which takes into account both changes in stock price and dividends. The total return assumes that dividends were reinvested daily and is based on a $100 investment on December 31, 2013.
SOURCE: S&P Capital IQ
Due to the international scope and breadth of our business, we believe that a Peer Group comprising international public companies, which are representative of the customer group to which we sell our products, is the most appropriate group against which to compare shareholder returns. See the table below for the list of companies included in our Peer Group.
Peer Group Companies
Avon Products, Inc.
Hormel Foods Corporation
Campbell Soup Company
Kellogg Company
Church & Dwight Co., Inc.
The Estée Lauder Companies Inc.
The Clorox Company
McCormick & Company, Incorporated
The Coca-Cola Company
McDonald’s Corporation
Colgate-Palmolive Company
Nestle SA
ConAgra Brands, Inc.
PepsiCo, Inc.
Edgewell Personal Care Company(1)
The Procter & Gamble Company
General Mills, Inc.
Revlon, Inc.
Heinz (HJ) Co.(1)
Sensient Technologies Corporation
The Hershey Company
Unilever N.V.
Hillshire Brands Co.(1)
YUM! Brands, Inc.
(1)
In July 2012, Sara Lee Corp. spun off certain of its businesses and changed its name to Hillshire Brands Co. Heinz (HJ) Co. was acquired by Hawk Acquisition Holding Corp on June 7, 2013 and has only been included through that date. Hillshire Brands Co. was acquired by Tyson Foods on August 28, 2014 and has only been included through that date. Edgewell Personal Care has been included starting from July 1, 2015 when it spun off from Energizer Holdings.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA.
INTERNATIONAL FLAVORS & FRAGRANCES INC.
QUARTERLY FINANCIAL DATA
(UNAUDITED)
The following selected consolidated financial data is derived from our Consolidated Financial Statements. This data should be read in conjunction with the Consolidated Financial Statements and Notes thereto, and with Item 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
(UNLESS INDICATED OTHERWISE, DOLLARS IN MILLIONS EXCEPT PER SHARE AMOUNTS)
Overview
Frutarom acquisition
On October 4, 2018, we completed the acquisition of Frutarom Industries Ltd. (“Frutarom”). We acquired 100% of the equity of Frutarom pursuant to a definitive agreement and plan of merger entered into on May 7, 2018. Frutarom is an Israeli company that, through its subsidiaries, develops, produces and markets tastes, flavors and fine ingredients used in manufacturing food, beverages, flavors and fragrances, pharma/nutraceuticals, cosmetics and personal care products, primarily focused on natural products. The acquisition was made in order to strengthen and broaden our customer base, capabilities and geographic reach, and is expected to result in exposure to more end markets, including those with a focus on naturals and health and wellness.
The consideration paid to Frutarom shareholders was funded with (i) borrowings under our term loan credit agreement, (ii) amounts received from our offering of common stock that closed in September 2018, (iii) amounts received from our offering of TEUs that closed in September 2018, (iv) amounts received from our offering of €1.1 billion aggregate principal amount of senior unsecured euro-denominated notes that closed in September 2018, (v) amounts received from our offering of $1.5 billion aggregate principal amount of senior unsecured U.S. dollar-denominated notes that closed in September 2018 and (vi) the issuance of approximately 14.9 million shares of our common stock, which resulted in former Frutarom shareholders holding approximately 14.0% of our outstanding common stock at closing.
The transaction was valued, based on our stock price as of October 4, 2018, at approximately $7 billion, including the assumption of approximately $695 million of Frutarom's net debt, which we repaid concurrent with the closing of the transaction. Frutarom's operating results have been included in our operating results from October 4, 2018.
Company background
We are a leading innovator of sensory experiences that move the world. We co-create unique products that consumers taste, smell, or touch. Our expanded geographical footprint and product portfolio position us to better serve both our global customers and the growing regional, mid-sized and smaller specialty customers.
Through the acquisition of Frutarom, we increased our product portfolio with complementary adjacencies, such as natural colors, anti-oxidants for food preservation, nutraceuticals, ingredients for infant formula and proteins for elderly nutrition, and expanded core product lines with savory solutions aimed at the meat and fish industry, citrus and other naturals flavors, specialty ingredients and new cosmetic actives. As a result, we now have over 90,000 products within our portfolio that are provided to customers in approximately 195 countries, which includes a significant number of faster-growing small and mid-sized customers.
The 2018 combined sales of IFF and Frutarom, which combines the full year 2018 sales of both Frutarom and IFF, was approximately $5.1 billion which, management believes, makes us the second largest company in the taste, scent and nutrition industry. We expect that our combined cultures of innovation and partnership will allow us to further capitalize on this expansion to continue to offer our customers innovative and differentiated products. Based on our 2018 combined sales, approximately 35% of our customers are global consumer products companies while approximately 65% of our customers are small and mid-sized companies.
During the past few years, through acquisitions and the development of Tastepoint, we have leveraged our expertise to expand our North American mid-sized customer base. With the acquisition of Frutarom, which was principally focused on serving small and mid-sized companies globally, we have significantly increased our exposure to these faster-growing customers.
We operate in three business segments, Taste (previously "Flavors"), Scent (previously "Fragrances") and, commencing upon its acquisition, Frutarom. In 2018, our Taste business represented 44% of our sales, our Scent business represented 47% of sales and Frutarom represented 9% of sales. Based on our 2018 combined sales, our Taste business represented 34% of sales, our Scent business represented 36% of sales and Frutarom represented 30% of sales.
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 Scent
business consists of Fragrance Compounds and Fragrance Ingredients. Our Fragrance Compounds are defined into two broad categories, Fine Fragrances and 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 active and functional ingredients that are used internally and sold to third parties, including customers and competitors, and are included in the Scent business unit.
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 Flavor Compounds, 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. Consequently, we manage our flavors business geographically, creating Flavor Compounds in our regional creative centers which allow us to satisfy local taste preferences, while also helping to ensure regulatory compliance and production standards. We develop thousands of different flavors and taste offerings for our customers, most of which are tailor-made. We continually develop new formulas to meet changing consumer preferences and customer needs. Our Flavor Compounds are ultimately used by our customers in the following four end-use categories of consumer goods: (1) Savory, (2) Beverages, (3) Sweet and (4) Dairy.
Our Frutarom business creates and manufactures a naturals-focused suite of Flavor Compounds and specialty fine ingredients, largely targeting small, local and regional customers. Our Frutarom business seeks to capitalize on the health and wellness emphasis of consumers and deliver growth by offering customers natural flavor products that combine solutions to create natural colors, extending shelf life and natural functional food ingredients. Frutarom’s products are focused on three principal areas: (1) Savory Solutions, (2) Natural Product Solutions, which includes natural health ingredients, natural color and natural food protection, and (3) Taste Solutions.
2018 FINANCIAL PERFORMANCE OVERVIEW
Sales in 2018 increased 17% on a reported basis and 15% on a currency neutral basis (which excludes the effects of changes in currency), with the effects of the Frutarom acquisition contributing approximately 11% to reported growth rates and 10% to currency neutral growth rates. Taste achieved reported sales growth of 6% and currency neutral sales growth of 5%. Scent achieved sales growth of 6% on a reported basis and 4% on a currency neutral basis in 2018. From a geographic perspective, North America ("NOAM"), Europe, Africa and Middle East ("EAME"), Greater Asia ("GA") and Latin America ("LA") all delivered sales growth on a consolidated basis in 2018, led by EAME.
Overall, our 2018 results continued to be driven by our strong emerging market presence that represented 48% of total sales and experienced 17% growth on a reported basis and 16% growth on a currency neutral basis in 2018. We continue to benefit from our diverse portfolio of products and geographies and had sales growth in our Taste and Scent business units. Both Taste and Scent benefited from new win performance (net of losses). Exchange rate variations did not have a material impact on revenue in 2018. The effect of exchange rates can vary by business and region depending upon the mix of sales by country as well as the relative percentage of local sales priced in U.S. dollars versus local currencies. We saw currency neutral sales growth during each quarter of 2018.
Our 25 largest customers accounted for 47% of total sales in 2018; this percentage has remained fairly constant for several years. Sales to our largest customer across all end-use categories accounted for 9% to 12 % of our sales for each of the last three fiscal years. A key factor for commercial success is inclusion on our strategic customers’ core supplier lists, which provides opportunities to win new business. We are on the core supplier lists of a large majority of our global and strategic customers within flavors and fragrances.
Gross margin decreased 102 basis points ("bps") year-over-year, driven primarily by unfavorable price versus input costs (including the net impact of the BASF supply disruption), which was only partially offset by cost savings and productivity initiatives. Included in 2018 was $23.6 million of Frutarom acquisition related inventory "step-up" costs, $1.7 million of costs associated with operational improvement initiatives and $0.1 million of integration related costs, offset by $7.1 million income from net insurance recoveries from the previously disclosed FDA mandated product recall, compared to $15.9 million of acquisition-related inventory "step-up" costs, $11.0 million related to the FDA mandated product recall, $1.8 million of costs associated with operational improvement initiatives and $0.5 million of integration related costs in 2017. Excluding these items, adjusted gross margin decreased 142 bps compared to the prior year period.
Operating profit increased $31.3 million to $583.9 million (14.7% of sales) in 2018 compared to $552.6 million (16.3% of sales) in 2017. Included in 2018 were Frutarom acquisition related costs of $89.6 million, integration related costs of $7.2 million, restructuring and other charges of $4.1 million and operational improvement initiative costs of $2.2 million, partially offset by $7.1 million in income from net insurance recoveries from the previously disclosed FDA mandated product recall, acquisition related costs of $1.3 million and gain on sale of fixed assets of $1.2 million. Included in 2017 were restructuring and other charges of $19.7 million, acquisition-related costs of $20.4 million, $11.0 million relating to an FDA mandated product recall, reserve for payment of a tax assessment related to commercial rent for prior periods of $5.3 million, integration related costs of $4.2 million, pension settlement charges of $2.8 million, operational improvement initiative costs of $1.8 million and an additional charge related to litigation settlement of $1.0 million, partially offset by gain on sale of fixed assets of $0.2 million. Excluding these charges, adjusted operating profit was $677.4 million for 2018, an increase from $618.6 million for 2017, principally driven by volume growth, the impact of foreign exchange, and cost and productivity initiatives which was partially offset by price to input costs (including the impact of the BASF supply chain disruption) and increases Selling and administrative expenses. Foreign currency had a 3% favorable impact on operating profit in the 2018 period compared to a 1% unfavorable impact on operating profit in the 2017 period. Operating profit as a percentage of sales, excluding the above charges, decreased from 17.0% for 2018 compared to 18.2% for 2017, principally driven by lower margins as a result of price to input costs (including the net impact of the BASF supply chain disruption) and increases in Selling and administrative expenses, offset by cost and productivity initiatives and new win performance (net of losses)
Cash flows from operations were $437.6 million or 11.0% of sales in 2018 as compared to cash flows from operations of $390.8 million, or 11.5% of sales, during 2017. The increase in operating cash flows in 2018 as compared to 2017 was principally driven by lower litigation settlement and pension payments and higher net income, offset by higher net working (principally related to inventories).
Our capital spend was $170.1 million (4.3% of sales) during 2018. In light of our requirement to begin relocating one of our Fragrance Ingredients facilities in China, the ongoing construction of new facilities in India and Indonesia, and capital
requirements to integrate our recently acquired Frutarom business, we expect that capital spending in 2019 will be about 5-6% of sales (net of potential grants and other reimbursements from government authorities).
Effective the first quarter of 2018, we adopted new accounting guidance related to revenue recognition and the presentation of pension costs. The revenue recognition guidance was adopted effective the first day of fiscal 2018 and prior period amounts were not revised to conform to the new guidance. The adoption of the new revenue guidance did not have a material impact on our results of operations. The guidance related to the presentation of pension costs was applied retroactively and prior period amounts have been adjusted to conform to the new guidance. As noted in Note 16 to the Consolidated Financial Statements, the net effect of the change was to decrease operating profit and increase Other income.
2019 OUTLOOK
We believe that market conditions and the macro-economic environment will continue to be volatile in many markets in 2019 but that overall, there will be slight improvements as compared to recent years. Pressures from increasing costs and the impact of supply chain disruptions related to key ingredients used in the flavors and fragrance industry may reduce our currency neutral operating profit growth in 2019.
During 2018, the raw material cost environment continued its recent upward trend. We believe that, for the next several quarters, we will continue to see higher costs of raw materials across a range of categories. Raw material costs continue to be impacted by supply chain disruptions, mainly impacting our Scent business unit. We continue to seek improvements in our margins through operational performance, cost reduction efforts and mix enhancement as well as integration savings with Frutarom.
On a long-term basis, we expect that sales growth for the industry will generally be in line with the underlying assumptions that support our long-term strategic goals, albeit with some risk in the near term given the continuing global economic uncertainty. We believe changing social habits resulting from increased disposable income, improved focus on personal health and wellness awareness should help drive growth of our consumer product customers’ businesses.
Results of Operations
NMF: Not meaningful
_______________________
(1)
Adjusted operating margin for the year ended December 31, 2018 excludes Frutarom acquisition related costs of $89.6 million, integration related costs of $7.2 million, restructuring and other charges of $4.1 million, and operational improvement initiatives of $2.2 million, partially offset by FDA mandated product recall of $7.1 million, acquisition related costs of $1.3 million, and gain on sale of assets of $1.2 million.
Adjusted operating margin for the year ended December 31, 2017 excludes net legal charges/credits of $1.0 million, acquisition related costs of $20.4 million, gain on sale of assets of $0.2 million, operational improvement initiative costs of $1.8 million, restructuring and other charges, net of $19.7 million, FDA mandated product recall costs of $11.0 million, UK pension settlement charge of $2.8 million, tax assessment of $5.3 million, and integration related costs of $4.2 million.
Adjusted operating margin for the year ended December 31, 2016 excludes net legal charges/credits of $48.5 million, acquisition related costs of $12.2 million, gain on sale of assets of $7.8 million, operational improvement initiative costs of $2.4 million and restructuring and other charges, net of $0.3 million.
Cost of goods sold includes the cost of materials and manufacturing expenses; raw materials generally constitute approximately 50% of total inventory. R&D expenses relate to the development of new and improved molecules and technologies, technical product support and compliance with governmental regulations. S&A expenses include expenses necessary to support our commercial activities and administrative expenses principally associated with staff groups that support our overall operating activities.
2018 IN COMPARISON TO 2017
Frutarom's operating results have been included in our operating results from October 4, 2018.
Sales
Sales for 2018 totaled $4.0 billion, an increase of 17% from the prior year on a reported and 15% on a currency neutral basis. Sales growth reflected new win performance (net of losses) and favorable price to input costs in both Taste and Scent. On a reported and currency neutral basis, the effect of the acquisition of Frutarom was approximately 11% and 10%, respectively, to net sales amounts.
Sales performance by segment was as follows:
_______________________
(1)
Currency neutral sales growth is calculated by translating prior year sales at the exchange rates for the corresponding 2018 period.
Taste
Taste sales in 2018 increased 6% on a reported basis and 5% on a currency neutral basis versus the prior year period. Overall growth was primarily driven by new win performance (net of losses) and price increases (principally due to increases in raw material input costs). The Taste business delivered currency neutral growth across all regions.
Sales growth in the Taste business unit was led by NOAM, which were primarily driven by new wins and price increases (principally due to increases in raw material input costs), and followed by EAME. GA and LA sales growth was primarily driven by new wins.
Scent
Scent sales in 2018 increased 6% on a reported basis and 4% on a currency neutral basis. Year-over-year, 2018 sales growth reflected new win performance (net of losses) and price increases (principally due to increases in raw material input costs), which were partially offset by volume reductions on existing business.
Sales growth in the Scent business unit was led by Ingredients, which were primarily driven by price increases (principally due to increases in raw material input costs), followed by Fragrance Compounds, primarily driven by new wins partially offset by volume reductions on existing business.
Frutarom
Frutarom sales in 2018 were $359.6 million, which included approximately $264 million in sales of Flavor Compounds and approximately $97 million in sales of Ingredient product categories.
Cost of Goods Sold
Cost of goods sold, as a percentage of sales, increased 102 bps, to 57.7% in 2018 compared to 56.7% in 2017. Included in cost of goods sold was $23.6 million of Frutarom acquisition related inventory "step-up" costs, $1.7 million of costs associated with operational improvement initiatives, and $0.1 million of integration related costs, partially offset by $7.1 million related to an FDA mandated product recall, in 2018. For 2017, included in costs of goods sold was $15.9 million of acquisition-related inventory "step-up" costs, $11.0 million related to an FDA mandated product recall, $1.8 million of costs associated with operational improvement initiatives, and $0.5 million of integration related costs.
Research and Development (R&D)
Overall R&D expenses, as a percentage of sales, decreased to 7.8% in 2018 compared to 8.7% in 2017. The decrease in 2018 was principally driven by the effect of the acquisition of Frutarom which has a lower R&D spend as a percent of sales.
Selling and Administrative (S&A)
S&A expenses increased $137.3 million to $707.5 million, or 17.8% as a percentage of sales, in 2018 compared to $570.1 million, or 16.8% as a percentage of sales, in 2017. Included in 2018 were Frutarom acquisition related costs of $66.1 million and integration related costs of $6.1 million, partially offset by acquisition related costs of $1.3 million, compared to commercial real estate tax assessment charges of $5.3 million, acquisition and integration related costs of $4.5 million and $3.3 million, respectively, UK pension settlement charge of $1.9 million and net legal charges/credits, principally related to a litigation accrual of $1.0 million in 2017. Excluding these costs, adjusted S&A expense increased by $82.5 million, but decreased to16.0% of sales in 2018 compared to 16.3% of sales in 2017. The improved leverage is principally due to a decline in personnel related costs and the impact of our acquisition of Frutarom.
Restructuring and Other Charges
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, we expect to optimize our global footprint and simplify the Company's organizational structures globally.
The Company recorded $3.9 million and $20.6 million of charges related to personnel-related costs in 2018 and 2017, respectively, with no further anticipated personnel-related and other costs after the first quarter of 2019. The Company made payments of $7.3 million and $14.0 million related to severance in 2018 and 2017, respectively. The overall charges were split approximately evenly between Taste and Scent. No charges were allocated to the Frutarom segment. 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.
Amortization of Acquisition-Related Intangibles
Amortization expenses increased to $75.9 million in 2018 compared to $34.7 million in 2017. The increase of $41.2 million is principally due to the acquisition of Frutarom.
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 certain non-recurring items, Interest expense, Other expense, net and Taxes on income. See Note 15 to our Consolidated Financial Statements for the reconciliation to Income before taxes.
NMF: Not meaningful
_______________________
(1)
Includes $23.6 million related to amortization of inventory "step-up" costs.
Taste Business Unit
Taste segment profit increased $34.7 million to $395.2 million (22.7% of segment sales) in 2018 from $360.5 million (22.1% of segment sales) in the comparable 2017 period. The increase principally reflected the impact of cost savings and productivity initiatives and the impact of foreign exchange, partially offset by increases in Selling and administrative expenses.
Scent Business Unit
Scent segment profit increased $10.6 million to $329.5 million in 2018, compared to $319.0 million reported in 2017 primarily due to new win performance (net of losses) and price increases (principally due to increases in raw material input costs), which were partially offset by volume reductions on existing business. Segment profit as a percentage of segment sales decreased to 17.5% in 2018 from 18.1% in 2017 primarily due to the impact of unfavorable price versus input costs (including the net impact of the BASF supply chain disruption) and increases in R&D and Selling and administrative expenses, partially offset by new win performance (net of losses).
Frutarom Business Unit
Frutarom segment profit was $27.4 million for the fourth quarter of 2018 (7.6% of segment sales), excluding $23.6 million related to amortization of inventory "step-up" costs.
Global Expenses
Global expenses represent corporate and headquarter-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 2018, Global expenses were $74.7 million compared to $60.8 million during 2017. The increase was principally driven by lower gains from our currency hedging program, offset by reductions in incentive compensation expense.
Interest Expense
In 2018, interest expense increased $67.2 million to $132.6 million, compared to $65.4 million in 2017 primarily driven by $39.4 million of bridge loan commitment fees and $7.7 million of accrued, unpaid interest on the repurchased Senior Notes - 2007 and increased interest expense related to the public debt issued in 2018 to finance the acquisition of Frutarom. Average cost of debt was 4.3% for the 2018 period compared to 4.1% in 2017.
Other (Income) Expense, Net
Other income, net, decreased approximately $14.5 million to $35.2 million of income in 2018 versus $49.8 million of income in 2017. The decrease was largely driven by decreases in gains on foreign currency of approximately $8 million year over year as well as a decrease in pension related other net income.
Loss on extinguishment of debt
Loss on extinguishment of debt was $38.8 million in the third quarter of 2018. The loss on extinguishment of debt is driven by a $34.9 million make whole payment on the Senior Notes - 2007 and a $3.9 million realized loss on the termination of a fair value hedge.
Income Taxes
The effective tax rate was 24.1% in 2018 as compared to 44.9% in 2017. The year-over-year reduction principally relates to lower U.S. tax reform charges in 2018, partially offset by nondeductible Frutarom acquisition costs, an unfavorable mix of earnings, lower loss provisions, and a lower level of reversals of valuation allowances on U.S. state deferred taxes. Excluding $25.3 million related to the U.S. tax reform, Frutarom acquisition costs of $28.5 million, FDA mandated product recall costs of $1.6 million, integration related costs of $1.4 million, restructuring and other charges, net of $1.0 million, operational improvement initiative costs of $0.7 million, gain on sale of assets of $0.4 million and acquisition related costs of $0.3 million, the adjusted effective tax rate for 2018 was 18.4%. For 2017, the adjusted tax rate was 20.7% excluding $139.2 million related to the impact of the U.S. tax reform, legal charges/credits, net of $0.4 million, acquisition related costs of $6.5 million, gain on sale of assets of $0.1 million, operational improvement initiative costs of $0.5 million, restructuring and other charges, net of $5.5 million, FDA mandated product recall costs of $3.9 million, UK pension settlement charge of $0.5 million, tax assessment of $1.9 million, and integration related costs of $1.3 million.
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% and establishing a modified territorial system requiring a mandatory deemed repatriation tax on undistributed earnings of foreign subsidiaries. Beginning in 2018, the Act also requires a minimum tax on certain future earnings generated by foreign subsidiaries while providing for future tax-free repatriation of such earnings through a 100% dividends-received deduction for U.S. federal income tax purposes.
The Tax Act impacted the Company's consolidated results of operations during the 2017 fourth quarter. In particular, the transition to the new territorial tax system required the Company to record a one-time tax or “toll charge” which resulted in a provisional incremental tax expense of $100.6 million principally related to previously unremitted earnings on non-U.S. subsidiaries. The cash portion of the "toll charge" is payable in installments over 8 years beginning in 2018. In addition, the reduction of the U.S. corporate tax rate resulted in a provisional net deferred tax expense of $38.6 million related to the remeasurement of net deferred tax assets as a result of the reduction in the corporate income tax rate.
During the first quarter of 2018, the Company recorded an additional charge of $0.6 million to adjust an accrual related to withholding taxes on planned repatriations. During the second quarter of 2018, the Company paid the first installment of the “toll charge”. During the third quarter of 2018, the Company recorded a benefit of $8.0 million to adjust the provisional “toll charge” required from the transition to the new territorial tax system, and a benefit of $0.2 million to adjust the remeasurement of net deferred tax assets as a result of U.S. tax reform. During the fourth quarter, the Company completed its final assessment under SAB 118, and recorded an additional charge of $32.8 million to adjust an accrual related to the U.S. state impact and foreign withholding taxes on planned repatriations. The charge in the fourth quarter of 2018 is consistent with the Company's need to repatriate funds for debt repayment purposes.
