International Flavors & Fragrances Inc (IFF) 2007 Q1 法說會逐字稿

Welcome to the INternational Flavors & Fragrance 2007 first quarter teleconference and audio webcast. This conference is being recorded at the request of International Flavors & Fragrances. (OPERATOR INSTRUCTIONS)

I would now like to turn the call over to Yvette Rudich, Director of Corporate Communications for IFF. Mrs. Rudich, please go ahead.

Thank you for joining us today. With me are Rob Amen, Chairman and Chief Executive Officer; and Doug Wetmore, Senior Vice President and Chief Financial Officer. During the course of this webcast, we may make certain forward-looking comments. The complete text regarding our forward-looking statements is included in our press release and in our filings with the Securities and Exchange Commission. In addition, during this webcast, we may refer to certain non-GAAP financial measures in order to supplement our GAAP financial results. Examples of such measures include our discussion of local currency sales performance and applicable geographic regions and earnings per share excluding restructuring charges and other non-recurring items. We will leave this slide up for a moment to ensure that everyone has an opportunity to review it prior to continuing the webcast.

Now, here is what we plan to cover on today's call. Rob will begin with opening remarks and some highlights on the quarter and our business. Doug will then review our first quarter results. Following closing comments from Rob, we will then take your questions. With that, I will now turn the call over to Rob. Rob?

Thanks, Yvette, good morning. Thanks for joining us. Let's get into the highlights for the quarter. The key highlights for the quarter were clearly the strong sales growth of 11%. This comes on top of the sales growth of 10% that we recorded in the second half of last year, and I believe it's a further confirmation of the progress IFF is making. Doug will provide a more in depth analysis in a few moments.

Secondly, earnings per share growth of 19%. Normally the first quarter is not seasonally strong, so I'm pleased with this performance. I also want to note this is the best quarterly earnings per share excluding unusual items in IFF's history.

Now, looking into the composition of the sales increase, both business units grew at 11%. The impact of foreign exchange was somewhat different between the two and Doug will clarify this shortly. Operating profits improved because of the higher sales, but also because of good cost control. Bottom line is net income was up 17%, earnings per share up 19%, the difference because earnings, pardon me, the shares outstanding was reduced by 2%.

Last October, we announced the new business unit structure. Hernon and Nikola have done a superb job in creating focus and strategies and in building alignment throughout the organization. This alignment is helping IFF to improve its focus, make faster and better decisions and clearly to accelerate our growth. I'm very pleased with the Company' response to our new initiatives and structure. Now let's look at the two business units highlights.

Flavor sales were excellent in the quarter. I'm pleased with the performance with all customer groups and in the regions. Doug will give you details in a moment. Growth was achieved winning and growing faster than the market in the important region North America and Europe, and on top of that, we enjoyed superior growth in the emerging countries. I believe the Flavors business is building excellent momentum.

Fragrance sales of plus 11% was just terrific. This growth reflects the wins we reported to you over the past year or two. These wins come on top of good stability of existing business and I believe we continue to grow our share in this market. Functional fragrance growth was much improved with double digit growth in North America. Now, Doug, can you please provide some added insight into the quarter's performance?

Sure. Thank you, Rob, and good morning, everyone. Let's begin with an overview of sales. On this slide, you can see the break down of sales in growth by our two business units. Flavors achieved 11% growth in dollars on a 7% increase in local currency sales. Fragrances continued its strong performance of recent quarters also growing 11% in dollars on a 5% local currency increase in sales. The primary drivers of the difference between the local currency growth and the reported dollar performance was the strength of the euro and the pound sterling compared to the dollar. The euro was about 9% stronger than the prior year quarter while the pound was about 12% stronger. The difference of the exchange impact between Flavors and Fragrances is due to a great extent the linkage of selling prices in certain areas of the world to the dollar which is more pronounced on the fragrance side than on the Flavor side. I'll discuss the sales performance in a little more detail later by business unit.

Turning to the geographies. Our growth was solid in all regions of the world. North America continued its strong 2006 performance growing 8% in the quarter, replicating the 8% growth achieved in the fourth quarter last year. This performance was led by excellent results in both fine and functional fragrances with respective increases of 15% and 12%. Europe reported very strong growth, increasing 13% over the first quarter last year. Quarterly sales benefited from the strength of the euro and the pound versus the Dollar but the reported growth reflected a solid local currency increase of 4%. Latin America sales increased 4% as well. This growth was particularly strong in fine fragrance which grew 21% in the quarter and Latam Flavors also continued its strong performance in recent quarters increasing 14%.

