International Flavors & Fragrances Inc.
Q4 2013 Earnings Call Transcript

Published: 13 Feb 2014

[Operator:]

At this time I would like to welcome everyone to the International Flavors & Fragrances Fourth Quarter and Full Year 2013 Earnings Conference Call. [Operator Instructions] I would now like to introduce Shelley Young, Director of Investor Relations. You may begin.

[Shelley Young:]

Thank you. Good morning and good afternoon, everyone, and welcome to IFF fourth quarter and full year 2013 conference call. Earlier today, we issued a press release announcing our fourth quarter and full year 2013 financial results. A copy of the release can be found on our website at iff.com. Please note that this call is being recorded live and will be available for replay on our website. Before turning the call over Doug Tough and our senior management team, I'd like to read our forward-looking statements. 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 2013 and our outlook for 2014. 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 cautionary statement and risk factors contained in our 2012 10-K filed on February 26, 2013, and our press release that we filed this morning, all of which are available on our website. Today's presentation will include non-GAAP financial measures, which exclude those items that we believe affect comparability. A reconciliation of these non-GAAP financial measures to their respective GAAP measures is set forth in our press release that we issued earlier today on our website. For those of you who are new to our conference call, I'd like to introduce the participants on today's call. With me on the call is Doug Tough, our Chairman and CEO; Nicholas Mirzayantz, our President of Fragrances; Hernan Vaisman, our President of Flavors; and Kevin Berryman, our Executive Vice President and CFO. Now, I would 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 for 2014. After the prepared remarks, we will have some time for questions. Now I would like to provide you with an overview of our performance in quarter 4 of 2013. Our local currency sales growth in Q4 was 7% and reflects strong growth in both our Flavors and Fragrances business units. The emerging markets grew at 11%, which is the highest quarterly growth rate achieved this year. On a consolidated basis, the emerging markets grew at 5x the level of the developed markets in the quarter, and 50% of our sales were to the emerging markets. The overall growth was supported by positive volume on existing business and a steady level of new business wins, reflecting the collaboration among our creative, research and development, and consumer insights teams to provide our customers with products that will continue to delight their consumers. At the same time, we achieved continued margin expansion, which was supported by a moderate decline in our input costs and the many strategic initiatives that we have discussed all year, including productivity savings, mix and volume leverage. As previously forecast, in the quarter, there was no material impact related to the exit of low-margin sales activities in Flavors. As a result of the strong volume growth, combined with continued margin improvements, we were able to grow our adjusted operating profit by 13%, even as we invested close to 10% of our sales in R&D and absorbed costs related to increased incentive compensation expense. As a result, earnings per share increased by 11% to $0.92, and for the full year, our EPS increased by 12% to $4.46. In summary, all of our key growth metrics, including local currency sales growth, adjusted operating profit and adjusted earnings per share grew above our long-term targets. We are especially pleased with the strong performance, given the very strong Q4 results of last year that we were comparing to. The strong end of the year in Q4 has capped an excellent year of performance in 2013, especially when noting the still volatile global economic environment. We achieved local currency growth of 5% and, adjusting for the exit of low-margin sales activities in the Flavors business earlier in the year, we achieved like-for-like sales growth of 6% for the full year. This is the fourth consecutive year that we have achieved growth of at least 4% to 6%. In over the past 5 years, we have grown at a compound annual growth rate of 5% plus, at the higher end of our long-term growth target of 4% to 6%. Our top line growth continues to benefit from our geographic footprint, our focus on innovation and our ability to use our core expertise to provide