Ingredion Inc (INGR) 2012 Q3 法說會逐字稿

Welcome to the Ingredion Incorporated third-quarter 2012 earnings conference call. All participants have been placed on a listen-only mode until the question and answer session. (Operator Instructions). This conference is being recorded, if you have any objections please disconnect at this time. I would now like to turn the call over to Mr. Aaron Hoffman, Vice President of Investor Relations and Corporate Communications for Ingredion Incorporated. Sir, you may begin.

Thank you, Wendy. Good morning, and welcome to Ingredion's third-quarter 2012 earnings call. Joining me on the call this morning are Ilene Gordon, our Chairman and CEO, and Cheryl Beebe, our Chief Financial Officer. Our results were issued this morning in a press release that can be found on our website, Ingredion.com. The slides accompanying this presentation can also be found on the website, and were posted about an hour ago for your convenience.

As a reminder, our comments within this presentation may contain forward-looking statements. These statements are subject to various risks and uncertainties, actual results could differ materially from those predicted in the forward-looking statements, and Ingredion is under no obligation to update them in the future as or if circumstances change. Additional information concerning factors that could cause actual results to differ materially from those discussed during today's conference call or in this morning's press release can be found in the Company's most recently filed annual report on Form 10-K, and subsequent reports on Forms 10-Q and 8-K.

Now I am pleased to turn the call over to Ilene.

Thanks, Aaron, and let me add my welcome to everyone joining us today. We appreciate your time and interest. Ingredion posted another very good quarter in the face of headwinds that include rising corn costs, foreign exchange devaluations, and challenging macro economic conditions in a number of markets. In spite of these factors we achieved a record level of quarterly sales, operating income, and adjusted earnings per share.

As you digest the results, you will see that we continue to take appropriate pricing actions that allow us to generally cover higher input costs. And importantly we also continue to generate volume growth at the same time.

At the risk of being repetitive with previous quarters, I would stress that we have a business model that helps mitigate risk, while capitalizing on growth opportunities. It has enabled us to reliably deliver our guidance over many years, report very good results today, and raise our earnings outlook as we close out the year. The business model is predicated on producing value-added functional starch and sweetener ingredients for our customers, who are largely providing products in the food, beverage, and brewing markets. Said another way we sell to industries that are generally stable or growing and are important to consumers, and we thoughtfully mitigate risk along the way. Those risks include macroeconomic challenges in some markets, foreign exchange fluctuations, and input cost volatility.

As our results and our outlook indicate today, we have managed through these headwinds admirably. In fact, we have sufficient confidence in our outlook and the business model that during the third quarter we raised our dividend by 30% and are now at the high end of our 15% to 20% payout target. This comes on the heels of two dividend increases last year.

From an operational perspective, we saw particularly strong results in North America and Asia Pacific, which combined represent about two-thirds of our total business. Let's now take a quick look at each of the regions and their performance in the quarter.

Starting with North America, following a good first half, this region continues to deliver strong results highlighted by further volume growth to a variety of industries including beverage and brewing. This performance led to a record level of net sales and operating income in the quarter. Operating income grew by 33% as a result of the good volume trends and operational efficiencies.

It is worth noting that our business in Mexico continues to show good performance as we are well positioned to participate in the economic and population growth there.

Our South American business continues to face some challenges. Volumes are under pressure with slower economic activity. Currencies have devalued and inflation is increasing. In spite of these challenges, we are effectively managing through the volatility. We saw only modest volume declines and held operating income basically in line with last year. This is exactly how we would expect the business model to address the situation, with necessary incremental pricing and ongoing operating efficiencies, keeping us focused on delivering dollar profits, even if that costs us a bit of volume in the short-term. While 2012 is clearly a more difficult year than we had originally anticipated for this region, we are managing the situation well, and continue to be bullish about South America over the medium to long-term.

Turning to Asia Pacific, we delivered record net sales in operating income in the quarter. The results were driven by increased revenues to the food and beverage industries, as well as volume growth, incremental pricing, and operating efficiencies. We remain well situated to participate in the expected growth in this large diverse region.

And finally, our Europe, Middle East/Africa region continues to provide us -- to face a variety of challenges that we have highlighted since we first provided 2012 guidance in February. Volumes were essentially flat as we expected. Positively we were able to achieve sufficient pricing to offset higher input costs, though negative foreign exchange trends resulted in a decline in regional operating income, again, as we had expected.

