International Flavors & Fragrances Inc (IFF) 2014 Q2 法說會逐字稿

At this time, I would like to welcome everyone to the International Flavors & Fragrances second-quarter 2014 earnings conference call. All participants will be in a listen-only mode until the formal question-and-answer portion of the call. (Operator Instructions).

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

Thank you. Good morning and good afternoon, everyone. Welcome to IFF's second-quarter 2014 conference call.

Earlier today we distributed a press release announcing our second-quarter results. A copy of the release can be found on our IR website at www.iff.com. This call is being recorded live and will be available for replay on our website.

Please take a moment to review our forward-looking statements, which I will read out loud.

During the call, we will be making forward-looking statements about the Company's performance, particularly with regard to the third quarter and our outlook for the full year of 2014. These statements are based on how we see things today and contain elements of uncertainty.

For additional information concerning the factors that could cause actual results to differ materially from forward-looking statements, please refer to our cautionary statement and risk factors outlined in our 2013 10-K filed on February 25, 2014 and our press release that we filed this morning, all of which are available on our website.

Today's presentation will include non-GAAP financial measures, which exclude those items that we believe affect comparability. A reconciliation of these non-GAAP financial measures to their respective GAAP measures is set forth in our press release that we issued earlier today and is on our website.

With me on the call today is Doug Tough, our Chairman and Chief Executive Officer; Nicolas Mirzayantz, our President of Fragrances; Matthias Haeni, our President of Flavors; and Kevin Berryman, our Executive Vice President and Chief Financial Officer.

I would now like to turn the call over to Doug.

Thank you, Shelley, and good morning and good afternoon, everyone.

Before I start my formal comments, I would like to say how much I have enjoyed being part of IFF's journey these past five years. You will have read that as of September 1, I will be stepping down as Chief Executive Officer and turning the reins over to Andreas Fibig, who is currently an IFF Board member and was most recently with the German pharmaceutical company, [Fire]. I will make additional comments about the transition at the end of the presentation.

Turning to the agenda for today's call, I will provide an overview of the second quarter for consolidated IFF, followed by Nicolas Mirzayantz and Matthias Haeni who will provide their perspective on the performance of our fragrances and flavors business segments, respectively. Then Kevin Berryman will provide you with a financial review of our second quarter and turn the call back over to me for a balance of year outlook and some concluding comments before opening the call to your questions.

Turning to the second quarter of 2014, our local currency sales growth this quarter was 4%. As a reminder, our overall growth includes a percentage point of growth related to Aromor. We are comparing to strong like-for-like growth of 8% in the second quarter of 2013, supported by a high level of growth in both business units. This quarter our fragrances business delivered growth of 6%, which includes 2 percentage points of growth from Aromor. Our flavors business, up against a very challenging comparability period of 8%, delivered growth of 1% this year. Growth was again buoyed by a healthy level of new wins, which is indicative of the Company's emphasis on innovation and technology and the work we are doing with our customers to deliver superior products that will delight their consumers wherever they may be.

The emerging markets which comprise 49% of our sales continued to outpace the developed markets with mid-single-digit growth of 5%. We saw some softening this quarter in the developed markets, which contracted 1%.

It is worth highlighting that we achieved high single-digit and even double-digit growth in many of the emerging market countries, including Indonesia, China, India, and Argentina, along with solid growth in Brazil and Russia.

Looking at our growth on a two-year basis, our overall growth was 6%, comprised of 5% in flavors and 7% growth in fragrances, including Aromor. This growth is within our long-term targeted growth range.

Our profitability remains solid. The Company's gross profit margin improved 90 basis points versus the prior year and reflects our ninth consecutive quarter of year-over-year gross profit margin improvements. This quarter's improvement was primarily due to ongoing cost improvement initiatives, the net impact of price to input costs, and favorable currency impacts in certain markets due to the strengthening of the US dollar relative to emerging market currencies. Our adjusted operating profit increased 8% reflecting the benefits of margin expansion and lower incentive compensation accruals versus the high year ago levels which reduced our overall cost structure. The results of Aromor were not significant to our consolidated financial performance.

Notably, this quarter our adjusted earnings per share increased 21% to $1.37. EPS benefited from excellent organic profit results, a lower tax rate, reduced interest expense, foreign exchange gains on working capital and a slight reduction in the number of shares outstanding due to our share buy back program.

In summary, we continued to deliver strong profitability metrics above our long-term targets, even with more moderate sales growth.

It is important to note that one quarter is not indicative of a year. Our second-quarter topline growth of 4% was weaker than expected. That said, I remind you that we had a very strong first quarter with local currency sales growth of 7% and adjusted operating and EPS growth of 14% and 11% respectively. All metrics above are long-term targets.

Let's review our first half of the year results. Our local currency sales growth was 5%, comprised of 7% growth in fragrance and 3% growth in flavors. The 5% growth is within our long-term targets.

On a year-to-date basis, our profitability metrics are above our long-term growth targets. Adjusted operating profit increased 11% during the first half of 2014. This was driven by significant gross margin expansion of 160 basis points, primarily due to cost savings initiatives, as well as the benefit of net price to input costs and reduced incentive compensation accruals versus higher year ago levels. Our input costs continue to remain at elevated levels.