our customers with creative feeling products that their consumers enjoy. Our strategy is grounded in 3 strategic pillars and benefits from product diversification, and we believe the diversity of our business leads to greater stability and consistency of earnings. The vast majority of the products we make are those essentials that consumers consider part of their everyday lives, and that gives us confidence that consumers will use our customer's products in good times and in challenging times. Benefiting from the leverage in our P&L, our 5% increase in local currency sales resulted in adjusted operating profit growth of 11% and an EPS improvement of 12%. All of our profit metrics were above our long-term growth targets of 7% to 9% on adjusted operating profit growth and 10% adjusted EPS. At IFF, we have a well-articulated growth strategy that we believe will enable us to achieve our desired goal of profitable growth. I will briefly comment on our progress against our 3-pillar strategy. Here is the progress we have made in executing our strategy over the past year. Emerging markets accounted for 50% of our sales in the fourth quarter, the first time ever the emerging markets have represented 50% of our sales in any quarter. For the full year, emerging markets represented 49% of sales. We opened our Flavors manufacturing facility in Guangzhou, China and expanded our laboratories in Isando, South Africa and Hilversum, in the Netherlands. We continue to expand our facility in Gebze, Turkey, which will open in the first half of 2015. We have already completed Phase 1 of the expansion. The new complex will include additional capacity and a new creative and application center for the developing markets of Central and Eastern Europe, the Middle East and Africa. We announced construction of a new creative applications laboratory at our existing facility in Jakarta, Indonesia, as well as a new manufacturing facility on the outskirts of Jakarta. Our capital investments in new capacity, technology and creative application laboratories in Singapore, China, Turkey and Indonesia will approximate $250 million. Turning to innovation. We have accelerated the introduction of new molecules on both sides of the house to provide our perfumers and flavorsists with a broader palette from which to choose and provide them molecules that are high performing and cost effective. We're developing the next generation of our proprietary encapsulation capsules for use in new applications such as Hair and Personal Wash, in addition to Fabric Care. We are continuing to invest in biotechnology and are either on plan or ahead of plan regarding our biotechnology partnership initiatives with Amyris and Evolva. And earlier in 2014, we acquired Aromor, a privately held manufacturer and marketer of complex specialty ingredients, that are used in Fragrances and Flavors, with strong R&D capabilities. We are very excited about their portfolio of cost-effective specialty molecules, which will complement our existing Ingredients portfolio and provide a better array of molecules to our perfumers. In short, our commitment has never been stronger to innovation, as evidenced by the fact that over the last 3 years, we have increased our basic R&D expenditures by over 40%, or compound annual growth rate of nearly 13%. We are investing for the short, medium and long term. We are a commercial enterprise that continuous to focus on finding ways to enhance our returns to provide more value to our shareholders, and we have made continued progress regarding our third strategic pillar, maximizing our portfolio. More specifically, we concluded the exit of $60 million of low-margin sales activities in Flavors over the past 6 quarters, which further enhanced our consolidated margins by over 40 basis points. We have enhanced many internal process disciplines, such as our cost to serve and our go-to market models that make our processes more efficient and better align our resources with commercial opportunities. Economic Profit continues to expand within the organization and continues to provide a foundation for our disciplined approach to both investment and evaluation of business progress. Today, we believe our return on invested capital is the highest in the industry at 18.3%. And importantly, we improved the economic profit profile of our portfolio. Today, 94% of our portfolio is now economically neutral or positive, versus 65% in 2010. With that, I would like to turn the call over to Nicolas Mirzayantz, our Group President of Fragrances.

