International Flavors & Fragrances Inc (IFF) 2008 Q3 法說會逐字稿

At this time I would like to welcome everyone to the International Flavors and Fragrances third quarter 2008 earnings conference call. (OPERATOR INSTRUCTIONS) We request a limit one question per person.

And I would now like to introduce Yvette Rudich, Director of Investor Relations. Ms. Rudich, please go ahead.

Hello and welcome to IFF's third quarter 2008 conference call. With me are Rob Amen, Chairman and Chief Executive Officer, and Rich O'Leary, Interim Chief Financial Officer. Our earnings release and 10-Q were filed this morning and are available on our website at IFF.com under the Investor Relation's section.

As you know, during this call we may make forward-looking statements about the Company's performance. These statements are based on how we see things today so they contain elements of uncertainty. For additional information concerning factors that could cause actual results to differ materially from the forward-looking statements, I ask that you refer to the cautionary statement and risk factors contained in today's earnings release and in IFF's filings with the SEC, available on our website.

Some of today's prepared remarks will exclude those items that effect comparability. These excluded items are captured in our GAAP to non-GAAP reconciliations available on our website.

Here is what we're going to cover on today's call. Rob will open with an overview of our third quarter highlights and then follow that with some business-unit performance updates. Then Rich will provide a review of our Q3 financial results. Following with closing comments from Rob. Now, let me turn the call over to Rob, our Chairman and CEO.

Thanks Yvette. Good morning and welcome to those listening in. Now, let me get directly to our third quarter results. Despite the numerous economic challenges of the past several months, IFF posted a good quarter. Reported sales grew 6% measured in local currency sales were up 2%. Operating margins were 16.3%. Input costs rose slightly more than the 5% we have seen recently. Our overhead costs were flat year-to-year on a reported basis and this quarter also benefited from an unusually low incentive compensation expense which Rich O'Leary will discuss more later. Adjusted earnings per share were $0.75 a share versus $0.71 last year. I believe this isn't exactly comparable. Analytically there should be some level of compensation. My analytically adjusted EPS number would be $0.70 versus the $0.71 reported last year.

But let me turn to the business overviews. IFF again benefited from a strong sales performance in the Flavor business, up 5% in local currency. These results were driven by very strong growth in the key emerging markets. The European region which has been a concern recorded growth of 3% in local currency. In North America, sales were flat year-over-year. The sales growth was helped both by pricing and volume gains especially in the beverage and confectionary segments.

The Fragrance business performance in Q3 was in-line with our expectation and showed progress from earlier this year. Fine and beauty has been struggling since the end of 2007. I am pleased with the progress reported for this category. Yes, local currency sales were down 1% in the third quarter, but that is against a very strong year-ago quarter when sales in local currency grew 8%.

The inventory-related adjustment related to Christmas 2007 is over. We saw good sales growth in this category in July and August and in the early part of September. After mid-September, sales did weaken. Over-concerns for, unfortunately now, Christmas 2008. We have had a good improvement in wins over the past year. That said, fine fragrance faces a challenge given the current economic and retail conditions.

Functional fragrances were flat year-over-year. I was pleased to see the improvement in North America. Asia continues to grow while sales slipped in Latin America and Europe. The Ingredients business strategy is to prune and grow its product portfolio. Despite the selected pruning, sales were flat year-over-year. The fragrance business recovery is progressing. And yes, we have further to grow.

Those are the quarter headlines. Now Rich will take you into more detail. Richard?

Thanks Rob and good morning to all of you. This is the first time in presenting the results and you will see we made some changes to the format and content somewhat from prior quarters and, as always, there maybe slight differences in the tables due to rounding. Let's start by taking a look at consolidated sales. We had good results, but were not satisfied. Sales increased 6% on a reported basis, driven by continued gains in flavors, price, and positive currency. Local currency sales increased by 2%. This represents the 12th consecutive quarter of local currency sales growth.

On the next slide we can see the drivers that impacted year-over-year sales. Pricing added 2% across both businesses. This was better than previous quarters, but overall was still lagging input costs. We had a modest increase in sales volume and currency added another 4%. Conversely, mix was weaker mainly due to lower fine and beauty activity.

