International Flavors & Fragrances Inc (IFF) 2014 Q3 法說會逐字稿

At this time, I would like to welcome everyone to the International Flavors & Fragrances third-quarter 2014 earnings conference call. (Operator Instructions)

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

Thank you. Good morning and good afternoon, everyone. Welcome to IFF's third-quarter 2014 conference call. Earlier today, we distributed a press release announcing our third-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 statement, 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 our outlook for the fourth quarter and 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 contained 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 which 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 Andreas Fibig, our CEO; 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 Andreas.

Thank you, Shelley, good morning, good afternoon to everyone. This is my first earnings call as CEO of IFF and I want to say how pleased I am to be part of this great organization.

During my first two months, I've had the opportunity to travel to many parts of the IFF world, visiting customers and employees in Latin America, Europe, and the United States. And just returned from an exciting trip to India and the Middle East, where I saw firsthand how we combine our core values of passion, creativity, and expertise to partner with global and local customers to provide them with products that will delight their consumers.

I've only had the chance to speak with several of our analysts and investors and I look forward to meeting you all in person in due course.

I also want to acknowledge our former CEO and current Chairman, Doug Tough, for providing a seamless transition. His insight, guidance, and advice have proven beneficial and I thank him for all of his support.

As you may know, my career has been devoted to biopharmaceuticals, a different industry, but one with many similarities to the flavors and fragrance industry. Both industries operate on a global scale, both depend on constant innovation to deliver success, both demand consistent focus on productivity and excellence in implementation, and both require extremely close collaboration with customers and consumer insight.

IFF is a company with expansive global reach, a successful culture of innovation, strong financial results, and passionate employees. I personally believe we can continue to improve our long-term business performance and increase shareholder value by executing our three-pillar strategy of leveraging our geographic reach, strengthening our innovation platform, and maximizing our portfolio.

We are currently refreshing our strategy to make sure we have the necessary roadmap to drive our future growth. To put this in context, like any healthy company, we will regularly pressure test our priorities.

All that being said, IFF has a strong foundation and therefore, you can expect an evolution of strategy, not a revolution, as we look to how we can best work in close collaboration and partnership with our customers and their brands, continue to win in the marketplace, and provide value to our shareholders.

Turning to the agenda of today's call, I will provide an overview of the third-quarter results for consolidated IFF, followed by Nicholas and Matthias, who will provide their perspective on the performance of our fragrance and flavor business segments.

Then Kevin will provide you with a financial overview of our third-quarter and first nine months of the year and he will then turn the call back over to me for balance of year outlook and some concluding comments before opening the call for your questions.

Turning to the third quarter of 2014, we continue to report solid growth, thanks to the diversity of our business and continued momentum in the emerging markets, where we now have 50% of our sales, more than any of our competitors. Our local currency sales growth of 4%, which includes a point of growth relating to the Aromor acquisition, was in line with our expectations and similar to the second quarter.

Fragrances reported local currency sales growth of 5%, while flavors reported local currency sales growth of 2%. We achieved solid growth in every region, with the exception of North America, where we continue to face a challenging environment. In general, the trends on volume erosion improved over the prior quarter, but new win performance was at the low end of historical levels.

Latin America was our best performing region, increasing 9% in local currency. Flavors continued its very strong momentum, posting double-digit growth, while fragrances grew high single digits in the region.

Greater Asia increased 4% in local currency, double-digit growth in fine fragrances, and improved flavor results drove our performance in this region. EAME was up 6% in local currency, as a result of strong performance by both business units in the Middle East. North America continues to be challenging market for both flavors and fragrances.

The adjusted operating profit increased 7%, reflecting an increase in gross profit dollars combined with reduced research, selling, and administrative expense. Our third-quarter adjusted EPS increased a percentage point faster than our adjusted operating profit, growing 8% to $1.32.

On a year-to-date base, our local currency sales increased 5%, reflecting 6% growth in the emerging markets and 1% in the developed markets, in line with our long-term sales growth targets of 4% to 6%. By business unit, fragrances was up 7% on a year-to-date base, in part to the Aromor acquisition, while flavors had local currency sales growth of 3%.

Our fastest-growing region on a consolidated basis for the first nine months in 2014 were Greater Asia, Latin America, and EAME due to a strong growth in many emerging market countries around the world, which are large markets for IFF.

Sales growth combined with year-to-date gross margin improvement resulted in the Company's adjusted operating profit increase of 9%, at the upper end of the range of our long-term targets of 7% to 9%. Our adjusted EPS [of] $4.01 is up 13% year over year, reflecting our expanded growth and operating margins as well as lower interest expense and a lower effective tax rate.

Overall, we feel we are very well positioned versus our full-year forecast as we head into the fourth quarter.

I would now like to turn the call to Nicholas and Matthias, so they can provide greater details on fragrances and flavor results and operating performance.

Thank you, Andreas. Good morning and good afternoon, everyone. Fragrance's local currency sales growth this quarter was 5%, including 2 percentage points of growth for Aromor.