2017 IN COMPARISON TO 2016
Sales
Sales for 2017 totaled $3.4 billion, an increase of 9% from the prior year on both a reported and currency neutral basis. Sales growth reflected new win performance (net of losses) and the effects of acquisitions in both Taste and Scent. On both a reported and currency neutral basis, the effect of acquisitions was approximately 5% to net sales amounts.
Sales performance by segment was as follows:
_______________________
(1)
Currency neutral sales growth is calculated by translating prior year sales at the exchange rates for the corresponding 2018 period.
Taste
Taste sales in 2017 increased 9% on a reported basis and 10% on a currency neutral basis versus the prior year period. Acquisitions accounted for approximately 5% of the net sales growth on both a reported and currency neutral basis. Overall growth was primarily driven by new win performance (net of losses) and the impact of acquisitions, partially offset by decreases in volume. Globally, Taste growth included mid single-digit growth in emerging markets. Overall, emerging markets represented approximately 49% of total Taste sales.
Sales growth in Taste was led by NOAM followed by EAME, LA and GA, all primarily driven by new win performance (net of losses).
Scent
Scent sales in 2017 increased 9% on both a reported basis and currency neutral basis. Acquisitions accounted for approximately 5% of both reported and currency neutral sales growth. Year-over-year, 2017 sales performance was led by new win performance (net of losses) and the impact of acquisitions, partially offset by decreases in price. Globally, Scent growth included low single-digit growth in emerging markets. Overall, emerging markets represented 47% of total Scent's sales.
Sales growth in Scent was led by Ingredients, primarily driven by price increases (principally due to increases in raw material input costs), followed by growth in Fragrance Compounds, primarily driven by new wins (net of losses) partially offset by volume reductions on existing business.
Cost of Goods Sold
Cost of goods sold, as a percentage of sales, increased 146 bps, to 56.7% in 2017 compared to 55.2% in 2016. Included in cost of goods sold was $15.9 million of acquisition-related inventory "step-up" costs, $11.0 million related to an FDA mandated product recall, $1.8 million of costs associated with operational improvement initiatives, and $0.5 million of integration related costs, in 2017. For 2016, included in costs of goods sold was $7.6 million of acquisition-related inventory "step-up" costs, $2.4 million of costs associated with operational improvement initiatives and $0.7 million of costs related to accelerated depreciation.
Research and Development (R&D)
R&D expenses, as a percentage of sales, remained relatively consistent with the prior year period at 8.7% in 2017 compared to 8.3% in 2016. The slight increase in 2017 was principally driven by recent acquisitions, and, to a lesser extent, incentive compensation.
Selling and Administrative (S&A)
S&A, as a percentage of sales, decreased 160 bps to 16.8% versus 18.4% (or 16.3% and 16.6% on an adjusted basis in 2017 and 2016, respectively). Included in 2017 were commercial real estate tax assessment charges of $5.3 million, acquisition and integration related costs of $4.5 million and $3.3 million, respectively, UK pension settlement charge of $1.9 million and net legal charges/credits, principally related to a litigation accrual of $1.0 million, compared to net legal charges/credits,
principally related to a litigation accrual of $48.5 million, acquisition related costs of $4.5 million and severance costs related to the termination of a former executive officer of $1.4 million in 2016. During 2017, costs were higher as a result of recently acquired companies, offset by slightly lower legal and professional fees associated with various finance initiatives, and decreases in legal and patent fees.
Restructuring and Other Charges
Restructuring and other charges primarily consist of separation costs for employees, including severance, outplacement and other benefit costs.
Amortization of Acquisition-Related Intangibles
Amortization expenses increased to $34.7 million in 2017 compared to $23.8 million in 2016. The increase of $10.9 million is principally due to the acquisitions of Fragrance Resources and PowderPure in 2017, as well as recognizing a full year of amortization in 2017 from the acquisition of David Michael as compared to 2016.
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 certain non-recurring items, Interest expense, Other expense, net and Taxes on income. See Note 15 to our Consolidated Financial Statements for the reconciliation to Income before taxes.
Taste Business Unit
Taste segment profit increased $30.3 million to $360.5 million in 2017 (22.1% of segment sales) from $330.2 million (22.1% of sales) in the comparable 2016 period. The increase in segment profit and profit margin principally reflected productivity initiatives and solid top-line growth.
Scent Business Unit
Scent segment profit decreased $7.8 million to $319.0 million in 2017 (18.1% of segment sales), compared to $326.7 million (20.2% of sales) reported in 2016. The decrease in segment profit and profit margin was principally driven by the impact of acquisitions and unfavorable price versus input costs, partially offset by volume growth and the benefits from cost and productivity initiatives.
Global Expenses
Global expenses represent corporate and headquarter-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 2017, Global expenses were $60.8 million compared to $48.4 million during 2016. The increase was principally driven by lower gains on our cash flow hedging program and higher incentive compensation costs.
Interest Expense
In 2017, interest expense increased $12.4 million to $65.4 million, compared to $53.0 million in 2016 reflecting the impact of our issuance of Senior Notes - 2017 in the second quarter of 2017. Average cost of debt was 4.1% for the 2017 period compared to 3.8% in 2016.
Other (Income) Expense, Net
Other income, net increased approximately $26.0 million to $49.8 million of income in 2017 versus $23.8 million of income in 2016. The increase was largely driven by gains on foreign currency of approximately $13 million in the current year versus approximately $5 million in the prior year, as well as proceeds from certain life insurance policies of approximately $4 million in 2017.
Income Taxes
The effective tax rate was 44.9% in 2017 as compared to 22.7% in 2016. Excluding $139.2 million related to the U.S. tax reform, legal charges/credits, net of $0.4 million, acquisition related costs of $6.5 million, gain on sale of assets of $0.1 million, operational improvement initiative costs of $0.5 million, restructuring and other charges, net of $5.5 million, FDA mandated product recall costs of $3.9 million, UK pension settlement charge of $0.5 million, tax assessment of $1.9 million, and integration related costs of $1.3 million, the adjusted effective tax rate for 2017 was 20.7%. For 2016, the adjusted tax rate was 23.8% excluding $17.1 million, $4.1 million, $0.6 million and $0.1 million of tax benefits associated with pretax legal charges/credits, acquisition-related costs, operational improvement initiatives and restructuring related costs, respectively, as well as a $2.7 million tax charge related to the gain on sale of property. The year-over-year reduction principally reflects the reversal of certain valuation allowances on U.S. state deferred taxes.
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.
The Tax Act impacted our consolidated results of operations during the 2017 fourth quarter and is expected to continue to impact our consolidated results of operations in future periods. In particular, the transition to the new territorial tax system required us to record a one-time tax or “toll charge” which resulted in a provisional incremental tax expense of $100.6 million principally related to previously unremitted earnings on non-U.S. subsidiaries. The cash portion of the "toll charge" will be payable in installments over 8 years beginning in 2018. In addition, the reduction of the U.S. corporate tax rate resulted in a provisional net deferred tax expense of $38.6 million related to the remeasurement of net deferred tax assets as a result of the reduction in the corporate income tax rate. 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 Company’s provisional charge may be adjusted during 2018 and is expected to be finalized no later than the fourth quarter of 2018. Other provisions of the Tax Act that impact future tax years are still being assessed. Any material revisions in the Company's computations could adversely affect its cash flows and results of operations.
Based on our current assessment and understanding of the Tax Act and the Company’s current global operating structure, the Company believes its effective tax rate will be approximately 21% in 2018. The impact of the Tax Act may differ from this estimate, due to, among other things, changes in interpretations and assumptions the Company has made, additional
guidance that may be issued by the taxing authorities as well as operating and/or structural changes that the Company may take as a result of the Tax Act.
Liquidity and Capital Resources
CASH AND CASH EQUIVALENTS
We had cash and cash equivalents of $634.9 million at December 31, 2018 compared to $368.0 million at December 31, 2017, of which $434.6 million of the balance at December 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.
Effective utilization of the cash generated by our international operations is a critical component of our strategy. We regularly repatriate cash from our non-U.S. subsidiaries to fund financial obligations in the U.S. These repatriations totaled $155.1 million, $192.2 million and $134.5 million in 2018, 2017, and 2016, respectively. The Tax Act includes a mandatory one-time tax on accumulated earnings of foreign subsidiaries as of December 31, 2017, and as a result, all previously unremitted earnings for which no U.S. deferred tax liability had been accrued were subject to U.S. tax and will not be subject to additional U.S. federal tax when repatriated. However, such distributions could be subject to foreign withholding or other taxes, including state taxes. We have repatriated $155.1 million during 2018 and anticipate repatriating amounts in the future to provide for the cash needs of our U.S. operations and to repay debt. We anticipate the relevant foreign withholding and other taxes, including state taxes, to be approximately $88.8 million and have recorded the deferred tax liabilities accordingly.
RESTRICTED CASH
As discussed in Note 3 to the Consolidated Financial Statements, restricted cash of $13.6 million relates to amounts escrowed related to certain payments to be made to former Frutarom option holders in future periods.
CASH FLOWS FROM OPERATING ACTIVITIES
Operating cash flows in 2018 were $437.6 million compared to $390.8 million in 2017 and $550.1 million in 2016. The increase in operating cash flows from 2017 to 2018 was principally driven by lower litigation settlement and pension payments and higher net income, offset by higher net working capital (principally related to inventories). The decrease in operating cash flows in 2017 as compared to 2016 was principally related to the impact of increased core working capital requirements (trade receivables, inventories and accounts payable) and due to payments on legal claims along with severance, integration and acquisition costs.
Working capital (current assets less current liabilities) totaled $1.81 billion at year-end 2018 compared to $1.13 billion at December 31, 2017. This increase in working capital of $685.8 million primarily reflected increases in accounts receivable and inventory offset by increases in accounts payable and other current liabilities as compared to the prior year.
We 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. We estimate that, as a result of participating in the programs, the beneficial impact on cash provided by operations decreased approximately $16.9 million in 2018, compared to an increase of approximately $7.6 million and $34 million in 2017 and 2016, respectively. The cost of participating in these programs was immaterial to our results in all periods.
CASH FLOWS USED IN INVESTING ACTIVITIES
Net investing activities in 2018 utilized $5.0 billion compared to $299.9 million and $355.5 million in 2017 and 2016, respectively. The increase in cash paid for investing activities was primarily driven by higher payments for acquisitions. In 2018, we acquired Frutarom for approximately $7 billion (net of cash acquired) of which $4.9 billion was paid in cash. In 2017, we acquired Fragrance Resources and PowderPure for approximately $137.5 million (net of cash acquired) and $54.2 million (net of cash acquired), respectively, in addition to a purchase price adjustment of $0.7 million related to David Michael in 2017.
Additions to property, plant and equipment were $170.1 million, $129.0 million and $126.4 million in 2018, 2017 and 2016, respectively (net of grants and other reimbursements from government authorities). These investments largely arise from our ongoing focus to align our manufacturing facilities with customer demand, primarily in emerging markets, and new technology consistent with our strategy.
In light of our requirement to begin relocating one of our Fragrance Ingredients facilities in China, the ongoing construction of new facilities in India and Indonesia, and capital requirements to integrate our recently acquired Frutarom
business, we expect that capital spending in 2019 will be about 5-6% of sales (net of potential grants and other reimbursements from government authorities).
CASH FLOWS PROVIDED BY FINANCING ACTIVITIES
Net cash provided by financing activities in 2018 increased to $4,870.7 million, compared to cash used in financing activities of $42.6 million and $34.4 million in 2017 and 2016, respectively. The increase in 2018 versus 2017 was principally driven by Frutarom related financing activities where we issued $3.3 billion of debt, including €1.1 billion aggregate principal amount of the 2018 Euro Senior Notes, $1.5 billion aggregate principal amount of the 2018 USD Senior Notes, $139.5 million aggregate principal amount of the Amortizing Note portion of the TEUs and $350 million aggregate principal amount of the Term Loan, as compared to $493.9 million of 2047 Notes issued in 2017. We also issued $2.3 billion of equity in the third quarter of 2018 to finance the Frutarom acquisition, including $1.6 billion of our common stock and $685.5 million of the stock purchase contract portion ("SPC") of the TEUs. Additionally, we repaid $288.8 million of our Senior notes - 2007, including the loss on extinguishment of debt of $38.8 million.
At December 31, 2018, we had $4,553.1 million of debt outstanding compared to $1,639.2 million outstanding at December 31, 2017.
We paid dividends totaling $230.2 million, $206.1 million and $184.9 million in 2018, 2017 and 2016, respectively. The cash dividend declared per share in 2018, 2017 and 2016 was $2.84, $2.66 and $2.40, respectively.
Our capital allocation strategy is primarily focused on debt repayment to maintain our investment grade rating. We will also prioritize capital investment in our businesses to support the strategic long term plans. The company is also committed to maintaining its history of paying a dividend to investors determined by our Board of Directors (“Board”) at its discretion based on various factors, and finally will be very selective in pursuing value creating strategic M&A over the near term.
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 $279.7 million available under the amended repurchase program as of October 31, 2017, the Board of Directors re-approved on November 1, 2017 a $250.0 million share repurchase authorization and extension for a total value of $300.0 million available under the program, which expires on November 1, 2022. Based on the total remaining amount of $280 million available under the repurchase program, approximately 2.1 million shares, or 1.9% of shares outstanding (based on the market price and shares outstanding as of December 31, 2018) could be repurchased under the program as of December 31, 2018. On May 7, 2018, we announced that we were suspending our share repurchases until our deleveraging target is met following our acquisition of Frutarom.
CAPITAL RESOURCES
Operating cash flow provides the primary source of funds for capital investment needs, dividends paid to shareholders and debt service repayments. We anticipate that cash flows from operations and availability under our existing credit facilities will sufficient to meet our investing and financing needs. 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.
As discussed above and in Note 10 to the Consolidated Financial Statements, in connection with our acquisition of Frutarom, we repaid the $250 million outstanding principal amount of the Senior notes - 2007, plus accrued and unpaid interest of $7.7 million and a make whole payment of $34.9 million and $3.9 million realized loss on the termination of a fair value hedge, in addition to $695 million of Frutarom's net debt concurrent with the closing of the transaction. In the next three years, we expect to reduce our net debt by repaying our outstanding liabilities upon maturity using the proceeds from operating cashflows and from the suspension of our share repurchase program.
During the fourth quarter of 2018, we acquired Frutarom for approximately $7 billion (net of cash acquired). The cash portion of the consideration was approximately $5 billion, which was funded from the proceeds from issuing $3 billion in net new debt, issuing $2.3 billion in equity. We also issued of treasury shares worth $2.1 billion.
During the second quarter of 2017, we acquired PowderPure for approximately $54.2 million (net of cash acquired), which was funded from existing resources.
During the first quarter of 2017, we acquired Fragrance Resources for approximately $137.5 million (net of cash acquired), which was funded from existing resources.
During the fourth quarter of 2016, we acquired David Michael for approximately $237.5 million (net of cash acquired), which was funded from existing resources.
Credit Facility and Senior Notes
We supplement short-term liquidity with access to capital markets, mainly through bank credit facilities and issuance of commercial paper.
Commercial Paper
Commercial paper issued by the Company generally has terms of 90 days or less. As of December 31, 2018 and 2017, there was no commercial paper outstanding. The revolving credit facility is used as a backstop for the Company's commercial paper program. The maximum amount of commercial paper outstanding during 2018 and 2017 was $85 million and $107.5 million, respectively.
Credit Facility and Term Loan
On May 21, 2018, June 6, 2018 and July 13, 2018, the Company and certain of its subsidiaries amended and restated the Company’s existing amended and restated credit agreement with Citibank, N.A., as administrative agent (as amended, the “Amended Credit Facility”) in connection with the acquisition of Frutarom, to, among other things (i) extend the maturity date of the Amended Credit Facility until June 6, 2023, (ii) increase the maximum ratio of net debt to EBITDA on and after the closing date of the acquisition and (iii) increase the drawn down capacity to $1,000 million, consisting of a $585 million tranche A revolving credit facility (which provides for borrowings available in U.S. dollars, euros, Swiss francs, Japanese yen and/or British pounds sterling, with a sublimit of $25 million for swing line borrowings) (“Tranche A”) and a $415 million tranche B revolving credit facility (which provides for borrowings available in U.S. dollars, euros, Swiss francs, Japanese yen and/or British pounds sterling, with sublimits of €50 million and $25 million for swing line borrowings) (“Tranche B” and, together with Tranche A, the “Revolving Facility”). The interest rate on the Revolving Facility will be, at the applicable borrower’s option, a per annum rate equal to either (x) an adjusted LIBOR rate plus an applicable margin varying from 0.75% to 1.75% or (y) a base rate plus an applicable margin varying from 0.00% to 0.750%, in each case depending on the public debt ratings for non-credit enhanced long-term senior unsecured debt issued by the Company. Other terms and covenants under the Amended Credit Facility remain substantially unchanged. The Amended Credit Facility is available for general corporate purposes of each borrower and its subsidiaries. The obligations under the Amended Credit Facility are unsecured and the Company has guaranteed the obligations of each other borrower under the Amended Credit Facility. The Company pays a commitment fee on the aggregate unused commitments; such fee is not material.
On June 6, 2018, the Company entered into a term loan credit agreement to replace a portion of the bridge loan facility, reducing the amount of the bridge loan commitments by $350 million. Under the term loan credit agreement, the lenders thereunder committed to provide, subject to certain conditions, a senior unsecured term loan facility (as amended, "Term Loan") in an original aggregate principal amount of up to $350.0 million, maturing three years after the funding date thereunder. The proceeds from the term loan were received on October 3, 2018.
The Term Loan bears interest, at the Company’s option, at a per annum rate equal to either (x) an adjusted LIBOR rate plus an applicable margin varying from 0.75% to 2.00% or (y) a base rate plus an applicable margin varying from 0.00% to 1.00%, in each case depending on the public debt ratings for non-credit enhanced long-term senior unsecured debt issued by the Company. Loans under the Term Loan will amortize quarterly at a per annum rate of 10.0% of the aggregate principal amount of the loans made under the Term Loan on the funding date, commencing December 31, 2018, with the balance payable on October 3, 2021. The Company may voluntarily prepay the term loans without premium or penalty.
The Amended Credit Facility and Term Loan contain various covenants, limitations and events of default customary for similar facilities for similarly rated borrowers, including the requirement for us 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, including the pro forma effect of the acquisition of Frutarom, of not more than 4.5 to 1.0, which shall be reduced to 4.25 to 1.0 as of the end of September 30, 2019, 4.0 to 1.0 as of the end of March 31, 2020 and to 3.5 to 1.0 as of the end of March 31, 2021.
As of December 31, 2018 we had no of borrowings under our Amended Credit Facility but $350 million outstanding for the Term Loan. The amount which we are able to draw down on under the Amended Credit Facility is limited by financial covenants as described in more detail below. As of December 31, 2018, our draw down capacity was $1 billion on the Amended Credit Facility and $350 million on the Term Loan. See Note 10 to the Consolidated Financial Statements for further information on the credit facility and loan.
At December 31, 2018 and 2017 we were in compliance with all financial and other covenants, including the net debt to adjusted EBITDA ratio. At December 31, 2018 our Net Debt/adjusted EBITDA(1) ratio was 3.56 to 1 as defined by the credit facility agreements, 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.
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(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:
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(1)
Specified items for the 12 months ended December 31, 2018 of $123.4 million consist of acquisition related costs, operational improvement initiatives, integration related costs, restructuring and other charges, net, FDA mandated product recall, and Frutarom acquisition related costs.
(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 stock-based compensation and gain on sale of assets.
Senior Notes
2047 Notes. On May 18, 2017, we issued $500.0 million face amount of 4.375% Senior Notes ("2047 Notes") due 2047 at a discount of $1.8 million. We received proceeds related to the issuance of these 2047 Notes of $493.9 million which was net of the $1.8 million discount and $4.4 million in underwriting fees (recorded as deferred financing costs). In addition, we incurred $0.9 million in legal and professional costs associated with the issuance and such costs were recorded as deferred financing costs. In connection with the debt issuance, we entered into pre-issuance hedging transactions that were settled upon issuance of the debt and resulted in a loss of approximately $5.3 million. The 2047 Notes bear interest at a rate of 4.375% per annum, with interest payable semi-annually on June 1 and December 1 of each year, commencing on December 1, 2017. The 2047 Notes will mature on June 1, 2047. See Note 10 to the Consolidated Financial Statements for further information on the 2047 Senior Notes.
2024 Euro Notes. On March 14, 2016, we issued €500.0 million face amount of 1.75% Senior Notes ("2024 Euro Notes") due 2024 at a discount of €0.9 million. We received proceeds related to the issuance of these 2024 Euro Notes of €496.0 million which was net of the €0.9 million discount and €3.1 million underwriting discount (recorded as deferred financing costs). The 2024 Euro Notes bear interest at a rate of 1.75% per annum, with interest payable on March 14 of each year, commencing on March 14, 2017. The 2024 Euro Notes will mature on March 14, 2024. See Note 10 to the Consolidated Financial Statements for further information on the 2024 Euro Notes.
2023 Notes. On April 4, 2013, we issued $300.0 million face amount of 3.20% Senior Notes (“2023 Notes”) due 2023 at a discount of $0.3 million. We received proceeds related to the issuance of these 2023 Notes of $297.8 million which was net of
the $0.3 million discount and a $1.9 million underwriting discount (recorded as deferred financing costs). In addition, we incurred $0.9 million of other deferred financing costs in connection with the debt issuance. The discount and deferred financing costs are being amortized as interest expense over the term of the 2023 Notes. The 2023 Notes bear interest at a rate of 3.20% per year, with interest payable on May 1 and November 1 of each year, commencing on November 1, 2013. The 2023 Notes mature on May 1, 2023. See Note 10 to the Consolidated Financial Statements for further information on the 2023 Notes.
Senior Notes - 2007. In September 2007, we issued an aggregate of $500.0 million of senior unsecured notes in four series, with $250.0 million due in 2017, $100.0 million due in 2019, $50 million due in 2022 and $100.0 million due in 2027. During the third quarter of 2017, the $250.0 million series note matured and was repaid in full. See Note 10 to the Consolidated Financial Statements for further information on the Senior Notes - 2007.
Financing of the Acquisition of Frutarom
Bridge Loan Facility
In connection with entering into the merger agreement with Frutarom in May 2018, the Company entered into a debt commitment letter for up to a $5.45 billion 364-day unsecured bridge loan facility to the extent the Company had not received $5.45 billion of net cash proceeds (and/or qualified bank commitments) from a combination of (a) the issuance by the Company of a combination of equity securities, equity-linked securities and/or unsecured debt securities and/or (b) unsecured term loans, in each case, at or prior to completion of the acquisition. On May 21, 2018, the Company, Morgan Stanley Senior Funding, Inc. and certain other financial institutions entered into a bridge joinder agreement to the commitment letter to provide for additional bridge commitment parties. As a result of the Company's entering into the debt and equity financing as discussed above, the bridge loan facility was terminated on September 26, 2018. In connection with the bridge loan commitment, the Company incurred $39.4 million of fees which are included in Interest expense in the Consolidated Statement of Income and Comprehensive Income in the year ended December 31, 2018.