Adjusted operating profit growth was supported by increased segment profit in both business units. Our adjusted earnings per share grew 16% in the first half of 2014. The double-digit growth in our adjusted EPS reflects our expanded gross and operating margins, lower interest expenses as a result of refinancing and the benefits of our share repurchase program, as well as favorable trends on foreign exchange so far this year.

Of note, our operating and earnings-per-share profitability growth metrics are above our long-term growth targets.

I would now like to turn the call over to Nicolas and Matthias so they can provide more detail on their respective units. Nicolas?

Thank you, Doug. Good morning and good afternoon, everyone.

Turning to our fragrance business unit, fragrance had local currency sales growth of 6% this quarter compared with 8% growth in the second quarter of 2013, which was our highest growth quarter last year. Our 6% growth includes approximately 2 percentage points of growth from our Aromor acquisition when sales are captured in fragrance ingredients.

On a two-year basis, excluding Aromor, our sales growth is also 6%, which compares quite well with our long-term growth targets. This quarter the emerging markets grew at 6% or twice the rate of our developed markets and represented 51% of our fragrance compound sales. We achieved strong growth in the emerging markets of China, Indonesia and Brazil, which is one of our strongest fragrance markets and where we have a leadership position.

Our overall sales performance was the result of a strong pipeline of new wins in our compounds business, which includes both our fine fragrances and consumer fragrances and used categories.

Fine fragrances grew 14% in both Latin America and greater Asia. This growth was offset by declines in our EAME region due to customer order patterns.

Let me remind you that year-to-date sales in EAME increased 5%. North America was flat this quarter compared with a 13% growth in the year ago quarter. That said, North America grew by 11% for the first six months of 2014. Although our overall fragrance category was flat this quarter on a two-year basis, fine fragrances had growth of 7%, which is above our long-term target and market performance.

Turning to consumer fragrances, this category had solid growth of 5% compared with 8% growth in the prior year quarter. Growth this quarter was led by high single digit growth in toiletries and mid-single-digit growth in fabric care, personal wash, and home care.

Hair care also grew this quarter.

North America and Asia delivered double-digit growth, and Latin America was also positive. This was offset by a slight decline in EAME.

Turning to our ingredients business, fragrance ingredients delivered local currency sales growth of 21%, which includes 17% of growth from Aromor. The growth in fragrance ingredients reflect continued strong sales of key IFF product families. Excluding the planned migration of some volume from fragrance ingredients to compounds, fragrance ingredients will have grown by 9%. This quarter marks our final quarter of the planned migration of volume from fragrance ingredients to compounds.

In summary, we achieved solid top-line growth thanks to the strength and diversity of our portfolio, customer base, and in use categories. On a year-to-date basis, our fragrance business grew 7%, which includes 2 percentage points of growth from Aromor and is within our long-term targets.

Turning to our profitability, we were able to leverage our 6% local currency sales growth into higher segment operating profit to achieve very strong business unit performance. Our gross margins benefitted from volume gains and productivity savings, combined with a favorable impact of price to input costs and currency benefits offset by a small negative mix impact due to the reduced growth in fine fragrance. Our input costs continued to remain at elevated levels.

The gross margin expansion, combined with decreased incentive compensation accruals from the high year ago levels, drove an improvement in our segment profit margins. These benefits were offset in part by increased RSS spending to support business growth. For the quarter, our segment profit increased 19% or an increase of $14 million. Year-to-date our segment profit has improved by $32 million or 23%.

Here are a few additional areas I'd like to highlight. Number one, we are seeing the impact of some higher raw material costs in our inventories, especially natural oils and petrochemicals. We expect input cost pressures to impact our P&L around the end of the year and to be developing headwind for 2015. We are proactively engaging pricing discussions with select customers to offset the inflationary pressure.

Number two, this quarter we completed the purchase price accounting related to Aromor, and as a result, we will now have modest ongoing amortization expense in our P&L.

Number three, as planned this quarter, we closed our fragrance ingredients plant in Augusta, and we will see the cost benefits in H2. As always, our focus is on efficiency and making sure our operations are cost effective and competitive.

These recent initiatives support our strategic focus to drive improvements in our ingredients business.

Turning to our third-quarter outlook, for the third quarter, we are expecting continued top-line momentum in the business. We expect the rate of improvement in year-over-year gross margin to moderate in H2, especially when compared with the improvements we made in gross margins in the first half of 2014.

We look forward to updating you next quarter. I will now turn the call over to Matthias, our new Group President of Flavors.

Good morning and good afternoon, everyone.

Again, challenging comps of 8% a year ago, flavors delivered local currency sales growth of 1% in the second quarter of 2014. As a reminder, the second quarter of 2013 was our strongest like-for-like quarter of last year.

New wins, which were at historical levels in the second quarter, continue to be a growth driver of our business. The volume from new wins was offset by a higher level of erosion on existing businesses, especially in North America where we had several very large new product launches in the second quarter of 2013.