The overall performance reflect growth in all regions, except North America due to market challenges. The emerging markets continued to be a driver to our growth, up 7% overall. And 51% of our fragrance compound business, which include consumer fragrances and fine fragrances, were to the emerging markets more than any of our competitors in the industry.

Our performance validated continued work on the part of our teams globally to collaborate and partner with our global, regional, and local customers to provide them with innovation and fragrances that will delight their consumers as well as our investment and expertise in consumer insights.

In addition, we continue to benefit from our diverse portfolio of end-use product categories, geographies, and customers. In that way, new wins in one part of our portfolio can offset challenges in other areas.

Our compound business was up 3% in local currency, led by 6% growth in Latin America, 5% growth in Greater Asia, and 4% growth in EAME.

Turning to our end-use categories, consumer fragrances increased 4% in local currency this quarter, with widespread growth across all regions led by 7% in EAME and 5% in Latin America. The overall increase was primarily driven by double-digit gains in our fabric care category, further solidifying our leadership position in this category.

Our strong performance in fabric care in large part reflects market acceptance of our unique encapsulation technology, which has been a strong driver to our consumer fragrance business for many quarters. Home care and toiletries also experienced growth this quarter.

It is also important to note that on a year-to-date basis, consumer fragrances is up 5% in local currency, with growth in all of our end-use categories due to our strong consumer insight, partnership with both global and local customers, and our pipeline of new products.

Moving into fine fragrances, local currency sales declined by 1% this quarter. Strong growth in Latin America and Greater Asia was offset by market weakness in North America, which is facing challenges. On a year-to-date basis, fine fragrances is up 3%, which is above market growth in volume.

Turning now to our ingredient business, fragrance ingredients delivered growth of 16%, including sales from Aromor. Ingredient organic growth was 2%. This performance reflects strong growth of specialty ingredients, including Aromor, as well as key IFF product families, including natural oils.

On a year-to-date basis, ingredients are up 20%, including sales growth from Aromor. In summary, we achieved good growth this quarter, fueled by the emerging markets and double-digit growth in fabric care.

From a profitability perspective, productivity improvements and cost savings initiatives were marginally offset by mix due to a decline in our fine fragrances sales. In addition, our operating cost reflects a lower level of incentive comp.

The net result was positive, as segment profit increased 7% or $5 million year over year and segment profit margin expanded 20 basis points to 20.9%. On a year-to-date basis, our segment profit has increased by $38 million or 17%.

I would like to add more color on the state of our business before turning to our forecast. I am pleased to report that we gain entrance into a new core leased in North America, reflecting months of work by our teams.

We made progress on our fragrance ingredients rationalization plan that started in the second quarter of 2013. We closed our Augusta, Georgia, ingredient manufacturing facility during the quarter and we are beginning to see the cost savings, which we are being used to offset the start-up cost associated with our newer plants.

We also made progress on our [system EBITDA] journey this quarter. IFF was identified as a leader in Climate Change Reporting and we will now be included in the Climate Disclosure Leadership Index as part of the Carbon Disclosure Project.

You may recall that over the summer, we opened the largest solar installation in the flavors and fragrance industry in our facility in Hazlet, New Jersey. This put us at the forefront of using renewable energy in the flavors and fragrance industry.

We continue to make progress in our integration with Aromor. We are meeting key milestones and we are pleased with the collaboration and progress, especially on the innovation front.

Turning now to our fourth-quarter outlook, we are comparing to a very strong Q4 in 2013, which was driven by double-digit growth in fine fragrances and high single-digit growth in consumer fragrances. Against this comparable, we are expecting to have modest organic growth in the fourth quarter.

I will now turn the call over to Matthias, our Group President of Flavors.

Thank you, Nicolas. Good morning and good afternoon, everyone. Against a challenging global environment that many of our customers have commented on, flavors had local currency sales growth of 2% this quarter, up sequentially from 1% growth in the second quarter.

The overall performance reflects new wins, which continue to be healthy, but were offset by higher volume erosion on existing business. The flavors business delivered local currency sales growth in Latin America, in Greater Asia, and in EAME.

The performance in these three regions was offset by a sales decline in North America. Sales to the emerging markets, a growth driver to the business, increased 6%, while sales to the developed markets declined 2%.

Looking at each region in greater detail, EAME had favorable local currency sales growth of 3% this quarter, a sequential improvement over Q2. High single-digit growth in beverage and low single digit growth in dairy were only partially offset by declines in sweets and in savory.

Greater Asia also experienced a sequential improvement over Q2. Local currency growth of 3% was led by high single-digit gains in savory, only partially offset by declines in beverages and in sweets.

Our performance in North America improved sequentially this quarter due to lower volume erosion in beverage, as we communicated last quarter. We also saw double-digit gains in dairy this quarter in North America.

