International Flavors & Fragrances Inc (IFF) 2012 Q2 法說會逐字稿

At this time I would like to welcome everyone to the International Flavors & Fragrances second-quarter 2012 earnings conference call. All participants will be on a listen only mode until the formal question-and-answer portion of the call. Participants will be announced by their name and company. And in order to give all participants an opportunity to ask their questions, we request a limit of one question per person.

I would now like to introduce Shelley Young, Director of Investor Relations. You may begin.

Thank you, Operator. Good morning and good afternoon everyone, and welcome to IFF's second-quarter conference call. Earlier today we issued a press release announcing our second-quarter 2012 financial results. A copy of the release can be found on our website at IFF.com. Please note that this call is being recorded live and will be available for replay for up to one year on our website.

Before turning the call over to management, I would like to take care of a few housekeeping items. Please keep in mind that during this call we will be making forward-looking statements about the Company's performance, particularly with regard to the second-half and full-year 2012. These statements are based on how we see things today and contain elements of uncertainty.

For additional information concerning factors that could cause actual results to differ materially from forward-looking statements please refer to our forward-looking statements and risk factors contained in today's 10-Q filing with the SEC, as well as our 2011 10-K filed on February 28, 2012, and our press release that we filed this morning, all of which are available on our website.

Some of today's prepared remarks will discuss non-GAAP financial measures, which excludes those items that we believe affect comparability. A reconciliation of these non-GAAP financial measures to their respective GAAP measure is set forth in our press release that we issued earlier today and on our website.

Now I would like to introduce the participants on today's call. With me today is Doug Tough, our Chairman and CEO; Hernan Vaisman, our President of Flavors; Nicolas Mirzayantz, our President of Fragrances; and Kevin Berryman, our Executive Vice President and CFO.

Now I would like to turn the call over to Doug Tough, our Chairman and CEO.

Thank you, Shelley, and good morning and good afternoon everyone. We are pleased with our performance this quarter, especially in light of the macroeconomic challenges presented by the ongoing difficulties in Western Europe and external sales volume declines in our Fragrance Ingredients business.

Despite these challenges, we are able to deliver solid top-line growth and even stronger double-digit earnings per share growth due to our efforts to diversify our revenue base, focus on our customers and control our costs.

Our diversity in terms of our customers, our end use categories and our geographic footprint allowed us to continue to grow our business this quarter and deliver local currency sales growth of 4%, and on a like-for-like basis local currency sales growth of 5%.

The growth we achieved this quarter, the highest since the first quarter of 2011, is due to the momentum we have established in many areas of the business. Our global reach and our customer intimacy enabled us to better serve our customers and capitalize on opportunities that are available today for market share growth.

IFF's growth this quarter was driven by our Flavors business, which delivered 8% local currency growth on top of 8% local currency growth in the prior-year quarter. The year-over-year performance reflects the balanced and the consistent nature of our business and the strong and growing presence we have in emerging markets.

We also saw growth in our Fragrances Compounds business this quarter, which delivered 6% local currency sales growth. Solid growth in both the Fine and Beauty Care and the Functional Fragrance categories offset continued erosion in Ingredients. Nicolas Mirzayantz will provide more details on our Ingredients business later in the call.

As anticipated, this quarter was an inflection point for our business in terms of volume, costs and profitability, and we are pleased with the results.

Raw material cost increases starting to ease this quarter, however, they remain at high levels. As you know, raw material prices have been increasing for the last five quarters on average by 11% each quarter. We have been able to mitigate this inflation through pricing, resulting in a more favorable relationship between raw material price increases and pricing this quarter.

Our other margin-enhancing efforts, including cost efficiencies and volume leverage when combined with pricing, led to gross margins expanding 210 basis points to 41.8% this quarter versus 39.7% in the year ago and 40.2% in the first quarter of 2012.

Our adjusted operating profit increased 8% to $132.3 million, driven by gross margin expansion and our cost management discipline. Our adjusted operating margin expanded 130 basis points to 18.3% of sales from the second quarter of 2011.

Our enhanced operating profit, combined with lower interest expense and other income and expense gains, resulted in our ability to achieve earnings per share of $1.08 this quarter. We were able to achieve these results off of modest top-line growth due to a continued focus on margin improvement opportunities, which include the exit of low-margin business that Hernan will talk to.

I will know turn the call over to Hernan and Nicolas, who will provide you with an update on the progress of our business units, and then to Kevin Berryman, our CFO, who will provide an overview of our financial performance. After their respective sessions I will give you some perspective on our outlook for the balance of the year.