As I turn the call over to Cheryl for a review of the results, I will reiterate that we remain confident in our business model over the long-term, and are pleased that we delivered good results through nine months, raised full-year guidance this quarter, and increased our dividend at the same time. Cheryl?

Thank you, Ilene. Let me add my welcome, and thanks for joining the third-quarter earnings call for Ingredion. As Ilene indicated, we are quite pleased with how the quarter turned out. It is a great way to launch Ingredion.

Before we get to the charts, let me add a little color around the quarter. We came into the quarter with a view on pricing and volume. We expected North America and Asia Pacific to continue to deliver on pricing, volume, and cost-efficiencies. In fact, they did better than we expected.

For South America we expected softer volumes and operating income to be in line with last year. That is what we would deliver this quarter.

With respect to EMEA, we are expecting modest volume growth, and that foreign exchange would continue to impact operating income. Volume was basically flat and operating earnings declined about $2 million, again in line with expectations.

So the internal beat was driven by a combination of better performance in North America and Asia Pacific, and a lower tax rate. We had guided to an estimated annual tax rate related to adjusted earnings per share of between 31% and 33%. After completing the third quarter, the estimated annual tax raised used to calculate adjusted EPS is forecasted to be between 29% and 30%. The tax rate improvement is based primarily on several discrete tax items that occurred in the third quarter.

Turning to the slide, reported earnings per share was $1.45 and that includes $0.07 of restructuring impairment charges related to exiting our relatively small joint-venture in China, the North American network optimization, and Kenya. Add back the $0.07 and the adjusted earnings per share is $1.52, which is a record EPS on an adjusted basis.

Lastly we took the opportunity to refinance the Company's revolver balance by issuing a five-year bond at a coupon rate of 1.8%. We have a very nice ladder of longer term maturities.

Moving on to the third-quarter income statement highlights, net sales grew by $51 million, or 3% reaching a record level of $1.7 billion. Total Company corn costs were down 1% on a dollar basis. Energy costs were in line with last year. The majority of our facilities ran very well, and generated operating efficiency benefits.

Gross profit dollars were up $37 million, and margins expanded 170 basis points. As I have pointed out before, with currency fluctuations and with input cost movements, looking at the margin percentages can be misleading. It is more appropriate to look at the dollar increase.

Operating expenses were $137 million, or about 8% of sales, and reflect the increase in costs to support a larger business. Reported operating income was $169 million, up $27 million from last year's $142 million. The reported numbers include $10 million of restructuring, impairment, and integration costs, whereas last year's reported operating income includes $9 million of said costs.

Reported diluted earnings per share were $1.45, up $0.33 per share from $1.12 last year. The reported numbers for 2012 include $0.07 of charges versus last year's charges of $0.08.

The $51 million increase in net sales came from another quarter of strong price/mix and volume which contributed $76 million and $48 million respectively. This was more than sufficient to offset the weaker foreign currency impact of negative $73 million.

On a regional basis North America net sales grew 10%, or $88 million on a combination of strong price/mix improvement of 6%, and volume growth of 4%. South America's net sales declined 12% or $49 million, though we continue to see positive price/mix at 4%. However, volumes still remain soft and were down 3%, and weaker foreign currencies had a negative 13% impact. The Brazilian real devalued 24%, and the Argentine peso devalued about 10% versus last year.

Asia Pacific grew net sales by 11% or $20 million, on a combination of strong volume growth of 12% and price mix improvement of 3%, which was more than enough to offset the weaker currency impact of negative 4%. EMEA was down 6% or $8 million with positive price/mix of 2%, basically flat volume, and negative foreign exchange of 8%, reflecting a weaker euro, Pakistan rupee, and pound.

Turning to the third-quarter operating income bridge, North America grew operating income $25 million or 33%, again reflecting price/mix volume and operating efficiency improvements. Corn costs were roughly up 5%. As we indicated earlier in the year, the layout of our corn costs would vary by quarter. We saw higher year-over-year increases in the first half than what we expect for the second half.

South America operating income was down 2% or $1 million. Given the significant currency devaluations in Brazil and Argentina along with lower volumes, the results held up fairly well on a combination of price/mix and lower corn costs. Asia Pacific grew $9 million, or 43% on volume and price/mix. EMEA was down $2 million, or 9% on weaker currencies and volumes.

Corporate were expenses up approximately $3 million. Corporate expenses reflect the investment in people and systems to run a larger business. The $10 million of restructuring, impairment, and integration costs are related to $4 million for the impairment of our small China JV, $3 million for accelerated depreciation, $1 million for Kenya, and $1 million for smaller asset impairments. Integration costs for the quarter were $600,000, as we have concluded the integration on our original schedule.

