International Flavors & Fragrances Inc (IFF) 2012 Q4 法說會逐字稿

At this time, I would like to welcome everyone to the International Flavors & Fragrances fourth-quarter and full year 2012 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 of Investor Relations. You may begin.

Thank you, Jennifer. Good morning and good afternoon, everyone, and welcome to IFF's fourth-quarter and full year 2012 conference call. Earlier today, we issued a press release announcing our fourth-quarter and full year 2012 financial results. A copy of the release can be found on our website at ir.iff.biz. Please note that this call is being recorded live and will be available for replay for up to one year on our website. Before turning the call over to Doug Tough and our Senior Management team, I'd like to read our forward-looking statement.

Please keep in mind that during this call, we will be making forward-looking statements about the Company's performance, particularly (technical difficulty) fourth quarter and full year 2012 and our outlook for 2013. These statements are based on how we see things today and contain elements of uncertainty. For additional information concerning factors that could cause actual results to differ materially from forward-looking statements, please refer to our forward-looking statements and risk factors contained in our 2011 10-K filed on February 28, 2012 and the press release 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. 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 on our website. For those of you who are new to our conference calls, I would like to introduce the participants on the call. With me today is Doug Tough, our Chairman and CEO; Nicolas Mirzayantz, our President of Fragrances; Hernan Vaisman, our President of Flavors; and Kevin Berryman, our Executive Vice President and CFO. Now I'd like to turn the call over to Doug Tough.

Thank you, Shelley. Good morning and good afternoon to everyone. Our focus on the call this morning is to provide an overview of our fourth-quarter and full year operating performance, give you an update on our strategy, take you through a review of each of our business units, and provide our current outlook on 2013. After the prepared remarks, we will leave time for your questions. Turning to the fourth quarter, we achieved local currency sales growth of 8%, which continues the accelerating growth momentum we have seen in each quarter this year. If we exclude the impact of the exit of low-margin Flavors businesses to get a more consistent year-over-year comparison, then on a like-for-like basis, we achieved 10% growth, which is the highest we have achieved since the third quarter of 2010.

This broad-based growth across all categories and regions was due to strong new-customer wins in both business units, as well as growth in our base business, owing to our ability to create consumer preferred flavors and fragrances. Once again, our growth was buoyed by double-digit growth of 11% in the emerging markets, which accounted for 49% of sales in this quarter, up from 47% last year, as well as 6% growth in the developed markets. If we exclude the impact of the exit of low-margin Flavors business to get a more consistent year-over -year comparison, then on a like-for-like basis, we achieved 10% growth, making this the highest performance we have achieved since Q3 of 2010.

Looking at our growth by business unit, our Fragrance business delivered 13% growth this quarter, and our Flavors segment achieved 7% like-for-like growth. Our top-line performance says a lot about the progress we have made this year in finding new and better ways to serve our customers and provide them with innovative products that are desired by consumers all around the world. Our ability to deliver strong top-line performance demonstrates the diversity of our global organization, our ability to work with regional and global customers, and our continued focus on innovation.

Importantly, our gross margin performance increased 430 basis points over the year-ago quarter. This reflects our strong volume growth, increased manufacturing leverage and volume gains, as well as portfolio optimization through the exit of low-margin Flavor sales activities. In addition, this quarter, the net positive impact of price in relation to input costs resulted in margin expansion. Raw material costs, however, remain at historically high levels, and on a year-to-date basis are up nearly 4%, and over the past two years, they are up 14%.

The strong top-line performance also allowed us to achieve adjusted operating growth of $8 million, or 9%, and adjusted EPS growth of 12% this quarter to $0.83 per share. Our local currency sales, operating profit, and EPS growth are in line with our long-term growth target. Importantly, the strong top-line growth we achieved in the fourth quarter of 2012 enabled us to meet our long-term local currency sales growth targets for 2012. Looking at our total performance for the full year 2012 and on a two-year and three-year average to reflect long-term trends, we have achieved our top-line growth targets of 4% to 6% for the consolidated Company on a one-year, two-year and three-year average basis.

Total Company growth was supported by solid performance from Flavors, despite the impact of discontinued sales activities and strong growth from Fragrance Compounds. On a three-year average basis, which combines our strong performance in 2010 with more modest performance levels in 2011 and '12, our three-year average growth is 8% for both Flavors and Fragrance Compounds. Fragrance Ingredients growth has been pressured over the last few years and has had a negative impact on the Fragrance business and on our total top-line performance. Still, on a three-year basis, our Fragrance business achieved 6% local currency growth.

Before turning the call over to Nicolas and Hernan, who will provide you with an update on the progress of the Fragrances and Flavors business units, respectively, I would like to provide some perspective on the progress we have made executing our strategic priorities. We have a clearly articulated corporate strategy, and we are focused on driving the business forward using three guiding strategic pillars. Firstly, we want to accelerate our growth in the emerging markets by expanding our manufacturing footprint, increasing our understanding of local customers, and providing technical expertise to markets outside the United States.