Greater Asia, which includes India, also achieved very strong growth driven mainly by new wins and improved volumes. Greater Asia sales increased 9% in local currency and 11% in dollars. Flavors growth led the Asia performance with a strong 15% local currency growth. Local currency sales to our top 30 customers which now account for about 57% of our consolidated sales grew 9% in the quarter, continuing the pace of growth achieved for the full year 2006. Now let's discuss each of the businesses performance in a little more detail.

Effective with the first quarter this year, we've begun reporting segment data on a business unit basis. In early April, we filed an 8-K with 2005 and 2006 quarterly and year-to-date segment data prepared on the same basis of presentation in order to facilitate comparison. The information filed with this 8-K is also available on our website. As you can see from this slide, Flavors had a very solid start to the year in the first quarter. The very strong operating profit leverage results from the solid sales performance enhanced by very good cost control.

Now looking at the Flavors sales growth, this chart depicts the percentage growth in Flavors sales in both local currency and reported dollars since 2006. As is evident, the local currency sales performance for Flavors has been consistently improving over the last eight quarters driven by increased wins, improving volumes, and improving macrotrends.

Turning to the Fragrance business unit, Fragrances also had a very solid start in the first quarter with an 11% increase in sales driving operating profit growth of 13%. As was the case in Flavors, new wins and volume growth of existing business drove improved performance. While the unit generated positive operating profit leverage, mix did impact Fragrance operating results. The mix impact resulted primarily from strong sales growth of lower margin Fragrance ingredients. Fragrance ingredients also had somewhat lower selling prices in certain areas. These factors along with the cost of sailing up production of our new China and fragrance ingredient facility tempered the profit impact of the sales growth. However, continued solid cost control mitigated the impact of these elements and overall, fragrances delivered a very solid 13% increase in operating profit.

Now, turning to Fragrance sales in a little more detail, functional Fragrance sales grew 5% on a 1% increase in local currency, resulting from a combination of volume growth and new wins. Fine and beauty continued its outstanding performance of the last three years growing 11% in dollars and 5% in local currency. The fine fragrance performance was driven both by new product introductions and continued demand for existing creations. Ingredients reported a very strong performance in the first quarter with a 17% increase in overall sales on an underlying 13% local currency increase. The ingredient growth was driven by volume, partially offset by downward pricing on some ingredients as I mentioned moments ago.

Turning to Fragrance sales trends over the last couple of years, this chart depicts the percentage growth in fragrance sales in both local currency and dollars the last three years. As is evident, the local currency sales performance has been quite strong for the past several quarters driven by the new wins and sustained success of existing creations. That strength has been most evident in fine fragrance and beauty care but we've begun to see improvement in functional fragrances and ingredients. We stated in past calls that we knew the pace of growth delivered in the third and fourth quarters of 2006 was not likely to be sustained at such high levels; however, we are quite confident that we're growing faster than the market overall and in so doing, are increasing our share of the fragrance market.

Rob reviewed the consolidated financial results. Let me go into them in just a little more detail. In summary, the 2007 first quarter included an 11% sales increase resulting in a 9% increase in gross profit. As commented on, the gross margin decline as a percent of sales resulted from a combination of product mix, notably the higher sales of Fragrance Ingredients and Flavors, some lower ingredient selling prices and the start up cost as we scale up production of the ingredient facility in China. While both R&D and selling and admin expenses increased this quarter in absolute value terms compared to the prior year quarter, exchange was a significant element of this increase. Excluding exchange, R&D would have declined 2% versus the prior year quarter and selling and admin would have increased about 3%. As a percentage of sales, both R&D and selling and admin declined from the prior year quarter to 8.2% and 16% respectively. The end result, an 18% increase in operating profit compared to a year ago. It bears mentioning that this operating profit for 2006 is as reported in our segment note in the 10-Q, the $81 million in 2006 reflects just under 700,000 of restructuring costs. There were no restructuring costs in the 2007 quarter.