I would now like to introduce our Group President of Flavors, Hernan Vaisman.

Thank you, Doug. I am pleased to report that this quarter the Flavors business delivered 9% local currency growth on a like-for-like basis, which exclude approximately 1 percentage point associated with the strategic exit of low-margin sales activities, on top of the 8% local currency growth that we delivered in the second quarter of 2011.

This is our 26th consecutive quarter of local currency sales growth. This quarter we delivered strong growth across all regions and categories with sequential growth over the first quarter in every region. Our Beverage category achieved double-digit growth this quarter while Savory, Sweet, Dairy also delivered solid growth.

In North America like-for-like growth was 12%, excluding the exit of low-margin sales activities. The best performing category was once again Beverage, which was up strong double-digits due to new, exciting wins in the [soft] beverage and other refreshing drinks.

Dairy also delivered double-digit growth in the second quarter. We also saw incremental sales related to our sweetness modulation tools. Savory also increased on a like-for-like basis owing in part to savory modulation tools as part of our health and wellness initiatives.

Within our EAME region like-for-like growth of 8% was led by strong growth in Savory. Western Europe continues to be in positive territory overall due to continued strong wins in the market and volume growth in the emerging markets of Africa and the Middle East.

In Latin America local currency growth was 6%, led by double-digit growth in Sweet and a strong growth in Dairy and Beverage. We are looking to improve our sales momentum in Latin America.

Greater Asia is our largest region, and once again this region delivered strong growth with 9% local currency growth. On a like-for-like basis Greater Asia grew at 10%. This growth was led by double-digit growth in Dairy and high-single-digit growth in Beverage, Savory and Sweet.

As you know, our Flavors business is heavily indexed in the emerging markets, which are growing at a much faster rate than other areas of the world due to changes in disposable income and lifestyle. People in these markets are not only looking for great, authentic taste and convenience, they are looking for healthier options in the food they eat.

To better support our customers in the emerging markets we are building new facilities in Singapore and China and expect to be making announcement of the opening of Singapore later this year and China early next year.

We continue to invest in building creative centers that expand our global footprint and put us in closer proximity to our customer base. In June we announced the opening of a new facility in Delhi, India to house creative, technical, sensory and sales professionals. This facility will help us to better serve our global and regional customers' present and future needs and create the best taste for the Indian market.

We have an 80-year history in India and this investment, together with our investment in Singapore and China, demonstrates our faith and commitment to the region.

This quarter Flavors in the emerging market achieved double-digit increase on a local currency basis for the 11th consecutive quarter. This performance was driven by double-digit local currency growth in Africa, the Middle East, Asia as well as strong growth in South Cone and Brazil.

Turning to profit. Second-quarter segment operating profit increased $10 million or 15.5% to $81 million. The strong volume, driven in part by new wins, favorable mix, pricing increase, the exiting of low-margin business and ongoing cost reductions, more than offset rising raw material costs and resulted in increased gross margins.

Improved, our gross margins more than offset increases in research, selling and admin expenses. Operating profit margin increased 170 basis points versus the previous year to 22.3%. This quarter RSA was negatively affected by a payment [to our biotech partner] as we reach a milestone in our collaboration much sooner than expected. We are excited about this collaboration and look forward to telling you more about this -- about the project as it evolves.

Looking ahead we expect to see consistent sales growth in the second half of 2012, led by continued momentum in the emerging markets, offset in part by the accelerated exit of low-margin sales activities, which [we] expect will be more than twice the level seen in the first half of this year.

However, our consistent underlying sales growth remains strong, driven by new businesses wins using our Sweetness and Savory modulation tools to make our customers end products healthier. We are excited about our future growth prospects.

With that I would like to turn the call over to Nicolas Mirzayantz, our Group President of Fragrances.

Thank you, Hernan, and good morning everyone. For Fragrances in the second quarter of 2012 local currency sales were flat compared with the prior-year quarter. Improved pricing, new business wins and favorable product mix were offset by declining Ingredients volume.

We saw positive trends in many areas of the business, resulting in a sequential improvement over the prior quarter in our Fragrances Compounds business. Local currency sales growth in Fine and Beauty Care increased 4% with strong growth in hair care in all regions and in toiletries, especially in Latin America and EAME. The Fine and Beauty category was up 29% in LATAM and 11% in Greater Asia.