In terms of profitability on slide 11, gross margin was down 190 basis points reflecting weaker sales mix, high input costs, and partially offset by price realization and currency. Operating margin improved 80 basis points to 16.3%. As we look at performance, we eliminate the effects of certain items. In the 2007 quarter, we had a charge of $5.9 million for the curtailment of our US pension plan. For the 2008 quarter, we had $2 million of cost to implement our global shared service center, and lastly, third quarter 2008, had much lower incentive comp expense compared to 2007. Let me walk you through the last item.

Incentive comp has accrued over the course of any year, however in assessing our results versus target loose the 9 months we determined that very little incremental expense was required during the third quarter 2008. However, on the end had the year-to-date expense been recorded equally, over the three quarters, an additional $5.7 million of expense would be reflected in the third quarter. Reallocating this $5.7 million and excluding the $2 million in implementation cost, the adjusted operating margin for the third quarter, 2008, was 15.7%. This compares to 16.5% for the third quarter, 2007, excluding the pension curtailment. This 80 basis-point gap represents a significant improvement compared to last quarter's gap of 140 basis points.

Now let's take a look at the individual business performance in a bit more detail. From a sales perspective, we're quite pleased with the 5% local currency sales growth for flavors business. We continue to see significant gains in our beverage business and solid growth in confectionary. These were slightly offset by lower activity in the dairy category. How does this translate to the bottom line? We had an 8% increase in operating profit and this reflects volume growth, solid sales mix, lower overhead expenses, and partially offset by higher input costs. At the same time, we continued to make select investments to support future growth. We do expect to achieve further price realization in the coming quarters and several cost mitigation programs should begin to benefit the fourth quarter.

Turning to our fragrance business on slide 14, there were mixed results for the quarter. Overall sales were flat in local currency. Greater Asia had solid growth of 6% in local currency, considering flat sales in China due to the Olympics. The rest of Greater Asia had local currency growth of 8%. Latin America had gains in fine fragrance and new business for ingredients, offset by lower functional fragrance activity. And in North America, fine and beauty was down 14%. But this is a far cry from the 30% decline in the first quarter, 2008. At the same time, we're encouraged by 7% growth in functional fragrances.

Fragrance operating profit declined 2% for the quarter. Lower fine and beauty lines and higher input cost represent a challenge. We have achieved some price realization, but we have a ways to go across most of the fragrance business. We will continue to focus on price realization and mix improvement. And we will make choices regarding this progressionary spending without jeopardizing those areas of the business that are growing.

Input costs are a major topic of discussion in today's environment. Let me update you on where we stand. For the quarter, input costs were up 5.4%, higher than the second quarter increase. Input costs are more than just raw materials, which account for approximately 70% of the total. In addition to raw materials, personnel costs are the next biggest category followed by items such as energy, shipping, packaging, and facility-related costs. We can't sit around and hope that the input costs abate. To mitigate increases, we're using a variety of tactics.

First , we work with our customers to achieve a reasonable cost recovery through pricing. Also, working with them we identify product reformulations or material substitutions that benefit both parties. Internally we regularly assess make versus buy options and we leverage gains in overall manufacturing efficiency and yields. As I mentioned earlier, we have made progress in cost recovery during the quarter, there is still a gap for the quarter and the 9 month period. (inaudible) on raw materials. On slide 17, you see the top five purchase categories. They represent approximately 7% of our total raw materials spend. And not surprisingly, building block like aroma chemicals and naturals are our largest categories. What are the influences on price? It ranges from crop availability for most naturals to the alternative use value for turpentine. The Petro chemicals we buy are not direct commodities. Instead, they are the byproducts of the crafting process. Overall, correlations are not strong enough for us to have many opportunities to hedge our raw material purchases.

We maintain strategic stocks to insure the availability of critical materials like naturals as well as to take advantage of pricing opportunities. We have a lot of money invested in inventory and there were some specific issues that required us to build inventories during the first half of 2008. These positions have begun to unwind and we have seen a corresponding drop in days inventory on-hand. And we expect to realize additional improvements in quantities on-hand during future quarters..