Now, looking at our evolution of earnings per share. Let me briefly review the components compared to the prior year quarter. I'll note that we haven't attempted as in the past to isolate exchange in the chart so the impact of the weaker dollar is embedded in each of the elements discussed except for the number of shares outstanding. The amounts are approximate as they are also subject to rounding, but starting with the 2006 quarter where we reported earnings per share of $0.58 per share, sales growth added $0.06 per share. Productivity added $0.04 per share. The strong sales growth facilitated the productivity improvements, an element of which is capacity utilization and absorption. The combination of changes and other income expense, interest expense and the 2006 restructuring charge decreased the current years earnings per share by about $0.01 per share. The biggest factor in this fluctuation between the two years is the increase in interest expense for which the primary reason is the overall increase in average interest rates on debt. In the 2006 quarter, our average interest rate was 2.3%. This year, it averaged 4.1%

Overall, the effective tax rate for the quarter was 28% compared to 28.7 in the prior year quarter adding about $0.01 per share. On this note as we discuss in more detail in our 10-Q, the Company adopted financial accounting interpretation Number 48, effective January 1, 2007. FIN 48 will likely entail increased volatility of the effective tax rate moving forward particularly on a quarterly basis. On an annualized basis, I would expect our effective tax rate to closely approximate what we reported for 2006. We've also reduced the number of shares outstanding by 2% compared to the 2006 period adding $0.01 per share. Taking all of these elements into account, earnings per share for the first quarter 2007 was $0.69 per share.

Now it's useful to put into context our quarterly earnings per share performance this year compared to the last several years, when excluding the restructuring charges and other non-recurring items such as the tax benefit of homeland and the gains on sales of assets in 2006 and taking into account stock splits over the years, as Rob mentioned, earnings per share this quarter represents the highest quarterly earnings achieved in the Company's history.

Now, let's look at cash flow for a minute. The detailed cash flow statement is available in both our press release and the 10-Q. 2007 cash flow from operations declined compared to the prior year quarter; however this performance was not unexpected. One of the main elements for that was the 2006 first quarter results were unusually high. Let me comment on that. The main drivers for the decline year on year were payment of about $45 million in incentive compensation in the first quarter of '07 relating to 06, compared to about $9 million in similar payments in 2006 relating to 2005. Additionally, the first quarter of this year, there were about $10 million of deferred compensation payments, mainly in connection with retirements for which there was no comparable amount in the 2006 quarter. Finally, interest payments increased about $13 million compared to the first quarter last year. This increase reflects shifts in payment dates, as the now retired $500 million in notes had interest payments in the second and fourth quarters of each year whereas the $375 million in private placement notes are paid in the first and third quarters.

For the full year 2007, I would continue to expect cash flow from operations to have about the same relationship to net income as it did in 2006. We remain pretty tight on capital spending with just under $9 million expended in the quarter and comparable to the prior year period, and having said that capital spending is expected to scale up somewhat in the second quarter. There's been no major change in gross debt outstanding. Our gross debt at March 31, 2007, was just over $812 million compared to $806 million at year-end. The increased dividend pay out reflects the 14% increase that we announced in our dividend in October last year, and we have continued to buyback our shares, albeit at a somewhat lower pace than in 2006 so let me update you on where we stand in this regard.

Year-to-date, we've spent just over $31 million in share repurchase and in so doing, we reacquired 700,000 shares. At quarter end shares outstanding stood at 89 million, down about 2% from the prior year. We have a remaining authorization of about 175 million at the end of the quarter. Now, I'd like to turn it back over to Rob for some additional comments and then we'll open the call to questions.

Thanks, Doug. I'd like to handle a couple of questions that are not really related to the quarters performance but issues that have been raised by some investors, the first of which is the European Chemical Regulation. This legislation, which is referred to as "Reach" will cover all chemicals made and used in the EU. Food ingredients such as Flavors are covered by existing legislation so they are largely exempted from "Reach" but the real issue is what are the implications of reach on IFF now and for the next few years? Reach legislation comes in phases. The first phase, which we're working on now, is the pre-registration of our existing portfolio of materials, and this I expect to have completed by November 2008 deadline. The next phase is really the big hurdle, and that comes in December 2010. At that time, we would have about 10 to 12 materials that would have to be tested and registered. Yes, this will involve some incremental testing but I don't expect it will be significant. Future deadlines will involve more numerous materials, but I don't know how many. I fully expect that many of these will be dealt with as part of an industry group or certified and categories. IFF has the expertise and capabilities to comply with the legislation and we'll continue to proceed prudently to support our customers and to management the cost of compliance.