Looking at the two-year average, flavors had solid growth of 5% on the like-for-like basis for Q2. The emerging markets continue to drive growth for our business. Representing 52% of sales, the emerging markets grew by 5%, led by double-digit growth of 15% in Latin America. The BRIC countries of Brazil, Russia, India, and China all performed well, reflecting our ability to work with both global and local customers in these markets.

Solid growth in the BRICs was offset by losses in other countries, including Thailand which was pressured by geopolitical risk. On a year-to-date basis, we grew by 8% in the emerging markets with 90% of our growth coming from these markets.

From a regional perspective in Europe, Africa, and the Middle East, local currency sales increased by 2% on top of 5% growth in the second quarter of 2013. Growth was strongest in beverages, sweet and dairy, partially offset by softness in savory. In greater Asia, this quarter we were disappointed in our flat growth versus 8% like-for-like growth in the year ago quarter. Gains in the savory and sweet end-use categories were offset by declines in beverages and dairy.

In North America, the operating environment continues to be challenging. Volume erosion on existing business was significant and more than offset our growth from new wins. As mentioned, this was driven by several large product launches last year, and we were comparing to growth of 11%, which is the most challenging comp of the year.

Finally, we saw continued very strong growth in Latin America of 15%, driven by our proprietary technologies in beverages, which resulted in very strong growth in the category, reflecting a very high level of new wins. On a year-to-date basis, Latin America has grown by 19%. The second quarter is the third consecutive quarter of double-digit growth in our Latin America region.

Turning to our profitability matrix, flavors gross margins remains strong at prior year levels as a result of our technology-driven winds and creative capabilities. Our segment profit improved by 1% or $0.9 million to $91 million or an increase of 20 basis points as a percentage of savings.

The improvement reflects flat gross margins combined with decreased incentive compensation provisions versus the high level of the year ago. Our input costs continue to remain at elevated levels. On a year-to-date basis, our segment profit increased 3.5% or $6 million for an increase of [40] basis points.

Turning to our outlook for the third quarter of 2014, we expect growth to be moderate, given the ongoing challenges in North America and Western Europe. We are carefully monitoring the situation, yet remain confident we can continue to leverage our innovation and technology to grow our business.

I also want to highlight that we have begun to see input cost pressure on some items in our inventory. We are expecting to see the increased cost pressures in our P&L around the end of the year, and we will likely see a headwind in 2015.

As a result, we have been proactively working with customers on price increases to help mitigate these inflationary pressures.

As of 2014, our current strategic initiatives and other cost savings should offset any cost increases in 2014.

With that, I will now turn the call over to Kevin, our CFO.

Thank you, Matthias, and good morning and good afternoon, everyone.

I'd like to turn back to our consolidated results, and on this slide, you can see that we delivered again strong operating metrics again in the second quarter on a consolidated basis. Our net sales of $788 million were up 4% on a reported basis and also on a local currency basis. Our consolidated sales includes the results from Aromor, which added a percentage point to our consolidated growth. This quarter fragrances comprise 52% of our sales and flavors the remaining 48%. Our growth was the result of our diversity in terms of regions, end-use categories and customers. Emerging markets grew 5% this quarter, and the developed markets declined by 1%, reflecting a challenging environment in North America for flavors and a slower growth in fine fragrance in western Europe during the second quarter.

Our adjusted gross margin this quarter improved by 90 basis points to 45.1%. This primarily reflects gross margin expansion in fragrance due to volume gains, certainly a result of strong new wins, currency benefits, as well as the favorable impact of price to input costs and internal improvement initiatives across both business units. This strong margin growth, combined with lower incentive compensation and favorable currency, resulted in an 8% increase in our adjusted operating profit to $156 million, resulting again in our operating profit margin rising to 19.8%, up 60 basis points from the year ago figure of 19.2%.

Our adjusted effective tax rate in the second quarter of 24.9% was favorable to our adjusted figure of 26.5% in the first quarter of 2013, reflecting higher earnings from lower tax jurisdictions and the effect of favorable tax settlements, partially offset by higher repatriation costs in the absence of the R&D tax credit in the current quarter. The strong operating profit growth when combined with foreign exchange gains, lower interest expense and the positive impact on earnings per share of our share repurchase program, this resulted in a year-over-year improvement of 21% in our adjusted EPS to $1.37.

Importantly, the growth in all of our profitability metrics in the second quarter are all at or above our long-term growth targets.

Now that we are halfway into the year, I wanted to put things into perspective by looking at our operating performance for the first half of 2014. It is important to note that on a year-to-date basis all of our growth targets are in line with or above our long-term growth targets. Our net sales of $1.6 billion increased 5% on both a reported and local currency basis, and of course, that includes approximately 1 percentage point of growth from Aromor. This is clearly within our long-term growth target of 4% to 6% organic growth.

Our adjusted gross margins also increased 130 basis points to 44.9%.

Regarding adjusted operating profit, it increased 11% in the first six months of 2014, reflecting in part lower incentive compensation accruals. This equates to a 110 basis point improvement in our operating profit to 20.2%.