Secondly, we want to strengthen our innovation platform to drive profitable growth by focusing on consumer trends, commercializing new ideas and products, and working with biotechnology firms to create sustainable products. And thirdly, we look to maximize our product portfolio to improve returns to our shareholders. We do this by focusing on margin-enhancing opportunities and by consistently analyzing and monitoring categories and looking for opportunities to increase profitability-enhanced returns.

As a global Company, over 75% of our sales are from outside the United States. IFF has had a presence in many of the emerging markets for over 50 years. We are well-indexed in emerging markets and continue to invest in manufacturing capacity and creative applications and sales offices in these markets to better serve global and local customers in the regions. As a result, we have benefited from the growth that is coming from providing consumer products to the global population that can now afford to buy consumer packaged goods. Our sales in the emerging markets grew 8% in 2012, and for the full year -- now represent 47% of our global sales, up from 46% last year.

To align our infrastructure to support our projected capacity requirements, in September of last year, we opened a new liquid Flavors and Fragrances facility in Singapore, and we expect to complete construction on our Flavors-dedicated facility in Guangzhou, China in the first half of 2013. In June, we opened a new facility in Delhi, India to house creative, technical, sensory, and sales professional for the Company's Flavors business unit. These investments underscore our long-term belief in the region, as well as the strength of our local IFF teams. We also announced a $50 million investment to expand our facility in Gebze, Turkey, which will serve the growing markets of Southeast and Central Europe and Africa. We expect the first phase of the expansion will be completed in the first half of 2013.

Through these investments, we have been able to optimize our manufacturing footprint, collaborate with our customers on a more global basis, and grow with our customers in the emerging markets. Strengthening our innovation platform continues to be most critical for future success. Innovation is a key growth driver and cultural imperative for IFF. Throughout our history, IFF's patented technologies and captive molecules have been game-changers for us, our customers, and the industry. This year, we aligned our innovation programs around key R&D platforms, each of which addresses a consumer need or anticipates a future preference. By aligning our resources around these platforms, each program is ensured the proper support and focus that it needs so that it can be further developed and eventually be accepted for commercial application.

We have a robust pipeline of new R&D products, and we are working to make each of them commercially viable, either through our own internal R&D efforts or working with partners who specialize in these areas. We issued a press release earlier this week on the successful outcome with an outside partner, Evolva Holding, in the preproduction and scale-up of a natural, sustainable vanillin through a biosynthetic group. Vanillin is a key flavor ingredient in many food products, so a dependable source should be welcome by our customers. Hernan will tell you more about this joint-development project.

The Scientific Advisory Board, announced in early 2012, has been fully active for one year. The Board is comprised of five scientific talents and are well-respected experts in their fields. They provide regular reviews of our ongoing initiatives and guide our development efforts. They have proven to be a very active and engaged Board, and their insights to-date for us have been invaluable.

Focusing internally, we continue to look for ways to improve returns with rigorous economic value analysis, by evaluating resource allocation, by category, by customer, and by region across both of our businesses, thereby appropriately aligning resources behind our advantage portfolio and reducing the costs associated with our negative economic profit businesses. This year, we implemented the realignment of our Functional Fragrance business to strengthen our ability to win new customers and business, expedite decision-making, and continue to deliver preferred customer fragrances.

We also exited approximately $28 million of low-margin sales activities in our Flavors business, which resulted in gross-margin expansion, both for Flavors and for the total consolidated Company. We have ingrained the concept of economic profit throughout the organization, which is helping to drive better resource allocation. By focusing on those areas that are most profitable to IFF, we believe we will increase the Company's profitability and better align resources with appropriate programs.

I will now turn the call over to Nicolas and Hernan, who will provide you with an update on the progress of our business units during the quarter and for the full year, and then to Kevin Berryman, our CFO, who will provide an overview of our financial performance. After their respective sections, I will give you some perspective on the outlook for 2013. And with that, I would like to introduce Group President of Fragrances, Nicolas Mirzayantz.

Thank you, Doug. And good morning and good afternoon, everyone. Fragrance performance was very strong in the fourth quarter, with double-digit sales growth and improving profits. Due to record-breaking new wins in Fragrance Compounds, including Fine and Beauty Care and Functional Fragrance, combined with a strong underlying growth in the base business, fourth-quarter reported sales increased 10%. Excluding the impact of local currency, Fragrance growth was 13% and was the highest local currency sales growth we have achieved in any quarter since the third quarter of 2010.

In line with our strategy of leveraging our geographic reach, 53% of our fourth-quarter Fragrance Compound sales were from the emerging markets, which grew at 17%. Brazil continues to be one of our leading markets and had a strong double-digit growth this year. Excluding Ingredients, Fragrance Compounds grew 15% this quarter due to strong growth in every region, led by Latin America. Globally, we have strengthened our [quarterly] participation and are very well-positioned for new business growth.

Our innovation platforms, including our encapsulation technology, drove double-digit growth this quarter in Fabric Care. We are a pioneer in developing this technology and continue to strengthen our leadership by leading the charge in term of exploring new application for its use. We are working with our customers to introduce encapsulation in other categories and regions. In total, products using our encapsulation technology had double-digit growth this quarter, and we have a very strong pipeline of new wins.