Another topic that has been raced several times is R&D and innovation and let me just give you some thoughts on that. When we created the business units, we aligned R&D along those business units, so we have flavors under the business unit, flavors and fragrance R&D under fragrance, and then there's a small corporate group that supports both of those with shared analytical resources and some other smaller activities.

I think of our R&D in four categories--Traditional R&D for flavor and fragrance molecules and taste systems, taste receptor cell research, I'll explain in a minute, naturals, and of course creative. The traditional R&D is working on developing molecules unique and new molecules for flavors and Fragrances and for improving the delivery of those systems either in taste or fragrance applications, and we continue to make progress there. Taste receptor cell research really is quite advanced work and that's where we have cloned the human taste receptor and we're screening our library of natural and synthetic materials for salt, for mouth feel, for sweet, and other things. That research has been going on a couple of years and will continue to go on. It's quite advanced and we continue to support it.

The area of naturals and nature inspired is very important, both because of the market trends towards natural health and wellness in the marketplace as well as new creativity for our flavors and our perfumes, and here, we do research involving natural materials to find new inspiration and new fragrances and flavors to bring to our teams. Certainly, the creative teams and here I'm talking about our perfumers and flavorists are an important part of our development area, as well as the application scientists, because it's one thing to create the molecule but ultimately, it has to be put into a winning formula and then provided in a final form whether taste system or a fragrance to be useful to the customer.

Now, what's the output of all of this, last year, I believe we reported 20 patented materials and in the First Quarter of '07, we registered a further 13 patents. Three of those materials were already used in winning formula this quarter. It's also important that we have a series of proprietary items. These are unique molecules that we've concluded we don't want to patent. They provide us either an advantage in cost or independence but we'll continue to pursue that. Equally as I said, those products have to be delivered. Now, an example of a delivery system is encapsulation, and encapsulation is proceeding as planned in fabric care, and we'll continue to look for expanded applications. Flavor systems that the provide for stability across a range of temperature and applications is another area that we continue to focus on, but I'm pleased with the response and the alignment of our research with our business units. We're seeing good productivity there, and I expect to see more.

Now, the priorities for 2007. Clearly, the first priority has to be to execute our business plan and to deliver the results. And I think the company is demonstrating it. We're showing very very good customer focus and we're improving. I believe the market opportunities are exciting. Q1 sales demonstrate that IFF can accelerate its growth by focusing and bringing unique products to our customers. We continue to have room to improve administrative and operational areas. I expect the initiatives under way will reduce overhead in 2008. We're assessing our operations to determine the opportunity gap and I hope to have this analysis completed by year-end. That again, will have impacted 2008 and future years.

We also have to build a stronger company, to be able to meet the challenges of growth. People are key, and we're focusing on this key initiative around the world. We have to develop our people to meet the challenges of innovation, customer service, and improved efficiency. Our business model will continue to evolve. We're developing plans to improve effectiveness and cost while maintaining our focus on quality and customers. This won't be a watershed event. Rather, a series of evolutionary changes that will enable IFF to be more nimble and cost efficient. IFF will continue to focus on the people and processes that enable us to develop unique winning products. Researchers, perfumers, flavorists, evaluators, application scientists are all part of this team, and we'll continue to build on this competitive advantage. All of this, I believe, will enable IFF to deliver the results in line with our financial goals.

The IFF team is committed to building this company and to delivering superior results. I believe IFF will be a very rewarding investment for our shareholders, for our customers, and for our employees and now Doug and I will be happy to answer your questions.

(OPERATOR INSTRUCTIONS) We'll go first to Jeff Zekauskas with JPMorgan.

Good morning, this is Silke Kueck for Jeff, how are you?

Hi, Slke.