[Nicolas Mirzayantz:]

Thank you, Doug. Good morning and good afternoon, everyone. 2013 was a strong year for Fragrance, building on the developing momentum we achieved in the second half of 2012. Fragrance delivered solid top line growth in every quarter due to a consistently high level of growth from new business wins, combined with lower erosion on the base business. We increased colleagues' participation with global, as well as regional customers. We ended the year with record levels of revenue, we improved our product portfolio and we are better positioned for future growth. Turning to fourth quarter results. The Fragrance business unit achieved strong local currency growth of 7%, which was on top of the 13% growth achieved in the fourth quarter of 2012. Our Fragrance Compound business had local currency growth of 9%, which more than offset the decline of 3% in Ingredients due to the transition of some volume from Ingredients to Compounds. Excluding the transition, Ingredients would have been positive for the second consecutive quarter. We are seeing continued signs of stabilization in our Fragrance Ingredient business and believe the steps we have taken to reduce costs, while increasing the specialty segment of that portfolio, will improve our company disposition and increase our win rate in Fragrance Compounds. Fragrance Compounds growth of 9% in this quarter is on top of the 15% growth seen in the year-ago quarter and was supported by a strong level of new wins in every category and every region. Our new business wins in 2013 are testament to our innovation and go-to-market capabilities and show good collaboration on the part of our consumer insight, sales and creative teams. The emerging markets continued to be a strong growth driver and accounted for 52% of Fragrance Compounds sales. This market grew at 9% and accounted for approximately 60% of the growth in the Fragrance business this quarter. In Fragrance Compounds, all regions had a very strong momentum. Greater Asia at 16% growth, followed by EAME with an 11% growth, Latin America grew by 7%, totaling a 27% growth in the prior year, and North America also experienced positive growth. Fine and Beauty Care had growth of 9% on top of 17% in the prior-year quarter, with 24% growth in EAME and 12% growth in Greater Asia. The fastest-growing subcategory was Fine Fragrance, led by double-digit growth in EAME. Growth of 10% in Functional Fragrance, on top of 10% growth in the prior-year quarter, was driven by double-digit growth in Fabric Care. Home Care and Personal Wash had solid growth, supported by strong results in Latin America and North America. Turning to Fragrance Ingredients. We've made a lot of progress this year in reshaping our portfolio and reorienting the business for growth. Earlier in the year, we made the announcement that we will close our Augusta manufacturing facility. We have also made progress with our investment with our biotech partner, Amyris, reaching milestones faster than originally expected. In mid-January, we announced the acquisition of Aromor, which has been a supplier to IFF of specialty ingredients over the past several years. And I will provide additional insights on Aromor at the end of my presentation. On a full-year basis, Fragrance revenues grew 6% on both a reported and local currency basis. Fragrance Compounds grew by 8%, equally balanced between Fine and Beauty Care and Functional Fragrance due to our creation capabilities, combined with our consumer insights and research and development teams. Fine and Beauty Care grew 8%, with growth in every subcategory. Both Fine Fragrance and Hair had high single-digit growth due to strong growth in the emerging markets. Toiletries also had solid growth due to strong growth in the emerging market as well. Functional Fragrance grew by 8% in large part due to double-digit growth in Fabric Care, which was supported by our encapsulation technology. The momentum in Ingredients has improved throughout the year, and we believe we have stabilized the business. All of the softness in the top line in the second half of 2013 was due to the transition of some volume from Ingredients to Compounds. If we exclude this volume, Ingredients would have seen positive growth in the second half of the year and flat for the full year. Turning to profitability. The 7% sales growth and combined with gross margin improvements due to both the net benefit of pricing versus input costs, as well as there are many strategic and productivity initiative, translated to operating profit growth of 16%, or $9 million. The improved profitability more than offset increased R&D and incentive compensation expenses. Our segment profit as, a percent of sales, increased 110 basis points over the prior year and was driven by moderating input costs, but still remaining ahead of elevated levels, productivity initiatives and volume and manufacturing leverage. Turning to the full year. Fragrance local currency sales growth of 6%, when combined with gross margin improvement and cost discipline, resulted in segment profit growth of 19% to $283 million. The segment profit, as a percent of sales, increased 200 basis points from 16.5% to 18.5%, as a result of the same factors that partially impacted Q4 results. Looking ahead, on the heels of a very strong Q4, we expect to see growth more in line with our long-term targets and more moderate than our growth in the fourth quarter. Although our Ingredients business has turned the corner and we're expecting positive growth in Q1, we're expecting the Fragrance Compound growth to be more moderate than our growth in the fourth quarter. Let's say we are tightly controlling our costs and expect to see operating cost improvement. In the last 6 months, we introduced 3 new substance and fragrance molecules through our creative teams, and we're ending the year with a strong pipeline of new ingredients. Before turning the call over to Hernan Vaisman, I wanted to provide some additional insights on our recently announced acquisition. As you may know, on January 16, 2014, we announced the acquisition of Aromor, a privately held manufacturer and marketer of complex specialty ingredients. We have been buying specialty ingredients from Aromor for many years. The acquisition brings numerous benefits to IFF. We have been evaluating our Ingredients business and looking to augment the specialty segment of our portfolio. Aromor's portfolio of specialty molecule is very complementary to our portfolio. At the same time, it strengthens the portfolio and position us for stronger and more profitable growth in Fragrance Compounds. Aromor has a very strong organization of world-class chemists, they have strong expertise and knowledge and know-how, and we will be investing in their capabilities for future growth. Collectively, we will be able to provide Aromor specialty ingredients to our perfumers who will have an extended palette of cost-advantage molecule, which will enable them to increase our win rates. Aromor has a strong financial profile. They have been growing quickly to $35 million of pro forma sales in 2013. They will, therefore, add a percentage point of growth to our 2004 Q revenue growth. Due to the specialty nature of their portfolio, their EBITDA margins are in line with our own and are expected to be accretive to our EPS in 2014. We are excited to welcome the entire Aromor team to IFF, and we are looking forward to be working with them to strengthen our Ingredient platforms. We are very pleased to announce this transaction and believe it will be value-enhancing to our Fragrance Compound business and will strengthen our portfolio of and leadership in Fragrance Ingredients. Now I would like to turn the call over to Hernan Vaisman, our Group President of Flavors.