Our Fine and Beauty Care category, which includes Fine Fragrance, Toiletries, and Hair Care, grew by 19% this quarter, driven by strong growth in Latin America, North America, and EAME. Fine Fragrance had double-digit growth due to continued success in driving new launches in Latin America, North America and Europe, including Lancome La Vie Est Belle, Bath and Body Works Cashmere Glow, and [Naturals kyaqueorbin]. Both Toiletries and Hair Care had also double-digit growth and contributed to overall strong performance. Our Functional Fragrances sales grew by 12% this quarter. This was our eighteenth consecutive growth quarter in Functional Fragrance, led by double-digit growth in Greater Asia and LatAm and double-digit growth in Fabric Care in Europe.

Turning to Fragrance Ingredients, which has been challenged this year, we saw positive growth of 6% due to short-term customer order patterns. We expect that Fragrance Ingredients top line will continue to be pressured, especially in high-volume commodity products, continuing the trend we have seen on our external portfolio, which now accounts for just under 10% of total Company sales. As we mentioned last quarter, we expect to see some Fragrance Ingredients volume migrate to Compounds during 2013, which will be higher value-add for our customers.

We were able to retain this business due to our vertical integration and unique expertise in providing both security of supply and sustainable solution that support our customers' growth objective. We expect the migration of this Ingredients volume to Compounds to put significant pressure on our Ingredients top-line growth in 2013. As we have said in the past, Ingredients is a strategic business for us, and we will continue to invest in this business, especially in higher-value specialty chemical area, while at the same time ensuring that we maintain a cost-effective portfolio, particularly in the price-sensitive commodity components.

Turning to the full year, the Fragrance business grew by 3%. Our Compound business grew by 7% with equal contributions from both Fine and Beauty Care and Functional Fragrance due to our platform of innovation and our ability to proactively provide our customers with solutions based on the strength of our creative, consumer insight, and research and development teams. The Fragrance business contributed to the consolidated Company's ability to deliver sales growth in line with our growth targets for the third year in a row. Importantly, the emerging markets accounted for 51% of our full year Fragrance Compound sales, which exclude Fragrance Ingredients. It is worth noting that 2012 was another record year for Fragrance, and we have achieved very solid momentum in many areas of the business.

From a profitability standpoint, segment operating profit increased $16 million, or 44%, to $53 million in the fourth quarter, from $37 million in the fourth quarter of 2011. As you know, our raw material costs have significantly increased for the last eight quarters, up 14% for the consolidated Company and even more for Fragrances. Today, they remain near historical levels. To protect our bottom line, we initiated both external and internal actions, including price increases, operational and commercial restructurings, and numerous other efficiency programs. Despite these efforts, the net impact of rising material costs have negatively impacted our margins.

In Q4 2012, we realized our first reduction in raw material costs. Also, the decline was small when combined with strong volume growth and improved mix of business, efficiency savings, and pricing, our operating margins increased this quarter. Turning to the full year, Fragrances generated segment profit of $238 million, or an increase of $11 million, compared with $227 million in 2011. Looking ahead, we are very encouraged by the strong new level of wins, our increased [core] participation, and the strength of our [increasing] volume, but are expecting a more moderate level of growth in the first quarter of 2013.

As for Fragrance Ingredients, in the first quarter of 2013, we expect top-line growth to remain under pressure, especially in the high-volume commodity area. I would like now to turn the call over to my colleague, Hernan Vaisman, our President of Flavors.

Thank you, Nicolas. Good morning and good afternoon, everyone. Flavors had a nice quarter of growth, marking our 28th consecutive quarter of local currency sales growth. On a like-for-like basis, which excludes the impact of exiting low-margins activities, we generated strong local currency sales growth of 7%. Our growth this quarter was reduced by 3.5 percentage points due to the exit of low-margin sales activities. Although this put continued pressure on the top-line growth, it had a favorable impact on gross margin for both Flavors and for the total Company and has helped us to improve the profitability of our overall portfolio in line with our strategy.

This quarter, our performance was supported by strong growth in North America, which delivered like-for-like local currency sales growth of nearly 15%, as well as strengths in emerging markets. Greater Asia, Latin America, and EAME delivered solid growth this quarter. Our like-for-like growth in North America of 15% was once again led by double-digit growth in Beverage. In EAME, we grew by 6% due to moderate growth in Beverage and Savory. Greater Asia, our largest region, delivered 5% like-for-like local currency sales growth, led by double-digit growth in Dairy and high single-digit growth in Savory. In Latin America, local currency growth on a like-for-like basis was 6%, led by double-digit growth in Beverage and positive growth in Savory. We continued to make progress in this region working with our regional customer to improve sales momentum in Latin America.

Turning to the full year, we delivered strong local currency sales growth of 8% on a like-for-like basis. This marks our third consecutive year of high single-digit sales growth, contributing to the consolidated Company's ability to deliver growth in line with our stated consolidated growth target of 4% to 6%. Flavors growth was supported by increased traction from [priorities] in our sweetness modulation and masking technologies. The use of innovative technologies help our customer create products that they stood out in their markets.