On slide 18, we see condensed income statement. The complete statement can be found in our filings. All the amounts showed on a reported basis, gross profit increased 1% year-over-year. versus a 6% increase in sales. The unfavorable leverage reflects weak sales mix, higher input costs that could only be partially offset by price recovery and currency. Overhead expense, which includes R & D and selling and admin was flat year-over-year.

Interest expense was up $9 million. $6 million of the increase relates to the 2007 [private] placement and another $4 million is due to wider LIBOR interest rate spreads on two currency swaps. It is worth noting that earlier this month we closed out one of the cross currency swaps as well as one of the fixed-to-floating rate swapped both at zero cost to the Company.

Bottom line, net income decreased 2% to $58 million. But combined with the 10% decline in average shares outstanding reported EPS was 9% higher. Excluding implementation costs in 2008 and the curtailment charge during 2007, adjusted EPS increased 6% to $0.75 per share versus $0.71 per share last year.

In a challenging environment, we have good financial results. Reported EBITDA increased 7% on a 2% local currency growth. In currency is another area of focus for most companies. In our case, for the third quarter 2008, we estimate the currency favorably impacted earnings per share by $0.03 compared to 2007. There is a lot of noise in that number, but all things being equal, I estimate that a 1% change in the US dollar exchange rate has a $0.01 per year impact on EPS.

Before going into the details on EPS year-over-year, let me take a moment to walk you through how we look at the third quarter results. This is our view, it is not GAAP-based. The adjustments we discussed earlier such as implementation cost and curtailment loss in 2007 are pretty straightforward. Incentive comps are a bit more complicated. It can't be reviewed in isolation. Instead, it moves in-line with the overall results of the Company.

At June 30, 2008, we had accrued $18 million. Based on Q3 results, and our estimates for the year, another $400,000 were recorded during the third quarter of 2008. From an accounting standpoint, it is not appropriate to restate prior quarters accruals to reflect the latest assessment of current performance. However, we think it is more reasonable to reflect an equal amount of expense in each quarter. Doing so, adds $5.7 million of expense, to the third quarter 2008. The S&A operating profit and EPS shown on slide 20, reflect this reallegation of one-third of the year-to-date incentive comp expense as well as the exclusion of the other items such as implementation costs and the curtailment charge that I mentioned earlier. On a management basis, S&A is down year-over-year, and the gap in operating profit margin for the third quarter is 80 basis points. The reallocation of incentive comp reduces the Q3 adjusted EPS by $0.05 to $0.70, while improving the first two quarters of 2008.

Turning to slide 21 summarizes the individual components impacting earnings per share. Reported EPS was $0.73 per share versus $0.67 last year. Where as adjusted EPS was $0.75 compared to $0.71 in 2007. Let me point out a few items. You see the EPS impact related to currency, input costs and interest expense, that I have expressed already. Net commercial includes volume, price, and mix. In this analysis, lower incentive compensation expense reflects the full year-over-year differential of $10 million. And finally, the lower share count associated with last year's ASR was $0.08 per share.

Maintaining liquidity and a solid balance sheet is important to all businesses. I feel good about where we are. We finished the quarter with more than $100 million in cash. We continued to generate healthy free cash flows. We have a commitment in place to roll over our YEN private placement later this month. And we have ample draw down capacity on our multiyear revolver.

In closing our management team's focus is on profit improvement. We have improved liquidity by reducing exposure to interest rate and currency fluctuations and we're working further to reduce our working capital requirements. Our foundation is solid. But we're working on alternative scenarios in case they are

Thanks Rich. Let me try to address the future. Looking ahead today is more challenging than usual. However, we remain positive. Over the past couple of days as I have read the announcement from many of our customers, I am encouraged that they are positive about the volume growth.

Our expectation is that growth will, however, slow. And it will be uneven as we look around the world. Europe and the United States will likely be in a recession for a few quarters. Latin America likely will slow from the recent rapid growth they have enjoyed but we believe will stay positive. Asia, too, will likely slow. Were planning for GDP growth in Greater Asia of 6% to 8%, down from the double-digit growth of the past few years. Input costs have been a burden this past year and we still haven't recovered all the increased costs we have absorbed. I am optimistic that the upward spiral of costs will abate, as we go through this global economic weakening.