Finally, our adjusted diluted EPS increased 16% to $2.69 for the first six months of 2014, ahead of our long-term growth targets.

Turning to our research, selling and administrative costs, RSA as a percent of sales increased 30 basis points from 25% of sales to 25.3% of sales or an increase of $10 million. The primary drivers of the increase include Aromor-related costs, including operating and amortization and acquisition costs, investment in commercial resources to support our three pillar strategy, currency impacts and several discrete items. These higher expenses were partially offset by reduced incentive compensation accrual versus the very high levels in the second quarter of a year ago.

We remain focused on maintaining cost discipline, while investing in R&D and other strategic growth opportunities. This quarter R&D spending was 8.4% of sales versus 8.5% in the prior year. The prior year figure, as you may recall, includes an initial payment to Amyris, as well as other investments in research and development.

Importantly, our emphasis on R&D has resulted in a stronger pipeline of innovation, and we continue to invest in our R&D platforms and the programs that support them. Our strong cash flow position and margins provides us with the continued flexibility to do so.

Turning to currency, here you see our customary chart showing the change in the strength of the euro relative to the dollar as the movement in the euro represents the largest variable relative to currency impact on our results.

As noted earlier, foreign exchange movements had a negligible impact on our top-line growth.

As it relates to our adjusted operating profit and EPS results for the quarter, year-over-year currency impacts were positive, and at the operating profit line, we continue to proactively manage our gross margin profile through our cash flow hedging programs.

During Q2, we specifically benefited from a stronger US dollar versus several of the emerging market currencies, which favorably impacted local expenses.

Finally, EPS growth also benefited from the absence of foreign exchange losses of working capital, which we experienced in the second quarter of 2013 due to the high level of volatility in foreign exchange markets in the second quarter of last year.

As a reminder, the 2014 -- for 2014, the majority of our euro exposure continues to be hedged at a rate of 132, close to the full-year average of 2013.

Turning to our cash flow, our operating cash flow in the first half of 2014 was $154 million compared with an operating cash flow of $118 million in the prior year quarter. The prior year cash flow included a $30 million incremental US pension contribution, and the year-over-year increase reflects the $34 million improvement in net income, partially offset by increased incentive compensation payments in the first quarter of 2014 versus the first quarter of 2013. As a percent of sales, the current quarter operating cash flow is 9.9% of sales compared with 7.9% in the year ago quarter.

Core working capital increased in absolute dollars to support business growth, however declined on a percentage of sales basis and is on track for targeted improvements that we outlined at the beginning of the year.

Turning to our capital structure, capital spending for growth and infrastructure and newer technology continues to be our most important use of cash. Over the past three years, we have been investing approximately 4.5% of sales on adding capacity where it's needed to optimize our geographic footprint and to ensure that our proprietary technologies are available to our customers around the globe.

We are also committed to returning capital to our shareholders in the form of dividends and share repurchases.

Yesterday our Board of Directors authorized a 21% increase, or $0.08, and a quarterly dividend of $0.47 per share, up from the $0.39 per share a year ago. This dividend is payable on October 7 to shareholders of record as of September 25. Including this authorization, IFF's quarterly dividend payment will have grown by a compound annual growth rate of 15% over the last four years.

The current authorization, importantly, reflects the Board's confidence in the Company's ability to continue to execute on its three pillar strategy. Based on the notable progress we've made in expanding our geographic footprint, developing our R&D pipeline and improving the margin profile of our portfolio, the double-digit increase in the dividend also reflects our strong cash flow position. This enables us to maintain a competitive dividend yield, continue to execute against our share buyback program, all while maintaining a strong amount of financial flexibility to aggressively explore M&A opportunities.

Regarding our share buyback program, on a year-to-date basis, we have spent approximately -- excuse me, approximately $34 million on share buybacks. Total program spending since the first quarter of 2013 is $86 million through the end of the second quarter. Based on our programmatic share buyback program, we continue to expect that we will spend more on share buybacks in 2014 than we did in 2013.

Finally, as noted, we continue to evaluate business development opportunities. We are targeting those opportunities that would provide us with access to new technology, geography or a business adjacency that would make strong strategic sense and leverage our expertise in science and technology. We have the financial flexibility to invest in both external business development activities, as well as our organic growth programs.

With that, I will turn the call back over to Doug.

Thank you, Kevin, Matthias, and Nicolas.

As you've heard from our teams, we've had a good first half of the year with local currency sales growth of 5% and adjusted operating profit and earnings-per-share growth of 11% and 16%, respectively, all in line with or above our long-term targets.

As you have heard, volume erosion on base business and flavors put pressure on our top-line growth, despite a level of new wins that was in line with historical norms. We expect to see continued erosion in the third quarter in flavors.

For the third quarter, we expect sales growth to be in line with our Q2 results as market conditions for flavors will remain challenging. We expect to see continued gross margin expansion but at a lower rate year-over-year, especially as we compare to the improved gross margin performance of the prior year and the improvements we saw in the first half of the year.

In addition, we are closely monitoring the input costs, and as Matthias and Nicholas indicated in their remarks, we expect to see some inflationary cost pressure around year-end, which will have an impact on our 2015 P&L.