Latin America continues to be our strongest performing region, up 12% in local currency sales. This is the fourth consecutive quarter of double-digit growth in Latin America due to a very strong level of technology-driven wins in beverages. Our performance overall reflects our strong collaborations with our customers as well as our focus on health and wellness solutions.

Our segment operating profit declined 2% to $79.7 million this quarter. Our segment profit margin was 22.2% compared with 23.2% in the third quarter of 2013. The decline in segment profit and profit margin was driven primarily by weaker operational performance, including less favorable absorption and new plant costs. Our operating costs reflect a lower level of incentive comp.

Turning to our outlook for the fourth quarter, we expect positive local currency sales momentum in the fourth quarter, with positive growth in North America. Our expectations for improved growth in Q4 is indicative of a positive trend, especially when comparing to the very strong performance of 7% growth in Q4 of 2013.

As you know, over the last few years, we have made significant commitments to step up our investments in the emerging markets in order to provide us with the critical capacity, creation capabilities, and sales offices to successfully compete in these faster-growing markets. In keeping with these plans, in 2012, we opened a new facility in Singapore and last year in the third quarter, we opened our Guangzhou, China, facility.

With our new investments in manufacturing capacity in Gebze, Turkey, and in Jakarta, Indonesia, we will have substantially completed our investment activity. These investments will support our growth for the foreseeable future and position us well with customers in the regions.

Due in part of lower sales growth this quarter, we were not able to fully absorb the additional costs related to the start up and opening of our China facility. Given the expected improvement in Q4 sales, the impact of these incremental costs will be reduced.

With that, I would like to turn the call over to Kevin, our CFO.

Thank you, Matthias, and good morning and good afternoon, everyone. Net sales of $774 million were up 4% on a reported basis and also 4% on a local currency basis, which excludes the effects of foreign currency impacts.

Our consolidated sales include the results of Aromor, which added a percentage point to our growth. This quarter, fragrance comprised 54% of our sales and flavors comprised the remaining 46%.

Our continued growth in a turbulent economic and customer environment is again a testament to the strength and diversity of our portfolio in terms of regions, end-use categories, and customers. Our diversity and capabilities allows us to realize growth in both challenging and more robust times.

The emerging markets grew 6% this quarter and the developed markets declined by 1%, reflecting continued challenges for both flavors and fine fragrance in North America during the third quarter.

Regarding gross margin, productivity, and cost savings in the quarter, including the benefits of the closure of our Augusta facility, were offset by the impact of unfavorable mix and operational performance, including lower absorption benefits and new plant-related costs.

The slight decline in gross margin was more than offset by ongoing control of our research, selling, and administrative costs, and lower incentive compensation costs versus the prior year, reflecting lower topline and operating profit growth versus plan. As a result, our adjusted operating profit increased 7% to $153 million and our adjusted operating profit margin improved 40 basis points to 19.8% this quarter.

Our adjusted effective tax rate in the third quarter of 24.5% was favorable to the prior year's rate of 26.2%. The tax rate reduction reflects higher earnings from lower tax jurisdictions, favorable provision to return adjustments and lower loss provisions, partially offset by higher repatriation costs and the absence of the research and development tax credit in the US in the current quarter.

We fully expect the drivers of our lower tax rate, including the greater mix of earnings from lower tax jurisdictions, to continue to be a driver to our improved effective tax rate for the full year versus year ago.

Our operating profit growth and lower effective tax rate drove the year-over-year improvement of 8% in our earnings per share, bringing our adjusted EPS to $1.32.

Turning to our nine-month year-to-date results, note that the growth in all of our metrics for the first nine months of 2014 are within or above our long-term growth target ranges. Our net sales of $2.3 billion increased 5% on a reported and local currency basis, including approximately a point of growth for Aromor.

Supported by improved gross margin, our adjusted operating profit increased 9% in the first nine months of 2014, reflecting in part lower incentive accruals. This equates to a 90 basis point improvement in our operating profit margin to 20.1%.

Finally, our adjusted diluted EPS increased 13% to $4.01 for the first nine months of 2014, a performance level that is well positioned versus our long-term growth target.

Turning to our research, selling, and administrative costs, RSA as a percent of sales decreased 60 basis points, from 24.8% of sales to 24.2% of sales. The decline as a percent of sales was driven primarily by lower incentive compensation expense, partially offset by several discrete items and the addition of Aromor.

We have instilled discipline in our cost controls so that we can continue to invest in research and development and position ourselves for continued acceleration in the development of our innovation pipeline. R&D investments will remain a focus, with spend remaining above 8% of sales.

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 foreign exchange variable relative to the impact on our results. As noted earlier, foreign exchange movements had a negligible impact on our topline growth.

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

As a reminder, the US dollar's strengthening versus the world's currencies does not materially impact IFF in many emerging market countries, as two-thirds of our sales are tied to harder currencies in the emerging markets, including the US dollar.