Adjusted earnings per share increased 27% from $1.20 to $1.52. The $0.32 increase came from margin improvement of $0.25, volume of $0.07, and other income of $0.01. These more than offset the $0.09 from weaker currencies. Non-operational changes contributed $0.08 total, and included $0.09 from a lower tax rate, about 27% versus 31% last year; $0.01 each from lower shares outstanding, 77.8 million versus 78.1 million last year; and non-controlling interest. Net financing costs were up $0.03 reflecting an FX gain in last year's number.

I want to point out that the tax rate this quarter is lower due to a number of discrete tax items. The annual estimated reported tax rate is expected to be around 27%. The tax rate forecast reflects the tax valuation allowance of $12.8 million, the restructuring tax benefits of $13 million, discrete tax items of about $9 million, and our assumption around the mix of income. The tax rate used for adjusted EPS guidance is between 29% and 30%.

On a year-to-date basis net sales were up $216 million, or 5%. Gross profit increased $58 million, or about 7%. Gross profit margins improved 40 basis points.

Reported operating income declined $22 million from $505 million last year. Included in last year's operating income is the $58 million NAFTA settlement, which more than offset the $27 million in restructuring, impairment, and integration costs. This year's operating income number includes about $31 million of the same type of costs. Thus on an adjusted basis operating income increased $41 million, or 9%.

Reported earnings per share declined $0.04 and adjusted earnings per share increased $0.54. Net sales for North America rose 12% or $297 million on positive price/mix of 7%, and strong volume growth of 5%. South America was down 8%, or $91 million. The negative impact of FX was 10%, negative volume of 3%, and was partially offset by the positive price/mix of 5%.

Asia Pacific's net sales grew 6%, or about $35 million. Volume growth was positive at 5%, followed by positive price/mix of 3%, and partially offset by a negative 2% in foreign exchange. EMEA declined 6%, or about $25 million, FX was negative at 7%, volume was negative at 3%, while price/mix was a positive 4%.

The operating income bridge for the nine months shows that North America contributed $51 million, South America was down $5 million, Asia Pacific generated $10 million, while EMEA was down $8 million. Corporate expenses were up $7 million, again reflecting the investment in people and systems. Restructuring, impairment, and integration costs amounted to $31 million.

The year-to-date earnings per share bridge shows positive margin contribution of $0.39, $0.14 from increased volumes, $0.04 from other income, and negative $0.20 from foreign exchange impact. A lower tax rate and financing costs contributed $0.09 and $0.05 respectively. A lower share count and non-controlling interests were worth $0.02 and $0.01. Taken together the result is $0.37 from operations, and $0.17 for non-operation changes.

Cash flow from operations was $563 million. The main drivers of the cash flow were net income and depreciation-amortization. The North American margin account contributed $44 million. Capital expenditures were $202 million, and we paid dividends of $49 million.

Moving to the income statement guidance. We have raised both the reported and the adjusted earnings per share range. The reported range is $5.30 to $5.40, up from $4.87 to $5.12, or a $0.36 increase at the midpoint. The adjusted range is now $5.47 to $5.57, compared to the previous range of $5.00 to $5.25. Two-thirds of the increase is a result of better business performance, and one-third from a lower tax rate. The integration restructuring costs have increased from $0.29 to $0.33, reflecting the decision to exit our relatively small Chinese joint venture.

As we mentioned on previous calls we expect FX headwind. We continue to anticipate about $0.27 of negative impact from the various currency declines. We are on track and expect to generate approximately $600 million in cash flow from operations. Capital expenditures are estimated to be around $300 million.

The fourth quarter outlook for North America is positive. We expect Mexican volumes to offset lower US volumes. Operating income growth should be up versus last year, but down from the third quarter on higher input costs.

For South America we expect net sales to be flat compared to a year ago, and operating income to be plus or minus 5% compared to a year ago. The range is dependent upon how volume comes in, in the quarter. With that said we expect the fourth quarter to show operating income improvement versus the third quarter.

Asia Pacific is expected to show continued growth in food and beverage volumes, and operating income is expected to increase due to volume and pricing. The fourth quarter will follow the same pattern as North America with operating income up year-over-year, but down compared to the third quarter.

Wrapping up the regional outlooks, EMEA is expected to show modest volume growth. Because of foreign exchange impact, operating income is expected to be in line with last year.