[Hernan Vaisman:]

Thank you, Nicolas. Good morning and good afternoon, everyone. Flavors finished the year strong with another solid quarter of positive growth of 7%. This marks our 32nd consecutive quarter of local currency sales growth and our fourth consecutive year of growth in the range of 6% to 9%. Emerging markets, up double-digits, made the biggest contribution to our growth and accounted for 53% of total sales in the fourth quarter. This growth was led by Latin America, which I will discuss in a minute. Sales growth benefited both from a solid level of new business wins, as well as sales growth from existing businesses. This quarter, there was no material impact on our sales related to the exit of low-margin sales activities. Looking at our growth on a regional basis. Latin America had a strong double-digit growth of 19%; EAME grew by 13%; and Greater Asia, our largest region, increased by 9%. The growth from these regions more than offset a decline in North America of 8%, in part to strong new launches last year in Beverage and very challenging comparable of 15% like-for-like growth in Q4 2012. We are very pleased with our strong performance in Latin America this quarter, where we experienced new business wins in the Beverage and Sweet, primarily driven by our delivery systems, our proprietary FlavorFit portfolio of health and wellness solutions and new molecules from our Citrus platform. On a category basis, all our category experienced growth. Savory, Beverage and Sweet all experienced mid- to high-single digit growth, and Dairy, although not as high, was positive. We continue to work with all our customers to provide creative solutions that result in long-lasting business for IFF. Customers appreciate our creative expertise and ability to translate trends into winning products. Turning to the full year. Our local currency sales growth was 4%, and excluding the impact of the exit of low-margin sales activities, our full year growth was 6%. This year, we exited approximately $25 million of low-margin business, resulting in an improvement to our portfolio and a 40-basis-point impact to our margins. Emerging market had growth of approximately 9%, or nearly twice the level of the developed markets, which has solid growth of approximately 5%, excluding the exit of low-margin sales activities. The emerging markets made the biggest contribution to our 2013 growth, especially our customers in China, Indonesia, Argentina and Thailand. The contribution to growth in these markets validates our decision to build capacity in this important markets, which continue to provide a runway for growth for many years to come. Over the past year, we successfully opened a new state-of-the-art facility in Guangzhou, China. We continue to expand our facility in Gebze, Turkey, and announced a $50 million investment in the new manufacturing and creative facilities in Indonesia. This investment express the company's commitment to provide innovative product solutions and ensure rapid supply to our customers in this market. And we are committed to further expanding our strong presence and capabilities in emerging markets. That said, we believe the potential in the developed markets for Flavors is just as high, if not higher, than the emerging markets. We are working with our customers in these more mature markets to provide them with products that will appeal to their consumers, such as our expanded FlavorFit portfolio that provides innovative approaches to address the challenges of health and wellness trends. During the year, we experienced a consistent and strong level of new business wins, reflecting the strong level of innovation in the business. In order to train the next generation of Flavors, we also launched our Flavor School [ph]. Turning towards profitability. Flavors gross margins continued to expand due to the net impact of price versus input costs and other strategic initiatives. When combined with the volume gains this quarter, it resulted in 12% segment operating profit growth, or $8 million to $17 million. Our segment profit margin increased 130 basis points to 20.3%, up from 19% in the prior year quarter. Turning to the full year. The gross margin expansion was due to the positive impact on margin of the exit low-margin sales activities and the net impact of price to input costs, combined with other strategic initiatives to reduce costs. The increased gross margin more than offset increases related to R&D investment and higher incentive compensation expense related to our full year performance. On a full year, our segment profit margin was at an all-time high of 22.7%, up 110 basis points from 21.6 in the prior year. Our segment profit totaled $324 million versus $298 million in the prior year, or an increase of 9%. The improved segment profits reflect strong volume growth, combined with the product gross margin expansion, which more than offset investment in R&D and increase in incentive compensation expenses. In short, 2013 was a year of strong performance while we also put plans in place to strengthen the Flavors organization for the future. Looking ahead to the first quarter of 2014, we expect our local currency sales growth to be more moderate versus Q4 and more in line with our long-term targets. I would now like to turn the call over to Kevin Berryman, our CFO.