Early this week, we announced the next phase of our relationship with Evolva. We are entering the preproduction phase to develop and a scale-up via third party natural vanillin for commercial application through a cost-effective natural and sustainable route. We are very pleased with our partnership and believe that the program with Evolva will increase the availability and sustainability of vanillin, which is a key flavor ingredient in many food products. We continue to work with R&D and creative teams to commercialize products that will provide us with a competitive edge in the market. We believe have found such a product in our collaboration with Evolva. I would like to add a final word on the managed exit of our low-margin sales activities. As we have noted, we expected the financial impact of these efforts to be done by the first half of 2013.

As a result, we will expect that our sales growth in the second half of the year would be stronger than the first half of the year due to the elimination of this impact. It should be noted that even with the impact of the discontinued sales, we are showing consistent solid growth level due to the underlying strength in the portfolio. Turning to our profitability this quarter, as Nicolas mentioned, this marked the first quarter in over two years that we realized declining raw material costs, which when combined with a more favorable category mix and the exit of low-margin sales activities, supported gross margin expansion. Raw material costs, however, remain elevated on a year-to-date basis and have had a negative impact on year-to-date margins.

The favorable gross margin was upset by increased incentive compensation expenses and resulted in the Flavors' fourth-quarter segment profit decrease of $1 million to $62 million this quarter. That said, on a full year basis, like-for-like local currency sales of 8%, combined with gross margin upside, resulted in Flavors' [seeing a] profit of $298 million, an increase of $14 million, or 5% from the prior year.

Looking ahead, the first quarter of 2013, we can see a more moderate growth level as we enter the quarter, and we are closely monitoring the situation. However, our underlying sales growth remains strong, driven by a strong pipeline of new business wins using our Sweetness and Savory (technical difficulty) [modulation] tools and other innovations. We are excited about our many collaborations, which are all based on creating value for consumers in every region of the world. With that, I would like to turn the call over to Kevin Berryman, our CFO.

Thank you, Hernan. And good morning and good afternoon, everyone. Turning to our quarter results, reported revenues for the fourth quarter totaled $681 million, compared with $644 million in the prior year quarter, or an increase of 6%. Our local currency sales growth increased 8%, as currency translation reduced our reported sales by 200 basis points in the quarter. On a like-for-like basis, our sales growth was 10% in the quarter. Our gross margins were 42.2% this quarter, up from 37.9% in the prior year, or an increase of 430 basis points.

The improved performance was due to favorable manufacturing leverage supported by strong volume growth; ongoing cost-savings initiatives; an improved sales mix, including the benefits of exiting low-margin sales activities in Flavors; and the continued benefits of pricing, which helped to offset the continued high level of input costs.

The strong sales and gross margin improvement in the quarter also resulted in higher levels of incentive compensation provisions in the quarter, resulting in research, selling, and administrative expenses being higher than normal levels and certainly well above last year when incentive compensation provisions were abnormally low. Our sales strength and gross margin expansion, however, more than offset these increases.

As a result, our adjusted operating profit increased 9%, or $8 million, to $99 million in the quarter. With interest expense down slightly year-over-year, and a lower effective tax rate due to a lower cost of repatriation, and reductions in tax provisions, we were able to drive a 12% increase in adjusted EPS growth to $0.83, up from $0.74 in the fourth quarter of 2011. To provide additional perspective on the underlying sales growth momentum in our business, we are including a graph of our quarterly like-for-like growth by business unit and for the total consolidated Company.

This graph highlights a sequential improvement we have achieved in our business in each successive quarter of the year buoyed by a strong level of new wins and an improvement in the growth of the base business. On a consolidated basis, our total Company like-for-like growth showed increased momentum in every quarter, from 1% in the first quarter to 5% in the second, 7% in the third, and finally to 10% in the fourth quarter. For the full year, total Company grew by 5% on a like-for-like basis. Importantly, this is the third year in a row that we have met our long-term local currency sales growth target.

Looking at the business units, Flavors has shown strong and consistent growth every quarter when eliminating impact of exiting low-margin sales activities. On a like-for-like basis, Flavors' sales growth ranged from 6% in the first quarter to 9% in both the second and third quarters. For the full year, flavors like-for-like growth was 8%.

Turning to our Fragrance business, an improving growth trend in our business was seen in every quarter, buoyed by new business wins and an improving growth trend in the baseline business, combined with some pricing to recover raw material price increases. This year, Fragrance declined 3% in the first quarter, was flat in the second, but then grew by 5% in the third and 13% in the fourth quarter. For the full year, Fragrance delivered 3% local currency sales growth.

Importantly, when further evaluating incremental growth momentum for Fragrance, it was largely driven by the combined results of our Fine and Beauty Care and Functional businesses, or the Fragrance business excluding the Fragrance Ingredient sales. The improving trend here was also impressive, as growth trended up consistently over the course of the year from minus 1% in Q1 to 15% in Q4. As a result, for the full year, both Fine and Beauty care and Functional grew by 7% in local currency sales.

To illustrate our strength in the emerging markets, I would also like to highlight the trend in our shifting sales mix from the developed markets to the emerging markets over the past three years. As you can note, the percentage of sales to the emerging markets has increased from 44% in 2010 to 46% in 2011, and finally to 47% in 2012. Importantly, during Q4 of 2012, at least 50% or more of our sales in our Compounds businesses, which are those businesses excluding our Fragrance Ingredient sales, were to the emerging markets.