I will now turn the call back to Ilene for closing remarks.

Thanks, Cheryl. As I have done on previous calls I will conclude with our strategic blueprint which continues to guide our decision making and strategic choices, with an emphasis on value-added ingredients for our customers. The blueprint is a good reflection of our successful business model, which enables the delivery of good results in an often volatile world.

With a broad portfolio of ingredients sold to many industries across a diverse geographic footprint, we have an enviable position. At the same time, investors can be assured that we have prudent, thoughtful, risk management practices. In sum, I believe that we are well positioned to deliver another good year, while always keeping an eye on our future growth opportunities. And now we are glad to take all your questions.

(Operator Instructions) Our first question today is from Farha Aslam with Stephens.

Good morning. Congratulations on an outstanding quarter.

Thank you.

I would like to delve a little bit more on what drove your volume in each of the different geographies. In particular Asia was very strong. Can you just provide us color about where the strength came from?

Yes, this is Ilene. Certainly as we mentioned on the North America piece, our strength and growth in Mexico for the beer and soft drink certainly was a large contributor to that growth. When you go to Asia, when you look at Korea, again that is another region where we have a good position in the soft drink and beer industry, and so the growth of those industries really contributed to our position. Certainly we also have food ingredient opportunities in the Korea area.

And for Thailand, again it is very focused on the food industry. We have a tapioca product that is used both domestically and exported, so again I think with the increase in demand for food products, with population growth and the economy we have been able to drive that growth in Thailand. So I would say that those were the two countries in the Asia Pacific area that really contributed the most to the volume growth.

And in South America, was the weakness in volume because the beverage producers, particularly the beer companies were implementing a lot of pricing, and as that has cycled through, is that why you are optimistic about the medium to longer term?

Yes, the beer companies in Brazil have continued to grow, but the demand has not been as strong as they had expected. So they are able to actually use a product, the grits that really is used when they are not looking for the ultimate through-put. Whereas our product, the high maltose is really very helpful to them when they are really trying to get out a lot of volume. So while they grew, they didn't grow as much as they thought they were going to grow or that they would like to grow, and therefore they were using a substitute product.

Now we are still very bullish on South America, because we see the beer companies' forecasts continue to be strong, and that the expectation for both the population growth, the growth of the middle class and the economy with the GDP forecast for Brazil now, still is people are using the 4% number. We expect that we will be able to continue to supply that industry, and even in a stronger way. Of course the sporting events are going to help in 2012 and 2016, and so a lot of infrastructure is being put in place now in the country, which should also generate some of that demand.

Great. Thank you very much.

Thank you, our next question is from Tim Ramey with D.A. Davidson.

Good morning. Let me add my congratulations on a great quarter. I think obviously it was a surprise to the Street that your margin performance was as good as it is. Yes, of course, you have told us this a thousand times, this is the way your business model is structured.

But just would love to get into the under the hood of how that actually occurred. Was it great planning, was it serendipitous pricing? Is there anything you can give us that would help us better understand such a great performance?

Sure. Tim, it is Cheryl. The performance was really driven on a combination of two things, the continued strong price/mix and the volume. If you look at the volume in North America and obviously North America has a significant weight on the business performance because it is over 50% of the business. And so the continuation of the 4% volume plus the combination of the continued pricing is really what is driving the North American.

On Asia Pacific, frankly, the volume was stronger than what we were expecting. At 12% I think that is one of the strongest volumes we have seen ex-acquisition volume in a number of years for Asia Pacific. As Ilene said, it was driven by a combination of the beverage industry in Korea, and the food industry in Thailand. And so those two are the main drivers of the continued strong performance and frankly they did better than what we were expecting.

Our operating team with all the volatility that shows up in the newspapers and every TV synopsis every night of what is happening in the world, they tend to be a conservative bunch, and they were not expecting their volumes to be quite as strong. And so the $0.36 beat relative to the midpoint and the guidance range upwind is really two-thirds from the operations, and that is North America and Asia Pacific.

We are not doing -- we are holding our own in South America and frankly I think we are holding our own in Europe, Middle East, Africa based upon the conditions with regards to currency devaluations, economic activity, and slightly slower return to the growth rates that we were expecting in South America. I hope that answers your question.

Sure. And Cheryl, you are a conservative bunch around Westchester too, but does that volume growth in Asia make you reset your sights on the growth outlook there, or do you think of this as quarterly variability?