Relative to the recent weakness in the euro, as you may know, the euro declined nearly 5% during the month of September and reached a low of $1.25 on October 6. Due to our hedging activities, however, where we have hedged the euro at a rate of $1.32 for the full year 2014, the majority of our exposure remains protected in 2014. And as a result, the results in Q3 were not, again, materially impacted by fluctuations in foreign currency exchange rates.

And importantly, for 2015, nearly 60% of our euro exposure is now hedged at a rate of $1.34, close to the effective year-to-date average for 2014. This effectively significantly reduces our exposure for 2015. At current rates, we believe the impact to earnings in 2015 to be immaterial.

Our operating cash flow in the first nine months of 2014 was $318 million, or 13.6% of sales, compared with $257 million, or 11.5% of sales, in the prior-year period. The increase in cash flow from operations was driven by a increase in net income in the first nine months of 2014, lower amounts of Spanish tax payments this year versus last, lower year-over-year pension contributions, which were partially offset by higher incentive compensation payments in 2014 versus 2013.

Importantly, our core working capital levels continue to show improvement year over year as a percent of sales as our five-quarter rolling average figures through the end of Q3 are down 90 basis points to 29.8% of our trailing 12-month sales versus the same metric year ago.

Turning to our capital structure and our uses of cash. As you know, 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 would expect that our spending will again be in the 4% to 4.5% of sales range for the full year 2014.

Regarding our share buyback program, on a year-to-date basis through Q3, we have spent approximately $52.5 million on share buybacks. Clearly, we now expect to spend well above our buyback program spending of $51 million in the prior full year as we will continue to buy back shares during Q4.

Finally, as noted, we continue to evaluate M&A 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 these external business development activities as well as support our core organic growth programs, such as our high value at stake initiatives and other programs designed to drive growth. All while still providing meaningful returns of cash to shareholders through dividends and share buybacks.

I will now turn the call back to Andreas.

Thank you, Kevin. As you've heard from the team, we've had a solid first nine months of the year, with local currency sales growth of 5% and adjusted operating profit and EPS growth of 9% and 13%, respectively -- all very much in line with our long-term targets.

Our emphasis on R&D has resulted in a stronger pipeline of innovation. Coming from my pharmaceutical background, I understand how important that is and I support our continued investment in our key R&D platforms and the programs that support them.

Our strong cash flow position provides us with the financial flexibility to continue to invest in growth-enhancing R&D. We have a strong pipeline of innovation that will continue to fuel our growth.

We are also studying shifts in the industry in both of our business units to anticipate the future of food and beverage and the future of scent in everyday products, so that we can continue to focus our R&D efforts on future growing trends to position IFF well as a strong partner to current and future customers.

Our overall performance this quarter puts us on track to deliver our most recent full-year estimate of 4% to 6% topline sales growth and double-digit growth in adjusted operating profit and adjusted earnings per share. Our outlook for topline growth for the fourth quarter is similar to the third quarter, and given the strong 7% growth we had in total in both business units in the fourth quarter of 2013, our outlook is indicative of improving trends, especially in flavors.

The fourth quarter will also benefit from an additional week in our 2014 financial calendar. We continue to leverage our innovation and technology to sustain our long-term growth performance.

So our key takeaways from this quarter's results are as follows. Our quarter three sales growth of 4% was driven by continued momentum in the emerging markets and solid new win performance.

The strength and diversity of our portfolio in terms of our customer mix, regions of operation, and end-use categories provides us with greater stability and allows us to drive growth in challenging times.

We continue to expand our operating profit margins due to our culture of passion, creativity, expertise, and innovation and a solid execution of our three-pillar strategy. We have leveraged our geographic reach, making emerging markets increasingly more important and valuable.

This quarter, our emerging markets contributed 50% of our sales growth. We are on target to continue to see this percentage grow. We have opened new manufacturing facilities in China and Singapore and have added new creative centers and sales offices in India and Dubai. As Matthias mentioned, we will be opening additional flavor plants and creative facilities in Turkey and Indonesia.

Our global footprint is bigger and better. We intend to win in the emerging markets. IFF is stronger in innovation. Our delivery technologies across both businesses continues to expand, with strong commercial acceptance.

Aromor and IFF have helped each other more than originally envisioned. We are commercializing innovative solutions, such as our proprietary FlavorFit brand and our fragrance encapsulation technology.

We are also partnering with biotech firms to have accesses to sustainable source of cost effective ingredients in both flavors and fragrances. We have continued to support our technology investment priorities by spending a good portion of our money in a very disciplined manner to secure the future and make certain we remain at the forefront of our industry by fueling a pipeline of growth and innovation and making continued investment in consumer insights.

Over the past five years, under Doug's leadership, IFF has been building its current position of strength. We are now poised to take advantage of new opportunities for growth across our divisions and markets around the world.

We have heard from many of our customers that they are struggling in the current environment. We are continuing to grow in line with our expectations. Our continued volume growth is a testament to the innovation, creative capabilities, and consumer insights.