As a result, we have been proactively working with customers on price increases to help mitigate these inflationary pressures. As to 2014, our current strategic initiatives and other cost savings should offset any cost increases in 2014.

Turning to the full year, given our current visibility, we now expect our full-year local currency sales growth to be in the range of 4% to 6%. Our full-year profitability metrics remain intact. Cost control and manufacturing efficiencies will continue to drive our operating profit growth. We are reconfirming our expectation for double-digit operating profit and earnings-per-share growth for the full year.

The investments we are making in R&D have resulted in a strong pipeline of innovation. We are confident that the commercialization of these technologies will result in continued sales growth and margin gains for the Company.

As most of you know, in late May, we announced IFF's CEO succession plan. Effective September 1, I will be stepping down as Chief Executive Officer and will remain active as IFF's Chairman. I have thoroughly enjoyed my time at IFF, but I've always said that at some point I would scale back my involvement to make time for other activities. I have just celebrated my 65th birthday, and I am looking forward to doing other things, including more time with my family, children, and grandchildren.

The Board has selected Andreas Fibig as the next CEO of IFF. Andreas has been a member of our Board since 2011 and has been actively involved in setting our strategy and charting a course for the future. Andreas comes to us from Bayer Pharmaceutical, where he has successfully introduced new pharmaceutical solutions and drove a profitable growth agenda. Importantly, he is known to the Board of Directors and to our senior management team who value his insight and his input. He understands the value of R&D and driving the innovation agenda, understands and helped develop our emerging market strategy, and has previous operating experience in the emerging markets.

Finally, Andreas has a successful track record with mergers and acquisitions and will be a great addition to IFF as the Company looks to further drive its profitable growth strategy both organically and through business development activities. We welcome him to IFF and look forward to working with him, and I look forward to introducing him to many of you.

Here are the key takeaways from our second-quarter call. In summary, our overall growth of 4% in the second quarter and 5% year to date reflect strong results in fragrances and mixed results in flavors. Our sales growth slowed in Q2 on account of greater erosion on existing business. We expect to see continued erosion in the third quarter in flavors, which has led us to reduce our full-year top-line sales forecast. The breadth and diversity of our portfolio provides greater stability to absorb variations in a particular region, category or customer. We can really see how effective this business model was for us this quarter as our overall growth of 4% had some great success which offset areas of weakness.

The second quarter compares to our most challenging quarter in 2013 from a top-line growth standpoint. We continue to believe strongly in our strategy and long-term growth potential, and we are positioning IFF for future success. Our commitment to innovation, portfolio enhancement and internal improvements support our strong gross margin profile. We remain focused on our three strategic pillars: leveraging our geographic footprint, enhancing our innovation and maximizing our portfolio.

I thank you for your participation today on our Q2 earnings call, and we will now open up the call for questions.

(Operator Instructions). Mark Astrachan, Stifel Nicolaus.

Best of luck in the future. I'm curious given recent M&A in flavors and fragrances and adjacent categories, are there still value accretive deals for IFF, and have you had to change the way you define value in terms of looking at that?

Good question, Mark. There's certainly been a recent spate of activity in a couple of areas. I think the broader question is, are there still opportunities there? And we believe the answer to that would be, yes, conceivably both within the organic footprint but also adjacencies which would leverage off of some of the skills and competencies we have, particularly in R&D. Some of the recent price points that have been achieved on a couple of the deals have certainly exceeded previous transactions, and that will weigh in on value. But I think as we have talked about in our three pillar strategy and the opportunities that continue to grow in the emerging markets, as that middle class comes forward, we think there's still robust opportunity for growth. So it's not a prerequisite that we have M&A activity, but we are certainly, as Kevin pointed out, we have the financial firepower to do so if the opportunity presents itself. And we remain eager, and we will evaluate things. But you have used a critical word in there which is, are there still value opportunities? And the economic profit discipline that we have instilled in the company will be germane to all the things we look at. And so we will have to have value in order to go forward. But we are confident there will be opportunities.

Got it. Okay. Thanks. And then just one follow-up for Matthias. Can you talk maybe a bit more about what's driving flavors erosion? Is it large customers? Is it local customers? Is it specific categories of weakness, and maybe even talk about how that flowed through the quarter?

Hi, Mark. This is Matthias speaking. As I tried to outline on the call, we had significant erosion, particularly in North America. In North America, we were also up to significant comparables of last year as we have seen a few very large product introductions last year. These were seasonal -- probably more trendy product launches, heavily supported by our customers in commercial. And we see in our shortfall versus prior year, approximately two-third of our shortfall is driven by a few select products and customers.

Turning to Q3, I think we will see some continued softness -- not only from these introductions in the comparables, but also from the market situation which turned to be a bit more challenging, and that has also been supported and communicated by many of our customers.

Thank you.

Lauren Lieberman, Barclays Capital.

Thank you. Good morning. I did just want to follow up I guess first on Asia. You mentioned specifically that China and India were still quite strong, Thailand being the source of weakness. But just for the math to work, I mean Thailand is about I think 2% of Company sales. So it just feels like there may have been something else that was a drag. Maybe it was a collection of things, but a little bit more color there would be really helpful.