Senior Unsecured Notes
On September 25, 2018 the Company issued €300.0 million aggregate principal amount of senior unsecured notes that mature on September 25, 2021 (the “2021 Euro Notes”). The 2021 Notes bear interest at a rate of 0.5% per year, payable annually on September 25 of each year, beginning September 25, 2019. Total proceeds from the issuance of the 2021 Notes, net of underwriting discounts and offering costs, were €297.7 million ($349.5 million in USD).
On September 25, 2018, the Company issued €800.0 million aggregate principal amount of senior unsecured notes that mature on September 25, 2026 (the “2026 Euro Notes”). The 2026 Notes bear interest at a rate of 1.8% per year, payable annually on September 25 of each year, beginning September 25, 2019. Total proceeds from the issuance of the 2026 Notes, net of underwriting discounts and offering costs, were €794.1 million ($932.2 million in USD).
On September 26, 2018, the Company issued $300.0 million aggregate principal amount of senior unsecured notes that mature on September 25, 2020 (the “2020 Notes”). The 2020 Notes bear interest at a rate of 3.4% per year, payable semi-annually on March 25 and September 25 of each year, beginning March 25, 2019. Total proceeds from the issuance of the 2020 Notes, net of underwriting discounts and offering costs, were $298.9 million.
On September 26, 2018, the Company issued $400.0 million aggregate principal amount of senior unsecured notes that mature on September 26, 2028 (the “2028 Notes”). The 2028 Notes bear interest at a rate of 4.45% per year, payable semi-annually on March 26 and September 26 of each year, beginning March 26, 2019. Total proceeds from the issuance of the 2028 Notes, net of underwriting discounts and offering costs, were $397.0 million.
On September 26, 2018, the Company issued $800.0 million aggregate principal amount of senior unsecured notes that mature on September 26, 2048 (the “2048 Notes” and collectively with the 2021 Euro Notes, 2026 Euro Notes, 2020 Notes, 2028 Notes, the "2018 Senior Unsecured Notes"). The 2048 Notes bear interest at a rate of 5.0% per year, payable semi-annually on March 26 and September 26 of each year, beginning March 26, 2019. Total proceeds from the issuance of the 2048 Notes, net of underwriting discounts and offering costs, were $787.2 million.
Tangible Equity Units - Senior Unsecured Amortizing Notes
On September 17, 2018, in connection with the issuance of the TEUs, the Company issued $139.5 million aggregate principal amount of Amortizing Notes. The Amortizing Notes mature on September 15, 2021. Each quarterly cash installment payment of $0.75 (or, in the case of the installment payment due on December 15, 2018, $0.73333) per Amortizing Note will constitute a partial repayment of principal and a payment of interest, computed at an annual rate of 3.79%. Interest will be calculated on the basis of a 360 day year consisting of twelve 30 day months. Payments will be applied first to the interest due and payable and then to the reduction of the unpaid principal amount, allocated as set forth in the amortization schedule in the indenture governing the Amortizing Notes. See Note 9 for further information on the TEUs.
There are no covenants or provisions in the indenture related to the TEUs that would afford the holders of the amortizing notes protection in the event of a highly leveraged transaction, reorganization, restructuring, merger or similar transaction involving the Company that may adversely affect such holders. If a fundamental change occurs, or if the Company elects to settle the SPCs early, then the holders of the Amortizing Notes will have the right to require the Company to repurchase the Amortizing Notes at a repurchase price equal to the principal amount of the Amortizing Notes as of the repurchase date plus accrued and unpaid interest. The indenture also contains customary events of default which would permit the holders of the Amortizing Notes to declare the notes to be immediately due and payable if not cured within applicable grace periods, including the failure to make timely installment payments on the notes or other material indebtedness, failure to give notice of a fundamental change and specified events of bankruptcy and insolvency.
Other Commitments
Compliance with existing governmental requirements regulating the discharge of materials into the environment has not materially affected our operations, earnings or competitive position. In 2018 and 2017, we spent $6.2 million and $27.9 million on capital projects and $21.7 million and $17.5 million, respectively, in operating expenses and governmental charges for the purpose of complying with such regulations. Expenditures for these purposes will continue for the foreseeable future. In addition, we are party to a number of proceedings brought under the Comprehensive Environmental Response, Compensation and Liability Act or similar state statutes. It is expected that the impact of any judgments in or voluntary settlements of such proceedings will not be material to our financial condition, results of operations or liquidity.
CONTRACTUAL OBLIGATIONS
At December 31, 2018, we had contractual payment obligations due within the time periods as specified in the following table:
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(1)
See Note 10 to the Consolidated Financial Statements for a further discussion of our various borrowing facilities.
(2)
Operating leases include facility and other lease commitments executed in the normal course of the business, including sale leaseback obligations included in Note 8 of the Notes to the Consolidated Financial Statements. Further details concerning worldwide aggregate operating leases are contained in Note 18 of the Notes to the Consolidated Financial Statements.
(3)
See Note 16 of the Notes to the Consolidated Financial Statements for a further discussion of our retirement plans. Anticipated funding obligations are based on current actuarial assumptions. The projected contributions beyond fiscal year 2021 are not currently determinable.
(4)
Amounts represent expected future benefit payments for our postretirement benefit plans.
(5)
Purchase commitments include agreements for raw material procurement and contractual capital expenditures. Amounts for purchase commitments represent only those items which are based on agreements that are enforceable and legally binding.
(6)
This amount represents the cash portion of the “toll charge” that is payable in installments over eight years beginning in 2018. This amount represents the seven remaining installments.
The table above does not include $48.9 million of the total unrecognized tax benefits for uncertain tax positions and approximately $3 million of associated accrued interest, and $88.8 million associated with the deferred tax liability on deemed repatriation. Due to the high degree of uncertainty regarding the timing of potential cash flows, we are unable to make a reasonable estimate of the amount and period in which the remaining liabilities might be paid.
Critical Accounting Policies and Use of Estimates
Our significant accounting policies are more fully described in Note 1 to the Consolidated Financial Statements. As disclosed in Note 1, the preparation of financial statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect reported amounts and accompanying disclosures. These estimates are based on management’s best judgment of current events and actions that we may undertake in the future. Actual results may ultimately differ from these estimates.
Those areas requiring the greatest degree of management judgment or deemed most critical to our financial reporting involve:
Business Combinations. From time to time we enter into strategic acquisitions in an effort to better service existing customers and to attain new customers. When we acquire a controlling financial interest in an entity or group of assets that are determined to meet the definition of a business, we apply the acquisition method described in ASC Topic 805, Business Combinations. In accordance with GAAP, the results of the acquisitions we have completed are reflected in our financial statements from the date of acquisition forward.
We allocate the purchase consideration paid to acquire the business to the assets acquired and liabilities assumed based on estimated fair values at the acquisition date, with the excess of purchase price over the estimated fair value of the net assets acquired recorded as goodwill. If during the measurement period (a period not to exceed twelve months from the acquisition date) we receive additional information that existed as of the acquisition date but at the time of the original allocation described above was unknown to us, we make the appropriate adjustments to the purchase price allocation in the reporting period the amounts are determined.
Significant judgment is required to estimate the intangibles and fair value of fixed assets and in assigning their respective useful lives. Accordingly, we typically engage third-party valuation specialists, who work under the direction of management, to assist in valuing significant tangible and intangible assets acquired.
The fair value estimates are based on available historical information, future expectations and assumptions deemed reasonable by management, but are inherently uncertain.
We typically use an income method to estimate the fair value of intangible assets, which is based on forecasts of the expected future cash flows attributable to the respective assets. Significant estimates and assumptions inherent in the valuations reflect a consideration of other marketplace participants, and include the amount and timing of future cash flows (including expected growth rates, discount rate and profitability), royalty rates used in the relief of royalty method, customer attrition rates, product obsolescence factors, a brand’s relative market position and the discount rate applied to the cash flows. Unanticipated market or macroeconomic events and circumstances may occur, which could affect the accuracy or validity of the estimates and assumptions.
Determining the useful life of an intangible asset also requires significant judgment. All of our acquired intangible assets (e.g., trademarks, product formulas, non-compete agreements and customer relationships) are expected to have finite useful lives. Our estimates of the useful lives of finite-lived intangible assets are based on a number of factors including competitive environment, market share, brand history, operating plans and the macroeconomic environment of the regions in which the brands are sold.
The costs of finite-lived intangible assets are amortized through expense over their estimated lives. The value of residual goodwill is not amortized, but is tested at least annually for impairment as described in the following note. For acquired intangible assets, the remaining useful life of the trade names and trademarks, product formulas, and customer relationships was estimated at the point at which substantially all of the present value of cumulative cash flows have been earned.
The periodic assessment of potential impairment of goodwill. We currently have goodwill of $5.4 billion, of which $4.2 billion relates to our acquisition of Frutarom and is subject to change upon completion of our allocation of the consideration transferred to the assets acquired and liabilities assumed from Frutarom. The allocation of goodwill among reporting units has not yet been completed but will be completed within one year from the Frutarom acquisition date, October 4, 2018.
In assessing the potential for impairment of goodwill, management uses the most current actual and forecasted operating data available and current market-based assumptions in accordance with the criteria in Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 350. The Company has identified five reporting units: (1) Flavor Compounds, (2) Fragrance Compounds, (3) Fragrance Ingredients, (4) Cosmetic Actives Ingredients and (5) Frutarom. These reporting units were determined based on the level at which the performance is measured and reviewed by segment management. In the case of Frutarom, the reporting unit determination is preliminary and is subject to change.
The Company performs an annual goodwill impairment test for its reporting units by assessing the fair value of the reporting units based on discounted cash flows. If a reporting unit’s carrying amount exceeds its fair value, the Company will record an impairment charge based on that difference, and the impairment charge will be limited to the amount of goodwill allocated to that reporting unit. The Company completed its annual goodwill impairment test as of November 30, 2018, which indicated no impairment of goodwill as the estimated fair values substantially exceeded the carrying values of each of these reporting units, except for the recently acquired Frutarom reporting unit for which the fair value is expected to approximate the carrying value.
The periodic assessment of potential impairment of finite-lived intangible assets. The Company reviews long-lived assets for impairment when events or changes in business conditions indicate that their full carrying value may not be recovered. An estimate of undiscounted future cash flows produced by an asset or group of assets is compared to the carrying value to determine whether impairment exists. If assets are determined to be impaired, the loss is measured based on an estimate of fair value using various valuation techniques, including a discounted estimate of future cash flows.
The analysis and evaluation of income taxes. We account for taxes under the asset and liability method. Under this method, deferred income taxes are recognized for temporary differences between the financial statement and tax return bases of assets and liabilities. A valuation allowance is recognized if, based on the weight of available evidence, it is more likely than not that some portion or all of the deferred tax asset will not be realized. The assessment of the need for a valuation allowance requires management to make estimates and assumptions about future earnings, reversal of existing temporary differences and available tax planning strategies. If actual experience differs from these estimates and assumptions, the recorded deferred tax asset may not be fully realized resulting in an increase to income tax expense in our results of operations.
We are subject to income taxes in the U.S. and numerous foreign jurisdictions. Significant judgment is required in evaluating our uncertain tax positions and determining our provision for income taxes. We first determine whether it is “more likely than not” that we would sustain our tax position if the relevant tax authority were to audit the position with full knowledge of all the relevant facts and other information. For those tax positions that meet this threshold, we measure the amount of tax benefit based on the largest amount of tax benefit that we have a greater than 50% chance of realizing in a final settlement with the relevant authority. Those tax positions failing to qualify for initial recognition are recognized in the first interim period in which they meet the more likely than not standard. This evaluation is made at the time that we adopt a tax position and whenever there is new information and is based upon management’s evaluation of the facts, circumstances and information available at the reporting date. We maintain a cumulative risk portfolio relating to all of our uncertainties in income taxes in order to perform this analysis, but the evaluation of our tax positions requires significant judgment and estimation in part because, in certain cases, tax law is subject to varied interpretation, and whether a tax position will ultimately be sustained may be uncertain. We do not currently believe that any of our pending tax assessments, even if ultimately resolved against us, would have a material impact on our results of operations and cash flows.
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.
The Tax Act impacted our consolidated results of operations during the 2017 fourth quarter. In particular, the transition to the new territorial tax system required us to record a one-time tax or “toll charge” which resulted in a provisional incremental tax expense of $100.6 million principally related to previously unremitted earnings on non-U.S. subsidiaries. The cash portion of the "toll charge" is payable in installments over 8 years beginning in 2018. In addition, the reduction of the U.S. corporate tax rate resulted in a provisional net deferred tax expense of $38.6 million related to the remeasurement of net deferred tax assets as a result of the reduction in the corporate income tax rate.
During the first quarter of 2018, the Company recorded an additional charge of $0.6 million to adjust an accrual related to withholding taxes on planned repatriations. During the second quarter of 2018, the Company paid the first installment of the “toll charge”. During the third quarter of 2018, the Company recorded a benefit of $8.0 million to adjust the provisional “toll charge” required from the transition to the new territorial tax system, and a benefit of $0.2 million to adjust the remeasurement
of net deferred tax assets as a result of U.S. tax reform. During the fourth quarter, the Company recorded an additional charge of $32.8 million to adjust an accrual related to the U.S. state impact and foreign withholding taxes on planned repatriations, and completed its assessment under SAB 118 with no further material change to the amounts previously recorded.
The Tax Act created significant international tax provisions, including a new category of income, global intangible low-taxed income (GILTI). The Company has elected to treat GILTI as a current period cost if and when incurred. This tax position resulted in an $8.2 million income tax expense for the year ended December 31, 2018.
The evaluation of potential litigation and environmental liabilities, where changing circumstances, rules and regulations require regular reassessment of related practices and anticipated costs. We are subject to certain legal claims regarding products and other matters, as well as environmental-related matters. Significant management judgment is involved in determining when it is probable that a liability has been incurred and the extent to which it can be reasonably estimated.
We regularly assess potential liabilities with respect to all legal claims based on the most recent available information, in consultation with outside counsel we have engaged on our behalf to handle the defense of such matters. To the extent a liability is considered to be probable and reasonably estimable, we recognize a corresponding liability; if the reasonably estimated liability is a range, we recognize that amount considered most likely, or in the absence of such a determination, the minimum reasonably estimated liability. To the extent such claims are covered by various insurance policies, we separately evaluate the right to recovery and estimate the related insurance claim receivable. Management judgments involve determination as to whether a liability has been incurred, the reasonably estimated amount of that liability, and any potential insurance recovery.
We regularly evaluate potential environmental exposure in terms of total estimated cost and the viability of other potentially responsible parties (“PRP’s”) associated with our exposure. Recorded liabilities are adjusted periodically as remediation efforts progress and additional information becomes available. Critical management assumptions relate to expected total costs to remediate and the financial viability of PRP’s to share such costs.
Determination of the various assumptions employed in the valuation of pension and retiree health care expense and associated obligations. Amounts recognized in the Consolidated Financial Statements related to pension and other postretirement benefits are determined from actuarial valuations. Inherent in such valuations are assumptions including expected return on plan assets, discount rates at which the liabilities could be settled, rates of increase in future compensation levels, mortality rates and health care cost trend rates. These assumptions are updated annually and are disclosed in Note 16 to the Consolidated Financial Statements. In accordance with GAAP, actual results that differ from the assumptions are accumulated and amortized over future periods and, therefore, affect expense recognized and obligations recorded in future periods.
We consider a number of factors in determining and selecting assumptions for the overall expected long-term rate of return on plan assets. We consider the historical long-term return experience of our assets, the current and expected allocation of our plan assets, and expected long-term rates of return. We derive these expected long-term rates of return with the assistance of our investment advisors. We base our expected allocation of plan assets on a diversified portfolio consisting of domestic and international equity securities, fixed income, real estate, and alternative asset classes.
We consider a variety of factors in determining and selecting our assumptions for the discount rate at December 31. For the U.S. plans, the discount rate was based on the internal rate of return for a portfolio of high quality bonds rated Aa or higher by either Moody’s or Standard & Poor's with maturities that are consistent with the projected future benefit payment obligations of the plan. For the Non-U.S. Plans, the discount rates were determined by region and are based on high quality long-term corporate bonds. Consideration has been given to the duration of the liabilities in each plan when selecting the bonds to be used in determining the discount rate. The rate of compensation increase for all plans and the medical cost trend rate for the applicable U.S. plans are based on plan experience.
With respect to the U.S. plans, the expected rate of return on plan assets was determined based on an asset allocation model using the current target allocation, real rates of return by asset class and an anticipated inflation rate. The target asset allocation consists of approximately: 20% in equity securities and 80% in fixed income securities. The plan has achieved a compounded annual rate of return of 4.9% over the previous 20 years. At December 31, 2018, the actual asset allocation for the U.S. plan was: 1% cash and cash equivalents, 25% in equity securities and 74% in fixed income securities.
The expected rate of return for the non-U.S. plans employs a similar set of criteria adapted for local investments, inflation rates and in certain cases specific government requirements. The target asset allocation, for the non-U.S. plans, consists of approximately: 40% - 70% in fixed income securities; 15% - 40% in equity securities; 5% - 20% in real estate; and 5% - 10% in alternative investments. At December 31, 2018, the actual asset allocation for the non-U.S. plan was: 36% in fixed income investments; 12% in equity investments; 8% in real estate investments, 3% in cash and cash equivalents and 41% in alternative investments.
Changes in pension and other post-employment benefits, and associated expenses, may occur in the future due to changes in these assumptions. The impact that a 0.25% decrease in the discount rate or a 1% change in the medical cost trend rate would have on our pension and other post-employment benefit expense, as applicable, is as follows:
The effect of a 1% increase in the medical cost trend rate would increase the accumulated postretirement benefit obligation and the annual postretirement expense by approximately $0.3 million and less than $0.1 million, respectively; a 1% decrease in the rate would decrease the obligation and expense by approximately $0.3 million and less than $0.1 million, respectively.
The ongoing assessment of the valuation of inventory, given the large number of natural ingredients employed, the quality of which may be diminished over time. We hold a majority of our inventory as raw materials, providing the greatest degree of flexibility in manufacture and use. As of December 31, 2018, we maintained 53% of our inventory as raw materials. Materials are evaluated based on shelf life, known uses and anticipated demand based on forecasted customer order activity and changes in product/sales mix. Management policy provides for an ongoing assessment of inventory with adjustments recorded when an item is deemed to be slow moving or obsolete.
Redeemable Non-controlling interest. Through some of our subsidiaries, we assume certain non-controlling interests that carry redemption features. Non-controlling interests, where we may be required to repurchase the non-controlling interest under a put option or other contractual redemption requirement, are reported in the Consolidated Balance Sheet between liabilities and equity, as redeemable non-controlling interest. We adjust the redeemable non-controlling interests when the redemption value exceeds the carrying value with changes recognized as an adjustment to additional paid-in capital.
Overall, we believe that we have considered relevant circumstances that we may be currently subject to, and the financial statements accurately reflect our best estimate of the impact of these items in our results of operations, financial condition and cash flows for the years presented. We have discussed the decision process and selection of these critical accounting policies with the Audit Committee of the Board of Directors.
New Accounting Standards
Please refer to Note 1 to the Consolidated Financial Statements for a discussion of recent accounting pronouncements.
Revenue Recognition - Adoption of ASC 606
In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers", with subsequent amendments, that provides for a comprehensive model to be used in accounting for revenue arising from contracts with customers (ASC Topic 606, Revenue from Contracts with Customers) (the “Revenue Standard”). Under the Revenue Standard, revenue is recognized to reflect the transfer of goods or services to customers in an amount that reflects the consideration to which 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 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 our products, principally flavor compounds and fragrance 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 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 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, 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 its 2018 fiscal year, results for our 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.
We 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, we also recorded an increase of $4.4 million in contract assets (which are included in Prepaid expenses and other assets), a decrease of $1.7 million in inventory, and an increase in taxes payable of $0.6 million.
The impact to revenues, gross profit and net income for the twelve months ended December 31, 2018 were reductions of $4.0 million, $2.6 million and $1.9 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
We recognize 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 we collect are excluded from revenues. We receive payment in accordance with standard customer terms.
The following table presents our revenues disaggregated by product categories:
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(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:
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(a)
Prior period amounts have not been adjusted based on the modified retrospective method.
Flavor and Fragrance Compounds Revenues
We account 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”).
We generate revenues primarily by manufacturing customized taste and scent compounds for the exclusive use of our customers. We combine 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 our contracts for Compounds products, we recognize 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. We estimate Variable Consideration amounts for each customer based on the specific agreement, an analysis of historical volumes and the current activity with that customer. We reassess our 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, we recognize revenue over time as it manufactures customized compounds that do not have an alternative use and for which the contracts provide us 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. We generally use 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.
Ingredients Revenues
We account 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.
We generate revenues primarily by manufacturing Ingredients products for the use of our customers. We combine the shipment of goods with their manufacture to account for both shipment and manufacture as the sole performance obligation.
Generally, we recognize 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. We estimate discounts based on an analysis of historical experience and current activity. We assess our estimates of discounts at each reporting date throughout the contract period and updates its estimates until the uncertainty has been resolved. During the current period, changes to estimates of discounts have been immaterial.
Contract Asset and Accounts Receivable
The following table reflects the balances in our contract assets and accounts receivable for the twelve months ended December 31, 2018 and 2017:
Non-GAAP Financial Measures
We use non-GAAP financial operating measures in this Form 10-K, including: (i) currency neutral sales (which eliminates the effects that result from translating its international sales in U.S. dollars), (ii) adjusted gross profit and adjusted gross margin (which exclude operational improvement initiatives, acquisition related costs, integration related costs, FDA mandated product recall and Frutarom acquisition related costs), (iii) adjusted operating profit and adjusted operating margin (which excludes operational improvement initiatives, acquisition related costs, integration related costs, legal charges/credits, net, tax assessment, restructuring and other charges, net, gain on sale of assets, FDA mandated product recall, UK pension settlement charges and Frutarom acquisition related costs), and (iv) adjusted selling and administrative expenses (which excludes acquisition related costs, integration related costs, legal charges/credits, net, tax assessment, UK pension settlement charges and Frutarom acquisition related costs) and (v) adjusted effective tax rate (which excludes operational improvement initiatives, acquisition related costs, integration related costs, legal charges/credits, net, tax assessment, restructuring and other charges, net, CTA realization, FDA mandated product recall, UK pension settlement charges, U.S. tax reform and Frutarom acquisition related costs). We also provide 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.
In addition, the Frutarom acquisition related costs have been separated from costs related to prior acquisitions. The Frutarom acquisition costs represent a significant balance and we believe this amount should be shown separately to provide an accurate presentation of the acquisition related costs. Our GAAP results and GAAP metrics do not change and this change has no effect on day to day business operations, or how we manage our business.
We have included each of these non-GAAP measures in order to provide additional information regarding our underlying operating results and comparable year-over-year performance. Such information is supplemental to information presented in accordance with GAAP and is not intended to represent a presentation in accordance with GAAP. In discussing our historical and expected future results and financial condition, we believe it is meaningful for investors to be made aware of and to be assisted in a better understanding of, on a period-to-period comparable basis, financial amounts both including and excluding these identified items, as well as the impact of exchange rate fluctuations. We believe such additional non-GAAP information provides investors with an overall perspective of the period-to-period performance of our business. In addition, management internally reviews each of these non-GAAP measures to evaluate performance on a comparative period-to-period basis in terms of absolute performance, trends and expected future performance with respect to our business. A material limitation of these non-GAAP measures is that such measures do not reflect actual GAAP amounts. We compensate for such limitations by using these measures as one of several metrics, including GAAP measures. These non-GAAP measures may not be comparable to similarly titled measures used by other companies.