We continue to deliver innovation to our customers, in both good times and more challenging times. It is an honor and privilege to be part of this wonderful organization and I'm looking forward to meeting each of you on the phone or listening via webcast.

A final note before I close. I am very pleased to tell you that IFF will be participating at the Consumer Analyst Group of New York, or CAGNY, conference, which is the largest consumer conference in the world. It is held in Boca Raton, Florida, during the third week in February.

IFF will be presenting on Thursday, February 19, and cosponsoring a dinner that evening. This will be my first investor conference as CEO and I look forward to meeting many of you there.

We are also conducting our biannual investor day on June 2, 2015, to be held at the venue in New York City and we are already gearing up for that event. You will be hearing more about it in the coming months.

We will now open the call up to your questions.

(Operator Instructions) Jeff Zekauskas, JPMorgan.

Good morning. It's Silka Kueck for Jeff. How are you?

Good morning, Silka.

Good morning. Matthias, a couple of questions. The first is what gives you the confidence for positive volume growth in the fourth quarter in flavors, given that you are running up against 7% local currency growth? But even if you could do flat growth, it would be pretty good.

This is Matthias speaking. Thank you very much for your question. While we are still learning the culture, we see definitely a very positive trend for the fourth quarter and we are confident that we will further build on the momentum, which we have built on already in Q3 over Q2. We see positive momentum in North America.

As you may recall, in Q3, we shared with you that we will see some continuous pressure in Q3 in North America, particularly because of [divergence], yet we also see improvements and we are confident that we will see a continued momentum going forward.

Okay. Can you quantify what the effects are of the extra week? Like, either by the segments or for the Company as a whole? Because normally, the rate of sales per week is probably something like $55 million.

And even if it's over the very end of the year and you used half of that amount, that's sort of like 3% or 4% of growth right there. Is that the reason why you are confident about the fourth-quarter sales growth? Or maybe can you just give some thoughts around that?

Sure, Silka. This is Kevin. A couple comments to make as it relates to the last calendar week in any particular year. The sales that normally occur in that last week are very, very limited.

The reason is a variety of things. One of them being the fact that oftentimes, our customers aren't even open to be able to receive shipments that we would be wanting to make. So the last week of the year -- of the calendar week in any year is the smallest week by far as it relates to the particular issue that you are alluding to.

Having said all of that, it's somewhat volatile, because it kind of, depending upon which customers need an extra top off in inventory, which don't, and so there's a volatility in the numbers. And so the benefit is certainly probably less than what you are alluding to.

I would say in general, as both Nicolas and Matthias have already outlined, our comparables for year-ago fourth quarter certainly are very, very strong, and so that's going to play some overall headwinds as it relates to how our numbers will look for Q4 this year.

Having said all of that, we do fundamentally believe that the improving trends in the business, as certainly outlined by Matthias, combined with any of the potential benefits associated with the extra week, which are probably a lot smaller than what you are suggesting -- all of that translates into a -- an in-line quarter, let's say, versus what we have been showing over the last couple.

Okay. If I can ask a last question and then get back into queue, do you have a view yet on what your corporate expenses may look like in the fourth quarter? Do you expect a similar ramp down of incentive comps of a couple of million dollars?

Perhaps we can take it -- a more detailed question off-line, if you would like to go, but I would say that Q4 is probably -- if you are talking about the unallocated piece, it's probably somewhat in line, as we will show lower incentive comps in Q4 versus year ago.

Okay. Thanks very much for answering the questions. I'll get back into queue.

Faiza Alwy.

So I just wanted to ask a question about North America and the relative weakness there, in particular in fine fragrances. I know Nicolas mentioned that the category has been weak, but we haven't really been hearing that too much from any of the large beauty players.

So I'm wondering if there is a timing issue there or what your sense of -- what your sense is of Christmas. And then just generally, I think Andreas had mentioned that the new wins level in North America were lower than historical levels. So if you could just expand on that a little bit, that would be great. Thanks.

Yes, this is Nicolas, and thank you for the question. You're right; there is definitely a sequential performance that we have to take into consideration. If you look at -- or Q1 North America in fine fragrance grew by 29%, which is definitely far above the market performance.

So some customers had ordered early, so I think that we need to take this into consideration, because on a year-to-date basis, fine fragrance in North America is still positive, growing by 1% and globally by 3%.

In addition, I think it is fair to say that some of our customers are facing challenges in different type of [channel of] distribution. And also one key component for us -- we had some disappointing results on a very important launch that took place in 2013, where we did not see the repeat purchase that we had expected.

So if you take the three component into consideration, it gives you a better perspective on the performance in Q3 in North America, more specifically.

Okay. So do you think Q4 is going to improve relative to year-to-date trends?

In North America, Christmas, where you were asking some questions about the Christmas performance. As you know, it's too early to anticipate what consumer will be doing. It will be starting soon. So I think that versus the performance that we had in Q3, it will be an improvement.

Okay. And then do you think your -- what do you think of your new wins level in fine fragrances?