As of today, our order intake for Q4, 2008, indicates sales will be at or slightly higher than Q4, 2007, as measured in local currency. This could improve, or decline, as the quarter progresses. But we're encouraged, given what we see today.

I believe the results for the quarter were good. Our flavors business continues to be a stellar performance with good sales growth everywhere, but flat in the United States. Our fragrance business is improving and has more to do to restore margins and to bill sales. Our focus is on improving profitability. More needs to be done to recover the increased cost of materials and input costs. Our efforts to drive out costs from our organization will continue. We will balance our drive for improved results with investing and people and assets to meet the needs of our future growth.

I am comfortable with our sound liquidity position and modest leverage. And I believe IFF strategy to help consumer products Company build brands is the right strategy and will enable IFF to flourish and grow. Now Sarah, Rich and I will be happy to respond to the questions.

Thank you, sir. Ladies and gentlemen (OPERATOR INSTRUCTIONS) We will take our first question from Jeff Zekauskas with JPMorgan.

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

Good. How are you?

I guess I will ask my one question and then get back in the queue. Can you give us a little bit of an outlook on what you expect, when you expect growth to slow going forward. That is, what I remember is that in the fourth quarter, the fragrance business generally already had more difficult conditions. I think the fine fragrance business was down 7% in local currencies, ingredients was down 1%, I think functional was down 1% and the flavor business was still strong at like 10%, local currency growth. So is this slowing in the fourth quarter related mostly to the flavor business or other businesses continue to slow from these levels?

You lost me at the end.

Is it the flavor business that is slowing or other businesses - - as the fragrance business? Does it continue to slow even though the comparisons don't seem all that stringent?

Well, at this stage as I said, it is early in the quarter and it is really hard to to project ahead. But I am not seeing the slowing. I told you that I thought our sales would be at, or slightly above, the year-ago quarter. Our flavors business has been quite strong. They have consistently grown, I think Rich mentioned it is either 12 or 13 quarters in-a-row of local currency sales growth. We have seen the trajectory in the third quarter come down a little bit and there were some unusual circumstances. We did see a slowdown in Asia we think in part due to the industrial restrictions in China during the Olympics. And it is very hard to see - - we have seen our customers' results coming out. Most of them are talking about modest - - I will call it generally in the 1% to 2% volume growth range.

The fragrance business has been flatter. We have gone through that. So I am not sure I come to the conclusion you have. We are not either projecting a decline nor are we suggesting that the flavors business is going to go into a decline.

I guess just to clarify. It seems like the rate of growth, though, are slowing and so what I was trying to figure out is whether the rate of growth that is slowing, this pertains to the flavor business, whether the rate of growth could also slow in a year-over-year basis in the fragrance business?

It is very hard for me to imagine that the rate of growth of our enterprises, as we go into an economic downturn, are going to accelerate. I think it is going to be uneven. I don't have the data and I am not willing to share that forecast. There was clearly a slowing in our third quarter relative to the prior six month for the enterprise. I don't have anything more to say other than we believe we're going to be either neutral or slightly higher and there is a lot of this quarter left. I don't really want to give you a hard forecast because I think that will - -I just don't have the data to backup that forecast.

Okay that's fair enough. I will get back into queue, thank you.

Thank you, Silke.

We will take our next question from Michael Sison with Key Banc.

Hey, good morning.

Good morning.

When you think about the markets heading into a recession, maybe give us a little bit of a picture historically. Do the flavors and fragrance industry typically stay positive, is it typically flatish, is it typically down a little bit?

My understanding, as you know, I don't have a long history here - - but my understanding is that volumes have been relatively stable. Not uniformly, not consistently, but relatively stable . I think this downturn is going to be different. We don't understand the severity of the downturn nor are we dealing with the same global economy. Certainly, I think people are expecting a fairly sharp contraction in the United States. Some contraction in Europe.

We haven't dealt with China in prior periods. The growth we have enjoyed in Greater Asia, for example, in the flavors business, even this year has been 10% and 20% higher. So is that going to decline to 5% or 10%? We will see. We know we have hundreds of millions of new consumers in China who are probably not going to turn the clock back. I think we have a different scenario where the developed world may be a little bit more typical with volumes being flat to slightly positive and most consumer staples. The emerging world, I believe, staying positive in its growth. So I think those two things - - At this stage, I don't see that our strategy of balancing focus on the emerging world and growth there, with continued market share gains in the developed world as needing to be

Then a quick follow-up. When you look at the 2009 and think about all the new project wins that you have accumulated this year, how much growth does that support based on just the wins that will commercialize into '09 versus '08 next year?