Hello, Lauren. This is Matthias speaking again. Thank you for your question. I really try to outline in Asia we had seen a mix picture. We had seen China, India growing strongly, and we had seen some challenges in Southeast Asia. Not only Thailand, which was very much impacted by geopolitical situations and unfavorable market situations, we have also seen some challenges in Indonesia in the second quarter. However, I would like to remind in the first quarter in Indonesia we had very strong double-digit growth, and we expect to see a normalized pattern going forward.

Okay. And then overall, at least in the way that I was modeling the quarter, North America actually was a little better than I expected. It was really EAME that kind of stood out as weaker than expected. As least as far as Western Europe goes, you know, a lot of your customers, at least the publicly traded ones, have been talking about things maybe seeming a little bit better from a consumer standpoint there. So if maybe we could get a little bit of color on both flavors and fragrances, what you are seeing in western Europe and if the sources of weakness we did there was more developed or developing markets? Thanks.

This is Matthias, again. In western Europe, we experienced some of the challenges. I think it's not across the board. It is with a few select customers. We keep on winning thanks to our technology program, in particular where we help customers to reduce calories in products but also to reduce sodium. We have a strong approach of pipeline, but as I outlined, we see some challenges relative to erosion of the business.

Nicolas, you may want to add something?

Yes. Good morning. It's Nicolas here. Too, I would separate obviously the fine fragrance and the consumer goods. As you saw, we had a very strong Q1 in fine fragrance at plus 18%. I think it's more related to other patterns, which had affected our performance in Q2. So overall 5% growth for the first six months, which is above market performance. So I think that is there, but you obviously watch the overall environment and the economic situation.

When I look at consumer fragrances, we have seen some pocket, obviously, of instability in the region, especially Middle East/Africa but also Eastern Europe, which is impacting the demands on our customers, affecting consumer demand, which has created some pocket of headwinds.

So we are seeing some improvement as our customers are mentioning. Will it be a meaningful improvement? I don't expect so. But at least, we will see some improvement. So it's really a mixed performance according to the countries or subregions that you are talking about.

Okay. Thank you.

Mike Sison, KeyBanc.

Morning, everyone. Doug, congrats, again, and happy birthday to you.

Thank you, Mike.

In terms of your outlook for 2014 for double-digit EPS growth, you don't really need a lot of growth in the second half to get there. Can you maybe give us a little bit of help of how you see the second half? I know you don't like to give guidance on a quarterly basis, but are you implying that maybe the second half is in double digits because your first half was pretty impressive?

Mike, how are you? This is Kevin. I'll make just a few comments. We don't imply anything as it relates to what the second half of the business actually looks like in terms of performance level. But I think the mere fact that we are calling for strong double-digit growth in both operating profit and the EPS I think is indicative that again we feel that our second half of the year is going to warrant good performance. At the end of the day, we do have, as outlined, kind of a reduction from what we would have originally said on the topline. We had a 5% to 7% range. Now we are a 4% to 6%. That doesn't mean anything other than probably the high end of our range before is probably unlikely now. And so consequently we continue to believe that we have a good second half of the year.

Great. Thank you. And then a quick question on fine fragrances, Latin America still seems to be an area that continues to do well. I've heard Brazil is kind of a sore spot for some folks. Any worries there that that business will slow down, or do you have a pretty good backlog of new products to keep that momentum going as we head into the second half of the year?

Mike, it's Nicolas, again. As you know, last year we had a very strong first half. We grew 29%, which was far above the market performance. Here you saw that after some challenge, but it was mostly due to strong comp, minus 15% in Q1 versus plus 38% last year. We have allowed new good growth, 14% above 20% last year. So we have a good strong pipeline of new wins, but it is fair to say that across categories Brazil has faced some slower growth rate across customers and product categories.

So all pipelines of new wins is strong, and now it will be we have to see other markets and the consumer demand will develop in the next few months. But our performance relative to the market is strong. Now what we will have to is see what will be the impact of overall consumer demand.

Okay. Great. And one quick one in North America flavors, in terms of the market sentiment, are customers opting not to launch as many new products as we head into the second half of the year? Or is it maybe some attrition of the base business that may be going away faster than you would of thought?

This is Matthias speaking. First, I cannot tell you what our customers are going to launch in the second half of this year. I can tell you that we have a strong approach of pipeline. Our commercial performance, which means the wins are in line with historical levels, yet still need the pressure on the few select customers, and volume remains strong. We firmly believe we have the ability to win. We have a significant approach of pipeline and very strong innovation pipelines that did make a significant difference, which is a lasting difference for our customers and IFF.

Right. Thank you.

This is just an augmentation to what Matthias is talking through. If you look at the top line in the second quarter, our growth from the new wins continue to be very solid. Where we saw the weakness, as Matthias outlined, really is more flavor specific, and it's the erosion on existing business, which Matthias has already outlined that some of that is associated with some discrete items on specific customers.