A. Reconciliation of Non-GAAP Metrics
(a)
For 2018, represents accelerated depreciation related to a plant relocation in India and Taiwan asset write off. For 2017, represents accelerated depreciation and idle labor costs in Hangzhou, China.
(b)
For 2018, represents adjustments to the contingent consideration payable for PowderPure, and transaction costs related to Fragrance Resources and PowderPure within Selling and administrative expenses. For 2017, represents the amortization of inventory "step-up" included in Cost of goods sold and transaction costs related to the acquisitions of Fragrance Resources and PowderPure within Selling and administrative expenses.
(c)
For 2018, represents costs related to the integration of the Frutarom acquisition. For 2017, represents costs related to the integration of the David Michael and Fragrance Resources acquisitions.
(d)
Represents additional charge related to litigation settlement.
(e)
Represents the reserve for payment of a tax assessment related to commercial rent for prior periods.
(f)
For 2018, represents severance costs related to the 2017 Productivity Program and costs associated with the termination of agent relationships in a subsidiary. For 2017, represents severance costs related to the 2017 Productivity Program.
(g)
Represents the release of CTA related to the liquidation of a foreign entity.
(h)
For 2018, principally represents recoveries from the supplier for the third and fourth quarter, partially offset by final payments to the customer made for the effected product in the first quarter. For 2017, represents management's best estimate of losses related to the previously disclosed FDA mandated recall.
(i)
Represents pension settlement charges incurred in one of the Company's UK pension plans.
(j)
For 2017, represents charges incurred related to enactment of certain U.S. tax legislation changes in December 2017, including $38.6 million related to net adjustments on deferred tax assets, and $100.6 million related to taxes on deemed repatriation of earnings. For 2018, represents additional expense based on updated repatriation plans requiring accruals for withholding taxes on deemed repatriation.
(k)
Represents transaction-related costs and expenses related to the acquisition of Frutarom. Amount primarily includes $23.5 million of amortization for inventory "step-up" costs, $39.4 million of bridge loan commitment fees included in Interest expense; $34.9 million make whole payment on the Senior Notes - 2007 and $3.9 million realized loss on a fair value hedge included in Loss on extinguishment of debt; $12.5 million realized gain on a foreign currency derivative included in Other income; and $66.0 million of transaction costs included in Selling and administrative expenses.
(l)
Represents the adjustment to EPS related to the excess of the redemption value of certain redeemable noncontrolling interests over their existing carrying value.
(m)
Except for amortization, the income tax expense (benefit) on non-GAAP adjustments is computed in accordance with ASC 740 using the same methodology as the GAAP provision of income taxes. Income tax effects of non-GAAP adjustments are calculated based on the applicable statutory tax rate for each jurisdiction in which such charges were incurred, except for those items which are non-taxable for which the tax expense (benefit) was calculated at 0%. For fiscal year 2018, these non-GAAP adjustments were not subject to foreign tax credits or valuation allowances, but to the extent that such factors are applicable to any future non-GAAP adjustments we will take such factors into consideration in calculating the tax expense (benefit). For amortization, the tax benefit has been calculated based on the Company's adjusted worldwide effective tax rate.
(n)
For 2018, net income is reduced by income attributable to noncontrolling interest of $2.5M.
(o)
The sum of these items does not foot due to rounding.
B. Foreign Currency Reconciliation
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(1) Includes items impacting comparability of $93.5 million for the year ended December 31, 2018 and includes $66.0 million of items impacting comparability for the year ended December 31, 2017.
** Currency neutral amount is calculated by translating prior year amounts at the exchange rates used for the corresponding 2018 period. Currency neutral operating profit also eliminates the year-over-year impact of cash flow hedging.
Cautionary Statement Under the Private Securities Litigation Reform Act of 1995
Statements in this Form 10-K, which are not historical facts or information, are “forward-looking statements” within the meaning of The Private Securities Litigation Reform Act of 1995. Such forward-looking statements are based on management’s current assumptions, estimates and expectations and include statements concerning (i) our ability to achieve the anticipated benefits of the Frutarom acquisition, including our ability to capitalize on future growth opportunities and offer our customers innovative and differentiated products and our ability to achieve the cost-savings synergies; (ii) our ability to achieve long-term sustainable growth and increase shareholder value, (ii) the growth potential of the markets in which we operate, including the emerging markets, (iii) our expectations regarding our Ingredients business, (iv) our expectations regarding percentage of revenues that will be attributed to research and development in 2019; (v) expected developments in the regulatory regime in which we operate; (vi) our expectations regarding future price volatility of raw materials; (vi) our expectations regarding the impact of litigation; (vii) expected capital expenditures and cost pressures in 2019, (viii) expectations regarding our 2017 productivity program; (ix) our ability to innovate and execute on specific consumer trends and demands, and (x) our ability to reduce our net debt levels over the next three years. These forward-looking statements should be evaluated with consideration given to the many risks and uncertainties inherent in our business that could cause actual results and events to differ materially from those in the forward-looking statements. Certain of such forward-looking information may be identified by such terms as “expect”, “anticipate”, “believe”, “intend”, “outlook”, “may”, “estimate”, “should”, “predict” and similar terms or variations thereof. Such forward-looking statements are based on a series of expectations, assumptions, estimates and projections about the Company, are not guarantees of future results or performance, and involve significant risks, uncertainties and other factors, including assumptions and projections, for all forward periods. Our actual results may differ materially from any future results expressed or implied by such forward-looking statements. Such factors include, among others, the following:
•
risks related to the integration of the Frutarom business, including whether we will realize the benefits anticipated from the acquisition in the expected time frame;
•
unanticipated costs, liabilities, charges or expenses resulting from the Frutarom acquisition;
•
the increase in our leverage resulting from the additional debt incurred to pay a portion of the consideration for Frutarom and its impact on our liquidity and ability to return capital to its shareholders;
•
our ability to successfully market to its expanded and decentralized Taste and Frutarom customer base;
•
our ability to effectively compete in its market and develop and introduce new products that meet customers’ needs;
•
our ability to successfully develop innovative and cost-effective products that allow customers to achieve their own profitability expectations;
•
the impact of the disruption in our manufacturing operations;
•
the impact of a disruption in our supply chain, including the inability to obtain ingredients and raw materials from third parties;
•
volatility and increases in the price of raw materials, energy and transportation;
•
our ability to comply with, and the costs associated with compliance with, regulatory requirements and industry standards, including regarding product safety, quality, efficacy and environmental impact;
•
the impact of any failure or interruption of our key information technology systems or a breach of information security;
•
our ability to react in a timely and cost-effective manner to changes in consumer preferences and demands;
•
our ability to establish and manage collaborations, joint ventures or partnership that lead to development or commercialization of products;
•
our ability to benefit from its investments and expansion in emerging markets;
•
the impact of currency fluctuations or devaluations in the principal foreign markets in which it operates;
•
economic, regulatory and political risks associated with our international operations;
•
the impact of global economic uncertainty on demand for consumer products;
•
the inability to retain key personnel;
•
our ability to comply with, and the costs associated with compliance with, U.S. and foreign environmental protection laws;
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our ability to realize the benefits of its cost and productivity initiatives;
•
our ability to successfully manage its working capital and inventory balances;
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the impact of the failure to comply with U.S. or foreign anti-corruption and anti-bribery laws and regulations, including the U.S. Foreign Corrupt Practices Act;
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our ability to protect its intellectual property rights;
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the impact of the outcome of legal claims, regulatory investigations and litigation;
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changes in market conditions or governmental regulations relating to our pension and postretirement obligations;
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the impact of future impairment of our tangible or intangible long-lived assets;
•
the impact of changes in federal, state, local and international tax legislation or policies, including the recently enacted Tax Cuts and Jobs Act, with respect to transfer pricing and state aid, and adverse results of tax audits, assessments, or disputes;
•
the effect of potential government regulation on certain product development initiatives, and restrictions or costs that may be imposed on the Company or its operations as a result; and
•
the impact of the United Kingdom’s expected departure from the European Union in 2019.
The foregoing list of important factors does not include all such factors, nor necessarily present them in order of importance. In addition, you should consult other disclosures made by the Company (such as in our other filings with the Securities and Exchange Commission (“SEC”) or in company press releases) for other factors that may cause actual results to differ materially from those projected by the Company. Please refer to Part I. Item 1A., Risk Factors, of this Form 10-K for additional information regarding factors that could affect the Company’s results of operations, financial condition and liquidity.
We intend our forward-looking statements to speak only as of the time of such statements and do not undertake or plan to update or revise them as more information becomes available or to reflect changes in expectations, assumptions or results. We can give no assurance that such expectations or forward-looking statements will prove to be correct. An occurrence of, or any material adverse change in, one or more of the risk factors or risks and uncertainties referred to in this report or included in our other periodic reports filed with the SEC could materially and adversely impact our operations and our future financial results.
Any public statements or disclosures made by us following this report that modify or impact any of the forward-looking statements contained in or accompanying this report will be deemed to modify or supersede such outlook or other forward-looking statements in or accompanying this report.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
We operate on a global basis and are exposed to currency fluctuation related to the manufacture and sale of our products in currencies other than the U.S. dollar. The major foreign currencies involve the markets in the European Union, Great Britain, Mexico, Brazil, China, India, Indonesia, Australia and Japan, although all regions are subject to foreign currency fluctuations versus the U.S. dollar. We actively monitor our foreign currency exposures in all major markets in which we operate, and employ a variety of techniques to mitigate the impact of exchange rate fluctuations, including foreign currency hedging activities.
We have established a centralized reporting system to evaluate the effects of changes in interest rates, currency exchange rates and other relevant market risks. Our risk management procedures include the monitoring of interest rate and foreign exchange exposures and hedge positions utilizing statistical analyses of cash flows, market value and sensitivity analysis. However, the use of these techniques to quantify the market risk of such instruments should not be construed as an endorsement of their accuracy or the accuracy of the related assumptions. For the year ended December 31, 2018, the Company’s exposure to market risk was estimated using sensitivity analyses, which illustrate the change in the fair value of a derivative financial instrument assuming hypothetical changes in foreign exchange rates and interest rates.
We enter into foreign currency forward contracts with the objective of reducing exposure to cash flow volatility associated with foreign currency receivables and payables, and with anticipated purchases of certain raw materials used in operations. These contracts, the counterparties to which are major international financial institutions, generally involve the exchange of one currency for a second currency at a future date, and have maturities not exceeding twelve months. The gain or loss on the hedging instrument and services is recorded in earnings at the same time as the transaction being hedged is recorded in earnings. At December 31, 2018, the Company’s foreign currency exposures pertaining to derivative contracts exist with the Euro, Japanese Yen, British Pound, Australian Dollar and Indonesian Rupiah. Based on a hypothetical decrease or increase of 10% in the applicable balance sheet exchange rates (primarily against the U.S. dollar), the estimated fair value of the Company’s foreign currency forward contracts would increase or decrease by approximately $60 million. However, any change in the value of the contracts, real or hypothetical, would be significantly offset by a corresponding change in the value of the underlying hedged items.
We use derivative instruments as part of our interest rate risk management strategy. We have entered into certain cross currency swap agreements in order to mitigate a portion of our net European investments from foreign currency risk. As of December 31, 2018, these swaps were in a net asset position with an aggregate fair value of $1.09 million. Based on a hypothetical decrease or increase of 10% in the value of the U.S. dollar against the Euro, the estimated fair value of the Company’s cross currency swaps would change by approximately $60 million.
At December 31, 2018, the fair value of our EUR fixed rate debt was €1.62 billion. Based on a hypothetical increase of 10% in foreign exchange rates, the estimated fair value of the Company’s EUR fixed debt would increase by $200 million.
At December 31, 2018, the fair value of our USD fixed rate debt was $2.35 billion. Based on a hypothetical increase of 10% in interest rates, the estimated fair value of the Company’s US fixed debt would decrease by $84 million.
We purchase certain commodities, such as natural gas, electricity, petroleum based products and certain crop related items. We generally purchase these commodities based upon market prices that are established with the vendor as part of the purchase process. In general, we do not use commodity financial instruments to hedge commodity prices.
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
See index to Consolidated Financial Statements on page 68. See Item 6 on page 30 for supplemental quarterly data.
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
None.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES.
Evaluation of Disclosure Controls and Procedures and Changes in Internal Control over Financial Reporting.
Our Chief Executive Officer and Chief Financial Officer, with the assistance of other members of our management, have evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Form 10-K. Based on such evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures are effective as of the end of the period covered by this Form 10-K.
We have established controls and procedures designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms and is accumulated and communicated to management, including the principal executive officer and the principal financial officer, to allow timely decisions regarding required disclosure.
Changes in Internal Control Over Financial Reporting.
On October 4, 2018, we completed the acquisition of Frutarom and are in the process of incorporating Frutarom into our internal control over financial reporting structure and our evaluation of internal control over financial reporting and related disclosure controls and procedures. Our Chief Executive Officer and Chief Financial Officer have concluded that, other than working to incorporate Frutarom as mentioned above, there have not been any changes in our internal control over financial reporting during the fourth quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting.
Our management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. Our internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of our internal control over financial reporting as of December 28, 2018. SEC guidance permits companies to exclude certain acquisitions from the assessment of internal control over financial reporting during the first year following the acquisition. Accordingly, management excluded from its assessment the internal control over financial reporting at Frutarom, which was acquired on October 4, 2018 and whose financial results constitute approximately 9% of net sales and 29% of assets of the consolidated financial statement amounts as of and for the fiscal year ended December 28, 2018.
In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”) in its 2013 Internal Control - Integrated Framework.
Based on this assessment, management determined that, as of December 28, 2018, our internal control over financial reporting was effective.
PricewaterhouseCoopers LLP, our independent registered public accounting firm, has audited the effectiveness of our internal control over financial reporting as of December 28, 2018 as stated in their report which is included herein.
ITEM 9B.
ITEM 9B. OTHER INFORMATION.
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.
The information relating to directors and nominees of the Company is set forth in the IFF 2019 Proxy Statement and is incorporated by reference herein. The information relating to Section 16(a) beneficial ownership reporting compliance that appears in the IFF 2019 Proxy Statement is also incorporated by reference herein. See Part I, Item 1 of this Form 10-K for information relating to the Company’s Executive Officers.
We have adopted a Code of Business Conduct and Ethics (the “Code of Ethics”) that applies to all of our employees, including our chief executive officer and our chief financial officer (who is also our principal accounting officer). We have also adopted a Code of Conduct for Directors and a Code of Conduct for Executive Officers (together with the Code of Ethics, the “Codes”). The Codes are available through the Investors - Corporate Governance link on our website www.iff.com.
Only the Board of Directors or the Audit Committee of the Board may grant a waiver from any provision of our Codes in favor of a director or executive officer, and any such waiver will be publicly disclosed. We will disclose substantive amendments to and any waivers from the Codes provided to our chief executive officer and principal financial officer (principal accounting officer), as well as any other executive officer or director, on the Company’s website: www.iff.com.
The information regarding the Company’s Audit Committee and its designated audit committee financial experts is set forth in the IFF 2019 Proxy Statement and such information is incorporated by reference herein.
The information concerning procedures by which shareholders may recommend director nominees is set forth in the IFF 2019 Proxy Statement and such information is incorporated by reference herein.
The items required by Part III, Item 11
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.
The items required by Part III, Item 12 are incorporated herein by reference from the IFF 2019 Proxy Statement to be filed on or before April 30, 2019.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.
The items required by Part III, Item 13 are incorporated herein by reference from the IFF 2019 Proxy Statement to be filed on or before April 30, 2019.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTANT FEES AND SERVICES.
The items required by Part III, Item 13 are incorporated herein by reference from the IFF 2019 Proxy Statement to be filed on or before April 30, 2019.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES.
All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto.
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders of International Flavors & Fragrances Inc.
Opinions on the Financial Statements and Internal Control over Financial Reporting
We have audited the accompanying consolidated balance sheets of International Flavors & Fragrances Inc. and its subsidiaries (the "Company") as of December 28, 2018 and December 29, 2017, and the related consolidated statements of income and comprehensive income, of shareholders’ equity and of cash flows for each of the three years in the period ended December 28, 2018, including the related notes and schedule of valuation and qualifying accounts and reserves for each of the three years in the period ended December 28, 2018 appearing on page S-1 (collectively referred to as the “consolidated financial statements”). We also have audited the Company's internal control over financial reporting as of December 28, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company as of December 28, 2018 and December 29, 2017, and the results of their operations and their cash flows for each of the three years in the period ended December 28, 2018 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 28, 2018, based on criteria established in Internal Control - Integrated Framework (2013) issued by the COSO.
Basis for Opinions
The Company's management is responsible for these consolidated financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in Management's Report on Internal Control over Financial Reporting, appearing under Item 9A. Our responsibility is to express opinions on the Company’s consolidated financial statements and on the Company's internal control over financial reporting based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud, and whether effective internal control over financial reporting was maintained in all material respects.
Our audits of the consolidated financial statements included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
As described in Management’s Report on Internal Control over Financial Reporting, management has excluded Frutarom Industries Ltd. and its subsidiaries (“Frutarom Industries Ltd.”) from its assessment of internal control over financial reporting as of December 28, 2018, because it was acquired by the Company in a purchase business combination during 2018. We have also excluded Frutarom Industries Ltd. from our audit of internal control over financial reporting. Frutarom Industries Ltd. is a wholly-owned subsidiary whose total net sales and total assets excluded from management’s assessment and our audit of internal control over financial reporting represent approximately 9% and 29%, respectively, of the related consolidated financial statement amounts as of and for the year ended December 28, 2018.
Definition and Limitations of Internal Control over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
We have served as the Company’s auditor since 1957.
INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED STATEMENT OF INCOME AND COMPREHENSIVE INCOME
See Notes to Consolidated Financial Statements
INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED BALANCE SHEET
See Notes to Consolidated Financial Statements
INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED STATEMENT OF CASH FLOWS
See Notes to Consolidated Financial Statements
INTERNATIONAL FLAVORS & FRAGRANCES INC.
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY
See Notes to Consolidated Financial Statements
INTERNATIONAL FLAVORS & FRAGRANCES INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1. NATURE OF OPERATIONS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Nature of Operations International Flavors & Fragrances Inc. and its subsidiaries (the “Registrant,” “IFF,” “the Company,” “we,” “us” and “our”) is a leading creator and manufacturer of tastes and scents (including cosmetic active ingredients) used to impart or improve taste and scent in a wide variety of consumer products. Our products are sold principally to manufacturers of perfumes and cosmetics, hair and other personal care products, soaps and detergents, cleaning products, dairy, meat and other processed foods, beverages, snacks and savory foods, sweet and baked goods, and pharmaceutical and oral care products.
Fiscal Year End The Company has historically operated on a 52/53 week fiscal year generally ending on the Friday closest to the last day of the year. For ease of presentation, December 31 is used consistently throughout the financial statements and notes to represent the period-end date. The 2018, 2017 and 2016 fiscal years were 52 week periods. For the 2018, 2017 and 2016 fiscal years, the actual closing dates were December 28, December 29, and December 30, respectively.
Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts and accompanying disclosures. These estimates are based on management’s best knowledge of current events and actions the Company may undertake in the future. Actual results may ultimately differ from estimates.
Principles of Consolidation The consolidated financial statements include the accounts of International Flavors & Fragrances Inc. and those of its subsidiaries. Significant intercompany balances and transactions have been eliminated. To the extent a subsidiary is not wholly owned, any related noncontrolling interests are included as a separate component of Shareholders’ Equity.
Revenue Recognition Revenue from contracts with customers is recognized when the contract or purchase order has received approval and commitment from both parties, has the rights of the parties and payment terms (which can vary by customer) identified, has commercial substance, and collectability of consideration is probable.
For the Company's Flavors, Fragrances Compounds and Frutarom products, revenue is recognized for the majority of contracts when the Company satisfies its performance obligation by transferring control of the goods to the customer. Revenue is recognized over time for a small number of contracts, and the amount of revenue recognized is based on the extent of progress towards completion of the promised goods, using the output method.
For the Company's Fragrances Ingredients products, revenue is recognized for the majority of contracts when the Company satisfies its performance obligation by transferring control of the goods to the customer.
Sales are reduced, at the time revenue is recognized, for applicable discounts, rebates and sales allowances based on historical experience. Related accruals are included in Other current liabilities in the accompanying Consolidated Balance Sheet.
The Company considers shipping and handling activities undertaken after the customer has obtained control of the related goods as a fulfillment activity. Net sales include shipping and handling charges billed to customers. Cost of goods sold includes all costs incurred in connection with shipping and handling.
Foreign Currency Translation The Company translates the assets and liabilities of non-U.S. subsidiaries into U.S. dollars at year-end exchange rates. Income and expense items are translated at average exchange rates during the year. Cumulative translation adjustments are shown as a separate component of Shareholders’ Equity.
Research and Development Research and development (“R&D”) expenses relate to the development of new and improved tastes or scents, technical product support and compliance with governmental regulation. All research and development costs are expensed as incurred.
Cash Equivalents Cash equivalents include highly liquid investments with maturities of three months or less at date of purchase.
Restricted Cash Restricted cash is comprised of cash or cash equivalents which has been placed into an account that is restricted for a specific use and from which the Company cannot withdraw the cash on demand.
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 sale 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 $16.9 million in 2018, compared to an increase of approximately $7.6 million and $34 million in 2017 and 2016, respectively. The cost of participating in these programs was immaterial to our results in all periods.
Inventories Inventories are stated at the lower of cost (on a weighted-average basis) or net realizable value. Our inventories consisted of the following:
Long-Lived Assets
Property, Plant and Equipment Property, plant and equipment are recorded at cost. Depreciation is calculated on a straight-line basis, principally over the following estimated useful lives: buildings and improvements, 10 to 40 years; machinery and equipment, 3 to 20 years; information technology hardware and software, 3 to 7 years; and leasehold improvements which are included in buildings and improvements, the estimated life of the improvements or the remaining term of the lease, whichever is shorter.
Finite-Lived Intangible Assets Finite-lived intangible assets include customer relationships, patents, trade names, technological know-how and other intellectual property valued at acquisition and amortized on a straight-line basis over the following estimated useful lives: customer relationships, 11 - 23 years; patents, 11 years; trade names, 14 - 28 years; and technological know-how, 5 - 28 years.
The Company reviews long-lived assets for impairment when events or changes in business conditions indicate that their full carrying value may not be recovered. An estimate of undiscounted future cash flows produced by an asset or group of assets is compared to the carrying value to determine whether impairment exists. If assets are determined to be impaired, the loss is measured based on an estimate of fair value using various valuation techniques, including a discounted estimate of future cash flows.
Goodwill Goodwill represents the difference between the total purchase price and the fair value of identifiable assets and liabilities acquired in business acquisitions.
In assessing the potential for impairment of goodwill, management uses the most current actual and forecasted operating data available and current market-based assumptions in accordance with the criteria in Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") 350. The Company has identified five reporting units: (1) Flavor Compounds, (2) Fragrance Compounds, (3) Fragrance Ingredients, (4) Cosmetic Actives Ingredients and (5) Frutarom. These reporting units were determined based on the level at which the performance is measured and reviewed by segment management. In the case of Frutarom, the reporting unit determination is preliminary and is subject to change.
The Company performs an annual goodwill impairment test for its reporting units by assessing the fair value of the reporting units based on discounted cash flows. If a reporting unit’s carrying amount exceeds its fair value, the Company will record an impairment charge based on that difference, and the impairment charge will be limited to the amount of goodwill allocated to that reporting unit. The Company completed its annual goodwill impairment test as of November 30, 2018, which indicated no impairment of goodwill as the estimated fair values substantially exceeded the carrying values of each of these reporting units, except for the recently acquired Frutarom reporting unit for which the fair value is expected to approximate the carrying value.