I think it is more quarterly variability. Let me address Korea. Korea we are seeing more sales to the beverage industry. With next year's pricing on corn and with Thai sugar being down, there is what I am going to call, we are going to have to see whether or not we grow that volume or maintain that volume.

So I think our long-term projections, Tim, of 3% to 4% relative to volume for the Company is still a good place to be.

Terrific. Thanks for your help.

You are welcome.

Thank you. Our next question is from David Driscoll with Citi Research.

Good morning, everyone.

Good morning.

Congratulations on the results. Absolutely stellar. Great work. I wanted just to ask a little bit about the United States. Maybe you can build on some of the comments you have already made.

Obviously we had the warmest July in US recorded history. Can you talk about what that did to your end customers in the United States, and how that affected the quarter itself, if we could start there?

Okay. Yes, it is Ilene, David. Certainly the warm summer helped in the US in the beverage consumption. What is interesting is Mexico also had a very good summer in demand and shipments, but it was a little bit cooler than normal in Mexico. But in spite of that, the demand for beer and soft drinks was still there.

So I think that certainly weather helps in terms of the demand, but I think that most of the strength that you see in North America is really from Mexico, and the demand for both beverage and the food products as a result of the growth of the population and the growth of the middle class.

Maybe just my second and final question, and I will pass it on, is just back on this concept of the price of high fructose versus the price of sugar in different markets. Do you have any concern that because of where corn is you start to bump up against substitution maximums on the price of high fructose? Can you go over that a little bit more?

Of course, we are always tracking to see what is happening with sugar, and there are differences around the world. Certainly in the US there has been enough of a gap, 30% to 40%, and we expect that to continue certainly in the US market.

I think in Mexico it has come together a little bit more, but we still see the importance of the blending being used by the customers. And then as Cheryl just mentioned, in Korea, that is another market where you might get a narrowing of the gap. But again the soft drink companies will be I expect using a blend of both depending on the different brands.

So it's certainly something to be watched, but there is always another crop coming in sugar. And so we expect there to be -- certainly the good dynamics that we have already experienced to continue.

I really appreciate those comments. Great results, and I will pass it along. Thank you.

Thank you.

Our next question is from Ken Zaslow with BMO Capital Markets.

Good morning everyone. A couple of questions I have. One is on Asia, the profitability, do you think this is more of a sustainable new rate? I know not this quarter. I heard what you said about the fourth quarter, but generally speaking do you think that you have reached a new profitability level, given what you have done on the Asian Pacific business, can you talk about that?

Sure, Ken. It is Cheryl. I think the Asian Pacific business with having added in the specialty starch business through the acquisition gives us an improved outlook performance and profitability, whereas before it would have been predicated just really the driver would have been South Korea, and then what I call the volatility that would come from the changes in how much we are selling to the beverage industry because of the weight. And so I think as we look long term, the growth prospects and the profitability prospects for Asia Pacific are very solid and strong.

Great. Would you guys be surprised if in 2013 you were not able to achieve your long-term growth targets?

Ken, it is really too early to comment on 2013. As you know we are still in the early stages of contracting in North America, and we are expecting higher raw material costs next year. And as we discussed in the past we will sacrifice volume to achieve appropriate pricing pass throughs.

So in terms of next year, the success will really be about how well we achieve that pricing and how well various economies hold up in the turbulent times. Because you have heard some positive surprises on volume, and we are looking for better volume certainly in South America than we have had this year.

When I look at our history we have been able to pass through significantly higher input costs really over the last few years, and we would anticipate doing the same in 2013. But clearly 2013 has some unique challenges driven by the drought in the US, and therefore, the implications on pricing and sourcing of corn.

So we believe the dynamics are good. We still believe in our long-term targets. But we are really not ready to commit to the 2013 yet.

There was a competitor of yours that put out, they said that on a dollar margin basis they expect to at least hold, if not increase modestly their margins in North American high fructose corn syrup. Would you guys be of that same camp, given how negotiations have started?

Yes, I think it bodes well for that type of comment, and for what we are seeing to be able to pass on the corn costs. But again as I said it is very early.

And then just on a nonoperating side for 2013, just thinking about it, FX should be waning, interest rates should be lower, and tax rates should be higher. Could you just give us some parameters to that?

Sure, assuming everything is equal, the four quarters of FX headwinds should mitigate. I don't think we are looking at any significant stepdowns on the currencies. Argentina when you look at the rate of inflation versus the rate of devaluation, I'd keep my eye on Argentina. But if I could forecast that one I would be a very wealthy lady, I wouldn't be a CFO.