In Functional Fragrance we saw strong growth led by Fabric Care. Local currency sales growth of 7% was positive for the 16th consecutive quarter as new business wins, less erosion in the base business, and the realization of price increases continued to drive results. The Functional Fragrance category was up 11% Latin America, up 6% in Greater Asia, and up 8% in EAME.

Our Fragrances Compounds business was up 6% overall, lead by strong growth in Latin America and Greater Asia. This growth reflects the strength of our strategic relationships with our global and regional customers and our long-standing presence in the emerging markets.

Sales from encapsulation technology continued to increase double-digit and supported the growth in our Functional Fragrance business.

Unfortunately, we are facing continued challenges in both Western Europe and in Fragrance Ingredients. Our total Fragrance business in EAME had negative local currency growth due to a 4% decline in Fine and Beauty Care and 24% decline in Ingredients, offset in part by the growth of 8% in Functional Fragrances.

Sales in our EAME region were negatively affected by the ongoing Eurozone issues and the effect of economic uncertainty and unemployment on disposable income.

Now I would like to say a few words on Fragrance Ingredients, since this has been a concern to investors. Over the past year we have seen continued deterioration on the external sales components of our Fragrance Ingredients business. This has prompted a thorough strategic review of our Ingredients business.

Unprecedented increases in input costs and the resulting change in both competitive pricing and our customers' willingness to take additional supply chain risk to minimize their own input cost pressures, have resulted in a change in industry dynamics.

With the availability of cheaper materials from low-price manufacturers in China and India we are seeing incremental pressure on the top-line, particularly in those nonpatent protected ingredients that are commonly found in the marketplace.

Our strategic review and evaluation of options to improve the overall performance of our Ingredient business has confirmed that the Ingredient business has been and continues to be of strategic value to IFF due to the supply of cost advantage Ingredients to our Fragrances Compounds business and the profitable sales of Ingredients to external customers at acceptable margins.

Overall, we have maintained our gross margin in this business even on the lower volume. I want to make clear that we are not looking to close or sell this business based on our current views. However, changes to operating models are required. We are now developing the specifics for how we will execute against a plan that will reduce cost to levels consistent with the existing realities of the market.

We will be communicating further actions to you at the appropriate time, so as not to impact our competitive positioning and ability to successfully execute.

After four challenging quarters, our continued focus on cost savings initiatives and discipline, improved mix and pricing allowed us to more than offset continued, although lower, increases in raw material input costs. As a result of these factors gross margins expanded over the prior year, helping support gross margin expansion at the consolidated level and resulted in improved segment operating profit.

Segment operating profit increased 2% or $1 million this quarter to $64 million. Our segment operating margin expanded 90 basis points to 17.7%, up from 16.8% a year ago.

We expect category and geographic diversification to help mitigate continued volume declines in Fragrance Ingredients. We expect to see continued momentum in Fine and Beauty Care, and moderate growth in Functional Fragrances. And we're encouraged by the pipeline of new business in our Fine and Beauty Care and Functional categories, as well as continued traction against our encapsulation technology. But we still must be mindful of potential economic weakness in Europe, where economies are under pressure and in Ingredients.

We also expect continued margin recovery as we continue to implement further increases in pricing and focus on cost efficiencies and cost discipline.

Now I would like to turn the call over to Kevin Berryman, our CFO.

Thank you, Nicolas, and good morning and good afternoon everyone. Reported revenues for the second quarter totaled $721.3 million, an increase of 1% versus the prior-year quarter. Excluding the impact of foreign currency, local currency sales increased 4%.

On a like-for-like basis, excluding the impact of lower-margin discontinued sales activities, our local currency sales growth was 5%, reflecting improved sales trends in many parts of our global business.

As you have heard from Hernan, Flavors achieved high-single-digit growth in every region and 8% growth overall. This is on top of 8% growth in the year-ago quarter, which speaks to the consistency and stability of this business. Excluding the impact of discontinued business, Flavors growth was 9%, led by a long list of new product wins among a diverse set of customers.

In Fragrance, the growth in Fine and Beauty Care and Functional was much improved from the first quarter, although the 6% local currency growth in Compounds was offset by volume softness in Ingredients, resulting in flat Fragrance local currency sales growth for the quarter.

I want to say a few words about our performance in Europe. We have seen some weakness in Western Europe, particularly in those countries whose economies are challenged by low growth and high unemployment.