It is strong. Now that the pipeline of new product is for next year, so we have a strong pipeline for 2015 and even 2016, so we are strengthening a strategic partnership with some of our customers and the pipeline of new wins of what we have already secured so early in our period is actually quite strong.

Okay. And then just generally, like I said, Andreas had mentioned that new wins has been below historical levels in North America. So can you just talk about which categories that might be in?

If you look at the performance of consumer fragrance, it has been still very, very good in North America. So if you look at the year-to-date performance -- so I think that it's -- if you look in North America for year-to-date, it's a plus 7%, so I think it shows to the strength of the portfolio.

We have in some pockets in different parts some lower volume of wins, so it's not so much a win rate, but the size of the business which has been secured. So I think that we need to see the absolute performance and relative performance, so we're still very confident about the pipeline of new product and the win rate in relationship to the business we are working on.

Okay. And then Kevin, if I can just ask about the gross margin. I think it was lower than what we had expected and it was down year over year. So is there -- can you just update us on input costs? I know you'd previously mentioned that you were looking to take some pricing next year. If you can just update us on that, that would be great.

Yes, probably not a lot of new news here. Things are trending as we would have been saying over the last couple quarters, actually. So I think at the end of the day, we do see pockets of items that are showing inflation pressure and those are the areas that we're certainly going to be having discussions with customers relative to pricing.

The inflation that we're talking about is a very different level of inflation than what we experienced back in 2011 and 2012. So again, we're talking more modest levels and well within our ability to work with customers on a fact-based discussion, relative to pricing needs to help offset some of those pressures.

As it relates to Q3 and Q4, we always said that our improvement or gross margin profile was going to be moderating in terms of the year-over-year improvement. I think you saw that obviously in Q3 and now it's further challenged in Q3, specifically because of some of the operational items that were alluded to by Matthias.

So at the end of the day, we still feel good about our ability to continue to drive gross margin longer term, but there is certainly some things that we're going to need to work on as it relates to pricing to help offset some of those pressure points that will be further developing as we enter into 2015.

Okay, great. Thank you.

Mark Astrachan, Stifel.

So I wanted to follow up on the last question on gross margins and just sort of think about it bigger picture, longer term. So oil price is down, obviously a positive. The natural piece, I suspect, hasn't really changed that much. But maybe talk about puts and takes of those two, relatively speaking.

And then more broadly, what needs to be done longer term to achieve gross margin expansion going forward -- 2015, 2016, 2017 -- beyond the measures that you have taken already. And holistically, how do you think about gross margins from here and step progression?

And then price increases that you had previously discussed, I think that was probably more on the natural side. Related to the first part of the question on oil versus naturals is if you get some relief there, do you have to give back some of that pricing or is that going to offset prior input cost pressures that you have talked about historically?

Let me take that, Mark -- this is Kevin. So a couple reactions to your question and specific comments. First thing, you're right -- oil has been falling in terms of price points. We're -- I don't know what the numbers are today, but we've gotten close to the $80 figure.

So that will ultimately provide some benefits hopefully to us longer term as it relates to synthetics that are oil derivatives. But keep in mind that those oil derivatives are second and third derivatives and they probably have some impact long term. They don't have immediate impact.

Many of our items as it relates to oil -- for example, freight and whatnot -- are priced through to customers regardless. So if freight costs go up, customers pay for it. If freight costs go down, they get the benefit.

So it's not really -- it's a pass-through cost more versus a -- kind of item that needs to be priced to. So I think that summing up the dynamic as it relates to oils, the naturals still are the areas where we see the pressure points developing, which tend to be focused in certain areas that will require the pricing that we've talked about.

Wrapping that up into a longer-term comment, as we've said historically -- and I think Andreas would certainly agree with the comment -- what's going to enable our ability to continue to drive healthy gross margin is healthy innovation. And if we effectively are able to do that, that translates into our ability to have a robust gross margin longer term.

All of the other things -- opening of plants -- all of these other things will put some pressures potentially on a quarter or two. But at the end of the day, if we can deliver against that innovation, we will see good gross margin levels long term.

Great. That's helpful, Kevin. And then, secondly, so Andreas, welcome, first of all. And I wanted to get your commentary on the M&A outlook.

So progressively, the commentary has changed over recent years. The commentary about going into adjacent categories crept through commentary beginning last year, more so through the summer. What do you think about that broadly?

Obviously, your background is a bit broader than just consumer products from Kevin and other managers in the business, past and present. So how do you think about what that means? Is that still a focus going forward and how do you think about M&A broadly?

Yes. Mark, thank you. Thank you for the question. First of all, I would say we still have a good runway in terms of growth in the F and F business, which I think is important.

But if you look at the F and F business, then you have seen with the Aromor acquisition that we have made a move forward in one of our core areas. And that is certainly always a possibility and we are illustrating basically every quarter what kind of opportunities we have.

But we are not desperate on this front, so it has to be an opportunity which really makes sense for us from a strategic point of view and from the financial point of view as well. I think that's important and we will be very disciplined in executing on M&A. We will not do it at every price.