[Kevin C. Berryman:]

Thank you, Hernan, and good morning, good afternoon, everyone, on a snowy New York day. Turning to the fourth quarter, I'd like to view some key metrics and provide you with perspective on the importance of each. Our local currency sales growth in the fourth quarter was 7%, following 8% growth in the fourth quarter of 2012. On our third quarter earnings call, you might recall we were more cautious in tone, given the challenging comparison to the fourth quarter of 2012 when we delivered 15% growth in Fragrance Compounds and 7% like-for-like growth in Flavors. This quarter's growth of 7%, on top of 10% like-for-like growth in the prior year, speaks to many important things about IFF, not the least of which is our ability to harness the power of our creative, sales and development teams to deliver products that customers value. The emerging markets continue to be a strong growth driver and it's important to maintain perspective on the strengths of these markets, given the growth in the consumer market and the strength of the demand for products, which are rapidly becoming part of their emerging, more consumer-oriented lifestyles. Our margins expanded an additional 160 basis points in the quarter, based on moderation in input costs, combined with the strength of our strategic initiatives. I will touch on this later, as we still face an overall headwind to our margins due to the strong inflationary environment we faced in 2011 and 2012. The margin expansion and volume gains resulted in adjusted operating profit growth of 13%, or $13 million, on top of 9% growth in the fourth quarter of 2012. Our adjusted EPS improves 11% this quarter on top of 11% growth in 2012. I've shown this slide before, and I think it's important because this shows our continued progress in capturing the growth in the emerging markets. A key component of our growth plan is to capture the benefits of the wealth creation that's occurring in the fast-growing emerging markets. The slide highlights our increasing strength in the emerging markets over the last 3 years. Our percentage of sales in the emerging markets has increased from 44% in Q1 2010 to 50% in the fourth quarter of 2013. We believe our index to the emerging markets is the highest in our industry and is reflected in our strong organic growth rates. Over the last 3 years, our compound annual growth rate in the emerging markets is nearly 9%, and we believe that the emerging market opportunity remains largely intact given the long-term trends of 1 billion-plus new consumers entering the market to purchase consumer packaged goods for the first time. Turning to the next slide, I have also shown this one before, which provides insight to our gross margin progression in light of historically high input cost increases. This slide demonstrates that even though we are seeing margin gains of 210 basis points in 2013, the net impact of historical rising input cost on our margins continues to be a headwind. If we look at the period full year 2010 to full year 2013, you will see the factors that are leading to the gross margin improvement between the 2 years. We chose the full year of 2010 since that is the last comparable full year period prior to the large increase in input costs that we saw and experienced in 2011 and 2012. Over the 3-year period, the net impact of pricing and input cost has been a negative 130 basis points on our gross margins, as evidenced by the red bar. As you know, we proactively worked with customers to implement pricing increases to reduce the strong pressure from these higher input costs and limit the inflationary pressure to the 130 basis points noted on the slide. However, the importance of the execution of our strategy, where we adopt numerous measures to improve our margins, including the exit of low-margin sales activities, cost-savings initiatives, innovation enhancements, manufacturing efficiencies and restructuring and other gross margin improvement efforts, cannot be overstated. These strategic improvements had a 340-basis-point improvement positive impact on our margins over the 3-year period, as shown by the green bar on the chart. This more than offset the negative 130-basis-point reduction from the net impact of input costs and pricing. Importantly, going forward into 2014, we are seeing some input costs increasing, which will require us to have selective and targeted discussions with some customers regarding price increases. Turning to our RSA costs. Our adjusted RSA, as a percent of sales, increased 70 basis points from 27.6% to 28.3% of sales. The higher RSA reflects additional incentive compensation provisions related to our strong performance in 2013 and other miscellaneous costs, including acquisition-related costs of Aromor. For the second year in a row, our strong performance in Q4 triggered higher incentive accruals to our AIP program, and as a result, we have higher provisions in Q4 2013 versus Q4 2012. Other incremental costs we incurred in the fourth quarter are related to nonstructural expenses that add approximately $5 million to $6 million to fourth quarter RSA costs. We also incurred higher R&D expenses this quarter, related to our investments in innovation. R&D increased 13% year-over-year and, as a percent of sales, increased to 9.7% of sales in the fourth quarter of 2013, up from 9.1% in the fourth quarter of 2012. If we're to exclude these non-structural costs and additional incentive compensation accruals from RSA, then our sales and administrative costs would have increased more in line with inflation, and this would have resulted in our RSA, as a percent of sales, falling versus the year-ago quarter. Again, we remain disciplined in our approach to spending, and going forward, cost discipline will be a continued focus while we strategically invest in research and