Maybe a question to start with on the flavor side. When I look at the description of growth in the flavor side by region, you most often cite new product wins, and so is it possible that like this quarter, you saw a nonrepresentative rate of growth because of new product launches and getting ready for new product starts and going forward, the rate of growth, may be slowing. I was also surprised that there was no mention of like market share gains on the flavor side, although you did point it out on the fragrance side.

Silke, it's true. We didn't point that out. And that's simply an oversight. I mean, if we're growing at that rate, we certainly believe we're growing share in the flavors market, and it's an oversight and we probably should have been clearer on that. It's really hard to project that we can sustain 11% growth. We're certainly committed to trying it. I'm not going to be suggesting one level of growth or another. Part of this is about winning the business. Part of it is about the customers launch times. We're quite encouraged in the activity going on with new briefs and new work with the customers leads me to believe that there's a lot of opportunity for us to continue to grow.

Yes. My second question, so Danesco said that they would be putting up their flavor business for sale, is that something that you would look at?

Actually, I just, someone mentioned the press release and we don't tend to comment on that, so no comment.

You generally look at all things that become available or you generally aren't interested?

Well, as we said, our strategy on acquisitions is we want to add things which provide new capabilities or competitive products to IFF's portfolio, and that's what we're after. We want to grow as an enterprise, there's no question, but we're comfortable with our size and our resource capabilities today, and we continue to look for ways to augment our organic growth.

And a few small housekeeping items. Can you break out the amortization charges by segment?

The amortization charges are really quite minor.

Yes. It's only about $3.6 million.

Right.

Consolidated on a quarterly basis. I don't have that broken out any further, but just overall, if you want to, it's probably pretty much follows the split between flavors and Fragrances on a sales perspective.

And maybe one last one?

Yes, Silke, we can queue back up, but I think we should give some other folks a chance.

Sure, I'll go back in queue.

Okay, thank you.

We'll go next to John Roberts with Buckingham Research.

Good morning, guys.

Hi, John.

Could you provide a little bit more granularity on the gross margin and it's a little confusing here. In the latter chart, you said mix and productivity contributed 4% favorable, so I assume mix was favorable sort of overall but you cited mix as a negative factor in gross margins and of course, they were down in fragrance and up in flavors, so kind of break things apart a little bit better for us.

Well remember, John, the earnings per share chart is actually not percent but actual per value or in this case pennies per share value. From a consolidated basis, the mix, with flavors has typically carried slightly lower gross margins although by the time you get to the operating profit level, they are pretty close to fragrances, and the ingredients sales have typically carried somewhat lower gross margins, so that is the mix effect on a consolidated basis. I think you might be thinking of the comment I made on the sales, of the flavor profitability where the sales growth within flavors drove improved gross margin and operating profit margin in the flavors business unit.

So flavors it was a volume leverage effect?

As well as, yes, it's mix. It's volume, and as we've said over many calls, if we get that sales growth, we begin to see very quick operating profit leverage, but again, on the consolidated basis, the sales mix between flavors and fragrances and the very strong growth of the ingredients sales were what contributed to the overall decline in gross profit as a percentage of sales.

Great thanks. I'll get back into queue.

Thanks, John.

We'll go next to Douglas Chudy with KeyBanc Capital Markets.

Good morning. Congratulations on the quarter. A couple of quick questions. First can you comment on the trends you've seen in the underlying growth market? I think previously we've mentioned that it could be around 2% and you continue to expect that you can outpace the underlying market growth. Can you provide any more commentary on that?

That's a great question. Getting ready for this call, we certainly looked at a number of companies who operate in our space and when you take a look at the large consumer products companies, they are reporting significantly higher volume growth in that 2% in most consumer products and fine fragrance may not be overall as an industry but in the functional and flavors. Let's take a look at the world. We've got a concurrent expansion and it may not always be this way. We've got a very good expansion in Europe and I think our results there reflect that both West and East. Latin America, India, China, the economies are growing and the marketplace of our products are growing nicely, and the U.S, While growth in the U.S. may be slowing, it's still expanding. So I don't think we should generalize in terms of trend line economic growth from a condition of global expansion, but we've got a very encouraging market and that's really helping us with our 11%.

Okay, and secondly, it sounds like you got some exciting new product backlog. Can you give some commentary on what contribution that's making to sales growth?