Income Taxes The Company accounts for taxes under the asset and liability method. Under this method, deferred income taxes are recognized for temporary differences between the financial statement and tax return bases of assets and liabilities, based on enacted tax rates and other provisions of the tax law. The effect of a change in tax laws or rates on deferred tax assets and liabilities is recognized as income in the period in which such change is enacted. Future tax benefits are
recognized to the extent that the realization of such benefits is more likely than not, and a valuation allowance is established for any portion of a deferred tax asset that management believes may not be realized.
The Company recognizes uncertain tax positions that it has taken or expects to take on a tax return. Pursuant to accounting requirements, the Company first determines whether it is “more likely than not” its tax position will be sustained if the relevant tax authority were to audit the position with full knowledge of all the relevant facts and other information. For those tax positions that meet this threshold, the Company measures the amount of tax benefit based on the largest amount of tax benefit that it has a greater than 50% chance of realizing in a final settlement with the relevant authority. Those tax positions failing to qualify for initial recognition are recognized in the first interim period in which they meet the more likely than not standard. The Company maintains a cumulative risk portfolio relating to all of its uncertainties in income taxes in order to perform this analysis, but the evaluation of its tax positions requires significant judgment and estimation in part because, in certain cases, tax law is subject to varied interpretation, and whether a tax position will ultimately be sustained may be uncertain.
Interest and penalties related to unrecognized tax benefits are recognized as a component of income tax expense.
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 has been adjusted during 2018. The impact of the Tax Act was finalized in the fourth quarter of 2018.
During the first quarter of 2018, the Company recorded an additional charge of $0.6 million to adjust an accrual related to withholding taxes on planned repatriations. During the second quarter of 2018, the Company paid the first installment of the “toll charge”. During the third quarter of 2018, the Company recorded a benefit of $8.0 million to adjust the provisional “toll charge” required from the transition to the new territorial tax system, and a benefit of $0.2 million to adjust the remeasurement of net deferred tax assets as a result of U.S. tax reform. During the fourth quarter, the Company completed its final assessment under SAB 118, and recorded an additional charge of $32.8 million to adjust an accrual related to the U.S. state impact and foreign withholding taxes on planned repatriations. The charge in the fourth quarter of 2018 is consistent with the Company's need to repatriate funds for debt repayment purposes.
Retirement Benefits Current service costs of retirement plans and postretirement health care and life insurance benefits are accrued. Prior service costs resulting from plan improvements are amortized over periods ranging from 10 to 20 years.
Financial Instruments Derivative financial instruments are used to manage interest and foreign currency exposures. The gain or loss on the hedging instrument is recorded in earnings at the same time as the transaction being hedged is recorded in earnings. The associated asset or liability related to the open hedge instrument is recorded in Prepaid expenses and Other current assets or Other current liabilities, as applicable.
The Company records all derivative financial instruments on the balance sheet at fair value. Changes in a derivative’s fair value are recognized in earnings unless specific hedge criteria are met. If the derivative is designated as a fair value hedge, the changes in the fair value of the derivative and of the hedged item attributable to the hedged risk are recognized in Net income. If the derivative is designated as a cash flow hedge, the effective portions of changes in the fair value of the derivative are recorded in Accumulated other comprehensive income ("AOCI") in the accompanying Consolidated Balance Sheet and are subsequently recognized in Net income when the hedged item affects earnings. Ineffective portions of changes in the fair value of cash flow hedges, if any, are recognized as a charge or credit to earnings.
Software Costs The Company capitalizes direct internal and external development costs for certain significant projects associated with internal-use software and amortizes these costs over 7 years. Neither preliminary evaluation costs nor costs associated with the software after implementation are capitalized. Costs related to projects that are not significant are expensed as incurred.
Net Income Per Share Under the two-class method, earnings are adjusted by accretion amounts to redeemable noncontrolling interests recorded at redemption value. The adjustments represent in-substance dividend distributions to the noncontrolling interest holders as the holders have a contractual right to receive a specified amount upon redemption. As a result, earnings are adjusted to reflect this in-substance distribution that is different from other common shareholders. In addition, the Company has unvested share based payment awards with a right to receive nonforfeitable dividends and thus are considered participating securities which are required to be included in the computation of basic and diluted earnings per share.
Basic earnings (loss) per share represents the amount of earnings for the period available to each share of common stock outstanding during the period. Basic earnings (loss) per share includes the effect of issuing shares of common stock assuming (i) the prepaid stock purchase contracts (“SPC”) are converted into the minimum number of common stock under the if-converted method, and (ii) an adjustment to earnings (loss) to reflect adjustments made to record the redeemable value of redeemable non-controlling interests. Diluted earnings (loss) per share also includes the effect of issuing shares of common stock, assuming (i) stock options and warrants are exercised, (ii) restricted stock units are fully vested under the treasury stock method, and (iii) the incremental effect of the prepaid stock purchase contracts (“SPC”) converted into the maximum number of common stock under the if-converted method.
Stock-Based Compensation Compensation cost of all stock-based awards is measured at fair value on the date of grant and recognized over the service period for which awards are expected to vest. The cost of such stock-based awards is principally recognized on a straight-line attribution basis over their respective vesting periods, net of estimated forfeitures.
Financing Costs Costs incurred in the issuance of debt are deferred and amortized as part of interest expense over the stated life of the applicable debt instrument. Unamortized deferred financing costs relating to debt are presented as a reduction in the amount of debt outstanding on the Consolidated Balance Sheet. Unamortized deferred financing costs relating to the revolving credit facility are recorded in Other assets on the Consolidated Balance Sheet.
Redeemable Non-controlling Interests Non-controlling interests in subsidiaries that are redeemable for cash or other assets outside of the Company’s control are classified as mezzanine equity, outside of equity and liabilities, at the greater of the carrying value or the redemption value. The increases or decreases in the estimated redemption amount are recorded with corresponding adjustments against Capital in excess of par value and are reflected in the computation of earnings per share using the two-class method.
Adoption of Highly Inflationary Accounting in Argentina U.S. GAAP requires the use of highly inflationary accounting for countries whose cumulative three-year inflation rate exceeds 100 percent. In the second quarter of 2018, the Argentine peso rapidly devalued relative to the U.S. dollar, which along with increased inflation, indicated that the three-year cumulative inflation rate in that country exceeded 100 percent as of July 1, 2018. As a result, the Company adopted highly inflationary accounting as of the beginning of the third quarter of 2018 for its subsidiary in Argentina. Under highly inflationary accounting, the functional currency of the Company's subsidiary in Argentina became the U.S. dollar, and its results for the third and fourth quarter have been recorded on that basis. The net effect of the adoption of the U.S. dollar as the functional currency did not result in a material change to the Company's Consolidated Balance Sheet or the Consolidated Statement of Income and Comprehensive Income. For the year ended December 31, 2018, the Company's Argentina subsidiary represented less than 3% of the Company’s consolidated net sales and less than 1% of its consolidated total assets as of December 31, 2018.
Recent Accounting Pronouncements
In October 2018, the FASB issued Accounting Standards Update ("ASU") 2018-16, “Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate ("SOFR") Overnight Index Swap ("OIS") Rate as a Benchmark Interest Rate for Hedge Accounting Purposes." The ASU allows for the use of the OIS rate based on the SOFR as a U.S. benchmark interest rate for purposes of applying hedge accounting under ASC 815, Derivatives and Hedging. The ASU is effective for fiscal years beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the impact this guidance will have on its Consolidated Financial Statements.
In August 2018, the FASB issued ASU 2018-15, “Intangibles - Goodwill and Other - Internal - Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of the FASB Emerging Issues Task Force).” The ASU aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). This guidance is effective for fiscal years beginning after December 15, 2019, and for interim periods within those fiscal years, with early adoption permitted. The Company is currently evaluating the impact this guidance will have on its Consolidated Financial Statements.
In August 2018, the FASB issued ASU 2018-14, "Compensation - Retirement Benefits - Defined Benefit Plans (Subtopic 715-20)", which modifies the disclosure requirements on company-sponsored defined benefit plans. The ASU is effective for fiscal years beginning after December 15, 2020 on a retrospective basis to all periods presented. Early adoption is permitted. The Company is currently evaluating the impact this guidance will have on its Consolidated Financial Statements.
In August 2018, the FASB issued ASU 2018-13, "Fair Value Measurement (Topic 820)", which modifies, removes and adds certain disclosure requirements on fair value measurements. The ASU is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2019. The amendments on changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty should be applied prospectively for only the most recent interim or annual period presented in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. Early adoption is permitted. The Company is currently evaluating the impact this guidance will have on its Consolidated Financial Statements.
In June 2018, the FASB issued ASU 2018-07, "Compensation - Stock Compensation (Topic 718)" intended to reduce cost and complexity and to improve financial reporting for nonemployee share-based payments. This guidance expands the scope of Topic 718, Compensation-Stock Compensation which currently only includes share-based payments to employees to include share-based payments issued to nonemployees for goods or services. This guidance is effective for public companies for fiscal years beginning after December 15, 2018, including interim periods within that fiscal year. The Company is currently evaluating the impact this guidance will have on its Consolidated Financial Statements.
In February 2018, FASB issued ASU 2018-02, "Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income" which allows for a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Act, in addition to requiring certain disclosures about stranded tax effects. This guidance is effective for periods beginning after December 15, 2018, with an election to adopt early. The Company is currently evaluating the impact this guidance may have on its Consolidated Financial Statements.
In August 2017, FASB issued ASU 2017-12, "Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities" which eliminates the requirement to separately measure and present hedge ineffectiveness and aligns the presentation of hedge gains and losses with the underlying hedge item. This guidance is effective for fiscal years beginning after December 15, 2018. Early adoption is permitted. The amended presentation and disclosure requirements are to be applied prospectively while the amendments to cash flow and net investment hedge relationships are to be applied on a modified retrospective basis. The Company is currently evaluating the impact this guidance will have on its Consolidated Financial Statements.
In May 2017, the FASB issued ASU 2017-09, "Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting" which clarifies changes to the terms or conditions of a share-based payment award that require an entity to apply modification accounting. This guidance is effective for the current year. The Company has determined that this guidance does not have an impact on its Consolidated Financial Statements as it is not the Company's practice to modify the terms or conditions of a share-based payment award after it has been granted.
In March 2017, the FASB issued ASU 2017-07, "Compensation - Retirement Benefits (Topic 715): Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost" which requires employers who present a measure of operating income in their statement of income to include only the service cost component of net periodic pension cost and postretirement costs in operating expenses. This guidance is effective for 2018, and as required, has been applied on a full retrospective basis. The impact of the adoption of this standard on January 1, 2018 was a decrease in operating profit by approximately $28.8 million and $14.4 million for the fiscal year 2017 and 2016, respectively, and corresponding increases in Other (income) expense, net as presented in the Company's Consolidated Statement of Income and Comprehensive Income for the respective periods. There was no impact to Net income or Net Income per share in either period. See Note 16 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 November 2015, the FASB issued ASU 2016-18, "Statement of Cash Flows (Topic 230): Restricted Cash" which requires the statement of cash flows to explain the change during the period in the total cash, cash equivalents and amounts generally described as restricted cash. Amounts generally described as restricted cash and restricted cash equivalents should be
included with cash and cash equivalents when reconciling the beginning and ending total amounts shown on the statement of cash flows. Retrospective presentation is required. The company retroactively applied this new guidance as of December 30, 2017, the first day of the Company’s 2018 fiscal year
In August 2016, the FASB issued ASU 2016-15, "Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments" which requires changes to the classification of certain activities within the statement of cash flows. This guidance is effective for the current year, and the Company has determined that this adoption does not have an impact on its Consolidated Statement of Cash Flows.
In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments", with subsequent amendments, 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.
In February 2016, the FASB issued ASU 2016-02, "Leases (Topic 842)", with subsequent amendments, which requires changes to the accounting for leases and supersedes existing lease guidance, including ASC 840 - Leases. Among other things, ASU 2016-02 requires recognition of a right-of-use asset and a liability for future lease payments for contracts that meet the definition of a lease and also requires disclosure of certain information about leasing arrangements. ASU 2016-02 is effective January 1, 2019. On July 30, 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which, among other things, allows companies to elect an optional transition method to apply the new lease standard through a cumulative-effect adjustment in the period of adoption. The Company adopted the standard on December 29, 2018, the first day of its 2019 year, using the optional transition method. The Company has made substantial progress in executing its implementation plan. It is in the process of revising its controls and processes to address the lease standard and has substantially completed the implementation and data input for the lease accounting software tool that it will use post adoption. The Company is electing certain practical expedients including the expedient that allows it to carry forward prior lease classifications under ASC 840. Adoption of the standard is expected to have a material impact on the Company's consolidated statement of financial position due to the addition of lease assets and liabilities related to operating leases. ASU 2016-02 also requires expanded disclosure regarding the amounts, timing and uncertainties of cash flows related to a company’s lease portfolio. The Company is evaluating these disclosure requirements and is incorporating the collection of relevant data into its existing financial reporting processes in preparation for disclosure in 2019. The Company does not expect ASU 2016-02 to have a material impact on its annual results of operations and/or cash flows.
Revenue Recognition - Adoption of ASC 606
In May 2014, the FASB issued ASU 2014-09, "Revenue from Contracts with Customers", with subsequent amendments, that provides for a comprehensive model to be used in accounting for revenue arising from contracts with customers (ASC Topic 606, Revenue from Contracts with Customers) (the “Revenue Standard”). Under the Revenue Standard, revenue is recognized to reflect the transfer of goods or services to customers in an amount that reflects the consideration to which the Company expects to be entitled in exchange for those goods or services. Companies have the option to apply the new guidance under a retrospective approach to each prior reporting period presented or a modified retrospective approach with the cumulative effect of initially applying the new guidance recognized at the date of initial application within the Consolidated 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 flavor compounds and fragrance 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 ingredients products that, generally, are commodity products with alternative uses and not customized (“Ingredients products”).
With respect to the vast majority of the Company’s contracts for Compounds products, the Company currently recognizes revenue on the transfer of control of the product at a point in time as the Company does not have an “enforceable right to payment for performance to date” (as set out in the Revenue Standard). With respect to a small number of contracts for the sale of Compounds, the Company has an “enforceable right to payment for performance to date” and as the products do not have an alternative use, the Company recognizes revenue for these contracts over time and records a contract asset using the output method. The output method recognizes revenue on the basis of direct measurements of the value to the customer of the goods or services transferred to date relative to the remaining goods or services promised under the contract.
With respect to the Company’s contracts related to Ingredients products, the Company currently recognizes revenue on the transfer of control of the product at a point in time as such products generally have alternative uses and the Company does not have an “enforceable right to payment for performance to date.”
As the Company adopted the Revenue Standard using the modified retrospective method effective the first day of its 2018 fiscal year, results for its 2018 fiscal year are presented under the Revenue Standard while prior period amounts are not adjusted and continue to be reported in accordance with our historic accounting under ASC Topic 605, which required that revenue was accounted for when the earnings process was complete.
The Company recorded a net increase to retained earnings of $2.1 million as of the first day of its 2018 fiscal year due to the cumulative impact of adopting the Revenue Standard. In connection with the adjustment to retained earnings, the Company also recorded an increase of $4.4 million in contract assets (which are included in Prepaid expenses and other assets), a decrease of $1.7 million in inventory, and an increase in taxes payable of $0.6 million.
The impact to revenues, gross profit and net income for the year ended December 31, 2018 were reductions of $4.0 million, $2.6 million and $1.9 million, respectively, as a result of applying the Revenue Standard as compared to the amounts that would have been recognized under ASC Topic 605.
Revenue Recognition
The Company recognizes revenue when control of the promised goods is transferred to its customers in an amount that reflects the consideration it expects to be entitled to in exchange for those goods. Sales, value add, and other taxes the Company collects are excluded from revenues. The Company receives payment in accordance with standard customer terms.
The following table presents the Company's revenues disaggregated by product categories:
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(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:
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(a)
Prior period amounts have not been adjusted based on the modified retrospective method.
Flavor and Fragrance 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 taste and scent 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 the Company's products, returns are not material.
Ingredients Revenues
The Company accounts for a contract when it has approval and commitment from both parties, the rights of the parties and payment terms (which vary by customer) are identified, the contract has commercial substance, and collectability of consideration is probable.
The Company generates revenues primarily by manufacturing Ingredients products for the use of our customers. The Company combines the shipment of goods with their manufacture to account for both shipment and manufacture as the sole performance obligation.
Generally, the Company recognizes a sale at the time when it ships the product from their manufacturing facility to their customer, as this is the point when control of the goods or services has transferred to the customer. The amount of consideration received and revenue recognized is impacted by discounts offered to its customers. The Company estimates discounts based on an analysis of historical experience and current activity. The Company assesses its estimates of discounts at each reporting date throughout the contract period and updates its estimates until the uncertainty has been resolved. During the current period, changes to estimates of discounts have been immaterial.
Contract Asset and Accounts Receivable
The following table reflects the balances in our contract assets and accounts receivable for the twelve months ended December 31, 2018 and 2017:
Reclassifications
As discussed above, the Company has reclassified certain components of net periodic benefit expense (income) to Other income (expense), net.
NOTE 2. RESTRUCTURING AND OTHER CHARGES
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, we expect to optimize our global footprint and simplify the Company's organizational structures globally. In connection with this initiative, the Company expects to incur cumulative, pre-tax cash charges of $27 million, consisting primarily of $25 million in personnel-related costs and an estimated $2 million in facility-related costs, such as lease termination, and integration-related costs.
The Company recorded $3.9 million and $20.6 million of charges related to personnel-related costs in 2018 and 2017, respectively, with no further anticipated personnel-related and other costs after the first quarter of 2019. The Company made payments of $7.3 million and $14.0 million related to severance in 2018 and 2017, respectively. The overall charges were split approximately evenly between Taste and Scent. No charges were allocated to the Frutarom segment. 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.
2015 Severance
During 2015, the Company established a series of initiatives intended to streamline its management structure, simplify decision-making and accountability, better leverage and align its capabilities across the organization and improve efficiency of its global manufacturing and operations network. As a result, the Company recorded charges for severance and related costs pertaining to approximately 150 positions that were affected. During 2016, the Company recorded a credit of $1.7 million related to the reversal of severance accruals that were determined to be no longer required. During 2017, the Company made payments of $0.2 million related to severance and recorded a credit of $2.3 million related to the reversal of severance accruals that were determined to be no longer required.
Roll Forward of Liability
Movements in severance-related accruals during 2016, 2017 and 2018 are as follows:
NOTE 3. ACQUISITIONS
Frutarom
On October 4, 2018 (the "Closing"), the Company completed its acquisition of Frutarom Industries Ltd. (“Frutarom”). The Company acquired 100% of the equity of Frutarom pursuant to a definitive agreement and plan of merger entered into on May 7, 2018 ("Merger Agreement"). Frutarom is an Israeli company that, through its subsidiaries, develops, produces and
markets flavors and fine ingredients used in manufacturing food, beverages, flavors and fragrances, pharma/nutraceuticals, cosmetics and personal care products, including natural products. The acquisition was made in order to strengthen IFF's customer base, its capabilities and geographic reach, and is expected to result in more exposure to numerous end markets, including those with a focus on naturals and health and wellness.
The acquisition was accounted for using the purchase method of accounting in accordance with ASC Topic 805, Business Combinations, with IFF identified as the acquirer. As a result of the acquisition, Frutarom's assets, liabilities and results of operations were included in the Company’s financial statements from the acquisition date. Frutarom contributed net sales of $359.6 million for the year ended December 31, 2018 and a segment profit of $27.4 million for the year ended December 31, 2018.
Purchase Price
The following table summarizes the aggregate purchase price consideration paid to acquire Frutarom (in thousands, except share and per share data):
At the Closing, each issued and outstanding Frutarom ordinary share was exchanged for $71.19 in cash and 0.2490 of a share of the Company's common stock (the "Merger Consideration").
As part of the acquisition, each Frutarom stock option and restricted share unit (“RSU”) that was vested at the Closing was canceled in exchange for the right to receive Merger Consideration, reduced by the exercise price per share for each vested option. Upon Closing, IFF paid $19.2 million in cash and issued 67,046 shares to the holders of vested options and RSUs.
Frutarom stock options and RSUs that were unvested at the Closing were canceled in exchange for the right to receive cash equivalent to the Merger Consideration reduced by the exercise price per share for each unvested option. These awards require the option holders to continue employment until the end of the original vesting period. If an employee is terminated and the right to such options has not been forfeited, the employee is entitled to a pro-rata portion based on the vesting period that has been completed at the termination date. The Company funded a separate escrow account for the amount related to the unvested awards in the amount of $13.6 million. This amount is designated as Restricted cash on the Consolidated Balance Sheet. The Company attributed the fair value of $7.0 million of the unvested awards to pre-acquisition services and the remainder will be recognized in the post-acquisition period over the required remaining service period.
Pursuant to the Merger Agreement, the Frutarom shareholders were entitled to a closing dividend. The per share dividend was equal to the product of (a) aggregate amount of per share cash dividends declared by IFF with a record date occurring on or after the date of the Merger Agreement and prior to closing of the Merger, multiplied by, (b) Frutarom’s shares outstanding as of the Closing multiplied by the exchange ratio of 0.2490. The closing dividend payment of $21.1 million has been included in the total purchase consideration amount.
A portion of Frutarom’s existing debt was repaid concurrent with the Closing. Frutarom's debt, which was not legally assumed by IFF but was paid at Closing, was approximately $695.0 million.
To finance the acquisition, the Company used cash on hand and borrowed approximately $3.3 billion of additional debt, consisting of $2.8 billion of senior unsecured notes, $350.0 million in term loans and $139.5 million of tangible equity units. See Note 10 for further details.
The Company issued 14.9 million shares as a portion of the purchase consideration resulting in former Frutarom shareholders holding approximately 14% of the Company's outstanding common stock as of the Closing. Additionally, the Company issued 16,500,000 TEUs in an underwritten public offering for net proceeds of approximately $665.1 million.
The Company acquired pre-existing contingent consideration arrangements that are subject to change based on future earnings. Amounts are payable in 2019, 2020, and 2021. The fair value of the contingent consideration has been recorded on the opening balance sheet in the amount of $43.6 million. The liability will be periodically re-assessed and any changes will be recorded in the consolidated statement of operations.
As part of several acquisitions made by Frutarom, noncontrolling interest holders of the acquired entities were granted options to sell their respective interests to Frutarom (“put option”) and Frutarom held a mirroring option to buy the interests on the same terms (“call option”). IFF determined that the put options cannot be separated from the noncontrolling interests and the combination of a noncontrolling interest and its redemption feature require each noncontrolling interest to be classified as a redeemable noncontrolling interest. The redeemable noncontrolling interests were initially measured at fair value as of the acquisition date using a discounted cash flow approach, inclusive of the put and call provisions.
Purchase Price Allocation
The Company allocated the purchase consideration to the tangible net assets and identifiable intangible assets acquired based on estimated fair values at the acquisition date, and recorded the excess of consideration over the fair values of net assets acquired as goodwill. The purchase price allocation is preliminary and is subject to change. The Company is currently finalizing the valuation of property, plant and equipment (including estimated useful lives), goodwill, intangible assets (trade names, product formulas, customer relationships and favorable/unfavorable leases, including estimated useful lives), and leases, in addition to ensuring all other liabilities and contingencies have been identified and recorded. Additionally, the Company is finalizing the projected combined future tax rate to be applied to the valuation of assets, which could impact the valuation of goodwill and intangible assets. The determination of the fair value of assets and liabilities will be finalized as soon as the valuation is completed which is expected to be during 2019.