Overall our Flavors business continues to grow, but our Fragrance business, which accounts for nearly two-thirds of the volume in Western Europe, has been pressured by both the weakness in the European economies as well as pressure in Ingredients. On the positive side, we are not heavily indexed to the countries that are most under economic pressure. And even though our volume is somewhat impacted, our geographic diversity has muted the impact.

As you know, we have a large geographic footprint in both developed and emerging markets. We are extremely well-indexed in the emerging markets, perhaps better than any of our competitors, and we're seeing emerging market growth of 9% this quarter on a local currency basis, led by very high growth in Indonesia, Singapore and Malaysia and Vietnam.

The emerging markets represented 48% of our sales in the second quarter, up from 46% of sales in the first quarter, so they continue to grow much faster than the developed markets.

Many of you have been asking about our Ingredients progress, and I wanted to add a few words to what Nicolas has shared with you about the strategic review. As he said, we're developing a detailed plan for making changes to our business model. I would like to provide some insights into how that will play out over the near term.

Due to the complexities of the business, we do not expect to see any material changes to our business in the near term, especially in the third quarter; however, we do believe our plan will result in a stronger and more sustainable foundation longer-term.

Turning to bottom-line growth, adjusted operating profit increased 8% to $132.3 million this quarter due to pricing actions and volume gains, which more than offset increases in raw material costs and increased incentive compensation accruals.

Interest expense declined $1.4 million in the quarter, reflecting lower levels of outstanding debt. And other income, expenses improved $1.9 million year-over-year, due to favorable exchange gain and losses on outstanding working capital balances.

I would also like to talk briefly about our second-quarter tax rate. This year our effective tax rate was 27.7% versus 27.4% a year ago. This is primarily due to a reserve adjustment related to one of our tax evolving cases in Spain, other provision adjustments on uncertain tax positions, and the absence of an R&D tax credit in the US during the second quarter of 2012.

Despite the slightly higher tax rate of 27.7%, adjusted EPS was still able to increase 11% to $1.08, up from $0.97 in the second quarter of 2011, when excluding restructuring and other charges of $0.04 per share in the prior-year quarter.

As expected, and as we discussed on our first-quarter conference call, our raw material cost increases started to moderate in the second quarter. As you can see on this slide, material costs were up 5% this quarter, and they are growing at a slower rate than in the second quarter of 2011 when they were impacted by a 12% cost increase.

While increases in raw material costs are moderating, they remain at high levels. Since the second quarter of 2011 we have seen on average an 11% increase in raw material cost each quarter. We saw the highest increase in the third quarter of 2011. Again, we expect that raw material cost increases will continue to ease over the balance of the year.

In the second quarter, with the easing of raw material cost increases, increased realization of pricing and achievement of other margin improvement initiatives, we believe we have reached an inflection point in our gross margin percentage from both Q1 2012 and the year-ago period. As a result, our consolidated gross margins improved to 41.8% compared with 39.7% in the second quarter of 2011, reflecting gross margin improvements in both businesses, although both remain below the gross margin pre-inflation level of 2010.

This gross margin improvement resulted in adjusted operating profit margins improving to 18.3%, up from 17% in the prior-year quarter or a 130 basis point improvement.

From an overhead cost standpoint, RSA expense as a percentage of sales increased 80 basis points to 23.5% of sales, up from 22.7%. The increase in RSA reflects continued R&D spend of close to 8% of sales, combined with planned spend and sales activities to support our growth at the emerging markets and higher pension costs.

The year-over-year change in RSA is expected to increase in the second half of the year, primarily due to increased compensation accruals in the second half of 2012 over the second half of 2011.

Foreign exchange in the second quarter had an approximate 300 basis point impact on the top-line, but had a lesser impact on profitability as a result of our cash flow hedging activities, which we have discussed in the past.

Looking ahead, over 70% of our euro dollar exposure in 2012 remains hedged at a rate near $1.39. However, given the deterioration of the euro with current rates at $1.24, we expect headwinds from foreign exchange to increase despite our hedging activities.

The full-year FX impact on our EPS is approximately $0.05 versus what we outlined on our first-quarter call when the euro was trading more in the range of $1.30. Of course, this will be affected by any change in rates throughout the second half of the year. Note also that we are nearly 50% hedged against the euro for 2013 at levels that approximate $1.30.

From a cash flow perspective for the first half of the year our operating cash flow increased by $133 million over the first half of 2011. This was driven by increases in net income, improved core working capital, lower incentive compensation payouts in the first quarter of the year, and lower tax payments.