I can't give you a number on that largely because that is one factor. Right now we enjoy growth in part because of the new wins, and the new wins more than offset the erosion we saw in old business. I can't forecast what that erosion is going to be for you, Mike, so I can't give you a net growth number. I feel very good about the wins we are carrying forward.

The flavors business continues to do well. Its current products are performing. It is picking up good wins. Our fragrance business, quite honestly - - we wouldn't have done as well in fine fragrance this quarter except that they had such good win rate last year. That has continued into this current year. I think they have some good momentum in fine fragrance. We have more work to do on functional. It really will depend upon what we see with our customers erosion of existing products.

What is the gross number?

I didn't give you one.

Yes, I know. Okay. I will get back in queue, thanks.

Yvette reminds me, routinely. We have had long-term goals in-place since the fall of 2006 of sales growth of greater than 4% measured in local currency, operating margins, and expansion and earnings per share growth of 11%. Those are strategic goals. Those are not earnings guidance. Those are the goals with which we use to prioritize initiatives in the Company and to which we hold ourselves accountable. They are built into our strategic planning and our compensation systems.

It is hard hard for me - - I don't think it would be credible for me to say I feel as confident about having 2009 be consistent with those today as I might have been a year ago. I am not prepared to say we're abandoning those goals. I simply think it is a harder period of time to look forward into. My colleagues and I are working hard to continue to improve both the sales growth because we have lots of opportunities with innovation, which is what our customers want, and product growth, with margin recovery.

Rich outlined - - we're starting to see some improvement recovery with our customers but we have a lot more work to do. We have absorbed a lot. We have to work with them to restore that, not just by simply raising prices which won't help them, but we have a series of other options. We are not abandoning our long-term goals, and I am not going to revise them here, but I have to say that it is probably going to be more of a challenge to achieve those goals in 2009.

Thank you.

Thanks Mike.

Thank you. We will take our next question from Lauren Lieberman with Barclays.

Hi, good morning. This is actually Ryan Bennett sitting in for Lauren today.

Good morning Ryan.

I wanted to follow-up on that last question. When you talk about your win rates. Has there been any change in terms of conversion-to-product launches? Are your customers beginning to pull back on new product activity just given the consumer environment.?

That is a good question. A couple things going on. As of right now, we are not seeing a diminution in the requests from our customers to work on new initiatives. The activity and the value of briefs that we are working on in flavors and in fragrances is higher today than it was was at a comparable period a year ago.

Now there is some change in that. There is more focus on, instead of just new products, it is help us take the cost out or help us a different price point. But the number of initiatives is, as I said, higher than a year ago.

Just a quick follow-up on that. My question was more just in terms of not the new initiatives that you are working on but in terms of, are they actually launching?

That's the second part of it. We have not seen any change from a typical pattern. At any given time, some projects, even when they are completed, they don't launch. I am going to look to my colleague across the table. I am not aware, [Nicolas], I am not aware of any meaningful change in pattern of halting projects once me are completed. Nothing - - we don't have any visibility in that line right now.

Right. Just then on profitability, can you give us - - first off, can you give us a sense in terms of the local currency sales growth this quarter? How much of it came from volume growth versus pricing?

If you look at the slide, we had volume, you have positive growth in the flavors business, and there is a mix impact somewhat. The volume accounted for $2 million of the increase in sales and price was about $13 million.

Got it. I guess my question is, and just looking at profitability holistically, one of the things you cite as the driver of the profitability challenge this quarter is the raw material cost, head winds. But I just have to believe that the volume challenge has to be resulting in some sort of negative operating leverage. I wonder if you could comment on whether less fixed cost absorption is a factor in just the margin performance and what the outlook is for the next couple of quarters.

Yes, it does have an impact. That's embedded in the mixed component which was unfavorable $4 million for the quarter. And that's why we're doing some of the things as we mentioned in terms of looking at our cost structures and we will continue to look for productivity gains and efficiency gains.