development and other business development opportunities. A foreign currency translation this quarter had a minimal impact on our reported sales. The more limited volatility in the euro-dollar exchange rate, combined with hedging activities with the euro, has resulted in foreign currency impacts having an insignificant impact on our operating profit results. The operating impact on our full year results was also muted. For 2014, we are nearly 80% hedged against the euro at levels that approximate $1.32 per euro -- euro per dollar, effectively consistent with the average exchange rate levels for the full year 2013. At current rates, the operating impacts on our 2014 results is expected to continue to be benign. Given the recent volatility we have seen in some emerging market currencies, I would like to remind those on the call about our emerging market foreign currency profile. As you know, IFF sales into emerging markets are significant. Importantly, while 50% of our sales are through the emerging markets, a significant portion of these are not subject to foreign exchange risk to the extent that you might imagine. More specifically, much of our sales in the emerging markets are subject to commercial arrangements that significantly reduce the currency volatility on our results. Specifically, various commercial terms allow us to better align our foreign exchange exposure on sales with developed market currencies or harder currencies such as the euro or U.S. dollar. Therefore, as you can see in this chart, of the 50% of our sales that are to the emerging markets, approximately 2/3 are aligned with U.S. dollars or other hard currencies, leaving less than 1/3 that are fully exposed to local currency volatility. Turning to our cash flow. As you know, our business is very cash-generative, and we are pleased with our improved operating cash flow performance this year. For 2013, our operating cash flow was $408 million, or 13.8% of sales, versus $324 million, or 11.5%, of sales in 2012. There are some large items impacting our comparability that I would like to discuss. First, last year, we had a cash outflow of $105.5 million related to our Spanish income tax settlement for the 2004 to 2010 years. This outflow was included in our 2012 full year number; number two, in 2013, the company made $30 million of contributions to our qualified U.S. pension plans, or an incremental $15 million versus normal levels; and finally, number three, also in 2013, we made $33 million in payments related to Spanish tax assessments for the 2010 to -- excuse me, 2002 and 2011 tax years. If we exclude these items to make the year-over-year comparison more representative, then our cash flow would have improved from $430 million to $456 million, or an increase of 6%. Turning to our capital structure. We are making progress on our share buyback program. Through the end of the year, we repurchased approximately 656,000 shares at an average price of $78 per share. We spent approximately $51 million on this effort, meeting our expectations for the year. And given current market dynamics, we would expect to spend a minimum $75 million in share repurchases in 2014, effectively offsetting any share count pre-associated with option grants. Our current quarterly payment dividend of $0.39 per quarter based on our 2013 net income provides a payout ratio of approximately 35%. And this is versus a payout ratio of 30% associated with our previous quarterly dividend of $0.34, which we had at the beginning of the year. Per our normal process, our evaluation of an increase in our quarterly dividend level will be completed during the third quarter of this year. Turning to our long-term financial targets. These targets, as you know, provide our view on the expected growth of our business for 3 key metrics. Our targets call for 4% to 6% local currency sales growth, 7% to 9% adjusted operating profit growth and 10-plus percent adjusted EPS growth. I would like to benchmark our actual performance on a 5-year, 3-year and 1-year basis against these targets. First, looking at our local currency sales growth, our long-term targets call for growth of 4% to 6%. If we look at our 5-year compound annual growth rate, our local currency growth was 5%. On a 3-year basis, we experienced growth of 4%, and on a 1-year basis, our growth was 5%, reflecting our strong performance in 2013. It is also important to remember that on a like-for-like basis, our growth would have been 6% in 2013. We have met our local currency sales growth targets on a compounded 5-, 3-, and 1-year basis. And importantly, our growth from new wins in 2013 was at a 5-year high, which is a good foundation of that growth that we saw this past year. Turning to our adjusted operating profit growth. Our long-term growth targets call for adjusted operating profit growth of 7% to 9%. On a 5-year basis, our compound annual growth rate was 8%. On a 3-year basis, it was 8%. And looking at our 1-year growth, we achieved adjusted operating profit growth of 11% in 2013. Consistent with our performance against our local currency sales growth target, we have met our adjusted OP growth targets on a compounded 5-, 3- and 1-year basis. For 2013, there was a clear acceleration in our profit growth. Finally, turning to our adjusted EPS growth targets. On a 5-year basis, we achieved a compound annual growth rate of 10%. On a 3-year basis, it was also 10%. And for the full year 2013, we achieved growth of 12%. And again, we have met our adjusted EPS growth targets on a compounded 5-, 3- and 1-year basis. Importantly, we have met all of these objectives while remaining committed to our investment in innovation with R&D expenses nearing 9% for the full year 2013 and 9.7% in the fourth quarter. Let me now turn it over to Doug to provide some comments regarding our 2014 outlook.