As anticipated, capital expenditures increased in-line with our guidance due to our investments in Singapore and China. And we expect capital spending to approach 5% of sales for the full year 2012.

Our investments in Singapore and China are progressing well and we will continue to be focused on supporting our strategic growth with a specific concentration on the emerging markets and the addition of new technology platforms.

Our history has proven a willingness to return cash to shareholders, and our Board authorized a quarterly dividend of $0.34 per share of the Company stock, an increase of $0.03 from the quarter -- current quarterly dividend of $0.31 per share. We expect to continue to increase our dividend in-line with earnings growth, while investing in attractive growth opportunities.

I would also like to make some comments regarding our recently announced settlement with the Spanish tax authorities. As a result of the settlement, we will record an after-tax charge of $72.4 million or $0.88 per share in the third quarter of 2012. We have agreed to pay an aggregate amount of EUR86 million or approximately $106 million before the end of the year.

The settlement was the result of recent discussions and we are satisfied with the outcome. Not only does it remove much uncertainty related to our past tax position, but importantly, we were able to agree upon the key principles that will establish the Company's tax basis in Spain for 2012 and future years.

We expect to formalize this agreement before the end of 2012, and believe the terms of our agreement will not have a material impact on our effective tax rate going forward.

With that I would like to turn the call over to Doug for his perspective on the balance of the year.

Thank you, Kevin. Although we are pleased with our performance this quarter, we are mindful of the challenges that lie ahead related to slowing macroeconomic growth in Western Europe, the foreign exchange headwinds coming from the strengthening of the dollar versus the euro, and ongoing top-line pressure we anticipate on the Ingredients business.

Although we are cautious about the second half of the year, we are positive about many aspects of our business. We have seen strong and consistent growth from Flavors in every region, and our Fragrance Compounds business enjoyed strong growth in Greater Asia and Latin America.

We have an often said that our customers' products that are resilient even in a slowing economy, and we are seeing signs of this. Given the strength of our customer relationships based in part on our ability to provide them with valuable insights related to consumer preferences, as well as our robust pipeline of innovation from R&D, we expect to continue to grow.

From a top-line perspective, we expect to see continued local currency sales growth in Flavors, offset in part by the accelerated exit of low-margin sales activities in the second half of this year.

In Fragrances, we expect momentum to improve in Fine and Beauty Care, while also maintaining solid growth in Functional. In total, we believe that many parts of our business will demonstrate continued growth.

The one area where we see risk to our forecast is in Ingredients, as current trends remain weak on our external portfolio due to price competition on non-patented ingredients that are commonly found in the marketplace. Ingredients, although an important part of our business, accounts for less than 10% of our external sales and we want to put their performance into perspective.

We expect to see Fragrance Ingredients continue to experience top-line pressure in the near term, certainly during the third quarter. Decisions that are made by our customers based on price, or anything else for that matter, have long-term implications for the business and we need to adjust our business model as needed to the new insights and to the current market dynamics.

With regard to margin trends, we expect that raw material costs will continue to stabilize at current rates. We expect our gross margins will continue to trend above year-ago levels.

With regard to earnings per share, it is our policy not to give guidance. However, excluding the impact of the Spanish tax settlement we believe that if our business continues to perform as we expect it, we will be able to deliver year-over-year earnings per share growth more in-line with the current marketplace estimates.

We will continue to make investments in our business which are vital to sustained long-term, profitable growth, which remains our focus. Overall, we remain cautiously optimistic in our outlook, given the lagging and uneven recovery cycle, the foreign exchange pressures and softness in Ingredients.

In conclusion, our strong performance this quarter is a result of our geographic footprint, our product diversity and our ability to work with our customers year in and year out to develop new products that define the industry and delight consumers.

Going forward we remain cautiously optimistic in our outlook, given the lagging economic growth in many areas of the globe. We will proactively manage our performance and calibrate our costs in-line with our top-line growth as we continue to execute against our business plans.

With that, here at IFF we would be glad to take any questions you may have.

(Operator Instructions). Mark Astrachan, Stifel Nicolaus.

Two quick questions. One, Kevin, on incentive comp, can you just give us an idea of what you think the headwinds will be in the back half of the year given some of the comparisons from a year ago?

And then more just a broader comment, could you talk a bit about the competitive outlook for pricing over the balance of this year. And then maybe Hernan and Nicolas could give a bit of an update on how they're thinking about it in their own businesses, especially versus some of the competition that seems to want to continue to take more pricing?