So that's in the core area. In the adjacent areas, that's something where we certainly look as well, because we have seen that there might be some opportunities in growth and if you look at some of our competitors and you have seen these kind of moves.

But having said all of that, it has to make sense. Sense in a broader picture that it matches with our R&D capabilities. I think that's important, and it should match with our customer segmentation and our customer base as well. So these are the two prerequisites for us.

So in short, certainly, we are looking. We are evaluating our opportunities, but we will be very disciplined in executing on them.

Thanks, Andreas. I just wanted to follow up on what you mean by saying your R&D capabilities. So what do you think IFF does best? What do you think could be areas for improvement?

I would say -- as you know, we are executing on our 10 R&D platforms and I think we are doing very well. I have had the chance in my first two months to spend time in our laboratories with our R&D people and we are looking at -- I think it's really impressive what I've seen here, even with my different -- a different background.

I think we're doing very well. And if you look at some of the innovation which came out of the research that -- like encapsulation technology, I think that's really a best-in-class technology we have here.

So I think we are doing very well. And if I am saying this in the context of an acquisition, then I take just Aromor as an example, because with the collaboration between our chemists and the Aromor chemists, we are coming up now with really interesting solutions and that's even above what we expected.

So when we go for an M&A target, then it should fit into our R&D capabilities as well. Does it make sense for you?

It does, perfect. Thank you.

Lauren Lieberman, Barclays.

I know you talked a little bit about win rates and momentum in the fragrance business, but I was curious as to the same question in terms of flavors and if you're starting to see the impact from commercializing the vanillin innovation?

This is Matthias speaking. Thank you for your question. I would like to outline first we had and we always reported in last two quarters, we have seen significant pressure from our base business on erosion and we partially offset it by very strong new wins.

And we had wins across the regions and also strong wins in North America. These wins will allow us to continue the momentum when we move into Q4.

Coming to your question on our technology on natural vanillin, we have outlined that we will not see the commercial performance before Q1 or Q2 next year. We are right now -- we are working in our labs.

We successfully scaled up in our research labs and our flavorists, they are working in it and building it into the new recipes for our customers. So coming back to your question, I think we will report back to you when we are meeting again or calling again in Q1 next year.

Okay, great. And then I also wanted to just ask in general -- very broad question around the health of emerging markets. I think last quarter, Kevin, you had mentioned some destocking in Indonesia and Southeast Asia.

So I just wanted to just check in on that issue -- has that kind of run its course? Have any other markets popped up as areas of modest destocking?

Hi, Lauren. This is Kevin. I think that the emerging markets are holding firm versus what we saw earlier in the year. And as a matter of fact, you saw the 6% growth, which was in line or improving, actually, versus previous quarters.

So overarching, we feel good about the continued growth opportunities in the emerging markets. Pluses and minuses here and there, but in general, it is still going to continue to be the growth driver, all else being equal.

Okay, great. Thank you.

Curt Siegmeyer, KeyBanc Capital.

Just wanted to follow up on the flavors growth in Latin America with regard to the new business wins in beverage. That's obviously driven some pretty good growth there.

Could you guys maybe give us a sense how that double-digit growth compares to the underlying market in that region and do you feel like you have enough opportunities in that market to continue to outperform, assuming that you are longer term? Or should we expect that level of growth to moderate here going forward?

Thank you, Curt. This is Matthias speaking. We have seen significant new wins -- significant success with new technologies which we have launched, started to launch five, six quarters ago. We saw very good momentum and we do see continued good strong momentum with new wins coming in.

I cannot tell you exactly what the underlying market growth will be. We reckon it's going to be in the area of 4%, 5%. And we're very pleased with the performance which we have.

I'm confident we will see a strong momentum going into Q4 this year. And we are excited in the project pipeline which we have and we are really very pleased that we can make a significant difference with our technology programs in Latin America.

Great. And then just a follow-up, if I could also. In the flavor segment, you talked about the plant costs that you guys dealt with in the quarter. Do you have a sense where margins would have been, excluding the absorption issues in the new plant costs?

And you mentioned sort of a moderation in fourth quarter's. Should we maybe expect this to be behind us by the time first quarter rolls around or should the issues continue to persist somewhat?

Yes, Curt. This is Kevin. Let me take that. I think that if you think about some of the issues that we saw in Q3, we think there will be a lessening impact as it relates to some of those issues going forward.

But certainly, the investments in the new factories and the cost structures that will be coming on board as it relates to those new plants, obviously that's going to be there. So we still feel good about the long-term historical algorithm relative to gross margin, which, again, is driven by the innovation comment that we were talking to earlier.

That is still a picture that we like and we support and believe will happen long term. There will be some improvements in the short run as it relates to probably some of the items we saw in Q3 will not repeat and some of the other items that will continue to be a tail -- a headwind that we're going to just have to overcome through good productivity and innovation longer term.