So there is some other general erosion that we have seen in flavors, but the thing that is most important and what we are driving relative to our innovation programs continues to be robust, and we see that pipeline being -- continuing to look pretty solid.

Right. Thank you very much.

Jeff Zekauskas, JPMorgan.

Good morning. It is [Zelda] in for Jeff. I waas wondering if you can indicate how much of the gross margin contribution this quarter came from volume price mix and how much may have been from favored pricing over raw materials?

We haven't disclosed that information, but ultimately we had drivers of volume mix because of the amount of our growth was more limited this quarter and, especially as Nicolas outlined, mix was not as positive as it normally is because of the fine fragrance situation that he suggested. But we saw good cost reduction initiatives. We saw some benefits on net pricing, and there was some currency -- all were adding up to be some positives as it relates to the gross margin.

And in terms of the savings that you expect going forward, there are benefits from the plant closure in Augusta. My recollection is that was on an annual basis, maybe to deliver something like $6 million to $8 million. Do you think you may be able to get half of that in the second half, and what was the effect of the amortization expenses from Aromor that are falling away?

A couple of things. The $6 million to $8 million is still the expectation on an annual basis, so we would expect given the timing of the closures that we would get roughly half of that. Most of the cost as it relates to the acquisition, which we will refer to, are really relative to the amortization costs, so those will be ongoing.

Regardless, the net impact to Aromor on a total basis is immaterial within the context of the profitability of the Company.

And lastly, I guess I ultimately would just like to revisit the North American flavor issue one more time. So the comparisons are really -- in North American flavors were very difficult, and I agree your commentary wasn't different than what your competitors said. Though, in the second half, the comparisons are becoming noticeably easier. So one of the questions is, is there one more quarter of headwind because there's something customer specific, or is it going to be two or three more quarters of headwind?

I thank you for your question. We will see continued softness in the third quarter in North America. You are right. We see these comparisons easing in the fourth quarter. We also expect third quarter to improve relative to our second-quarter performance in North America flavors.

Thanks very much. I'll get back in the queue.

Rohini Nair, Deutsche Bank.

Thank you. Doug, wishing you all the best as you move on to the next adventure. A few more questions from me on North America flavors. I guess I just love to understand whether you are actively taking any steps towards stemming this volume erosion that you're talking about, or is it just that you eventually anticipate an improvement in the consumer environment?

Along with that, what are you seeing from those specific challenged customers that you think they can improve on? Is it that their new product development is really not up to par? Are they not managing their inventories correctly? It would just be great to have your thoughts around that.

I think in North America as we see some pressure overall in the market, we see more and more customers also being very cautious in product launches, and cautiousness is often a result of being seasonal launches. And if the season launch is not going to be a big success, they would take it off the market.

I think we see and will see continued situations in North America where very large customers are bringing so-called limited time offerings to the market. We see it in many of the categories, and if these limited time offerings are not very strongly supported by commercials and marketing advertisements, you will see erosion quickly.

Now I'm confident that with the approach of pipeline which we have and what we are working with our customers, we are working much more on iconic brands again, brands which are in the marketplace for quite some time; extensions of brands which will stay for a long period of time; and it remains to be seen what we will get (inaudible) in the fourth quarter. We have some visibility on the third one, and we feel confident.

As for the fourth and beyond, we will see what type of dynamics we are going to experience.

I would just want to build on something Matthias said, which is in the context of what are the actions being taken. And there's probably a couple. There's obviously a financial discipline associated with costs and investments. But we actually see some significant opportunities in the North American market, particularly with some customers. So both account management and focus of innovation, as well as opening of offices to support these customers. That's actually on our horizon because of the confidence we have in the innovation pipeline. So there's as much if not more authentic-based activities as there are defensive in terms of returning the business of North America to gross.

That's helpful. Thanks. If I could have just one quick follow-up. Those categories that you are seeing that are weak, is it basically across the board -- sweet, savory, dairy, beverage -- or are you seeing it more concentrated?

I think it is more concentrated towards savory and beverages, and we keep on making valuable inroads in other categories. The isolated cases I was referring to from last year were in probably two categories only. It's mainly related to beverages.

Thank you so much. I'll pass it on.

Jonathan Feeney, Athlos Research.

Good morning. Thank you very much. Just one question I had. With some of the pressures in developed markets, flavors business specifically, what's the competitive landscaping like? Has there been an uptick in bid activity or in competitive shuffling as presumably your competitors in flavors are feeling some of the trends you are feeling right now? And to the extent you can mention the pricing environment as it relates to that competitive activity, I would appreciate it. Thank you.

I think I tried to outline, we see some pressure in North America. We see some pressure in western Europe. Nevertheless, given our opportunity and ability, coupled with the very strong approach of pipeline and our innovation programs, we are obviously -- these opportunities materializing for us very positively going forward. We have a lot to offer to our customers, and what our offering is not only adding great flavors, in our offering, we are also in the position to add taste to products. And with taste, we also at the same time are engineering together with customers on lower-cost recipes for their own consumers.

So overall I'm very confident that we see opportunities in both in the developed market but also in the developing markets. And our growth and model and growth thesis remains strong, and we have a very sound, solid foundation in the flavors business unit.