Well, about of the sales growth in the current quarter, as an example, about 60% of it came from new wins although as we've mentioned, various times in the past, that may very well be business that was won a year or two ago that is only now being launched, and the balance is really due to volume growth on existing business, and I think that the positive there is we've created flavors and fragrances that are succeeding in the marketplace and are demonstrating longer lives than perhaps some of our products had before, so it's really winning more business and sustaining existing business.

And just quickly, finally, what about the encapsulation. Can you maybe break out what that's contributing to growth?

We've said this year, it will accelerate as the year goes on but this is a year we expected the end cap to be roughly between 1 and 2% of our sales and that it would continue to accelerate in 2008. And a lot of that depends on the timing of the launches of the products from our customers which is really something that is beyond our control to a very great extent.

Thank you very much.

Thank you.

We'll go next to Fabian Wenner with UBS.

Yes, good morning, gentlemen. Thanks for taking my questions. Congratulations on the results. Very quickly, on the organic growth rate that you published in your press release, I just wondered whether these 17, 11% for the subdivision are organic growth figures and that's the first question. And then secondly, you were explaining you were gaining market share, I just wondered, is that mainly from a small company, from small competitors because when you look at your peers, the four large ones in the space, they all seem to be growing at about 5%, so well above the 3% historic guidance. And that's the second question. Thirdly, just very quickly, when you look at companies like Records and Keezer, and so on, they seem to have very good results recently and growth in fragrance has seemed to reflect that. Is there anything apart from the regional growth that you discussed just now that is driving this growth in fragrances?

Now, that's a mouthful of a question. Let me go back over it. If I don't answer it all, please remind me if I've missed something. First, all of our growth is organic. We've made no acquisition in the past year so all of this is coming off of our existing efforts, and that's what's so exciting to have the base business performing this well.

No currency effect in there?

The currency effect is the difference between the 11% we said was the reported sales and--.

6% of local currency, so there was about a 5% favorable currency effect and then as I mentioned during some of my comments there was certainly an unfavorable effect on expenses, on a leg for leg basis I think R&D would have been down about 2% and S&A would have been up about 3%.

Now, to the question of, we don't have perfect market data. We estimate it. We certainly feel that if we're growing at the rate we're growing at 6% local currency terms, we're growing market share, and when we take a look at our big consumers as I told you, we see some very very good growth in their volume. I can't, because I don't have the data, to tell you from whom we're taking that share from.

Yes.

Clearly, the big global companies and even big regional companies are looking to the people who can provide them uniqueness and breadth of coverage, greater technologies, so I think the big players are having a certain advantage in the marketplace and we're going to continue to double down on that so we can make more of that advantage. Okay?

Okay. And growth in fragrances? Is there anything within the segment particular that you see that has changed, any trends in any product segment?

Well, I think Rob mentioned the fine fragrance element is really the one that the growth is probably still fairly low, but I think the other is driven to a very great extent by GDP and disposable income which really drives consumption of products that would include functional fragrance, such as a laundry soap or a detergent or a bath soap.

Okay, thank you very much.

I mean, I think if you will, for a moment, break the world down into sort of disposable earnings buckets, the United States and Western Europe, you've got fine fragrance growing fairly slowly and functional is growing something for the market, something in line with GDP. In the emerging world, the growth in functional is far faster than the reported GDP's because you're getting people who are below, if you will, the modern consuming level moving into being modern consumers and so we're getting much more rapid growth in functional fragrance and in flavors. Those are the dynamics of the world and that's what's driving the market demand.

That's helpful. Thank you very much.

(OPERATOR INSTRUCTIONS) We'll go next to [Veto Mehnsa] with Sandler Capital.

Hi, guys, terrific quarter. Just one question. It was in the 10-Q and I think it was in the press release. You guys mentioned a Chinese facility that dragged on gross margin a little bit as you ramped it. Wondering if you could give a little better magnitude of how much of a drag it was?

That's the new China fragrance ingredient facility we constructed during Oh, five and early '06 and we began Commissioning I believe September or October last year. The impact in the current quarter was probably between 20 and 30 basis points on gross margin. It will diminish a little bit during the course of Q2, and I suspect it will be fairly de minimus in Q3.

Wow, okay. Thank you very much. Appreciate it. Great quarter.

Thank you.

We'll take our follow-up question from John Roberts with Buckingham Research.