[Douglas D. Tough:]

Thank you, Kevin, Hernan and Nicolas for the remarks on the company's performance. 2013 was a very exciting year for us as we continued to execute on our 3-pillar strategy while investing in the future growth and profitability of the company. We are pleased with the momentum on both sides of the business and believe that we are well positioned for growth due to the many steps we have taken to augment our profitability and strengthen the company. We are expecting continued success in 2014. We have the right teams in place to continue to provide customers with superior customized products that deliver improved performance to their consumers. We expect to deliver local currency growth in the range of 5% to 7%, reflecting the addition of Aromor, continued new business wins and volume growth in the faster growing and more mature markets. This includes our organic growth rate range of 4% to 6% with an additional point of growth associated with our acquisition of Aromor. We also expect to see strong levels of adjusted profit and earnings per share growth in 2014 as our business continues to see top line and operating momentum and we benefit from the reset of our expected incentive-based compensation expense to a 100% target level in 2014. As a result, operating profit growth is expected to be up double digits with EPS seeing commensurate strong improvement. Regarding our first quarter of 2014, as Nicolas and Hernan pointed out, we expect more moderate -- modest top line growth in Q1 following a strong Q4 and, hence, performance more aligned with our long-term growth rates in Q1. Regarding EPS, we expect a muted level of growth through the absence of the R&D tax credit in 2014, which was reinstated in Q1 2013. Regardless of these impacts in Q1, we believe our full year outlook is achievable. I thought I would wrap up with a brief summary of our investment theses. We partner with the world's leading global consumer companies. Our flavors and fragrances are the key component in the world's finest perfumes and best known consumer brands and are often the key reason behind a consumer's purchase decision. Yet our products only contribute 1% to 4% of the overall cost of a finished product, creating a great value proposition for our customers. We are geographically diversified. Our focus on the fast-growing emerging markets is not new. We have had footholds in many of the developing markets, such as India, for more than 50 years. As our customers in the emerging markets grow their businesses, they have the ability to leverage our long-standing presence and our extensive market knowledge to help drive growth in their brands. The company generates healthy cash flows, which allow us to reinvest back into the business as we strive to reallocate resources towards higher return activities while still maintaining financial flexibility and returning capital to shareholders. Lastly, we have an experienced and a talented employee base whose dedication and commitment drive the company forward in line with their strategic plans. In conclusion, we are very well positioned in the market for continued success. Our investments in Asia and EAME are proceeding as planned and are vital to sustaining our long-term growth and delivering the best service to our customers. Our strong growth reflects the ability of our people to collaborate effectively and leverage our R&D, creative offering and geographic footprint to create solutions for our customers. And finally, we were able to achieve all of this through the strengths of our business model and the expertise of our people. This year, we are celebrating our 125th anniversary at IFF. Our employees continue to drive our success by creating exceptional products and providing superior service. We share this milestone with our customers, our partners and our shareholders. I thank you for your participation this morning. I will now open up the call for questions.

[Operator:]

[Operator Instructions] And your first question comes from Mark Astrachan from Stifel, Nicolaus.

[Mark S. Astrachan:]

I wanted to ask about the split between pricing mix or contribution from pricing mix in the fourth quarter, and then also get a sense of expectations for contribution in 2014 to input costs. I hear what you said. I know one of your largest competitors they talk about also seeing or having some expectations for pricing. So maybe just give us a bit of -- a sense of how that worked out in 2014, and then just what the housekeeping numbers were in third -- '14 -- '13.

[Kevin C. Berryman:]

Mark, this is Kevin. I'll take a stab. I will tell you that pricing in 2013 was muted, certainly in the back half of the year especially. So you can consider that the growth dynamic associated with Q3 and Q4 was largely a result of our strong new wins. You heard the mention that our 2013 year, as it relates to growth from new wins, was a record. So very, very strong level of performance in 2013. For 2014, we are seeing selective areas where input costs are increasing, and we would expect to have targeted and selective discussions with customers to have pricing, but we don't see that as being a material dynamic in the overall kind of picture for our growth in 2014. Overall, we don't see a significant acceleration in our input costs, but we see -- are seeing some specific ones that we're going to need to take some pricing actions on.

[Mark S. Astrachan:]

Great. And then just one follow-up. Nonstructural expenses in RSA, what are those? And what was -- or how should we think about that going forward?

[Kevin C. Berryman:]

Well, we specifically called it out, Mark, because we don't expect that those are going to be seen to ultimately recur on an ongoing basis. But effectively, we have some costs associated with our acquisition of Aromor. That's clearly in the Q4 numbers. We had some legal project costs. We had some tax costs that we incurred relative to our emerging market presences. So if you look at those kind of items that -- well, making up the bulk of those, clearly the call-out is to suggest that we shouldn't necessarily see those levels of expenses going forward in Q4 2014.

