International Flavors & Fragrances Management Discusses Q4 2012 Results … – Seeking Alpha

International Flavors & Fragrances (IFF) Q4 2012 Earnings Call February 7, 2013 10:00 AM ET

Operator

At this time, I would like to welcome everyone to the International Flavors & Fragrances Fourth Quarter and Full Year 2012 Earnings Conference Call. [Operator Instructions] I would now like to introduce Shelley Young, Director of Investor Relations. You may begin.

Shelley Young

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 1 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 with regard to the 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’d like to introduce the participants on today’s call. With me on the call 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.

Douglas D. Tough

Thank you, Shelley, and 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 Flavors 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-year — year-to-date basis, are up nearly 4%, and over the past 2 years, they are up 14%.

The strong top line performance also allowed us to achieve an adjusted operating profit 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 2-year and 3-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 1-year, 2-year and 3-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 3 year-average basis, which combines our strong performance in 2010 with more modest performance levels in 2011 and ’12, our 3-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 3-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 in executing our strategic priorities. We have a clearly articulated corporate strategy, and we are focused on driving the business forward using 3 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 40% — 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 professionals 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 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 route. Vanillin is a key flavor ingredient in many food products, so a dependable source should be welcomed by our customers. Hernan will be telling you more about this joint development project.

The Scientific Advisory Board, announced in early 2012, has been fully active for 1 year. The Board is comprised of 5 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 advantaged portfolio and reducing the cost 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.

Nicolas Mirzayantz

Thank you, Doug, and good morning and 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 & 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 [indiscernible] 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 were 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 & 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 & Body Works, Cashmere Globe [ph] and [indiscernible]. Both Toiletries and Hair Care had also double-digit growth and contributed to overall strong performance.

Our Functional Fragrance sales grew by 12% this quarter. This was our 18th consecutive growth quarter in Functional Fragrance, led by double-digit growth in Greater Asia and Lat Am, 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 a 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’ve 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 & Beauty Care and Functional Fragrance due to a 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 Compounds 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 $60 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 8 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, and 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 or increased [indiscernible] participation and the strength of our existing 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.

Hernan Vaisman

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-margin sales activities, we generated a 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 our 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 strength 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 continue to make progress in this region, working with our regional customers 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 product use in our sweetness modulation and masking technologies. The use of innovative technologies help our customer create products that 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 scale-up, via third party, a natural vanillin for commercial application through a cost-effective natural and sustainable growth. 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 we 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 this second half of the year will 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 levels due to the underlying strength in the portfolio.

Turning to our profitability this quarter. As Nicolas mentioned, this marked the first quarter in our 2 years that we realized declining raw material costs, which when combined with a more favorable category mix and the exit of lower-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 offset by an increase in 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 a gross margin upside, resulted in Flavors’ segment profit of $298 million, an increase of $14 million or 5% from the prior year.

Looking ahead. In 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 strong pipeline of new business wins using our sweetness and Savory 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.

Kevin C. Berryman

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 in 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 the 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 the 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 cost 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 the incremental growth momentum for Fragrance, it was largely driven by the combined results of our Fine & Beauty Care and Functional businesses or the Fragrance business excluding the Fragrance Ingredients 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 & Beauty Care and Functional, grew 7% — 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 3 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 on our Compounds businesses, which are those businesses excluding our Fragrance Ingredients sales, were to the emerging markets. Specifically in Q4, the emerging markets accounted for 50% of all Flavors sales and 53% of our combined Fine & 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 8 quarters where we’ve actually seen them decline, albeit at 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 2 years. In fact, over the last 2 years, we have seen our input costs rise by 14%. While both businesses faced significant cost pressure, it was more 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 1/3 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 from 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 enhance our innovation efforts.

Regarding foreign currency impacts. In the fourth quarter, foreign currency had a 200 basis-point impact on our 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 we 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 also 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 1.3x [ph] from 0.7x in 2011. On this basis, looking at a 2-year average, our operating cash flow to net income conversion rate is at a healthy 1.0x.

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 the 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 in 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 buyback program are indications of our confidence in the future.

With that, I’d like to turn the call over to Doug for his outlook on 2013.

Douglas D. Tough

Thank you, Nicolas, Hernan and Kevin. We are pleased with the progress we’ve 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 a 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 & Beauty Care and maintain solid growth in Functional. While we expect to see improved volume trends 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 our 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.