Sure, no problem, this is Kevin. Good morning to you. Look, I think in terms of the incentive comp the way I would direct you is to look at our second-quarter numbers. That is pretty much very close to a normalized level of incentive comp and that would probably be a good measure to talk to or to model out for the balance of the year. That would not be a bad assumption, assuming we can continue to perform at our level of expectations.

As you know, the deterioration over the back half of last year resulted in us changing our incentive comp, so there will be differences versus year ago. But if you use the year-to-date figures they're going to be pretty close in terms of what our expectations might be going forward.

As it relates to pricing, I think as you look at our total pricing for the quarter, effectively we had nearly 3% of pricing that was seen in the quarter. However, I will let you know that is certainly skewed because of the dynamics of the Fragrance and the Ingredients business. So if you look at the 3% pricing number, or close to it, versus the 4% it looks like the majority of the sales growth is coming from pricing.

But if you eliminate the Ingredients dynamic, it really talks to just the effects relative to our Compound business. We actually saw greater than 50% of our growth in the Compound business came from volume with, let's call it, 45% coming from pricing.

So that continues to be an effort that we've been working on over the course of 2011. And there will be some subsequent discussions that continue to occur over the balance of 2012 as well, although much of the pricing has already been put in place.

Good morning. It is Nicolas. How are you? Mark, regarding your question about the pricing, it is important to mention that -- and as indicated -- input cost remained at high level in 2012, which required us to have ongoing discussions with our customers to capture additional price increase as needed. So we are still engaged in price increase discussion with our customers.

It is Hernan here. Similar comments what Nicolas mentioned. We are still having ongoing discussion with customers. However, we believe is that by the end of year we will be at least covering the whole impact of the input cost. Having said that, I mean, it will have a negative impact in the margin on a percentage basis.

Thank you.

Lauren Lieberman, Barclays.

I just wanted to first ask about Asia, and particularly China, if you have seen any kind of slowing in demand or deceleration in base business volume or if it is has been steady as she goes?

It is Hernan. Yes, in fact, we see deceleration in the volumes. I think that this is basically because you have a different consumer sentiment there.

Having said that, we are seeing now -- I mean, this quarter they start picking up a little bit. But the overall -- I mean, is this and the relationships in China, overall Greater Asia we are very strong. We have a very good momentum in Southeast Asia. That is why we started believing that it is going to keep on growing at the current rate.

I would say just one additional comment. I think that the strength of the Greater Asia numbers that we are -- that we have been able to show, even with some slowing in China, indicates the diversity of the portfolio and the ability to continue to drive growth even when there can be specific markets that show a little bit of softening versus others. So I think that is a positive relative to the ability to continue to post pretty good growth numbers up in the second quarter.

Sure. And then what about -- just say the same question for Nicolas, just in terms of Fragrance in China?

Yes, but we have seen also some pressure and lower demand in China. But to really echo what Kevin was saying, the introduction of new product using our encapsulation and the diversity in the region are enabling us to deliver good growth in the region and to offset some of the softness in China at the moment.

Okay, great. And then just also I was curious about your base business volume trends. I think erosion was a bigger issue Q4 and Q1, and then it sounded like as Q1 was ending and moving into Q2, the reason that you felt a little bit more confident was that the win rate here had already been strong, but base business volumes are stabilizing. So how did that develop through the quarter, I guess, from an aggregate basis? And then where do you stand on that as you look into the back half? Thanks.

I am sorry. Could you repeat the question again? I apologize.

Sure. So Q4 and Q1, you guys had already been talking about an accelerating rate of wins, but that the drag on the businesses in Compounds was -- base business was weak. So I am asking how that has evolved, because at the end of last quarter you said that things looking into Q2 were looking a little bit better when you were looking at the first month of the quarter from a base business standpoint. So I was curious about that dynamic, base business volume and the outlook for the rest of the year versus new wins.

Thanks for the repeat. Look, the underlying volume of the business did improve in the second quarter as we expected. Wins continued to be positive, so we saw good new win momentum, but we did see an improvement in the underlying volume of the existing business, which certainly helped support the improvement in the growth dynamics.

And was the bigger shift -- was there a greater improvement in the Fragrance side of the business, because obviously Flavors has been strong throughout?

I think directionally yes, but we saw improvements in both.

Okay, thanks.

Edward Aaron, RBC Capital Markets.

I wanted to start with a question on raw materials. So I think you were kind of running maybe up upper single-digits for the first half. And I think from last quarter you had mentioned an expectation for the year to be -- to have a modest inflation. So is it fair to assume that inflation will turn negative in the second half of the year on a year-over-year basis?