The following table summarizes the preliminary estimated fair values of the assets acquired and liabilities assumed (in thousands).
Accounts receivable and other miscellaneous receivables were recorded at their approximate fair value based on Frutarom’s expected collections. Finished goods and work-in-process inventory was valued using a net realizable value approach, including profit allowance, which resulted in a step-up of $31.5 million. The preliminary fair value of property, plant and equipment will be determined using a combination of the income approach, the preliminary market approach and the cost approach. The cost approach is based on current replacement and/or reproduction cost of the asset as new, less depreciation attributable to physical, functional, and economic factors.
Other liabilities includes a deferred tax liability of $45.0 million on deemed repatriation as the Company plans to repatriate certain funds to the U.S. and will be required to pay foreign withholding and other taxes, including state taxes, during the period when such repatriation occurs. This balance is preliminary and will be refined through the purchase accounting measurement period.
The Company has recognized $4.2 billion of goodwill, which is attributable to expected synergies generated by the integration of Frutarom including cross-selling benefits as well as cost synergies. The goodwill has all been assigned to the Frutarom reporting unit. Approximately $87.3 million of the goodwill associated with the Frutarom acquisition is deductible for income tax purposes. Any changes in the estimated fair values of the assets acquired and liabilities assumed in the acquisition may change the amount of the purchase consideration allocated to goodwill.
The preliminary amounts of the components of intangible assets have been recorded as follows:
Trade names and trademarks, product formulas, and customer relationships were valued using the relief from royalty method, or the multi-period excess earnings method, which are both variations of the income approach. Some of the more significant assumptions inherent in developing the valuations included the estimated net cash flows (including net sales, cost of goods sold, operating expenses, and contributory asset charges), royalty rates, attrition rates, and discount rates that appropriately reflect the risks inherent in each future cash flow stream, the assessment of each asset’s life cycle, competitive trends, as well as other factors. The assumptions used in the financial forecasts were determined by considering historical data as well as current and anticipated market conditions, industry growth rates, management plans, and market comparables. The intangible assets are being amortized on a straight-line basis over the respective useful lives.
Pro forma financial information
The following unaudited pro forma financial information presents the combined results of operations of IFF and Frutarom as if the acquisition had been completed as of the beginning of the prior fiscal year, or January 1, 2017. The unaudited pro forma financial information is presented for informational purposes and is not indicative of the results of operations that would have been achieved if the acquisition and related borrowings had taken place on January 1, 2017, nor are they indicative of future results. The unaudited pro forma financial information for the year ended December 31, 2018 includes IFF results, including the post-acquisition results of Frutarom, since October 4, 2018, and pre-acquisition results of Frutarom for the period January 1, 2018 through October 3, 2018.
The unaudited pro forma results for the years ended December 31, 2018 and December 31, 2017 is as follows:
The unaudited pro forma results for all periods presented include adjustments made to account for certain costs and transactions that would have been incurred had the acquisition been completed as of January 1, 2017, including amortization charges for acquired intangibles assets, adjustments for acquisition transaction costs, adjustments for depreciation expense for
property, plant, and equipment, and adjustments to interest expense. These adjustments are net of any applicable tax impact and were included to arrive at the pro forma results above.
Other
The Company incurred acquisition-related costs of $156.7 million for the year ended December 31, 2018. This amount primarily consists of the following: $39.4 million of bridge loan commitment fees included in Interest expense; $34.9 million make whole payment on the Senior Notes - 2007 and $3.9 million realized loss on a fair value hedge included in Loss on extinguishment of debt; $12.5 million realized gain on a foreign currency derivative included in Other income; and $66 million of transaction costs included in Selling and administrative expenses.
TAA
On December 7, 2018, the Company completed the acquisition of 100% of the outstanding shares of The Additive Advantage, LLC ("TAA"), a privately-held manufacturing and licensing company with facilities in North America. The acquisition was accounted for under the purchase method. TAA was acquired to strengthen IFF’s position in delivery capability and technologies, and to advance the R&D delivery platform with printable encapsulation solutions.
The Company paid $14.5 million for this acquisition, which was funded from cash on hand. Additionally, the Company recorded an accrual of $6.9 million representing the current estimate of additional contingent consideration payable to the former owners of TAA determined using the scenario-based method. In addition, as part of the acquisition, the Company assumed a loan of $0.5 million that had been due to the Company from TAA. This amount was included in the purchase consideration.
The purchase consideration was allocated principally to identifiable intangible assets including $11.4 million to In-process research and development ("IPR&D") and approximately $10.4 million to goodwill (which is deductible for tax purposes). IPR&D represents acquired printing technology that had not been completed as of the acquisition date. The fair value of IPR&D was determined using the income approach. IPR&D will be tested for impairment going forward, and will only be amortized once technological feasibility has been established. The rate utilized to discount the net cash flows to their present value reflects the risk associated with the intangible asset and is benchmarked to the cost of equity. 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 applying the technology to the Company’s existing product portfolio.
The acquisition agreement contains a provision for the payment of certain milestone amounts, which will be expensed as incurred post-acquisition, with a maximum amount that will be paid out of $5.4 million, as they are contingent on continued employment, as well as achievement of milestones related to the IPR&D programs.
No pro forma financial information is presented as the acquisition was not material to the consolidated financial statements.
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 including use of its revolving credit facility. Additionally, the Company recorded an accrual of approximately $1.4 million representing the current estimate of additional contingent consideration payable to the former owners of PowderPure. (The maximum earnout payable is $10 million upon satisfaction of certain performance metrics). The purchase price exceeded the preliminary fair value of existing net assets by approximately $48.0 million. The excess was allocated principally to identifiable intangible assets including approximately $27.5 million to proprietary technology, approximately $4.5 million to trade name and 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 Company's 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 were 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 reduced to zero during 2018 and resulted in a decrease in administrative expense of approximately $1.3 million.
No pro forma financial information for 2017 or 2016 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.
David Michael
On October 7, 2016, the Company completed the acquisition of 100% of the outstanding shares of David Michael & Company, Inc. ("David Michael"). The acquisition was accounted for under the purchase method. David Michael was acquired to strengthen the North American flavors business. The Company paid approximately $242.6 million (including $5.1 million of cash acquired) for this acquisition, which was funded from existing resources. The preliminary purchase price allocation was updated during the first quarter of 2017, resulting in a reduction in allocation of value to customer relationships. The related reduction in amortization expense was not material to the Consolidated Statement of Comprehensive Income. The purchase price allocation was finalized during the second quarter of 2017. Additionally, during the second quarter of 2017, the Company finalized the working capital adjustment and paid an additional $0.7 million. The purchase price exceeded the fair value of existing net assets by approximately $168.7 million. The excess was allocated principally to identifiable intangible assets including approximately $50.0 million related to customer relationships, approximately $8.4 million related to proprietary technology and trade name, and approximately $110.2 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 synergies from the addition of David Michael to the Company's existing Flavors business. The intangible assets are being amortized over the following estimated useful lives: trade name, 2 years; proprietary technology, 5 years; and customer relationships, 18 - 20 years.
No pro forma financial information for 2016 is presented as the impact of the acquisition was immaterial to the Consolidated Statement of Comprehensive Income.
NOTE 4. PROPERTY, PLANT AND EQUIPMENT, NET
Property, plant and equipment consisted of the following amounts:
Depreciation expense was $89.1 million for the year ended December 31, 2018, and $83.4 million and $78.6 million for the years ended December 31, 2017 and 2016, respectively.
NOTE 5. GOODWILL AND OTHER INTANGIBLE ASSETS, NET
Goodwill
Movements in goodwill during the years ended December 31, 2016, 2017 and 2018 were as follows:
_______________________
(a)
Other above principally represents the increase to Goodwill associated with the update of certain customer relationship assumptions in the final purchase price allocation of David Michael, as disclosed in Note 3.
(b)
In 2018, $4.2 billion primarily relates to our acquisition of Frutarom and is subject to change upon completion of the purchase price allocation.
Goodwill by segment was as follows:
The increase reflected in Taste above represents the finalization of the PowderPure purchase price allocation in 2018. The decrease reflected in Scent above represents the foreign exchange impact on Goodwill consolidated from subsidiary balance sheets in a functional currency other than USD. The increase reflected in Frutarom above represents the preliminary purchase price allocation of Frutarom as disclosed in Note 3.
The unallocated Goodwill above represents the preliminary purchase price allocation of TAA as disclosed in Note 3. The amount is currently unallocated pending further analysis of the use of the technology acquired in the acquisition which is expected to have applications to both Taste and Scent.
Other Intangible Assets
Other intangible assets, net consisted of the following amounts:
Amortization expense was $75.9 million for the year ended December 31, 2018, and $34.7 million and $23.8 million for the years ended December 31, 2017 and 2016, respectively. Amortization expense for the next five years and thereafter, based on preliminary valuations and determinations of useful lives, is expected to be as follows:
NOTE 6. OTHER ASSETS
Other assets consisted of the following amounts:
_______________________
(a)
Includes land usage rights in China and long term deposits.
NOTE 7. OTHER CURRENT LIABILITIES
Other current liabilities consisted of the following amounts:
NOTE 8. SALE AND LEASEBACK TRANSACTIONS
In connection with the disposition of certain real estate in prior years, the Company entered into long-term operating leases. The leases are classified as operating leases and the gains realized on these leases have been deferred and are being credited to income over the initial lease term. Such deferred gains totaled $29.9 million and $32.7 million at December 31, 2018 and 2017, respectively, of which $26.7 million and $29.5 million, respectively, are reflected in the accompanying Consolidated Balance Sheet under Deferred gains, with the remainder included as a component of Other current liabilities.
NOTE 9. TANGIBLE EQUITY UNITS
On September 17, 2018, the Company issued and sold 16,500,000, 6.00% TEUs at $50 per unit and received proceeds of $800.2 million, net of discounts and issuance costs of $24.8 million. Each TEU is comprised of: (i) a prepaid SPC to be settled by delivery of a specified number of shares of the Company's common stock, and (ii) a senior amortizing note (“Amortizing Note”), with an initial principal amount of $8.45 and a final installment payment date of September 15, 2021. The Company will pay equal quarterly cash installments of $0.75 per Amortizing Note on March 15, June 15, September 15, and December 15 of each year, with the exception of the first installment payment of $0.7333 per Amortizing Note which was due on December 15, 2018. In the aggregate, the annual quarterly cash installments will be equivalent to 6.00% per year. Each installment payment constitutes a payment of interest and a partial repayment of principal, computed at an annual rate of 3.79%. Each TEU may be separated by a holder into its constituent SPC and Amortizing Note after the initial issuance date of the TEUs, and the separate components may be combined to create a TEU after the initial issuance date, in accordance with the terms of the SPC. The TEUs are listed on the New York Stock Exchange under the symbol “IFFT”.
The proceeds from the issuance of the TEUs were allocated to equity and debt based on the relative fair value of the respective components of each TEU as follows:
The net proceeds of the SPCs were recorded as additional paid in capital, net of issuance costs. The net proceeds of the Amortizing Notes were recorded as debt, with deferred financing costs recorded as a reduction of the carrying amount of the debt in our consolidated balance sheet. Deferred financing costs related to the Amortizing Notes will be amortized through the maturity date using the effective interest rate method.
Unless settled early at the holder’s or the Company's election, each SPC will automatically settle on September 15, 2021 for a number of shares of common stock per SPC based on the 20 day volume-weighted average price (“VWAP”) of our common stock as follows:
At any time prior to the second scheduled trading day immediately preceding September 15, 2021, any holder of an SPC may settle any or all of its SPCs early, and the Company will deliver 0.3134 shares of its common stock for each SPC, subject to adjustment. Additionally, the SPCs may be redeemed in the event of a fundamental change as defined in the SPC.
NOTE 10. DEBT
Debt consisted of the following at December 31:
_______________________
(1)
Amount is net of unamortized discount and debt issuance costs.
(2)
Represents the rate on drawn down and outstanding balances. Deferred debt issuance costs are immaterial.
(3)
Includes bank borrowings, commercial paper, overdrafts and current portion of long-term debt.
Financing of the Acquisition of Frutarom
Bridge Loan Facility
In connection with entering into the merger agreement with Frutarom in May 2018, the Company entered into a debt commitment letter for up to a $5.45 billion 364-day unsecured bridge loan facility to the extent the Company had not received $5.45 billion of net cash proceeds (and/or qualified bank commitments) from a combination of (a) the issuance by the Company of a combination of equity securities, equity-linked securities and/or unsecured debt securities and/or (b) unsecured term loans, in each case, at or prior to completion of the acquisition. On May 21, 2018, the Company, Morgan Stanley Senior Funding, Inc. and certain other financial institutions entered into a bridge joinder agreement to the commitment letter to provide for additional bridge commitment parties. As a result of the Company's entering into the debt and equity financing as discussed in Note 3, the bridge loan facility was terminated on September 26, 2018. In connection with the bridge loan commitment, the Company incurred $39.4 million of fees which are included in Interest expense in the Consolidated Statement of Income and Comprehensive Income for the year ended December 31, 2018.
Term Loan
On June 6, 2018, the Company entered into a term loan credit agreement to replace a portion of the bridge loan facility, reducing the amount of the bridge loan commitments by $350 million. Under the term loan credit agreement, the lenders thereunder committed to provide, subject to certain conditions, a senior unsecured term loan facility (as amended, "Term Loan") in an original aggregate principal amount of up to $350.0 million, maturing three years after the funding date thereunder. The proceeds from the term loan were received on October 3, 2018.
The Term Loan bears interest, at the Company’s option, at a per annum rate equal to either (x) an adjusted LIBOR rate plus an applicable margin varying from 0.75% to 2.00% or (y) a base rate plus an applicable margin varying from 0.00% to 1.00%, in each case depending on the public debt ratings for non-credit enhanced long-term senior unsecured debt issued by the Company. Loans under the Term Loan will amortize quarterly at a per annum rate of 10.0% of the aggregate principal amount of the loans made under the Term Loan on the funding date, commencing December 31, 2018, with the balance payable on October 3, 2021. The Company may voluntarily prepay the term loans without premium or penalty. The term loan credit agreement contains various covenants, limitations and events of default customary for similar facilities for similarly rated borrowers, including a maximum ratio of net debt to EBITDA of 4.50x with step-downs over time.
Amended Credit Facility
On May 21, 2018, June 6, 2018 and July 13, 2018, the Company and certain of its subsidiaries amended and restated the Company’s existing amended and restated credit agreement with Citibank, N.A., as administrative agent (as amended, the “Amended Credit Facility”) in connection with the acquisition of Frutarom, to, among other things (i) extend the maturity date of the Amended Credit Facility until June 6, 2023, (ii) increase the maximum ratio of net debt to EBITDA on and after the closing date of the acquisition and (iii) increase the drawn down capacity to $1.0 billion, consisting of a $585 million tranche A revolving credit facility (which provides for borrowings available in U.S. dollars, euros, Swiss francs, Japanese yen and/or British pounds sterling, with a sublimit of $25 million for swing line borrowings) (“Tranche A”) and a $415 million tranche B revolving credit facility (which provides for borrowings available in U.S. dollars, euros, Swiss francs, Japanese yen and/or British pounds sterling, with sublimits of €50 million and $25 million for swing line borrowings) (“Tranche B” and, together with Tranche A, the “Revolving Facility”). The interest rate on the Revolving Facility will be, at the applicable borrower’s option, a per annum rate equal to either (x) an adjusted LIBOR rate plus an applicable margin varying from 0.75% to 1.75% or (y) a base rate plus an applicable margin varying from 0.00% to 0.750%, in each case depending on the public debt ratings for non-credit enhanced long-term senior unsecured debt issued by the Company. Other terms and covenants under the Amended Credit Facility remain substantially unchanged.
The Amended Credit Facility is available for general corporate purposes of each borrower and its subsidiaries. The obligations under the Amended Credit Facility are unsecured and the Company has guaranteed the obligations of each other borrower under the Amended Credit Facility. The Company pays a commitment fee on the aggregate unused commitments; such fee is not material.
In connection with the Amended Credit Facility, the Company incurred $0.7 million of debt issuance costs. As of December 31, 2018, the Company was in compliance with all covenants under this Amended Credit Facility. Total
availability under the Amended Credit Facility was $1.0 billion, with no outstanding borrowings as of December 31, 2018. As the Amended Credit Facility is a multi-year revolving credit agreement, the Company classifies as long-term debt the portion that it has the intent and ability to maintain outstanding longer than 12 months.
Senior Unsecured Notes
On September 26, 2018, the Company issued $300 million aggregate principal amount of senior unsecured notes that mature on September 25, 2020 (the “2020 Notes”). The 2020 Notes bear interest at a rate of 3.4% per year, payable semi-annually on March 25 and September 25 of each year, beginning March 25, 2019. Total proceeds from the issuance of the 2020 Notes, net of underwriting discounts and offering costs, were $298.9 million.
On September 25, 2018 the Company issued €300 million aggregate principal amount of senior unsecured notes that mature on September 25, 2021 (the “2021 Euro Notes”). The 2021 Notes bear interest at a rate of 0.5% per year, payable annually on September 25 of each year, beginning September 25, 2019. Total proceeds from the issuance of the 2021 Notes, net of underwriting discounts and offering costs, were €297.7 million ($349.5 million in USD).
On September 25, 2018, the Company issued €800 million aggregate principal amount of senior unsecured notes that mature on September 25, 2026 (the “2026 Euro Notes”). The 2026 Notes bear interest at a rate of 1.8% per year, payable annually on September 25 of each year, beginning September 25, 2019. Total proceeds from the issuance of the 2026 Notes, net of underwriting discounts and offering costs, were €794.1 million ($932.2 million in USD).
On September 26, 2018, the Company issued $400 million aggregate principal amount of senior unsecured notes that mature on September 26, 2028 (the “2028 Notes”). The 2028 Notes bear interest at a rate of 4.45% per year, payable semi-annually on March 26 and September 26 of each year, beginning March 26, 2019. Total proceeds from the issuance of the 2028 Notes, net of underwriting discounts and offering costs, were $397.0 million.
On September 26, 2018, the Company issued $800 million aggregate principal amount of senior unsecured notes that mature on September 26, 2048 (the “2048 Notes” and collectively with the 2021 Euro Notes, 2026 Euro Notes, 2020 Notes, 2028 Notes, the "2018 Senior Unsecured Notes"). The 2048 Notes bear interest at a rate of 5.0% per year, payable semi-annually on March 26 and September 26 of each year, beginning March 26, 2019. Total proceeds from the issuance of the 2048 Notes, net of underwriting discounts and offering costs, were $787.2 million.
As discussed in Note 17, the 2021 Euro Notes and 2026 Euro Notes have been designated as a hedge of the Company's net investment in certain subsidiaries.
Tangible Equity Units - Senior Unsecured Amortizing Notes
On September 17, 2018, in connection with the issuance of the TEUs, the Company issued $139.5 million aggregate principal amount of Amortizing Notes. The Amortizing Notes mature on September 15, 2021. Each quarterly cash installment payment of $0.75 (or, in the case of the installment payment due on December 15, 2018, $0.73333) per Amortizing Note will constitute a partial repayment of principal and a payment of interest, computed at an annual rate of 3.79%. Interest will be calculated on the basis of a 360 day year consisting of twelve 30 day months. Payments will be applied first to the interest due and payable and then to the reduction of the unpaid principal amount, allocated as set forth in the amortization schedule in the indenture governing the Amortizing Notes. See Note 9 for further information on the TEUs.
There are no covenants or provisions in the indenture related to the TEUs that would afford the holders of the amortizing notes protection in the event of a highly leveraged transaction, reorganization, restructuring, merger or similar transaction involving the Company that may adversely affect such holders. If a fundamental change occurs, or if the Company elects to settle the SPCs early, then the holders of the Amortizing Notes will have the right to require the Company to repurchase the Amortizing Notes at a repurchase price equal to the principal amount of the Amortizing Notes as of the repurchase date plus accrued and unpaid interest. The indenture also contains customary events of default which would permit the holders of the Amortizing Notes to declare the notes to be immediately due and payable if not cured within applicable grace periods, including the failure to make timely installment payments on the notes or other material indebtedness, failure to give notice of a fundamental change and specified events of bankruptcy and insolvency.
2047 Notes
On May 18, 2017, the Company issued $500.0 million face amount of 4.375% Senior Notes ("2047 Notes") due 2047 at a discount of $1.8 million. The Company received proceeds related to the issuance of these 2047 Notes of $493.9 million which was net of the $1.8 million discount and $4.4 million in underwriting fees (recorded as deferred financing costs). In addition, the Company incurred $0.9 million in legal and professional costs associated with the issuance and such costs were recorded as deferred financing costs. In connection with the debt issuance, the Company entered into pre-issuance hedging transactions that were settled upon issuance of the debt and resulted in a loss of approximately $5.3 million. The discount, deferred financing costs and pre-issuance hedge loss are being amortized as interest expense over the 30 year term of the debt. The 2047 Notes bear interest at a rate of 4.375% per annum, with interest payable semi-annually on June 1 and December 1 of each year, commencing on December 1, 2017. The 2047 Notes will mature on June 1, 2047.
2024 Euro Notes
On March 14, 2016, the Company issued €500.0 million face amount of 1.75% Senior Notes ("2024 Euro Notes") due 2024 at a discount of €0.9 million. The Company received proceeds related to the issuance of these 2024 Euro Notes of €496.0 million which was net of the €0.9 million discount and €3.1 million underwriting discount (recorded as deferred financing costs). In addition, the Company incurred $1.3 million of other deferred financing costs in connection with the debt issuance. In connection with the debt issuance, the Company entered into pre-issuance hedging transactions that were settled upon issuance of the debt and resulted in a loss of approximately $3.2 million. The discount, deferred financing costs and pre-issuance hedge loss are being amortized as interest expense over the eight year term of the debt. The 2024 Euro Notes bear interest at a rate of 1.75% per annum, with interest payable on March 14 of each year, commencing on March 14, 2017. The 2024 Euro Notes will mature on March 14, 2024.
As discussed in Note 17, the 2024 Euro Notes have been designated as a hedge of the Company's net investment in certain subsidiaries.
2023 Notes
On April 4, 2013, the Company issued $300.0 million face amount of 3.20% Senior Notes (“2023 Notes”) due 2023 at a discount of $0.3 million. The Company received proceeds related to the issuance of these 2023 Notes of $297.8 million which was net of the $0.3 million discount and a $1.9 million underwriting discount (recorded as deferred financing costs). In addition, the Company incurred $0.9 million of other deferred financing costs in connection with the debt issuance. The discount and deferred financing costs are being amortized as interest expense over the term of the 2023 Notes. The 2023 Notes bear interest at a rate of 3.20% per year, with interest payable on May 1 and November 1 of each year, commencing on November 1, 2013. The 2023 Notes mature on May 1, 2023.
Senior Notes - 2007
On September 27, 2007, the Company issued $500.0 million of Senior Unsecured Notes (“Senior Notes - 2007”) in four series under the Note Purchase Agreement (“NPA”): (i) $250.0 million in aggregate principal amount of 6.25% Series A Senior Notes due September 27, 2017, (ii) $100.0 million in aggregate principal amount of 6.35% Series B Notes due September 27, 2019, (iii) $50.0 million in aggregate principal amount of 6.50% Series C Notes due September 27, 2022, and (iv) $100.0 million in aggregate principal amount of 6.79% Series D Notes with interest payable on March 27 and September 27 of each year, commending on March 27, 2008. The Senior Notes - 2007 mature on September 27, 2027.