I would say this is a different - - we don't have big, continuous process facilities with the exception of our chemical plants and they continue to run full. Most of our converting or compounding facilities, are more flexible. Yes, if volume is down you get a little absorption, but it is not a key driver of corporate growth. Clearly ,we have to be looking at the alignment of our facilities longer term. I would say it's not a short-term P&L issue as much as a longer term issue of what is the array of facilities that we need to meet the challenges in the future.

Okay. And then just my last question. In terms of pricing, how much of the pricing in the quarter was coming from ingredients versus non-ingredients?

Help break that out.

Directionally?

It flows through because some of the ingredients flows through our compounding. The two can't get out of synch. It's a little bit like - - some place I have a little bit more familiarity. You can't get a [liner] board increase if you don't get a box increase. You can't get a compounding increase - - if you don't get the compound increase you're not going to be able to hold the ingredients increase. I wouldn't split those two up.

It seems as though you are getting price increases through to your customers on a functional and fine fragrance side?

Yes, we are.

Can you just give us a sense of how much you're looking to recoup? Is it 100% of the cost of inflation?

No, I don't think it is realistic to expect that our customers are going to give us 100% cost inflation. I think they expect us to do things to help offset a portion of that. So we're not looking to them to be 100% there. There can be change, there can be cost reductions, I don't think it is realistic for us to expect our customers to give us 100% recovery. I think it is a meaningful amount. Percentage doesn't matter. It is going to vary. This issue - - we don't deal with one quarter in isolation. The [drama] we have is we were slow to recover costs starting really in the fourth quarter of last year. We have been lagging. So we have a built up, if you will, an accumulated margin loss that we need to restore. There can be, in fact, at some point in the future, periods of time where we're getting price increases when some costs abate, but it has to even out over time and work for the two of us.

Got it, thanks so much.

Thank you.

(OPERATOR INSTRUCTIONS) We will take our next question from John Roberts with Buckingham Research Group.

Thanks. You had a $0.03 currency benefit in the current quarter. If rates hold at current levels, that flips obviously to a little bit of a head-wind here in the next quarter. At current rates, do you have any estimate is it $0.02 or what kind of head-wind are you facing from currency here in the short-term.

As I said in the discussion, we look at it, and this impacts on timing as costs and impacts flow-through inventories. It does not a direct correlation. On on a normal basis, a 1% change is about $0.01 per share, per year.

I know, but the math doesn't work out that way, always, instantaneously in the quarter. I was just saying, if things just stayed, if you were frozen where they were today and things didn't change do you have an estimate for the fourth quarter?

John, we can't forecast that.

I wasn't asking for forecast, I was just asking - -.

The Euro backed up to about $1.26 today.

That's right.

I don't know.

$1.28. It is so volatile it is very hard to forecast. I hate to put a number out there based on - - because people will forget the moment or the FX rate forward making the earnings calculations. I'm sorry, we can't do that.

It is going to be head-wind, as you said, but I don't have something that I am willing to say this amount.

Okay. You did provide some guidance towards flatish local currency sales growth in the fourth quarter. With the currency head-wind, whatever it is, would it make flat earnings a challenge for you in the fourth quarter, or do you think you have enough cost savings and internal action going on that would flat local currency sales and a currency head-wind you can somehow offset that?

We haven't, we aren't, and we're not going to give you guidance on quarterly earnings or annual earnings.

Okay. It was a good try, though,.

It was an imaginative way to get there.

I am unfamiliar with your YEN debt rollover issue, but given the rapid recent strengthening in the YEN is there a translated dollar cost here in the fourth quarter that we need to be aware of? The YEN has had a huge surge recently.

Yes.

It is a rollover an existing loan. There is not going to be a significant change in impact on a results.

And it really was entered into some number of years ago as a natural hedge against our YEN, our Japanese business. So, there is - - it is really an economic hedge as much as - -

That doesn't present some unique translation challenge here in the fourth quarter?

Not that I am aware of.

Okay. Thank you.

Thank you, we will take a follow-up from Jeff Zekauskas' line with JPMorgan.