And then can you give us any kind of early insight into how you're thinking about the cost backdrop for 2013 in light of some of the stuff we have seen with the drought impacting certain costs?

Let me take a crack at that, and then if any of my colleagues would like to jump in. Certainly if you look at our year-to-date figures on the input costs, if you just assume that we are flat over the balance of the year, we get to that moderate level of input cost that we have been talking about over the balance of the year, or for the full year.

So I think that it is probably too early to say at the end of the day exactly what happens on input cost by the end of the year, because it will depend upon the mix and the use and so on and so forth. But certainly it is trending in the right direction.

And then I would echo the comments of my business unit colleagues who have talked that the input costs continue to remain at elevated levels, and certainly well above the levels of 2010 before the inflation that we saw significantly over the course of the last 12 months or thereabouts. So certainly we are expecting to see that continue to improve.

As it relates to 2013, a little bit early to say at this particular point in time, and we will provide some additional guidance when the time is appropriate. But certainly the comments that we would make is we are continuing to see stability versus anything other than that, but it is too early to say for 2013.

Okay, thanks. And then I think you had mentioned in your prepared remarks that you thought that growth in Fine and Beauty would improve in the second half of the year. Can you maybe just speak to the drivers of that? Is it more of an easier comparison issue or is it -- are there some new wins that are flowing through that is going to give you some lift in the second half?

I think it is a combination of the two, but there is obviously a very good momentum in new wins, as we had spoke before. And then you know that there are different waves of launches for the new wins, and this year the majority of the wins in which we participate are more geared towards Q3 and Q4. So we're benefiting from this new introduction to the marketplace. And also another component is lower erosion levels. So the three combined are providing a good level of momentum and good level of confidence for the second half.

And then just my final question related to FX. So I think, Kevin, you had mentioned a $0.05 incremental headwind. Is that relative to what you were expecting when you reported last quarter or is that the total impact on a year-over-year basis for the year?

And then can you maybe just also help me understand, you know, $0.05 seems like -- I understand the euro has weakened quite a bit, but $0.05 seems like kind of lot just considering that you were about 70% hedged. So I'm just struggling with the math on that a little bit as it relates to the full year.

No problem. Look, it is the difference in the balance of the year in terms of how the euro has changed in value relative to when we were talking three months ago. The reason is, is because as you think about our structure of our cash flow hedges, those hedges are supporting investments or purchases of materials. Those materials go into inventory at the hedge levels. And consequently as we get closer to the end of the year the benefits of those hedges start to roll over into the 2013 year as opposed to seeing the benefits this year.

So effectively if the euro continues to deteriorate in this year specifically we will see incremental pressure, because the hedges that are impacting our current purchases will more likely than not impact next year as opposed to this year.

Thanks.

Jeff Zekauskas, JPMorgan.

When you look at your Fragrance business on a sequential basis, your revenues were flat and your operating profits were up $8 million. Can you parse the $8 million as to where that improvement came from? Was it raw materials? Was -- I don't know -- one-quarter of it raw materials, one-quarter of it price and then there are some cost efficiencies? How do you look at that $8 million number?

Good morning. It is Nicolas. The improvement was $1 million to $64 million. And I think that as we have mentioned, a lot of the margin improvement initiative, cost discipline, also the restructuring benefit that we announced earlier this year, and pricing actions are all contributing to offset the continued input cost increase and deliver some improvement in operating margins.

And then for the Company generally did your sequential prices increase in the quarter, and do you expect them to sequentially increase in the third quarter?

This is Kevin. Yes, they did. So if you look at two-year stacks of pricing, which is okay to think about it, yes, we did have higher levels of pricing in the second quarter. And given the discussion that both Hernan and Nicolas have alluded to in previous responses to questions, there is some incremental pricing that is continuing to be discussed with our customers over the balance of the year. So to the extent that those occur those would be sequential pricing on top of the sequential pricing we have been able to realize.

Okay, and then if I can just squeeze in the last one on Ingredients. The Ingredients business has contracted at a double-digit rate for four quarters in a row, so the comparisons will really ease. Come the third and the fourth quarter are you now expecting volume growth, but price erosion? Is that the operative dynamic or is there a different dynamic that you expect in the second half?

This is Kevin. I will take a crack, and then if some of us would like to read any additional color commentary that would be appropriate.