During the third quarter of 2017, the Company made a payment of $250 million on the Senior Notes - 2007. In connection with the acquisition of Frutarom and associated financing, the Company repaid the remaining outstanding $250 million of its Senior Notes - 2007 on September 17, 2018, including accrued and unpaid interest of $7.7 million and the associated make whole payment of $34.9 million. Additionally, the Company incurred a loss of $3.9 million on the termination of a fair value hedge which was recognized in earnings during the third quarter of 2018.
Redemption Provisions
The 2018 Senior Unsecured Notes, 2023 Notes, 2024 Euro Notes and 2047 Notes (collectively, the "Notes") share the same redemption provisions. Upon 30 days’ notice to holders of the Notes, the Company may redeem the Notes for cash in whole, at any time, or in part, from time to time, prior to maturity, at redemption prices that include accrued and unpaid interest and a make-whole premium, as specified in the indenture governing the Notes. However, no make-whole premium will be paid for redemptions of each note on or after the following date:
The indenture of each note provides for customary events of default and contains certain negative covenants that limit the ability of the Company and its subsidiaries to grant liens on assets, or to enter into sale-leaseback transactions. In addition, subject to certain limitations, in the event of the occurrence of both (1) a change of control of the Company and (2) a downgrade of the Notes below investment grade rating by both Moody’s Investors Services, Inc. and Standard & Poor’s Ratings Services within a specified time period, the Company will be required to make an offer to repurchase the Notes at a price equal to 101% of the principal amount of the Notes, plus accrued and unpaid interest to the date of repurchase.
Outstanding Borrowings
The following table shows the contractual maturities of our long-term debt as of December 31, 2018.
Commercial Paper
Commercial paper issued by the Company generally has terms of 90 days or less. As of December 31, 2018 and 2017, there was no commercial paper outstanding. The revolving credit facility is used as a backstop for the Company's commercial paper program. The maximum amount of commercial paper outstanding during 2018 and 2017 was $85 million and $107.5 million, respectively.
NOTE 11. INCOME TAXES
Earnings before income taxes consisted of the following:
The income tax provision consisted of the following:
Effective Tax Rate Reconciliation
Reconciliation between the U.S. federal statutory income tax rate to the actual effective tax rate was as follows:
The effective tax rate reflects the impact of deferred taxes on deemed repatriation and an unfavorable mix of earnings, partially offset by U.S. tax reform as discussed below and the reversal of a valuation allowance on certain state deferred tax assets. The 2018, 2017 and 2016 effective tax rates were also favorably impacted by the reversals of liabilities for uncertain tax positions of $3.9 million, $9.5 million and $7.5 million, respectively, principally due to statutory expiry and effective settlement.
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% and establishing a modified territorial system requiring a mandatory deemed repatriation tax on undistributed earnings of foreign subsidiaries. Beginning in 2018, the Act also requires a minimum tax on certain future earnings generated by foreign subsidiaries while providing for future tax-free repatriation of such earnings through a 100% dividends-received deduction.
The Tax Act impacted the Company's consolidated results of operations during the 2017 fourth quarter. In particular, the transition to the new territorial tax system required the Company to record a one-time tax or “toll charge” which resulted in a provisional incremental tax expense of $100.6 million principally related to previously unremitted earnings on non-U.S.
subsidiaries. The cash portion of the "toll charge" is payable in installments over 8 years beginning in 2018. In addition, the reduction of the U.S. corporate tax rate resulted in a provisional net deferred tax expense of $38.6 million related to the remeasurement of net deferred tax assets as a result of the reduction in the corporate income tax rate.
During the first quarter of 2018, the Company recorded an additional charge of $0.6 million to adjust an accrual related to withholding taxes on planned repatriations. During the second quarter of 2018, the Company paid the first installment of the “toll charge”. During the third quarter of 2018, the Company recorded a benefit of $8.0 million to adjust the provisional “toll charge” required from the transition to the new territorial tax system, and a benefit of $0.2 million to adjust the remeasurement of net deferred tax assets as a result of U.S. tax reform. During the fourth quarter, the Company completed its final assessment under SAB 118, and recorded an additional charge of $32.8 million to adjust an accrual related to the U.S. state impact and foreign withholding taxes on planned repatriations. The charge in the fourth quarter of 2018 is consistent with the Company's need to repatriate funds for debt repayment purposes.
The U.S. consolidated group has historically generated taxable income after the inclusion of foreign dividends which has allowed the Company to realize its federal deferred tax assets. In the future foreign dividends will be subject to a 100% dividends received deduction under the Tax Act and will not serve as a source of federal taxable income. However, as of December 31, 2018 the U.S. consolidated group is in a cumulative income position, and is expected to continue to be in a cumulative income position principally due to the inclusion of global intangible low-taxed income and expects to realize tax benefits for the reversal of temporary differences. The corresponding U.S. federal taxable income is sufficient to realize $52.9 million in deferred tax assets as of December 31, 2018.
Annually, the Company will generate foreign tax credits to utilize against federal tax due. As the Company does not expect sufficient foreign source income to utilize the entire amount of credits generated, it has recorded a valuation allowance on $3.8 million on the federal tax attributes and has not recorded a foreign tax credit on the expected foreign withholding taxes related to the Company’s change in indefinite reinvestment assertion as of December 31, 2018.
Further, as of December 31, 2018 the Company recorded a benefit for $6.7 million related to a valuation allowance release previously recorded against state deferred tax assets. This was principally due to certain state tax treatment of global intangible low-taxed income, along with other enactments under the Tax Act. The majority of the Company’s state deferred tax assets relate to net operating loss and tax credit carryforwards that have a specified carryforward period. Therefore, the Company has maintained a valuation allowance of $3.4 million on certain state tax attributes based on a state taxable income forecast. The main input into the forecast is the 2018 taxable income projection. Changes in the performance of the North American business, the Company’s transfer pricing policies and adjustments to the Company’s U.S. tax profile due to the Tax Act could impact the estimate.
Deferred Taxes
The deferred tax assets consisted of the following amounts:
_______________________
(a)
During 2018 and 2017, the Company increased its deferred tax assets by $5.9 million and by $58.8 million, respectively, relating to an adjustment to the 2017 and 2016 foreign net operating loss carryforwards, respectively. The entire adjustments of $5.9 million and $58.8 million were offset by corresponding adjustments in valuation allowances. These adjustments are not considered material to the previously issued financial statements.
The Tax Act created significant international tax provisions, including a new category of income, global intangible low-taxed income (GILTI). The Company has elected to treat GILTI as a current period cost if and when incurred. This tax position resulted in an $8.2 million income tax expense for the year ended December 31, 2018.
Net operating loss carryforwards were $209.4 million and $212.5 million at December 31, 2018 and 2017, respectively. If unused, $8.5 million will expire between 2019 and 2038. The remainder, totaling $200.9 million, may be carried forward indefinitely. Tax credit carryforwards were $17.8 million and $12.5 million at December 31, 2018 and 2017, respectively. If unused, the $17.8 million will expire between 2019 and 2038.
Of the $227.2 million deferred tax asset for net operating loss carryforwards and credits at December 31, 2018, the Company considers it unlikely that a portion of the tax benefit will be realized. Accordingly, a valuation allowance of $195.5 million of net operating loss carryforwards and $3.8 million of tax credits has been established against these deferred tax assets. In addition, due to realizability concerns, the Company established a valuation allowance against certain other net deferred tax assets of $3 million.
Uncertain Tax Positions
A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:
At December 31, 2018, 2017 and 2016, there were $47.3 million, $28.5 million, and $19.1 million, respectively, of unrecognized tax benefits recorded to Other liabilities and $3.6 million and $9.7 million recorded to Other current liabilities for 2018 and 2017, respectively. If these unrecognized tax benefits were recognized, all the benefits and related interest would be recorded as a benefit to income tax expense.
For the year ended December 31, 2018, the Company reduced its liabilities for interest and penalties by $1.1 million, net, and increased its liabilities for interest and penalties by $3.0 million, net, and $0.3 million, net for the years ended 2017 and 2016, respectively. At December 31, 2018, 2017 and 2016, the Company had accrued $3.0 million, $2.8 million and $0.8 million, respectively, of interest and penalties classified as Other liabilities and $1.3 million and $0.3 million in 2017 and 2016, respectively, recorded to Other current liabilities. No such liabilities were accrued for the year ended December 31, 2018.
As of December 31, 2018, the Company’s aggregate provision for unrecognized tax benefits, including interest and penalties, was $53.9 million, associated with various tax positions asserted in foreign jurisdictions, none of which is individually material. Of this total, $13.5 million is associated with the Frutarom acquisition.
Other
Tax benefits credited to Shareholders’ equity were de minimis for the year ended December 31, 2018, and were $0.1 million and $0.2 million for the years ended December 31, 2017 and 2016, respectively, associated with stock option exercises and PRSU dividends.
The Tax Act requires a mandatory deemed repatriation tax on undistributed earnings of foreign subsidiaries, and as a result, all previously unremitted earnings for which no U.S. deferred tax liability had been accrued have now been subject to U.S. federal tax and will not be subject to additional U.S. federal tax when repatriated. U.S. state and foreign withholding taxes, however, may still apply in certain jurisdictions. As a result of the Tax Act, the $2.0 billion held by the Company’s non-U.S. subsidiaries was subject to current tax in the U.S. in 2017. Management has changed its assertion with regards to earnings generated in 2018 and prior as part of its final analysis under SAB 118, and consistent with the Company's need to repatriate funds for debt repayment purposes. As we repatriate these funds to the U.S. we will be required to pay income taxes in certain U.S. states and applicable foreign withholding taxes during the period when such repatriation occurs. Accordingly, we have accrued a deferred tax liability of $88.8 million for the effect of repatriating the funds to the U.S. This balance consists of $43.8 million attributable to IFF non-U.S. subsidiaries, and $45.0 million associated with the Frutarom structure which is still preliminary and will be refined through the purchase accounting measurement period.
The Company has ongoing income tax audits and legal proceedings which are at various stages of administrative or judicial review, of which the material items are discussed below. In addition, the Company has other ongoing tax audits and legal proceedings that relate to indirect taxes, such as value-added taxes, capital tax, sales and use and property taxes, which are discussed in Note 20.
The Company also has several other tax audits in process and has open tax years with various taxing jurisdictions that range primarily from 2008 to 2017. Based on currently available information, the Company does not believe the ultimate outcome of any of these tax audits and other tax positions related to open tax years, when finalized, will have a material impact on its financial position.
NOTE 12. NET INCOME PER SHARE
Basic and diluted net income per share is based on the weighted average number of shares outstanding. A reconciliation of shares used in the computation of basic and diluted net income per share is as follows:
_______________________
(1)
For the twelve months ended December 31, 2018, the TEUs were assumed to be outstanding at the minimum settlement amount for weighted-average shares for basic earnings per share. See below for details.
(2)
Effect of dilutive securities includes dilution under stock plans and incremental impact of TEUs. See below for details.
On September 17, 2018, the Company issued and sold 12,667,947 shares of its common stock in an underwritten public offering for net proceeds of approximately $1.6 billion. Additionally, as part of the merger consideration for the acquisition of
Frutarom, the Company issued 14,901,445 shares using an exchange ratio of 0.2490 of a share of the Company’s common stock for each ordinary share of Frutarom issued and outstanding at closing. This issuance resulted in former Frutarom shareholders holding approximately 14% of the Company's outstanding common stock as of the closing on October 4, 2018.
As discussed in Note 9, the Company issued 16,500,000 TEUs, consisting of a prepaid SPC and a senior amortizing note, for net proceeds of approximately $800.2 million on September 17, 2018. For the periods outstanding, the SPC portion of the TEUs were assumed to be settled at the minimum settlement amount of 0.3134 shares per SPC for weighted-average shares for basic earnings per share. For diluted earnings per share, the shares were assumed to be settled at a conversion factor based on the 20 day volume-weighted average price (“VWAP”) per share of the Company’s common stock not to exceed 0.3711 shares per SPC.
The Company has issued shares of Purchased Restricted Stock ("PRS") and Purchased Restricted Stock Units (“PRSUs”) which contain nonforfeitable rights to dividends and thus are considered participating securities which are required to be included in the computation of basic and diluted earnings per share pursuant to the two-class method. The two-class method was not presented since the difference between basic and diluted net income per share for both common shareholders, PRS and PRSU holders was less than $0.02 per share for each year and the number of PRS and PRSUs outstanding as of December 31, 2018, 2017 and 2016 was immaterial. Net income allocated to such PRS and PRSUs during 2018, 2017 and 2016 was approximately $1.0 million, $1.0 million and $1.0 million, respectively.
An immaterial amount of Stock-Settled Appreciation Rights (“SSARs”) were excluded from the computation of diluted net income per share at December 31, 2018, 2017 and 2016.
NOTE 13. SHAREHOLDERS’ EQUITY
Dividends
Cash dividends declared per share were $2.84, $2.66 and $2.40 in for the years ended December 31, 2018, 2017 and 2016, respectively. The Consolidated Balance Sheet reflects $77.8 million of dividends payable at December 31, 2018. This amount relates to a cash dividend of $0.73 per share declared in December 2018 and paid in January 2019. Dividends declared, but not paid as of December 31, 2017 and December 31, 2016 were $54.4 million ($0.69 per share) and $50.7 million ($0.64 per share), respectively.
Share Repurchases
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 November 1, 2017 a $250.0 million share repurchase authorization and extension for a total value of $300.0 million available under the program, which expires on November 1, 2022.
A summary of the stock repurchase activity under the stock repurchase program, reported based on the trade date, is summarized as follows:
Based on the total remaining amount of $279.7 million available under the repurchase program, 2,114,998 shares, or 1.9% of shares outstanding (based on the market price and weighted average shares outstanding as of December 31, 2018) could be repurchased under the program as of December 31, 2018.
On May 7, 2018, we announced that we were suspending our share repurchases until our deleveraging target is met following our acquisition of Frutarom.
NOTE 14. STOCK COMPENSATION PLANS
The Company has various equity plans under which its officers, senior management, other key employees and Board of Directors may be granted options to purchase IFF common stock or other forms of stock-based awards. Beginning in 2004, the Company granted Restricted Stock Units (“RSUs”) as the principal element of its equity compensation for all eligible U.S.-based employees and a majority of eligible overseas employees. Vesting of the RSUs is solely time based; the vesting period is primarily 3 years from date of grant. For a small group of employees, primarily overseas, the Company granted stock options prior to 2008.
The cost of all employee stock-based awards are principally recognized on a straight-line attribution basis over their respective vesting periods, net of estimated forfeitures. Total stock-based compensation expense included in the Consolidated Statement of Income and Comprehensive Income was as follows:
The shareholders of the Company approved the Company’s 2015 Stock Award and Incentive Plan (the “2015 Plan”) on May 6, 2015. The 2015 Plan replaced the Company’s 2010 Stock Award and Incentive Plan (the “2010 Plan”) and provides the source for future deferrals of cash into deferred stock under the Company’s Deferred Compensation Plan (with the Deferred Compensation Plan being deemed a subplan under the 2015 Plan for the sole purpose of funding deferrals under the IFF Share Fund).
Under the 2015 Plan, a total of 1,500,000 shares are authorized for issuance in addition to 1,552,694 shares remaining available under the 2010 plan that were rolled into the 2015 Plan. At December 31, 2018, 837,196 shares were subject to outstanding awards and 1,927,617 shares remained available for future awards under all of the Company’s equity award plans, including the 2015 Plan (excluding shares not yet issued under open cycles of the Company’s Long-Term Incentive Plan).
The Company offers a Long-Term Incentive Plan (“LTIP”) for senior management. The targeted payout is 50% cash and 50% IFF common stock at the end of the three-year cycle and provides for segmentation in which one-fourth of the award vests during each twelve-month period, with the final one-fourth segment vesting over the full three-year period. Grants under the LTIP are currently earned upon achievement of defined Economic Profit ("EP") targets and the Company's performance ranking of Total Shareholder Return as a percentile of the S&P 500 ("Relative TSR"). EP measures operating profitability after considering (i) all operating costs, (ii) income taxes and (iii) a charge for the capital employed in the business. When the award is granted, 50% of the target dollar value of the award is converted to a number of “notional” shares based on the closing price at the beginning of the cycle. For those shares whose payout is based on Relative TSR, compensation expense is recognized using a graded-vesting attribution method, while compensation expense for the remainder of the performance shares (EP targets) is recognized on a straight-line basis over the vesting period based on the probable outcome of the performance condition.
The 2014-2016 cycle concluded at the end of 2016 and an aggregate 47,267 shares of common stock were issued in March 2016. The 2015-2017 cycle concluded at the end of 2017 and an aggregate 46,091 shares of common stock were issued in March 2018. The 2016-2018 cycle concluded at the end of 2018 and an aggregate 25,394 shares of common stock will be issued in March 2019.
In 2006, the Board of Directors approved the Equity Choice Program (the “Program”) for senior management. This program continues under the 2015 Plan. Eligible employees can choose from among three equity alternatives and will be granted such equity awards up to certain dollar awards depending on the participant’s employment grade level. A participant may choose among (1) SSARs, (2) RSUs or (3) PRSUs.
SSARs and Options
SSARs are a contractual right to receive the value, in shares of Company stock, of the appreciation in our stock price from the grant date to the date the SSARs are exercised by the participant. SSARs granted become exercisable on the third anniversary of the grant date and have a maximum term of 7 years. SSARs do not require a financial investment by the SSARs
grantee. No SSARs were granted in 2017 or 2016. Stock options require the participant to pay the exercise price at the time they exercise their stock options. No stock options were granted in 2018, 2017 or 2016.
SSARs and options activity was as follows:
The weighted average exercise price of SSARs and options exercisable at December 31, 2018, 2017 and 2016 were $64.96, $60.39 and $58.24, respectively.
SSARs and options outstanding at December 31, 2018 was as follows:
SSARs and options exercisable as of December 31, 2018 was as follows:
The total intrinsic value of options/SSARs exercised during 2018, 2017 and 2016 totaled $0.1 million, $1.2 million and $1.3 million, respectively.
As of December 31, 2018, there was $0.2 million of total unrecognized compensation cost related to non-vested SSARs granted; such cost is expected to be recognized over a period of 2.3 years.
Restricted Stock Units
The Company has granted RSUs to eligible employees and members of the Board of Directors. Such RSUs are subject to forfeiture if certain conditions are not met. RSUs principally vest 100% at the end of 3 years and contain no performance criteria provisions. An RSU’s fair value is calculated based on the market price of the Company's stock at date of grant, with an adjustment to reflect the fact that such awards do not participate in dividend rights. The aggregate fair value is amortized to expense ratably over the vesting period.
RSU activity was as follows:
The total fair value of RSUs that vested during the year ended December 31, 2018 was $18.7 million.
As of December 31, 2018, there was $24.7 million of total unrecognized compensation cost related to non-vested RSUs granted under the equity incentive plans; such cost is expected to be recognized over a weighted average period of 1.8 years.
Purchased Restricted Stock and Purchased Restricted Stock Units
In 2014, the grant of awards under the Equity Choice program provided for eligible employees to purchase restricted shares of IFF common stock and deposit them into an escrow account. For each share deposited in escrow by the eligible employee, the Company matched with a grant of a share of restricted stock or, for non-U.S. participants, a restricted stock unit. The shares of restricted stock and restricted stock units generally vest on the third anniversary of the grant date, are subject to continued employment and other specified conditions, and pay dividends if and when paid by the Company. Holders of restricted stock have, in most instances, all of the rights of stockholders, except that they may not sell, assign, pledge or otherwise encumber such shares. The PRSUs provide no such rights. During 2015, the Company modified the program so that all participants, including U.S. participants, began to receive a restricted stock unit instead of a share of restricted stock. Restricted stock units pay dividend equivalents and do not have voting rights.
The following table summarizes the Company's activity for the years ended December 31, 2018, 2017 and 2016:
PRSU activity was as follows:
The total fair value of PRS and PRSUs that vested during the year ended December 31, 2018 was $8.3 million.
As of December 31, 2018, there was $10.2 million of total unrecognized compensation cost related to non-vested PRS and PRSUs granted under the equity incentive plans; such cost is expected to be recognized over a weighted average period of 1.9 years.
Liability Awards
The Company has granted cash-settled RSUs ("Cash RSUs") to eligible employees that are paid out 100% in cash upon vesting. Such RSUs are subject to forfeiture if certain conditions are not met. Cash RSUs principally vest 100% at the end of three years and contain no performance criteria provisions. A Cash RSU's fair value is calculated based on the market price of the Company's stock at the date of the closing period and is accounted for as a liability award. The aggregate fair value is amortized to expense ratably over the vesting period.
Cash RSU activity was as follows:
The total fair value of Cash RSUs that vested during the year ended December 31, 2018 was $3.8 million.
As of December 31, 2018, there was $5.3 million of total unrecognized compensation cost related to non-vested Cash RSUs granted under the equity incentive plans; such cost is expected to be recognized over a weighted average period of 1.8 years. The aggregate compensation cost will be adjusted based on changes in the Company’s stock price.
NOTE 15. SEGMENT INFORMATION
The Company is organized into three reportable operating segments, Taste (previously "Flavors"), Scent (previously "Fragrances") and Frutarom; these segments align with the internal structure used to manage these businesses. Frutarom became a separate segment upon the acquisition of the company on October 4, 2018.
Taste is comprised of Flavor Compounds which are sold to the food and beverage industries for use in consumer products such as prepared foods, beverages, dairy, food and sweet products.
Scent is comprised of (1) Fragrance Compounds, which are ultimately used by our customers in two broad categories: Fine Fragrances, including perfumes and colognes, and Consumer Fragrances, including fragrance compounds for personal care (e.g., soaps), household products (e.g., detergents and cleaning agents) and beauty care, including toiletries; (2) Fragrance Ingredients, consisting of synthetic and natural ingredients that can be combined with other materials to create unique fine fragrance and consumer compounds; and (3) Cosmetic Active Ingredients, consisting of active and functional ingredients, botanicals and delivery systems to support our customers’ cosmetic and personal care product lines. 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.
Frutarom creates and manufactures a naturals-focused suite of flavor compounds, functional foods and specialty fine ingredients, largely targeting small, local and regional customers. Frutarom’s products are focused on three principal areas: (1) Savory Solutions, (2) Natural Product Solutions, which includes natural health ingredients, natural color and natural food protection, and (3) Taste Solutions.
The Company's Chief Operating Decision Maker evaluates the performance of these reportable operating segments based on segment profit which is defined as operating profit before restructuring, global expenses (as discussed below) and certain non-recurring items, Interest expense, Other income (expense), net and Taxes on income.
The Global expenses caption represents corporate and headquarter-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 reportable operating segments. Global assets are principally cash and cash equivalents and other corporate and headquarter-related assets.
Reportable segment information is as follows:
(a)
For 2018, represents accelerated depreciation related to a plant relocation in India and Taiwan asset write off. For 2017, represents accelerated depreciation and idle labor costs in Hangzhou, China.
(b)
For 2018, represents adjustments to the contingent consideration payable for PowderPure, and transaction costs related to Fragrance Resources and PowderPure within Selling and administrative expenses. For 2017, represents the amortization of inventory "step-up" included in Cost of goods sold and transaction costs related to the acquisitions of Fragrance Resources and PowderPure within Selling and administrative expenses.