Specifically, in Q4, the emerging markets accounted for 50% of all Flavor sales and 53% of our combined Fine and Beauty Care and Functional sales levels. At this rate, we believe we are well on track to have more than 50% of our total sales come from the emerging markets by 2015, consistent with the strategic objectives we have set for ourselves as part of our focus to leverage our geographic reach.

Turning to raw material costs, as you know, we have been closely monitoring our input costs. And this is the first quarter in eight quarters where we have actually seen them decline, albeit a modest level, down less than 2%. While that was nice to see, as many of you already know and which has been mentioned already, we have faced significant input [cost pressure] over the last two years. In fact, over the last two years, we have seen our input costs rise 14%. While both businesses faced significant cost pressure, it was most significant in Fragrances, where strong increases in naturals, petrochemicals, and feedstock ingredients drove strong double-digit increases in input costs.

Nevertheless, our gross margin improvement versus year-ago for the quarter and full year was 430 and 210 basis points, respectively, and was driven by strong innovations, improved product mix, cost-savings initiatives, and the exit of low-margin sales activity. Importantly, with the recent margin expansion, our margins have now recovered back to levels we saw in 2010 before the raw material costs began to rise. And the net benefit of pricing, input costs movements in the fourth quarter represented actually less than one-third of the total improvement in gross margin for this period. Simply put, advances in our gross margin for both Q4 and for the full year are fundamentally being driven by our execution against our strategy, which calls for driving innovation, optimizing our portfolio, and driving efficiency in everything that we do.

Looking ahead to 2013, based on our current outlook, we expect raw material costs to be relatively benign, which will result in costs that are flat to slightly increasing. From an overhead cost standpoint, adjusted research, selling, and administrative costs, or RSA costs, as a percentage of sales increased 380 basis points this quarter to 27.6%, up from 23.8% of sales in the prior year quarter. This increase reflects higher incentive compensation provisions this year due to achieving stronger volume growth versus expectations in Q4 and its impact on our performance versus our full year targets.

As a result, the fourth-quarter RSA expense contains incentive compensation provisions above more normalized levels and certainly well above last year, when provisions were abnormally low. Excluding the impact of the increased incentive compensation accrual for the current year quarter, adjusted RSA as a percent of sales would have actually fallen versus a year ago. This would result in a more normal level of leverage associated with our business model, whereby our growth would result in improved absorption of our fixed cost structure. Importantly, R&D investments continue to increase in support of our strategic pillar to our enhance innovation efforts.

Regarding foreign currency impacts, in the fourth quarter, foreign currency had a 200 basis point impact on top line but a limited impact on our bottom-line performance. Importantly, due to our cash flow hedging activities, there was limited impact on the fourth-quarter year-over-year operating profit margin. In short, our exposure to euro volatility in 2012 was significantly reduced as a result of our hedging efforts. Looking ahead to 2013, we are now nearly 80% hedged against the euro levels that approximate $1.29, effectively a rate that is consistent with the average exchange rate level for the full year 2012.

For 2012, cash flows from operations were $333 million, or 11.8% of sales, compared with $189 million, or 6.8% of sales for 2011. Of note, the cash flow in 2012 includes $105 million payment related to the Spanish tax settlement announced in Q3 of 2012. Cash flow from operations in 2011 includes a $40 million payment for a patent litigation settlement. If you exclude these aggregate payments from both years, our operating cash flow would have nearly doubled from $222.5 million to $438.5 million, a clear indication of the strength of our operating model. Our strong operating cash flow provides us with the ability to continue to make targeted investments in the growth of our business, targeting those projects with the greatest return while also returning cash to our shareholders.

This year, we made capital investments totaling $126 million, or nearly 5% of our sales, including new facilities in Singapore and China. We expect to have a similar level of spending as a percent of sales in 2013. In 2012, we also increased our quarterly dividend by $0.03, or nearly 10%, to $0.34. And in the fourth quarter, we paid out our dividend, that is usually and typically paid in January, in December. We announced a $250 million stock repurchase program, which will enable the Company to purchase nearly 5% of its outstanding shares based on the market price of our shares on December 31, 2012.

Finally, it is important to note that the cash flow conversion rate, measured as the conversion of net income into operating cash flow, and adjusting for the payments related to the patent settlement in 2011 and tax settlement in 2012, increased in [2012] (technical difficulty) [1.3] times from 0.7 times in 2011. On this basis, looking at a two year average, our operating cash flow to net income conversion rate is at a healthy 1 times. In summary, 2012 was an exciting year for IFF. We delivered broad-based top-line performance led by growth in the emerging markets. We were able to achieve local currency sales growth in line with our long-term targets for the third year in a row due to stability of our business in which diversification of categories, products, and customers supported our performance.

Our ability to anticipate consumer preferences with innovative products, such as those using our sweetness and sodium modulation tools and flavors, or those using our encapsulation technology in Fragrances, were critical drivers to our new-win successes. Our gross margin expansion was due to many different factors, including our operating leverage; continued cost discipline and cost-reduction efforts; strong innovation; improved product mix, including the exit of low-margin sales activities; and continued pricing actions to help offset the high level of input costs. Importantly, the operating results we achieved this year enabled us to invest in our business growth and to make changes in our capital structure.