Okay. Thank you very much.

Edward Yang.

Hi, good morning. Doug, I will echo everyone else's well wishes to you, and congratulations on a very successful run at IFF.

A question on pricing and raw materials. What percentage type of price increases do you need from your customers to offset some of the raw material prices pressures you are seeing?

Hi, Ed. This is Kevin. We haven't disclosed that, and as you would know, at the end of the year, when we talk to our Q4 results, we will give a perspective on what the expected inflation levels are, and that may give you a better indication as to what kind of pricing may be required to help offset that pressure.

But at the end of the day, we don't believe that we are faced -- just to make a few comments -- we don't believe we are faced with the situation back in 2011 where we had double digit input costs. But we do fundamentally believe that there are areas where we are going to have to take pricing to help offset input cost pressure beginning in 2015.

So we'll talk more about that at the end of the year during our Q4 call. But not to be an alarmist, there's no need for us to be thinking along the lines of what would have happened in 2011.

Your competitors will also, I would assume, be taking the same kind of positions because they will be interested in trying to recover some of the input cost pressures they could see as well.

Got it. And that's helpful, Kevin. Along that vein, I'm still -- I am surprised that you are talking about raw material pressures because, in general, it doesn't seem like the raw environment or the commodity environment is necessarily very heated right now. Our raw material price pressures, are they took driven by capacity reductions in certain areas or drought? Because I don't really see energy prices up all that much, and are there any offsets? You mentioned naturals as a place where you are seeing raw material pressures. But, in synthetics, are you seeing price declines to offset some of those pressures?

I think that you are right. The good thing about the diversity of our spend is that there is oftentimes pieces of the portfolio that will go up, and it's oftentimes offset at least to some extent by other pieces of the portfolio that will go down.

I would say the one area -- and you've already outlined it -- which we expect to in general have higher levels is in the naturals area. We've already called that in the past citrus as one particular area where we know there's going to be some increases versus our current levels, and there's a few others. But in general, the majority of the pressure points are seen in the naturals area. There will be some others in the fragrance ingredient side, but ultimately it's more in the naturals area at this particular point in time. And that's where we are focusing most of our discussions with our customers right now in terms of those future price increases.

All right. Thank you very much.

Sarah Donnelly, Gabelli & Company.

Good morning. I just wanted to ask about some of the weakness which you mentioned in savory and beverages. Can you just talk a little bit about demand and the technology you have around sodium and sugar substitutions and whether that continues to drive demand around new products or your new product pipelines in North America and how it's impacting it globally?

Yes. Hello, Sarah. This is Matthias, again. I mentioned before, in North America we have seen pressure on few select customers. So it's not across the savory market or it's not across the beverage market. So we have seen pressure for product introductions that were very trendy, very fashionable, heavily supported last year. And also we have seen our customers building up inventory for such a significant launch, and this is why we are also coming under pressure relative to last year's performance.

Coming into the project pipeline, I mentioned to you before we have a very strong project pipeline in both of what you described -- in sodium, as well as in sweetness or in calorie reduction. We are very active -- actively engaged with our customers with large global accounts, as well as with regional accounts to take calories out of recipes, not only in beverages, but also in other product offerings, in other categories. And we get very positive response, and our win rate typically is significantly higher once we can allocate technology into the recipe design with our customers.

Thanks.

Mark Astrachan, Stifel Nicolaus.

Yes. Thanks, again. I'm wanting to go back to the earlier M&A question. I'm curious how you would describe your customer's reception to your competitors to do more business with those that have engaged in M&A in sort of adjacent categories and offering more of a one-stop shop?

So, in other words, you go beyond flavors and fragrances, are customers more or less willing to engage with them? How do they sort of think about things broadly with the reception to do deals?

Well, it's a broad question, Mark, and maybe I'll take first swing at it, and then, Matthias, can weigh in with some second thoughts. It seems to be a bit of a mixed bag. Some -- there will be a certain degree of receptivity from some customers, probably smaller ones who are looking for a one-stop shop. But almost to the contrary, some of the other larger ones have unbundled things and aren't necessarily looking for that opportunity for a one-stop shop and to the contrary actually going the other direction.

So I think it's certainly early to tell. Some companies have that as their business model. It's not the IFF business model to be the one-stop shop.

Matthias, anything you want to say?

I can echo what Doug outlined. I think medium-sized or probably small-sized companies, they will appreciate a total product offering. It helps them in the facilitation of their recipe engineering, recipe design. They also get a lot of probably additional technical advices from companies offering a total solution.

When it comes to larger and, therefore, global accounts, they will typically ask you, Mark, to unbundle your total solutions and systems as they want to have control over individual ingredients, and there will be very limited appreciation for what we think as a total solution for it. It may change from account to account, but this is what we experience and this is what we are working with our customers on.

Got it. Thank you.

And there are no further questions at this time. I will now turn to call back over to Doug.

Thank you very much, operator. Thank you all for your participation on our Q2 call, and we will look forward to a discussion in early November with our Q3 results. Thank you.

Thank you for joining today's conference. You may now disconnect.