The second is interest expense should be lower, given the cash flow generation and the fact that we have a pretty low component of interest rates on our long-term debt.

And last but not least the tax rate. This year is somewhat unusual because of the number of restructuring items as well as some discrete tax items. Ultimately the tax rate is borne out by the mix of earnings, so this is truly a forward-looking statement, but as I have guided to in the past, the tax rate could be somewhere between 30% to 32% ex-discrete items or restructuring.

But that would be -- non-operating expenses would be relatively neutral next year, if you offset interest and taxes, is that fair?

Right.

Okay. Cool, thank you.

Ken, this is Ilene. And further to what I said before, when you look at the utilization in the industry, and that goes back to an earlier comment on the summer heat, and what we see today, that I think with the higher utilization that also bodes well for companies being able to pass through the corn costs.

Great, I really appreciate it.

Thank you. Our next question is from Akshay Jagdale with Keybanc Capital Markets.

Good morning. Congratulations on a good quarter. I just wanted to ask about Mexico. It seems like it has been, demand has been very strong. Based on my calculations very roughly, it looks like demand in Mexico for sweetener has been up double-digits. So correct me if I am wrong there, but if I am right, I am just trying to understand.

You mentioned population growth, and also the incomes rising. But I am trying to understand why that would lead to sort of 2X, the demand growing for sweeteners 2 times the rate of GDP growth. I may be missing some things.

But I'm just trying to get a little bit more color on what is going on in Mexico. How much is the underlying demand growing, and what is the sustainability of that?

Okay. I think you also need to think about the demand not just from the population and the growth of the middle class, there is the consumption of the beer and the soft drink. And we do know that there are brewers, so I don't know the exact demand number. I know that you are trying to back into that, but there are brewers in Mexico that actually export to different parts of the world, so even though there are an end customer that we are shipping to, there are brewers that I know and have heard that have exported. As an example, during the Olympics beer was shipped from Mexico to Europe, so that was contributing to some of that demand; it was being produced in Mexico.

So I think one would like to be able to calculate that, but I think you have to look at some of the exports of those products and where it is going. But Mexico is a market where we see opportunities not just for beer, but for sweetener and even for the food starches. And that would be the other part of the demand, the desire of the Mexican consumer for biscuits and food ingredients, for dressings, at both restaurants and in the grocery store.

That is a piece of that demand. But I think the big piece that you may not be factoring in is some of the exports.

And how sustainable is that, the export piece, in your opinion?

I am not a brewer in Mexico. I have got to believe that there are some economics that makes them successful from that location. And the brand owners certainly have strategies to develop around the world. So maybe an Olympics is more of a one-off. The next place we are all looking for is Brazil for their sporting events. But I think that a lot of it is sustainable, because of the population growth and the demand for more sophisticated products in Mexico.

Perfect. And just one last one. This is more general, related to how you manage risk. I was just at an industry conference this week. It seems like -- I just want to know how you manage the risk for corn basis.

There is -- obviously basis has expanded quite a bit. I was hearing this week that farmers are planning on holding on to their corn more so than usual. So can you help me understand? I get how you plan your forward hedges on corn. But how do you manage basis risk?

It's a combination. It is Cheryl. It is a combination of how our contracts are structured, as to whether or not the basis risk is in the formula for the pricing. Number two is where you can take a little bit more physical corn, so there is a bit of inventory management around it.

And then ultimately it goes back to our risk management on the gross to net corn ratio, of managing between those two end points based upon what we expect to see in the market, whether or not there is strong demand for corn which is moving the pricing or the opposite way. And I think the model that we are employing given the volatility we have seen over the last three years has actually served us well.

Great, thank you.

You are welcome.

Our next question is from Brett Hundley with BB&T Capital Markets.

Hi, it is actually Heather Jones.

Good morning.

Good morning. Congratulations on the quarter. I just have a couple of questions. First going to Asia Pacific and South Korea specifically. Talking about looking to 2013, Cheryl, you mentioned that you will have to see if you grow or maintain volume. And given where world sugar is relative with where HFCS will be given higher corn prices, wondering how you are thinking about that, that makes you believe that it is going to be flat to up, as opposed to a risk of it being down?

Well, it is the expectation that we have for our operating teams is that they have strong customer relations, and we are there in the good times and the bad times, so that we basically maintain the business. And it is the question of how much of the potential increase in costs, which I can't quantify at this point in time until we actually do some of the negotiations, that we bear versus what our customer bears.