We have invested and continue to invest in additional capacity and creative centers in the emerging markets of Asia. We are building a facility in Turkey, and we'll look for other opportunities to add capacity in those markets where changing demographics result in increased demand for customer products. We continue to invest more than 8% of sales annually on R&D programs, and as a result, we have a very strong pipeline of products based on our key R&D platforms. The business generates strong cash flow, and our quarterly dividend and authorization of a $250 million stock buy-back program are indications of our confidence in the future. With that, I would like to turn the call over to Doug for his outlook on 2013.

Thank you, Nicolas, Hernan, and Kevin. We are pleased with the progress we have made over the past few years in driving growth across both businesses based on our technology. While the business is both diverse and stable, reflecting its focus on consumer products, it is also growing as the emerging-markets middle-class population expands and increases their use of consumer products. The defensive and growing nature of our business, combined with our customer intimacy, innovation, and consumer insights enabled us to deliver solid results in a challenged environment.

Although we are mindful of economic volatility in various parts of the world, we are confident that based on our diversification, we will be able to offset softness in one part of our business with strengths in another. The accelerated momentum we see in the Flavor and Fragrance Compounds business is fueled by the strategic investments we have made in the emerging markets over many years, combined with our ability to provide customers with products that meet and surpass consumer expectations and lead to market-share growth for both our customers and for us.

We are committed to driving the business for the long term, creating new and innovative products that will appeal to consumers all over the world, and collaborating with global and local customers to bring these products to market. Given our progress on a number of value-enhancing initiatives, we expect our gross margins will continue to trend above year-ago levels. We have a committed and dedicated group of people whose mission is to see the Company succeed. We are pushing ahead to meet our internal financial objectives and have been able to deliver top-line growth in line with our long-term targets due to our diversity and our ability to provide value to consumers year after year in every region.

We have a robust R&D pipeline, which should provide us with longer-term growth while providing us with sustainable raw materials at lower costs. We are implementing our plans to make our Ingredients business more competitive, and we intend to provide you with an update on that business on our next earnings call. For the full year 2013, we expect the Company to achieve its long-term financial growth targets. For the first quarter of 2013, we expect to see continued local currency sales growth in Flavors, offset in part by the continued acceleration and exit of low-margin sales activities. In Fragrances, we expect momentum to moderate in Fine and Beauty Care and maintain solid growth in Functional. While we expect to see improved volume trend in Ingredients for the full year, we still expect year-over-year declines in the first quarter.

In conclusion, our strong performance at IFF this quarter is the result of our geographic footprint, our product diversity, and our ability to work with customers to develop new products that help shape the industry and delight consumers. We are well-positioned in the market, and we are selectively reinvesting in those areas where we see the most growth. Going forward, we expect continued momentum and growth. We will continue to proactively manage our performance and calibrate costs in line with our top-line growth as we continue to execute against our business plans. We will continue to focus on excellence in the execution of our strategies. I thank you all for your participation, and the Management team will be pleased to take any questions you may have.

(Operator Instructions)

Mark Astrachan, Stifel Nicolaus.

Thanks, and morning, everybody. A couple of questions for Nicolas and Hernan, broader strokes in terms of thoughts about what they are seeing in specific regions around the world in terms of pockets of strength, weakness? Specifically for Nicolas, there was a big increase in Latin America Fragrances in the quarter. If could you talk a bit about what contributed to that and how much of that should or will continue? That would be helpful. Thank you.

Mark, good morning. It's Nicolas. Mark, for your comments on Latin America, I think it is fair to say that we continue to strengthen our leadership on the market. As the market is growing, significant number of new consumers coming to the market and entering these categories. So we see an increased activity in terms of the retail market increasing, players going, entering new categories, new channel of distribution. So you should combine all this momentum and our strong strategy partnership we have in the region, we are enjoying more than our fair share of the growth of the market, so we continue to strengthen our leadership. Obviously, the growth was more significant than we expected in the fourth quarter, but right now, the pipeline of new wins and the continued activity in the market would indicate that we will continue to see good momentum going into 2013.

Mark, we have a mixed-bag situation. We started the year with Greater Asia delivering good growth at this point in time, but we're seeing other areas like a western Europe and even eastern Europe, that this production platform for western Europe, some kind of slow-downs and softness there. In US, we still see good growth, and in Latin America, gaining momentum. We are confident that why we believe that this is kind of moderate growth due to the discontinued business. We are on the right path. I think that really makes us very confident. We have a strong pipeline of projects in-house.

Mark, this is Kevin. Just one quick additional comment. I think that if we look at the broad portfolio across a lot of different regions, there was actually good, solid growth in a lot of countries. There was some stand-outs. Obviously, you picked one of them. But we saw some good, solid growth across a broad swath of countries and regions. We were pleased with that performance in the fourth quarter.

Thanks, guys.

Lauren Lieberman, Barclays Capital.

I wanted to know if you guys could talk a little bit about the Evolva partnership? A little bit of why it is important with this particular ingredient? Has it been a particular source of inflation? Has quality been an issue? Have there been shortages? And when you expect, presumably, if the scaling-up goes up well, when that will be commercialized and start to impact your business? Thanks.