Great, thanks a lot.

Jonathan Feeney, Athlos Research.

Kevin, you gave us a couple of helpful details, particularly around research and development spending being down a little bit. I'm wondering if you decline in maybe the prospects, medium term, for developed markets -- not for emerging markets, but for developed markets.

Maybe -- if that is given you an opportunity to maybe spend a little bit less on R&D over the next couple of years and with -- aside from that, are there any other areas of incremental cost savings -- and I'm talking just at the margin over the past six months -- that have maybe cropped up because of the underperformance in maybe the prospects for a developed market business in both -- and particularly in flavors, but really, mainly in flavors, but also maybe in fragrances too, given the weaker consumer environment? Thank you.

Thanks, Jonathan, for the question. Kevin here. I guess the first comment about R&D is the commitment to spend on future innovation remains steadfast. And at the end of the day, while R&D may have been year over year not a big increase or maybe even flattish or in the range of that number, the bottom line is that's driven more by some investments we were making last year relative to some of the R&D initiatives that we had, which had milestone payments, and not a fundamental change in terms of our commitment level.

So at the end of the day, our research and development continues to be an area we focus on. It continues to be an area that we believe is going to be a fundamental driver to our success today and in the future. And so at the end of the day, it's an area that we will continue to support.

Now to your bigger question relative to cost, look, I think at the end of the day, we are always evaluating any ways to be more cost effective and productive as it relates to our spend. And to the extent that there are those things, we continue to be disciplined in terms of the management of our short-term costs, at the same time ensuring that we are supporting our long-term growth outlook.

So a little bit long-winded, but that effectively means is when we do see pressure points in a short-term basis, we are diligent and disciplined in the management of our cost, have recognized those pressures, but without sacrificing the long-term growth aspiration, which even for the developed markets we think is still robust.

Thanks, Kevin. If I could ask one more detailed question. It seems like a lot of the capital spending and spending in general has been outside the US. You mentioned some repatriation expenses. Are those typical -- in your tax rates, are those typical or what kind of drilled that at the margin? That's it. Thank you.

As you think about the CapEx, yes. The investments -- I'm going to call them outside of the US, certainly, and more emerging markets. So it's more than just being outside the US.

It's really more emerging market-focused, associated with our drive to ensure, as Andreas mentioned, that we're going to win in the emerging markets. It's certainly a core plank of our strategy -- a pillar of our strategy.

As it relates to servicing buybacks or servicing dividends, to the extent that we want to do that, that continues to have a requirement that the cash that is generated across the world outside of the US is some percentage of it is brought home and combined with any cash for benefits we have here to be able to supply that.

And that's really what it's driven by. So to the extent that we continue to have opportunities to bring that cash home, we do.

Thanks very much.

John Roberts, UBS.

Welcome, Andreas. Yes. Kevin, I think this is the seventh time the R&D tax credit has initially been dropped, but it's always been retroactively put back in. Assuming that happens again, what would that do for your fourth quarter?

I don't know the numbers off the top of my head, but it would be certainly a headwind.

Okay.

I would say it's probably at least $0.03, $0.04.

It would be a tailwind, wouldn't it? You would get -- it's accrual. It would go back in.

I'm sorry, tailwind.

Yes, thank you. And then how is Aromor itself doing? You talked about how much it's added to that, but if you looked at Aromor by itself, is it up meaningfully year over year or had much higher margins as part of IFF, now that it's being integrated?

It is very much in line with what our expectations were. And if anything, the benefits as we're talking about relative to technology is about the ability to drive incremental value long term, which is actually very much part of why we did the deal and very exciting.

Perhaps Nicolas, you might want to add a comment?

Yes. Here, it's Nicolas. Also one of the key benefit of Aromor and the reason for the acquisition is the ability to drive higher win rate over time in our compound business, because we will gain access to their unique materials, had very attractive cost structures.

So really, the end game is to accelerate our growth in our compound business and also with the collaboration between our R&D and the very strong R&D team at Aromor to accelerate the pipeline of new molecules.

And then lastly, in fabric softener encapsulation, have the new wins been recent enough that this will carry forward for a few more quarters or do we start comping more difficult quarters sometime soon?

I think that the momentum do to our expertise in driving consumer preference with our fragrances but also in combination with our unique technology is providing us a very good pipeline moving forward. It's solid and now really the upload is how do we leverage the technology across all the categories. So the pipeline is strong, the win rate is strong, and we are not expecting a slowdown in that respect.

Thank you.

So operator, this is Kevin. Perhaps we can cut it there. We are past our end time. Let me turn it back over to Andreas for any final comments.

Yes. Thank you, Kevin, and thank you all for your time and the questions. And we will have our fourth-quarter earnings release at February 12 next year. And I hope that we see many of you during the CAGNY conference in February 19 in Boca Raton.

So thank you very much for your participation. Thank you and have a good day.

This does conclude IFF's quarter-three 2014 earnings conference call. You may now disconnect.