Yes, I have a follow-up question on an incentive comp. Normally it seems in the fourth quarter SG&A costs move up because of incentive comp, how should it look this year in the fourth quarter? Should we expect another step down or should it be more of like a normal quarter?

I am not sure I follow your logic that says it is going to go up in the fourth quarter because of incentive comp. I think with a lower growth of level of sales as a percentage of sales selling and admin expenses are going to go up from the prior quarter. Given the third quarter where we had very little expense, those costs will go up somewhat, but it depends on our results.

We have a pay-for-performance incentive plan. And if the Company - - performance would have to improve meaningfully to have compensation expense in the fourth quarter go up meaningfully. We took a look at it. Rich, we tried to provide as much detail - - we have roughly $18 million accrued.

Over $18 million.

We might top that up a little bit, but there is not going to be a significant increase in incentive comp, that I would expect.

Okay. A follow-up question regarding the shared services charge of $2 million in the quarter, which I think is different from like the employee separation costs, of, I don't know, $3, $3.5 million that would take in the second quarter. Should we see similar expenses going forward or is this it?

It is not a charge. What it was is we were in the process of transitioning our services to the outside provider and during this period we have duplicate costs. We have our existing people on-hand transferring the responsibility plus we're paying for their ramp up costs. I do expect it to be down from the $2 million that we had in the third quarter because we have gotten most of that done through the end of October. So, it will go down.

Okay. A last question on currency again. Maybe I am not factoring in the Asian currencies correctly, but if I just look at the Euro year-over-year, the Euro, on an average basis, was still up maybe like I don't know, 9% in the quarter. And the currency benefit of $0.03, seems too small or this 1%, $0.01, may not be the accurate impact from currency translation. Can you reconcile this for me?

Yes. There are really two components of the $0.03. On one hand, there is -- I call it an operating level. There is probably a $0.05 favorable impact. And then we had $0.02 unfavorable working capital, exchange gains and losses. If you look at the $0.05 and in our basis, taking the Euro as a proxy, it is up 11% , 12% quarter-over-quarter. If you take that and look at that on an annualized basis, it comes out pretty close to be the $0.01 per share on an annual

Okay. Maybe I w-ll follow-up on that off line. Thank you.

Thank you. We will take a follow-up from Michael Sison's line at Key Banc.

Rob, when you talked about - - I think you mentioned that in fine fragrances the June and July was performing pretty well then July-August was performing pretty well and then September was pretty weak, can you give us an order of magnitude of how September looked? Was it down significantly more than what the quarter did?

Let me just say early in September I thought we were going to be up year-over-year in fine fragrance, down in beauty care, and we wound up being down slightly. So now, September is the big driver of the quarter. Don't extrapolate that as you go forward. We saw a change in behavior as there seemed to be an increase in concern about this coming Christmas and people were lightening up. I think it is interesting, the concerns - - everyone getting over last year's inventory issue and concerns for this year, my belief that is the industry inventory is actually in pretty good shape. Hopefully, I have no idea what Christmas is going to be but hopefully we will not face in the fourth quarter, and first quarter, ahead of us, the inventory correction we faced last year.

Okay. Then are you seeing - - I mean I guess one question would be as consumers struggle in 2009, they could move from even higher-end branded functional fragrances or eat more at home. Does that affect your business on a mix basis at all when you look at the consumer stepping down in terms of what they buy.

Good question. You read in a number of companies' reports about how consumers are not eating out, they are eating at home and that is helping some people and hurting others. It will cause some shift. It won't make that material an impact on our mix. Clearly as we work with our clients, our clients are adjusting their offer to the consumers' needs of today.

There is a concern about people trading down, trading out, trading down and out of important, well known national brands into store brands and others. If it were to shift out and go into more store brands, that might have an adverse impact on us both in - - primarily in volume. If it stays within the family of brands, I think we can do our own because we designed that in so it shouldn't have that much of an impact.

Okay. Then, Rich, when you take a look at the shortfall between pricing and raw materials, can you clarify how far behind you are on year-to-date?

For the quarter about between $5 million and $6 million. I estimate for the nine months between $20 million to $25 million.

If raw materials fall heading into 2009, there seems to be a trend where a lot of commodities are coming down, petro, metal base, so on and so forth. Would you be able to hold on some pricing?