Lauren, you explain pretty well all. Basically, it's a very important flavor ingredient. To give you a kind of magnitude, if you think where potential of the market is [$10 billion], the first four, five flavors, one is vanilla. So this is one of the component of these kind of flavors profile. It's a very expensive raw material. Has a high volatility in the market. You have always problems in sourcing. So by doing that, we will be able to first have a very sustainable way of getting this product in a very cost-effective and sustainable way. I think that this is the key element of this partnership. We are really really exciting and we are really close to get -- we think if we can -- if we will be able to be successfully -- scale-up, manufacture, we will have the first [say 10% of market] by the end of this year. If it's growth that we expect, Lauren, I think we will see some good results by early or mid-2014.

Is the assumption that this will happen already in your numbers for the end of this year, or no?

No, I think that it is too early to say, because whenever you go to the market, Lauren, you have to go to samples. Customers need to taste the products, and only just after that start going to launch in the new or [existing environment]. So, that's why we are not contemplating in our numbers in 2013.

Okay. Thanks.

You're welcome.

I still have a question on incentive compensation. I know, Kevin, this is something we have gone a bit back and forth on before, but granted, it's all because of revenue growth came in so strongly. But the way that it works for you guys, it's sort of a circular reference, at least in terms of what I believe your long-term operating goals are. It's not just revenues. There's also an operating profit element to it. And because of the step-up in compensation above getting to normalized levels this quarter, you didn't hit your full-year operating margin target. So, I know it's tough. I understand it's a good thing, because everyone is getting paid, and the top line is there, but it is frustrating from an external standpoint to say the business is in such good shape, and then so much of it gets given back in a not terribly predictable way. I don't know. Is there a thought process going forward on how that can be managed differently, the formula could be shifted? Anything you can offer would be great.

Thanks for the question, Lauren. We are always thinking about ways to have an incentive compensation program that is directly aligned with performance, and effectively, we do. That has resulted, given some of the variability in our performance, in different levels of incentive comp. Certainly that occurred in Q4 this year. I think the specifics as it relates to Q4 was that the top-line performance really was stronger than we expected. Our local-currency sales growth jumped up above 4%. We talked to the 4% number, but it's almost close to rounding to 5%. It's a big number. It's bigger than what our expectations were, and it's relative to a strong November and December. Growth is a big part of our incentive comp dynamic. That translated into us having to increase our provisions for the quarter.

Having said all that, at the end of the day, we didn't hit our profit objectives. Consequently, the impact on our incentive comp was more about our growth and less about our profitability. I would also remind you, as it relates to 2011, we had very strong levels of operating profit growth in 2011, where we grow more than 10%. I believe the number was 11% in 2011. Our incentive comp was quite low, because we underperformed versus our expectations internally. There is the resetting of the comp, which ultimately has an impact on a comparable basis. Ultimately, as we look to drive incremental growth and innovation into our portfolio, we continue see a greater stability in the top line, which will translate into greater stability of our incentive comp levels.

Okay. Thank you.

Edward Aaron, RBC Capital Markets.

Thanks for the question. It sounds like you are maybe expecting a little bit slower growth in Fine and Beauty in Q1. Wondering if that's a reflection of the comparison getting a little bit tougher or if there was maybe some factors more specific to Q4, inventory restocking or whatnot that you don't expect to continue?

Hi, Edward. It's Nicolas. First of all, as you say, we saw very, very strong Q4 coming from the strengths of the existing business and (inaudible) having more confidence in the Christmas season, as well as a strong momentum in new wins. It was really across the different region, but mostly also driven by the strength in Latin and North America. Christmas was a positive in the US, mixed in Europe, and strong in Latin America. The fact that most of the strength came from Latin America and we see continued momentum, this will be a good balance to offset what could come as pressure points in Europe or other markets. Right now, it's too soon for us to understand the inventory level. One thing which is fair to say that it will not be the same pressure points that we saw in 2009 when you had a lot of inventory throughout the entire supply chain at the retail level and the customer level. It's too early to say at the moment, but obviously, a strong Q4 puts some tough comparison with Q1.

Thanks. Just a quick follow-up on the previous question regarding incentive comp. If you look at the full-year provision, the Q4 provision, where does that take you on a full-year basis relative to target for 2012?

Say again, Ed?

I am just wondering what the incentive comp shook out on a full-year basis relative to target in 2012? With the bigger Q4 provision, did that take you back up to target, or did it take you above your incentive comp target for the full year?

It's slightly above.

Thank you.

Jeff Zekauskas, JPMorgan.

This is Silke Kueck for Jeff. My recollection is that the Beverage business used to be more seasonal, where really it would pick up like in the second and third quarter. What led to the strength in the Beverage business in the fourth quarter? And why is North America up 15%?

Silke, basically, what I mentioned is, this remarkable growth in Beverages was brought new wins and we haven't had before. We are making great inroads in North America in a very important brands in the still beverage. This is the main reason that you have this, such a big increase.

Okay. I need to also ask a Fragrance question. In Fine Fragrances, the local-currency comparisons are very, very good, both for IFF and Givaudan, I think like up 19% and 15%. So who is losing share, or are the other comparisons just so easy?