Okay. One thought. I was wondering if you could speak to this, If like, given that we are not looking at a structural change in the US corn market but it is more drought-related, and thus unless we get another poor crop should be relatively temporary, how do you think your customers are going to be thinking about changing their recipes for something that would be a largely temporary issue? Just how are you all thinking about that?

Well, this is Ilene. Our customers are very focused on new products and ingredient solutions. And so while there are some headwinds for them to pass on their increased costs to consumers in some of their more basic products, most of the customers are really working on these new products, bringing them to market, product line extensions, that have different recipes and they are bringing them in at a higher price point, and they are considered potentially more niche products to start out with.

I think on what I call the staple products, certainly we offer solutions that help them take out higher costs of things like oil, or certain starches can be substituted for to help them, and we have a platform that we call Value Matters that we help customers work through those recipes. But I also think that the customers are very sensitive to the consumer tastes, and don't want to fiddle with the recipe for a proven product.

So I think it is a combination of strategies. It is looking at the costs that don't affect the taste, and then passing through their own input cost increases where it does matter, and then again really focusing on those new products and value-added products, which all of them talk about the healthy, the good for you segment.

Okay. Thank you. And finally on 2013 and I completely understand it is too early and all, especially to talk about achieving your long-term target of double-digit. But you mentioned that below the line items should be roughly neutral.

You have got this portfolio of modified specialty starches that generate pretty good margins and have been generating growth. Some of your regions are generating pretty decent volume growth. Just in broad strokes do you believe that you should be able to grow the EBIT line in 2013? I know you don't want to commit to your long-term double digit thing. But is it reasonable for us to assume that you are going to be able to grow of off this base in 2013?

Heather, it is Cheryl. Going back to Ilene's comment about the challenges next year, or they may be opportunities depending upon how it plays out, that if the business model holds as it has in the past -- and we have seen both corn prices up and corn prices down -- if we are able to continue to price through the input costs on a global basis, then one would expect operating income growth. If we are not able to pass through then that becomes a different challenge.

But again, predicated on the model and the comment about strong utilizations, economic activity may pick up, then that would bode well for growth in operating income. And if those two things don't occur, then that is a different story.

Perfect. Thank you so much.

You are welcome.

Thank you. Our next question is from Christine McCracken with Cleveland Research.

Good morning. Just on your comments relative to the inventory adjustment in the US that you are expecting here, I guess in the fourth quarter, I might have missed it. But is there anything specific, any particular industry that that is affecting or is it across the board?

I don't exactly know what you are referring to in terms of the inventory adjustments.

That you referred to in the slides, in North America.

The US volumes coming down?

Yes.

Our US operating team thinks that between food and beverage that typically in the fourth quarter there tends to be a bit of a contraction. And so they are looking for volumes to be slightly lower than what they were last year in the fourth quarter, but the Mexican volumes up. Obviously if they are too pessimistic, and there isn't a contraction, then there is some upside relative to the numbers.

But it is not any of this destocking of the supply chain that we saw in 2009. In fact, as we have said before, nobody really built up the supply chain very much since then.

So yes, certainly as Cheryl said, I think that we think that some customers might clean up their own year-end inventories, but that it is not a major change in any trend.

Okay. I just had questions since it was called out. In any case, just in terms of the specialty corn crop, because obviously that is a significantly smaller total harvest on a year-over-year basis, obviously and probably it has more of a price impact generally on the overall market. Are there alternatives, geographies that you can source some of these specialty products from, that may or may not have the same kind of weather issues on an annual basis?

And then do you manage your inventories so that you have sufficient carry in order to meet your needs for any kind of specialty corns that you might have lost this year in harvest?

That's a good question. This is Cheryl. We have a global supply chain so we look at sourcing from -- both the raw material and the finished products from our network, which would be in Asia Pacific, relative to the fact that we grow and produce modified starches in Australia in the specialty grains. We do the same thing in Brazil, and obviously then the US.

So the US specialty grain crop is more impacted, because it is grown in the Indiana geography, so we are using our global supply network to manage that. It is going to be a question of supply and demand and price. But I think that we will be able to manage our way through this.

Okay. Great. Just one last question. On that pricing that you passed through, you have done a great job obviously in several geographies in getting that corn cost through. Is there any place, any industry specifically where you are fighting a lot of resistance, just in terms of you have had several years now of price increases? And I am curious if they are hitting a limit in any particular area.