That is always the commercial dynamic. We have to get out there and work with our customers because - - we're certainly going to be looking for some incremental price relief. That's what we're focused on. But I will come back and we're getting the operating margins back on a structural basis towards that 18-plus percent is what we have to do. We think that's what we need to do to be able to continue to invest in the technologies and science that they want us to have, to create the products, as well as meet the needs of our share owners and others. We have to work with them to meet their needs and do it in such a way and at such a cost that we're able to achieve our financial goals.

Right. Then in terms of your free cash flow, you have cash in the balance sheet, you see where your stock is - - can you buy more stock? Are you looking to pay down debt? What is the priority for your cash at this point?

Sheer prudence says I would rather have the money in my jeans. I think our stock is certainly under-valued as many companies in today's market. I am not sure how deep or how long this economic correction is going to be. And so I have to turn - - Rich and I, our obligation is that we do the right thing long term. I don't want to interrupt key initiatives here. As we generate cash and we continue to generate a healthy amount of positive cash flow. We will let that accumulate on the balance sheet.

Okay.

It will make us sleep better.

Okay, great, thank you.

All right. Sarah, any more?

Yes, sir, we will take our next question from Frank Bisk with Pilot.

Hi, my question has been asked and answered, thank you.

Thank you.

Thank you. We will go next to John Roberts was Buckingham Research Group.

Thanks. There were a couple of notable recoveries in the business, I think. The North American functional fragrance sales [listed] 7% positive I think it was down from 18%, 19% the last couple of quarters here. Did you win back business you lost or was that new business that replaced business you lost or how did you achieve that flip?

I would love to be able to tell you we won back the business we lost. That is not the case. We won some new business in different areas. If you recall in the past, I have told you we were struggling in the fabric care area. That hasn't changed because when you lose that business you lose it for a few years, but we are picking up some good business in many other areas and so that's why I am encouraged and functional and I think the team in the US on functional is responding very well. A lot of good initiatives and I have a lot of confidence in that.

Secondly, the recovery in the fine fragrance and beauty care area seem to be in Europe. You went from down 9% last quarter in local currency sales in Europe fine fragrance and you were up 1% actually in Europe this quarter. Was that just specific wins of specific customers or was that the economy there versus the economy here?

No, I mentioned to you that really reflects the increased wins we had starting in mid-year last year. It is a long time for these wins to come to-market. So, we had a very good win rate, starting in the spring of last year, summer of last year. Those things are coming to market. The win-rate continues to be encouraging. The upside we're seeing comes from the new launches.

Thank you.

And we have one question in the queue, that comes from Richard O'Reilly with Standard and Poor's.

Thank you. Good morning, everyone. I just want to follow-up on the import costs. Rob, on one of your last slides you have a line that says lower input inflation expected in '09. Are you looking for your course to rise in '09, or do you think that you could actually see a decline overall?

I would hope we will see a decline. But at this juncture, there is no evidence in the market. And you don't know - - it is going to depend upon some currencies and depend upon crop yields. I do believe the rate of inflation will abate. Will it turn negative? I wish I had that foresight. I don't have it. I am being a little conservative and assuming that we will continue to have some modest inflation and input costs. If costs decline, that will be a positive.

Okay. I think my notes would say that you also saw a 5% rate in the second quarter, and I don't know what it was earlier in the year. So, you have been running at about 5% for the year?

Yes, we were up less than 5% in the first quarter. about 5% in the second quarter, and now a touch above 5% in the third quarter.

Okay, fine. Thank you.

Thank you.

At this time we have no further questions in the queue. Mr. Amen, I will turn things over to you for closing or any additional remarks.

Thank you very much. I really do appreciate your continued interest. I think we all need to stay focused on the fundamentals. I think the economic challenges are real. But at the same time, IFF is part of an industry that meets consumers fundamental needs.

I don't expect the commodity cycle that we see in some areas, either going up or coming down. I believe this Company is focused on building its business, with the key people, the key assets, the key markets. I appreciate your interest and continued support of IFF and we hope that we will continue to meet your expectations and do well. Thank you very much and I look forward to speaking with you.

That does conclude today's conference. Thank you for attending and have what nice day.