(c)
For 2018, represents costs related to the integration of the Frutarom acquisition. For 2017, represents costs related to the integration of the David Michael and Fragrance Resources acquisitions.
(d)
Represents additional charge related to litigation settlement.
(e)
Represents the reserve for payment of a tax assessment related to commercial rent for prior periods.
(f)
For 2018, represents severance costs related to the 2017 Productivity Program and costs associated with the termination of agent relationships in a subsidiary. For 2017, represents severance costs related to the 2017 Productivity Program.
(g)
For 2018, principally represents recoveries from the supplier for the third and fourth quarter, partially offset by final payments to the customer made for the effected product in the first quarter. For 2017, represents management's best estimate of losses related to the previously disclosed FDA mandated recall.
(h)
Represents pension settlement charges incurred in one of the Company's UK pension plans.
(i)
Represents transaction-related costs and expenses related to the acquisition of Frutarom. Amount primarily includes $23.5 million of amortization for inventory "step-up" costs, $39.4 million of bridge loan commitment fees included in Interest expense; $34.9 million make whole payment on the Senior Notes - 2007 and $3.9 million realized loss on a fair value hedge included in Loss on extinguishment of debt; $12.5 million realized gain on a foreign currency derivative included in Other income; and $66.0 million of transaction costs included in Selling and administrative expenses.
The Company has not disclosed revenues at a lower level than provided herein, such as revenues from external customers by product, as it is impracticable for it to do so.
The Company had no customers that accounted for greater than 10% of consolidated net sales in 2018. The Company had one customer that accounted for greater than 10% of consolidated net sales in each year for 2017 and 2016. The Company's largest customer had net sales of $356.8 million, $358.5 million and $364.8 million in 2018, 2017 and 2016, respectively. The majority of these sales were in the Scent reportable operating segment.
Total long-lived assets consist of net property, plant and equipment and amounted to $1,241.2 million and $880.6 million at December 31, 2018 and 2017, respectively. Of this total, $315.3 million and $219.1 million were located in the United States at December 31, 2018 and 2017, respectively, $104.0 million and $113.7 million were located in the Netherlands at December 31, 2018 and 2017, respectively, $74.0 million and $77.9 million were located in Singapore at December 31, 2018 and 2017, respectively, and $178.6 million and $135.8 million were located in China at December 31, 2018 and 2017, respectively.
Net sales are attributed to individual regions based upon the destination of product delivery. Net sales related to the U.S. for the years ended December 31, 2018, 2017 and 2016 were $952.6 million, $864.1 million and $735.3 million, respectively. Net sales attributed to all foreign countries in total for the years ended December 31, 2018, 2017 and 2016 were $3.0 billion,
$2.5 billion and $2.4 billion, respectively. No non-U.S. country had net sales in any period presented greater than 6% of total consolidated net sales.
NOTE 16. EMPLOYEE BENEFITS
The Company has pension and/or other retirement benefit plans covering approximately one-sixth of active employees. In 2007, the Company amended its U.S. qualified and non-qualified pension plans under which accrual of future benefits was suspended for all participants that did not meet the rule of 70 (age plus years of service equal to at least 70 as of December 31, 2007). Pension benefits are generally based on years of service and compensation during the final years of employment. Plan assets consist primarily of equity securities and corporate and government fixed income securities. Substantially all pension benefit costs are funded as accrued; such funding is limited, where applicable, to amounts deductible for income tax purposes. Certain other retirement benefits are provided by general corporate assets.
In connection with the acquisition of Frutarom, IFF acquired eight defined benefit pension plans. At December 31, 2018, US assets for these plans totaled $2.1 million and non-US assets for these plans totaled $19.5 million. IFF also assumed a number of defined contribution pension plans.
The Company sponsors a qualified defined contribution plan covering substantially all U.S. employees. Under this plan, the Company matches 100% of participants’ contributions up to 4% of compensation and 75% of participants’ contributions from over 4% to 8%. Employees that are still eligible to accrue benefits under the pension plans are limited to a 50% match of up to 6% of the participants’ compensation.
In addition to pension benefits, certain health care and life insurance benefits are provided to qualifying U.S. employees upon retirement from IFF. Such coverage is provided through insurance plans with premiums based on benefits paid. The Company does not generally provide health care or life insurance coverage for retired employees of foreign subsidiaries; such benefits are provided in most foreign countries by government-sponsored plans, and the cost of these programs is not material.
The Company offers a non-qualified Deferred Compensation Plan ("DCP") for certain key employees and non-employee directors. Eligible employees and non-employee directors may elect to defer receipt of salary, incentive payments and Board of Directors’ fees into participant-directed investments which are generally invested by the Company in individual variable life insurance contracts it owns that are designed to informally fund savings plans of this nature. The cash surrender value of life insurance is based on the net asset values of the underlying funds available to plan participants. At December 31, 2018 and December 31, 2017, the Consolidated Balance Sheet reflects liabilities of $43.6 million and $43.0 million, respectively, related to the DCP in Other liabilities and $22.2 million and $22.5 million, respectively, included in Capital in excess of par value related to the portion of the DCP that will be paid out in IFF shares.
The total cash surrender value of life insurance contracts the Company owns in relation to the DCP and post-retirement life insurance benefits amounted to $43.2 million and $45.2 million at December 31, 2018 and 2017, respectively, and are recorded in Other assets in the Consolidated Balance Sheet.
As of January 1, 2017, the Company changed its approach for calculating the discount rate which is applied to the Consolidated Balance Sheet and Consolidated Statement of Comprehensive Income from a single weighted-average discount rate approach to a multiple discount rate approach. The impact of this change for the full year 2017 was a reduction of approximately $8 million in pension expense.
During 2017, a pension settlement charge of $2.8 million was recorded related to one of the Company's U.K. plans. The settlement charge was triggered by the payment of large lump sum payments made to participants leaving the plan.
The plan assets and benefit obligations of the defined benefit pension plans are measured at December 31 of each year.
The amounts expected to be recognized in net periodic cost in 2019 are:
The weighted-average actuarial assumptions used to determine expense at December 31 of each year are:
Changes in the postretirement benefit obligation and plan assets, as applicable, are detailed in the following table:
The amounts recognized in the balance sheet are detailed in the following table:
The amounts recognized in AOCI are detailed in the following table:
The Company considers a number of factors in determining and selecting assumptions for the overall expected long-term rate of return on plan assets. The Company considers the historical long-term return experience of its assets, the current and expected allocation of its plan assets and expected long-term rates of return. The Company derives these expected long-term rates of return with the assistance of its investment advisors. The Company bases its expected allocation of plan assets on a diversified portfolio consisting of domestic and international equity securities, fixed income, real estate and alternative asset classes. The asset allocation is monitored on an ongoing basis.
The Company considers a variety of factors in determining and selecting its assumptions for the discount rate at December 31. For the U.S. plans, the discount rate was based on the internal rate of return for a portfolio of high quality bonds rated Aa or higher by either Moody’s or Standard & Poor's with maturities that are consistent with the projected future benefit payment obligations of the plan. For the Non-U.S. Plans, the discount rates were determined by region and are based on high quality long-term corporate bonds. Consideration has been given to the duration of the liabilities in each plan when selecting the bonds to be used in determining the discount rate. The rate of compensation increase for all plans and the medical cost trend rate for the applicable U.S. plans are based on plan experience.
The percentage of assets in the Company's pension plans, by type, is as follows:
With respect to the U.S. plans, the expected return on plan assets was determined based on an asset allocation model using the current target allocation, real rates of return by asset class and an anticipated inflation rate. The target investment allocation is 20% equity securities and 80% fixed income securities.
The expected annual rate of return for the non-U.S. plans employs a similar set of criteria adapted for local investments, inflation rates and in certain cases specific government requirements. The target asset allocation, for the non-U.S. plans, consists of approximately: 40% - 70% in fixed income securities; 15% - 40% in equity securities; 5% - 20% in real estate; and 5% - 10% in alternative investments.
The following tables present the Company's plan assets for the U.S. and non-U.S. plans using the fair value hierarchy as of December 31, 2018 and 2017. The plans’ assets were accounted for at fair value and are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company's assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of fair value assets and their placement within the fair value hierarchy levels. For more information on a description of the fair value hierarchy, see Note 17.
_______________________
(1)
Investments that are measured at fair value using the net asset value per share (or its equivalent) practical expedient have not been classified in the fair value hierarchy. The fair value amounts presented in the table above are intended to permit reconciliation of the fair value hierarchy to the amounts presented in the Consolidated Balance Sheet. The total amount measured at net asset value includes approximately $133.1 million and $159.6 million in pooled equity funds and $271.8 million and $288.2 million in fixed income mutual funds for the years ended December 31, 2018 and 2017, respectively.
Cash and cash equivalents are primarily held in registered money market funds which are valued using a market approach based on the quoted market prices of identical instruments. Other cash and cash equivalents are valued daily by the fund using a market approach with inputs that include quoted market prices for similar instruments.
Equity securities are primarily valued using a market approach based on the quoted market prices of identical instruments. Pooled funds are typically common or collective trusts valued at their net asset values (NAVs).
Fixed income securities are primarily valued using a market approach with inputs that include broker quotes and benchmark yields.
Derivative instruments are valued by the custodian using closing market swap curves and market derived inputs.
Real estate values are primarily based on valuation of the underlying investments, which include inputs such as cost, discounted future cash flows, independent appraisals and market comparable data.
Hedge funds are valued based on valuation of the underlying securities and instruments within the funds. Quoted market prices are used when available and NAVs are used for unquoted securities within the funds.
Absolute return funds are actively managed funds mainly invested in debt and equity securities and are valued at their NAVs.
The following table presents a reconciliation of Level 3 non-U.S. plan assets held during the year ended December 31, 2018:
The following weighted average assumptions were used to determine the postretirement benefit expense and obligation for the years ended December 31:
The following table presents the sensitivity of disclosures to changes in selected assumptions for the year ended December 31, 2018:
The effect of a 1% increase in the medical cost trend rate would increase the accumulated postretirement benefit obligation and the annual postretirement expense by approximately $0.3 million and less than $0.1 million, respectively; a 1% decrease in the rate would decrease the obligation and expense by approximately $0.3 million and less than $0.1 million, respectively.
The Company contributed $18.2 million to its non-U.S. pension plans in 2018. No contributions were made to the Company's qualified U.S. pension plans in 2018. The Company made $3.5 million in benefit payments with respect to its non-qualified U.S. pension plan. In addition, $5.2 million of payments were made with respect to the Company's other postretirement plans.
NOTE 17. FINANCIAL INSTRUMENTS
Fair Value
Accounting guidance on fair value measurements specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. These two types of inputs create the following fair value hierarchy:
•
Level 1 - Quoted prices for identical instruments in active markets.
•
Level 2 - Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets.
•
Level 3 - Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.
This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. The Company determines the fair value of structured liabilities (where performance is linked to structured interest rates, inflation or currency risks) using the London Interbank Offer Rate (“LIBOR”) swap curve and forward interest and exchange rates at period end. Such instruments are classified as Level 2 based on the observability of significant inputs to the model. The Company does not have any instruments classified as Level 3, other than those included in pension asset trusts included in Note 16. These valuations take into consideration the Company's credit risk and its counterparties’ credit risk.
The carrying value and the estimated fair values of financial instruments at December 31 consisted of the following:
_______________________
(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)
Derivative instruments include foreign currency contracts and cross currency swaps for 2018, and foreign currency contracts and interest rate swaps for 2017.
(4)
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.
(5)
The fair value of the Amortizing Notes of the TEUs is based on the most recently quoted price for the outstanding securities, adjusted for any known significant deviation in value. The estimated fair value of these long-term obligations is not necessarily indicative of the amount that would be realized in a current market exchange. See Note 9 for additional information on the TEUs.
Derivatives
The Company periodically enters into foreign currency forward contracts with the objective of reducing exposure to cash flow volatility associated with its intercompany loans, foreign currency receivables and payables and anticipated purchases of certain raw materials used in operations. These contracts generally involve the exchange of one currency for a second currency at a future date, have maturities not exceeding twelve months and are with counterparties which are major international financial institutions.
During the year ended December 31, 2017, the Company entered into several forward currency contracts which qualified as net investment hedges, in order to mitigate a portion of its net European investments from foreign currency risk. The effective portions of net investment hedges are recorded in other comprehensive income ("OCI") as a component of Foreign currency translation adjustments in the accompanying Consolidated Statement of Income and Comprehensive Income. Realized gains/(losses) are deferred in AOCI where they will remain until the net investments in the Company's European subsidiaries are divested. Four of these forward currency contracts matured during the year ended December 31, 2018 and as of December 31, 2018, there were no remaining contracts outstanding.
In the second quarter of 2018, the Company entered into a foreign currency contract and two interest rate swap agreements (collectively, the "Deal Contingent Swaps"), which were contingent upon the closing of the Frutarom acquisition, for a total notional amount of $1.9 billion. In the third quarter of 2018, the Company completed the offering and sale of the 2018 Senior Unsecured Notes (see Note 10 for additional information) and settled the Deal Contingent Swaps. The Company received $12.2 million for the foreign currency contract and $0.4 million for the two interest rate swap agreements which is included in Other income, net and Interest Expense, respectively, in the accompanying Consolidated Statement of Income and Comprehensive Income for the year ended December 31, 2018.
In the fourth quarter of 2018, the Company entered into certain cross currency swaps which qualified as net investment hedges in order to mitigate a portion of its net European investments from foreign currency risk. As of December 31, 2018, these swaps were in a net asset position with an aggregate fair value of $1.1 million which was classified as other current assets. Changes in fair value related to cross currency swaps are recorded in OCI.
Subsequent to the issuance of the 2021 Euro Notes and 2026 EUR Notes during the third quarter of 2018, 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.
Subsequent to the issuance of the 2024 Euro Notes during the first quarter of 2016, the Company designated the debt as a hedge of a portion of its net European investments. Accordingly, the change in the value of the debt that is attributable to foreign exchange movements is recorded in OCI as a component of foreign currency translation adjustments in the accompanying Consolidated Statement of Income and Comprehensive Income.
During the year ended December 31, 2017, the Company entered into several forward currency contracts which qualified as cash flow hedges. The objective of these hedges is to protect against the currency risk associated with forecasted U.S. dollar ("USD") denominated raw material purchases made by Euro ("EUR") functional currency entities which result from changes in the EUR/USD exchange rate. The effective portions of cash flow hedges are recorded in OCI as a component of Gains/(Losses) on derivatives qualifying as hedges in the accompanying Consolidated Statement of Income and Comprehensive Income. Realized gains/(losses) in AOCI related to cash flow hedges of raw material purchases are recognized as a component of Cost of goods sold in the accompanying Consolidated Statement of Income and Comprehensive Income in the same period as the related costs are recognized.
During the first quarter of 2016, the Company entered into and terminated two Euro interest rate swap agreements to hedge the anticipated issuance of fixed-rate debt. These swaps were designated as cash flow hedges. The effective portions of cash flow hedges are recorded in OCI as a component of Losses on derivatives qualifying as hedges in the accompanying Consolidated Statement of Comprehensive Income. The Company incurred a loss of €2.9 million ($3.2 million) due to the termination of these swaps. The loss is being amortized as interest expense over the life of the 2024 Euro Notes as discussed in Note 10.
During the fourth quarter of 2016 and the first quarter of 2017, the Company entered into interest rate swap agreements to hedge the anticipated issuance of fixed-rate debt, which are designated as cash flow hedges. The various hedge instruments were settled upon issuance of the debt on May 18, 2017 and resulted in a loss of approximately $5.3 million. As discussed in Note 10, the loss is being amortized as interest expense over the life of the 2047 Notes.
During the first quarter of 2013, the Company entered into three interest rate swap to hedge the anticipated issuance of fixed-rate debt, which are designated as cash flow hedges. The effective portions of cash flow hedges are recorded in OCI as a component of Losses/gains on derivatives qualifying as hedges in the accompanying Consolidated Statement of Income and Comprehensive Income. During the second quarter of 2013, the Company terminated these swaps and incurred a loss of $2.7 million, which it will amortize as Interest expense over the life of the 2023 Notes (discussed in Note 10).
The following table shows the notional amount of the Company’s derivative instruments outstanding as of December 31, 2018 and December 31, 2017:
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 December 31, 2018 and December 31, 2017:
_______________________
(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 years ended December 31, 2018 and December 31, 2017 (in thousands):
These net gains (losses) mostly 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 years ended December 31, 2018 and December 31, 2017 (in thousands):
_______________________
(1)
Interest rate swaps were entered into as pre-issuance hedges for our bond offerings.
The ineffective portion of the above noted cash flow hedges and net investment hedges was not material for the years ended December 31, 2018 and 2017.
The Company expects approximately $7.5 million (net of tax), of derivative gains included in AOCI at December 31, 2018, based on current market rates, will be reclassified into earnings within the next twelve months. The majority of this amount will vary due to fluctuations in foreign currency exchange rates.
NOTE 18. 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:
(a) Represents a foreign currency exchange gain from the release of a currency translation adjustment upon the liquidation of a foreign entity in 2017.
The following table provides details about reclassifications out of AOCI to the Consolidated Statement of Comprehensive Income:
_______________________
(a)
The amortization of prior service cost and actuarial loss is included in the computation of net periodic benefit cost. Refer to Note 16 to the Consolidated Financial Statements for additional information regarding net periodic benefit cost.
NOTE 19. CONCENTRATIONS OF CREDIT RISK
The Company does not have significant concentrations of risk in financial instruments. Temporary investments are made in a well-diversified portfolio of high-quality, liquid obligations of government, corporate and financial institutions. There are also limited concentrations of credit risk with respect to trade receivables because the Company has a large number of customers who are spread across many industries and geographic regions. The Company’s larger customers are each spread across many sub-categories of its segments and geographical regions. The Company had one customer that accounted for more than 10% of its consolidated net sales for the years ended 2017 and 2016, but less than 10% for the year ended 2018.
NOTE 20. COMMITMENTS AND CONTINGENCIES
Lease Commitments
Minimum rental payments under non-cancelable operating leases are $49.3 million in 2019, $42.2 million in 2020, $36.4 million in 2021, $32.2 million in 2022 and $229.6 million in 2023 and thereafter through 2059. The corresponding rental expense was $42.4 million, $37.8 million and $35.4 million for the years ended December 31, 2018, 2017 and 2016, respectively. None of our leases contain escalation clauses and they do not require capital improvement funding.
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 December 31, 2018, the Company had total bank guarantees and standby letters of credit of approximately $60.8 million with various financial institutions. Included in the above aggregate amount is a total of $17.5 million for other assessments in Brazil for various income tax and indirect tax disputes related to fiscal years 1998-2011. There were no material amounts utilized under the standby letters of credit as of December 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 $10.5 million as of December 31, 2018.
Lines of Credit
The Company has various lines of credit which are available to support its ongoing business operations. As of December 31, 2018, the Company had available lines of credit (in addition to the $1.0 billion of capacity under the Credit Facility as discussed in Note 10) of approximately $104.3 million with various financial institutions. There were no material amounts drawn down pursuant to these lines of credit as of December 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 has been incurred and the amount of the loss can be reasonably estimated. Because litigation is inherently unpredictable and unfavorable resolutions could occur, assessing contingencies is highly sensitive and requires judgments about future events. On at least a quarterly basis, the Company reviews contingencies related to litigation to determine the adequacy of accruals. The amount of ultimate loss may differ from these estimates and further events may require the Company to increase or decrease the amounts it has accrued on any matter.
Periodically, the Company assesses its insurance coverage for all known claims, where applicable, taking into account aggregate coverage by occurrence, limits of coverage, self-insured retentions and deductibles, historical claims experience and claims experience with its insurance carriers. The liabilities are recorded at management’s best estimate of the probable outcome of the lawsuits and claims, taking into consideration the facts and circumstances of the individual matters as well as past experience on similar matters. At each balance sheet date, the key issues that management assesses are whether it is probable that a loss as to asserted or unasserted claims has been 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 seven facilities operated by third parties at which investigation and/or remediation activities may be ongoing. The Company analyzes its 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 $3 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
Taste plants
During 2015, the Company was notified by Chinese authorities of compliance issues pertaining to the emission of odors from several of its plants in China. As a result, the Company's Guangzhou Taste plant in China was temporarily idled in 2015. The Company has made additional capital improvements in odor-abatement equipment at these plants to address these issues and built a second Taste plant in China, which began operating in the first quarter of 2019. The second taste plant is located in Zhangjiagang.
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 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 not reasonably estimable as of December 31, 2018.
The net book value of the Company's Taste plants (including both Guangzhou and Zhangjiagang) was approximately $108 million as of December 31, 2018.
Zhejiang Ingredients plant
In the first quarter of 2016, the Company received a request from the Chinese government to relocate its Scent Ingredients plant in Zhejiang, China (the plant is located in Hangzhou City in the Zhejiang province). Since then, the Company has been in discussions with the government regarding the timing of the requested relocation and the amount and nature of government compensation to be provided to the Company. In the fourth quarter of 2017, the Company concluded discussions with the government 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. Remaining payments will be paid to the Company based on specified milestones. The net book value of the current plant was approximately $21 million as of December 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 end of 2019.
Total China Operations
The total net book value of all nine plants in China (one of which is currently under construction) was approximately $194 million as of December 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.
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 $28.0 million. The Brazilian matters take an extended period of time to proceed through the judicial process and there are a limited number of rulings to date.
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 December 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 in the first quarter of 2018 for a total of $16.0 million, of which $3.0 million was paid in the fourth quarter of 2017 and $13.0 million was paid during the three months ended March 31, 2018.
For the year ended 2018, the Company received $13.1 million for the full and final settlement of its claim from the supplier and insurer for the affected product, which has been recorded as a reduction of cost of sales on the Consolidated Statement of Income and Comprehensive Income.
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 $10 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 21. REDEEMABLE NON-CONTROLLING INTERESTS
Through certain subsidiaries of Frutarom, there are certain non-controlling interests that carry redemption features. The non-controlling interest holders have the right, over a stipulated period of time, to sell their respective interests to Frutarom, and Frutarom has the option to purchase these interests (subject to the same timing). These options carry identical price and conditions of exercise, and will be settled in accordance with the multiple of the average EBITDA of consecutive quarters to be achieved during the period ending prior to the exercise date.
The following table sets forth the details of the Company's redeemable non-controlling interests:
The decrease in redeemable noncontrolling interests is primarily due to the exercise of options and the sale of a subsidiary during the fourth quarter of 2018.
(a)(3) EXHIBITS
____________________
*
Management contract or compensatory plan or arrangement
None.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
INTERNATIONAL FLAVORS & FRAGRANCES INC.
By:
/s/ Richard A. O'Leary
Name:
Richard A. O'Leary
Title:
Executive Vice President and Chief Financial Officer
Dated: February 26, 2019
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated:
INTERNATIONAL FLAVORS & FRAGRANCES INC. AND SUBSIDIARIES
SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
(IN THOUSANDS)
_______________________
(1)
The 2018 amount includes an adjustment to the 2017 foreign net operating loss carryforwards in the amount of $5.9 million, as discussed in Note 11 of the Consolidated Financial Statements.
(2)
The 2017 amount includes an adjustment to the 2016 foreign net operating loss carryforwards in the amount of $58.8 million, as discussed in Note 11 of the Consolidated Financial Statements.
(3)
The 2016 amount includes an adjustment to the 2015 foreign net operating loss carryforwards in the amount of $7.6 million, as discussed in Note 11 of the Consolidated Financial Statements.
(4)
The Company executed a legal entity restructuring that resulted in a significant reduction of fully valued deferred tax assets.
S-1