You guys had good traction on the SG&A and R&D productivity. I'm wondering if there's some similar opportunity on the gross margin side, given the mix effect that we kind of see here. Is there a product line rationalization or something that can shift that mix to have a meaningful impact on gross margin?

John, if you recall back over a couple quarters as we talked about how we're going to expand our operating margin, and to be honest with you I focused more on getting the operating margin up as opposed to just the gross margin, but we do have and several initiatives under way to rationalize our ingredients in supply chain to rationalize some of our formulas, all of that should help gross profit and operating profit margins. The initiatives we have on expense which really were undertaken by this team in early '06 are paying off now, but we've got a whole series of new initiatives because we've got to push that further. As I mentioned, our overhead expense and clearly, our operating facilities, how to prepare them for greater productivity and lower cost, so we haven't completed by any means the opportunities we have in those areas.

Thank you.

We'll take another follow-up question from Jeff Zekauskas with JPMorgan.

Yes, good morning. On the flavor side, can you talk about whether the product life cycles generally have shortened?

Oh, I don't think there's a meaningful shift. It's different country and region by region, but I don't think there's been a material shift in the past three months.

How about like the past year or two, just like generally trendwise, not just in the quarter but over like a longer period of time?

There's a long term trend of it getting shorter, but it's not dramatic. It's not something that I think I could look in the numbers or talk to the customer and see there's a major shift.

Okay. And maybe like on the question on SG&A, can you talk about what the benefit was from the headcount reductions undertaken last year and how much accruals by incentive comps impacted the quarter, the expense in the quarter?

Well, it's it certainly was an element that contributed to it, Silke, and I think the benefit will be more pronounced with those headcounts in the first half of the year than the second half because a lot of the personnel that were affected by those actions left the employ of the Company in the first and second quarters, so you'll see a little bit more benefit in the first half than the second half but I don't have, we estimate that the savings of those actions when we announced them and quite frankly I'm drawing a complete blank as to what they were, but pretty much that we're achieving those savings, that we intended to achieve at the time we announce the actions and those would be spread ratably over the four quarters of the year.

Okay, thanks very much.

And in terms of the compensation, you'll recall that the first quarter of '06 had very very low incentive comp. Based on the results from a cash flow--.

From cash flow but from last year, that's not an element of the P&L at which I think is what you're asking about, Silke.

I think she is blocked from asking a question.

Okay.

Is there any other questions?

We do have a question from Alex Richardson with Portland Health.

Hi, guys. I just wondered if you could talk us through the sequential increase in working capital. I don't know if that's part of inventory build. And secondly, just on R&D expenditure, whether or not you say it's sustainable at this slightly lower level?

Well, I guess I'll talk about the working capital, Rob. The second and the third quarters of the year are our biggest quarters and that's particularly pronounced on the fine fragrance side but fragrance overall because the second and third quarters you build stock for the holiday season believe it or not. Also during the summer months, in the northern hemisphere there's a tendency to launder more because of the hotter temperatures. Similarly on the flavor side during the summer months, there's more consumption of snacks and beverages so yes, there is an element of inventory build up from the end of the year to the first quarter and moving into the second quarter, but overall, if you look at our day sales and inventory, we're actually down about ten days from a year ago, and receivable days are pretty much constant, so it's just the normal seasonal fluctuation in the balance and also if you look at it from a value perspective, currency does impact the value of the reported assets on the balance sheet. Remember we have a lot of assets in Europe.

Okay, great.

R&D, I would expect R&D to remain roughly in total with about where it is. There may be some shifts within it, but I don't expect there to be a significant shift in the total dollar value of the R&D on a quarterly basis.

And remember, we said I believe in the third or fourth quarter call that R&D would decline as a percentage of sales because the sales growth was going to accelerate at a more rapid pace than the increase in the spending on R&D but that's not to say that we're not going to continue to spend increased R&D dollars but just at a lower pace.

Thanks, guys.

And that does conclude our question and answer session for today. At this time, gentlemen, I would like to turn the call back over to you for closing remarks.

Just in closing, we're really pleased not just with the results of the quarter but the momentum and I think our organization is quite energized by the results and we look forward to the balance of the year. Thanks for joining us today and we look forward to talking to you in the future. Goodbye.