I think as we outlined in our prepared remarks we continue to see that there will be pressure in our Ingredients business. It is something that we have been incorporating into our review of the business. And our actions that we are working on finalizing and developing are really embedding the most recent views as it relates to the Ingredient business.

So we continue to see some pressure certainly in the third quarter. There certainly has been volatility in this part of the portfolio. And Nicolas has already alluded to the fact that gross margin, however, has continued to be held in that business, which is a positive aspect, even with these pressures that we have seen on volumes. And so as we go forward we will provide additional updates into the future, but certainly in the third quarter we continue to expect to see some pressure.

It is Nicolas. As you know, the dynamic in the French Ingredients are really a contract commitment every six months. And as we are negotiating for the second half, some of these contracts were renewed and retained and some were not.

One thing which is important to mention is that we really elected to hold the margins. And some of the contract that were lost many of them were at margin that will be value destroying or AP negative. So we're seeing pressure for the second half of the year. And we know that margin protection was really important for us, and we didn't want to chase low-margin business.

Okay, thank you very much.

John Roberts, Buckingham Research.

After you take your actions on Fragrance Ingredients do you expect the external sales to remain large enough to justify separately reporting this business or do you think we might end up with it folded into both Fragrance -- Functional Fragrance and maybe even a little in Fine Fragrance?

John, it is Doug. I think we have to understand the full impact of the plan that we have. At this juncture we would leave it reporting as a standalone item. And I expect we would want to continue to do that in the short term, particularly as a function of it is very important from the Board to look at.

The important part about this, I think, is to understand how important it is within both supporting the current Compounds business, but also the focus of our R&D continues to be on the development of products and molecules, which we then would sell on an external market basis and not be subject to the vagaries of commodity pricing and high volume, but lower pricing that we have seen.

So we still see there is a bright future. We have done the economic profit analysis to understand how important this business is. Revisiting briefly a comment that Jeff made a while ago, we did not foresee the magnitude of the shift in volumes. We have had four quarters of some softness, and thought at this stage of the game we would be coming out of that trough and comparing it against an acceptable target in order to achieve growth. That hasn't happened, but that is really what the focus is right now.

But how important it both internally and continues to be externally. Despite the growth, it is still a large part of the volume. We will keep it -- we will keep the microscope on it at a very big level.

And then, secondly, was the incentive comp accrual above budget? And did you increase the rate sequentially or it was expected to be above year-over-year and it was in-line with what you were budgeting?

It was pretty close to budget.

Great, thanks.

Edward Yang.

Just some clarification. Did Kevin say that in Western Europe -- your Western Europe exposure, two-thirds of that is Fragrance?

Yes.

Okay. And just an update on your currency hedges. So you have -- you said that I think 70% this year at $1.39, 50% hedged on the euro in 2013 at $1.40. So what is the best way to think about that once those hedges all rollover and assuming the euro stays where it is? Does that mean that your base level of earnings from a translation basis is -- I calculate something back of the envelope maybe 3% or so.

This is just a quick comment. You mentioned $1.40 for 2013, it is actually $1.30.

Okay, got it.

In terms of the 50% coverage. So as we -- if the euro were to say at, for example, current levels and we continue to layer in hedges, that would obviously result in that number coming down over time, because of assuming that the rates in the futures as it relates to the current spot don't materially change, that will translate into a lower effective number at the end of the day when we finalize with our layering in of the hedge programs.

We haven't talked specifically about what the impacts will be, but certainly our hedging program doesn't eliminate ultimately dynamics of currency over the long term. It certainly eliminates volatility and fluctuation, and I think that is the way you need to think about it.

Okay. And on the Spanish settlement, it is about $100 million US, what is the timing of the payouts there -- does that affect interest expense?

Yes, we will be making payments. It is expected that that money will be paid over the course of the balance of the year. Probably the bulk of it is going to be in Q3, maybe most of it in Q3. We are effectively going to be able to access our revolver to make any potential payments in the short run.

But as you know, we have good cash flow dynamics in our business, so at the end of the day we will be able to fund the operations from our -- or fund the payment from our cash from operations.

And, consequently, once we do that we should be able to eliminate existing bank guarantees that are in place relative to those tax matters with Spain, and certainly the payments or the interest rates relative to our revolver are quite low.

All right. Thank you.

I am showing no further questions at this time.

Well, thank you very much to all the participants on the call discussing our second-quarter results, and particularly the relevant questions which came from the participants.

Thanks very much, and we look forward to participating with you on the third-quarter call in a few months.

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