We haven't seen any particular limit. Of course, it is a challenge certainly with consumers in terms of paying higher prices. But as you know, our product, we are a small part of the total ingredient costs for our customers. And so while there has been price increases for our ingredients that we successful passed through over the past few years, it is still a small part of the total.

And as customers focus on new products, good healthy products, more value-added products, our ingredients actually are a lower percent of the total consumer price even more. So I think it is certainly a challenge on the consumer, but I think with our value proposition, it will continue to be successful.

Thanks. Congratulations on a great quarter.

Thank you.

Thank you. Our next question is from Vincent Andrews with Morgan Stanley.

Thank you, and good morning everybody. Just to follow up on the customer inventory, and maybe it just has to do with the way the contracts are structured, or maybe you can just help me understand this. I would have thought because corn prices are higher and the perception would be that you guys are going to be asking for higher prices in next year's contract that customers would be building inventory exiting the year, not adjusting it. Which part of that am I not understanding?

I think it goes to the fact that we will reprice. We are not going to sell out our inventory at the lower price. We will manage it as we go through the fourth quarter.

Okay. So the contracts then -- maybe this is the part that I have forgotten. When you contract for the year you contract for the price not necessarily for the volume, so you have control in the fourth quarter of how much you are willing to sell at the price, and that is also part of why the inventories are going down?

Yes.

Okay. Now that makes perfect sense. And another follow-up on the weather questions. Last year we also had a very warm winter. And I don't know if that affects seasonal demand at all. Is there anything to be thought about there?

It is Ilene. I do recall that there was actually pretty good demand in the soft drink side and even some of the beer in the March/April time frame because of the US warmth. And if you recall our volume growth in the first quarter was 4%.

And so I think there was a little bit of that and, of course, nobody can forecast the weather and certainly the summertime was a nice temperature and the demand was there. But I think again when we talk about North America, we still point to Mexico as being the driver of the demand.

Okay. And then lastly, could you just touch a little bit on the industrial starch demand? Perhaps more in North America than anywhere else, that in my mind would be the most economically sensitive. Is there any concern about that going into the fourth quarter? Because traditionally, or maybe not traditionally, but that is where I would expect there to be some destocking if anywhere.

Industrial has been a smaller and smaller part of our business, as it relates to paper and corrugated. Certainly we actually put in our supply to the pharmaceutical industry of dextrose almost as an industrial product. But if you look at what we traditionally think of as industrial, in the paper and packaging, the corrugated industry has been growing 0.2%, 0.3%. 0.4% during this year. It has been steady growth in the last couple years but they have not come back to the levels of before 2009.

But we have moved our focus away from trying to really grow in that segment. So I don't think that there is any big upset from that industry in the fourth quarter. I think it has just been a low level of growth in that, in the corrugated and paper side, and the fourth quarter will be similar and that our growth will come from that food ingredient side and some pharmaceutical.

Okay. Thanks a lot, and very nice job in the operating environment.

Thank you. Our final question today is from Tim Ramey with D.A. Davidson.

Thanks for the follow-up. Ilene, you probably have a better window into the collective mindset of the food industry for relative to Prop 37, the California initiative. I have asked you this before, but we are getting closer and it looks more likely. Any thoughts on how the food industry reacts to that, and whether that positions you particularly well?

I read the same things that you do, and I believe the food industry is prepared to change their labeling accordingly. And they will certainly have to figure out if there is some impact on some of the food they are producing that they might have been labeling natural or organic that won't qualify, and I know there is a lot of pressure for it not to pass.

But if it does, we don't see it as a big impact on us, because we are serving our customers, and we always have lots of opportunities and options, whether it is GMO, it's non-GMO, our physically modified starches that really satisfy uniquely the clean label trends in both Europe and the US. Our patented product is one of the only ones that uses heat and not chemicals, and so again we see that potentially as an opportunity for us in some of those products on the west coast.

So your net takeaway is this is more about relabeling than reformulating?

Yes.

Okay. Thanks so much.

You are welcome. So now that we are at the end of the hour, I just want to make a quick comment to sum up that we believe that the Ingredion business model is performing very well and delivering strong results, and we believe that our model allows us to consistently deliver shareholder value, which is our clear focus and I believe that we have demonstrated. This quarter we delivered record sales, operating income, and adjusted EPS, and as we look to the final quarter of the year, we expect further strong year-over-year performance.

That brings our third quarter 2012 earnings call to a close. We would like to thank you again for your time today. Thank you.

Thank you. This does conclude today's conference. Thank you very much for joining. You may disconnect at this time.