It's very difficult to comment on the competition. The only thing, as I said before, what was very strong for us is the strength of our existing portfolio, where you have a lot of classics, and which are well-positioned in many markets. But also, we had a significant number of new wins. But more importantly, these wins were successful in the marketplace and provided market share gain for the brands we partnered with. We don't have industry data, so it's difficult to comment on this. But I want to provide you some insights on our performance.

If I could ask the last question on R&D. As a percentage of sales, R&D went up. Understand some it's due to incentive compensation. But does the higher level of R&D also reflect more development expenses as a function of winning new business? Or does it include milestone payments to Evolva? What else is in that R&D expense that it's so high?

We have been targeting that 8% level anyway. The fact we are a little bit higher I view is a good thing. You touched upon some of the items, such as the Evolva payment, but it's really a recognition that we are going to win through technology, win through investments. It's a continued push we have on a lot of agreed internal platforms, Silke.

Okay. Thanks very much. I will get back into queue.

Lauren Lieberman, Barclays.

Thanks. That was quicker than I expected. Pretty clearly, you guys are talking down revenue expectations for Q1, and I just -- I had already assumed that Q1 would be slower than this great number in Q4. But are you thinking about it as being a low point for the year? How down, or how much slower are we talking? Is it a kind of slowest growth in the year, or just slower versus Q4 and you want to make sure people don't assume that what you saw in Q4 may be boosted a little bit by some sales around holiday, [doesn't] continue per se into Q1?

Lauren, it's Doug. It's -- really, a reference point is Q4 of 2012. It will be lower off that level. I think from the comments that we made a few minutes ago, the year we are expecting to be in line with the long-term targets that we have said. So, I wouldn't read a lot into the lower level other than managing expectations against the plus 8 or the plus 10 [euro] like-for-like. I would just pick up, though, on something that Hernan said, which was the discontinued part of the low sales volume in Flavors is going to run through the first half and end at the end of the first half. And there will be I would say significant part in Q1 that will affect Flavors, but it will still be positive, clearly, for the first quarter.

Okay. Thank you.

Jeff Zekauskas, JPMorgan.

Thanks. If I can ask two more questions of clarification. Does the expansion into the emerging markets -- is that a benefit or a headwind to operating margin, or it's -- [doesn't] make a difference at all?

Silke, this is Kevin. Clearly, margin profiles by either customers or regions or whatever, they are not all exactly the same. But we do not see a reduction in our margin profile as it relates to our drive to have incremental business in the emerging markets.

Okay. Secondly, I was wondering what the order of magnitude of sales are now for encapsulation technologies? Was a comment made that you expanded the encapsulation product line from Fabric Care into other end markets and into other regions. I was wondering whether -- where you expanded and which regions and whether it's now part of shampoos, or soaps, or lotions? Maybe you could just expand a little bit? Thank you.

Silke, it's Nicolas. We are very pleased with the progress we are making. Some customers are going into market test with our new encapsulation systems into new categories. Obviously, Asia is one area where we are rolling out even further the technology, and which is good. We are able to enter a new countries and even enter new customers with the technology. We are pleased with this additional growth potential that we are developing at the moment.

Can you explain which product categories you are expanding into outside of Fabric Care?

Right now, I think it's confidential. We like our customers to have the privilege to do their market test in full confidence and then to be able to roll it out. We will leave the privilege to our customers that we partner with.

Fair enough. Thanks very much.

Mark Astrachan, Stifel Nicolaus.

Guys, follow-up on the guidance for '13 relative to long-term expectations. Does that include any benefit from what you talked about on the Ingredients-related restructuring that you say you will comment on in the second quarter? Then a broader question about operating margins. You saw a big increase in the Fragrance business for the year. Flavors didn't quite see the same increase that it has seen in recent years. A bit of directional color on how you see, a, the gap narrowing between the two and directional growth and profit in each of the business units going forward?

Mark, we will continue to provide -- this is Kevin. We will continue to provide you some insights as we are ready to disclose publicly what efforts are being executed in the Fragrance Ingredients. As we have said in the past, it's a fairly complex process, and the things being thought about have a lot of tentacles into our internal supply of product and across our facilities. So, it is complex. Likely, when we decide to do something, it's going to be impacting largely 2014 as opposed to 2013. The quick answer to your question is you would not have to assume benefits as it relates to that for us to be getting to the guidelines that have been established in terms of our objectives for the year.

In terms of Fragrance and Flavors, we continue to believe that there is opportunities to improve the gross margin profile due to all the things that we talked about over the course of this morning, innovation, continue to drive a mix on the portfolio to areas where we are advantaged, improving the margin profile for those areas which are less advantaged. All of those things we think have an opportunity for us to be able to drive incremental margin profile in both businesses. That is a critical part of our strategy. As you know, it's one of the pillars of our strategy, and we will continue to execute against it.

At this time, there are no further questions. Do you have any closing remarks?

We would like to thank all on the call today for their participation, particularly the questions that came at the end, and we look forward to talking with you in three months. Thank you kindly.

Thank you for joining today's International Flavors & Fragrances conference call. You may now disconnect.