[Mark S. Astrachan:]

Okay. So just to be clear, so that is in the adjusted numbers in the fourth quarter then?

[Kevin C. Berryman:]

Yes, it is.

[Operator:]

Your next question comes from Lauren Lieberman with Barclays.

[Lauren R. Lieberman:]

I wanted to know if you guys can, one, give us any news that you're at or ahead of schedule on all of your partnerships. Do you have an update on Evolva and vanilla -- vanillin being available to your flavorists and when that starts to impact flavor business trends. And then also just on Aromor, Nicolas, you talked a little bit more about sort of existing portfolio and why it was interesting but didn't really mention much the -- anything specific or -- maybe to put in layman's terms to the R&D capabilities that, that business brings in? But I think there were some things in the press release or whatever you got on Aromor so far that suggests there's something a little bit more interesting there, and I'd love to hear your perspective on that.

[Hernan Vaisman:]

It's Hernan here. Regarding the natural vanillin, as I mentioned in the previous call, I mean, we just finish this quarter, in fact in January 1, is scaled up. It was successful. Now the next step is to get these materials throughout all the creation centers in the world in order to get the flavorist, application teams familiar with it. And we plan to start going to present to customers and show it in the markets in the second part of the year. So we expect to get the first, I mean, revenues coming from these initiatives by the end of this year.

[Nicolas Mirzayantz:]

It's Nicolas. Regarding Aromor, without going into the specific, well, the key takeaway is that first of all, in terms of capabilities, they have complementary capabilities to ours. And therefore, our ability to develop new molecule is strengthened when you put our team and their team, number one. The number two is it's a complementary portfolio. There is no overlap in our portfolio of ingredients. So it's very incremental to us, both for our external sales of ingredient, but, most importantly, they are really critical ingredients I -- in fact specialty ingredients for perfumers to use in their creation. We know these ingredients very well because we are the -- a partner to Aromor for a very long time. So our perfumers know these ingredients very well and can use them rapidly at a higher level in their new creations moving forward.

[Lauren R. Lieberman:]

Okay, great. And then just a bigger question on R&D spending. Is it -- is this the right way to think about it? I know there's obviously a payback as you spend. But just curious, do you think there's sort of a mass level where you'd want to be spending as a percentage of sales? Or is it just as long as gross margins are expanding from some of your productivity and mix initiatives, that we just should always think about money going back into R&D just as we'd see your customers always spending back into their advertising budget. Is that sort of the right way to think about the financial model long term?

[Douglas D. Tough:]

Lauren, I think it's partly right. I mean, I think the analogy to investing in your business with advertising is a good one. We've certainly been over 8%, but I don't think it's as simple as just will it expand gross margin. There's a pretty disciplined approach within both the business units in concert with R&D and another units in the company that takes a look at the size of the price, the likelihood of getting the margin, the cost and use, the likelihood of regulatory approval, the time required and so on. So there are a number of factors that go into it. Now we evaluate all the projects that are on the docket with a view to which ones we think we can fund. And I'll have to say that where we are now in the disciplined approach that's really been brought to bear by a number of constituents in the company helps us understand where we think there's a really good return. So I'm very happy with where we are at our investment level. Clearly, if we have the opportunity to enhance that, we can do so. But the projects all go through a pretty disciplined rigor to be approved, and so we're not -- we're certainly not underspending but, frankly, nor do I see us overspending at this point. And we have quarterly reviews which document the probability, likelihood and the expected returns we're going to get.

[Kevin C. Berryman:]

Lauren, just one additional comment.

[Lauren R. Lieberman:]

Yes.

[Kevin C. Berryman:]

This is Kevin. We did have an accelerated milestone payment for Amyris in the fourth quarter. So that bumped up the fourth quarter numbers specifically higher than what would probably be determined to be kind of an ongoing level. So you should be aware of that.

[Operator:]

Our next question comes from Mike Sison from KeyBanc Capital.

[Michael J. Sison:]

You did a nice job generating good margin expansion in the strategic initiatives. Clearly, you're going to have some momentum in 2014. Can you just help us maybe get a feel of how much improvement you can see next year? And what are the areas that will drive that?

[Kevin C. Berryman:]

I think if you go back -- let's start from the foundation of what our 3-pillar strategy is. And obviously, the footprint, the -- leveraging the geographic footprint, strengthening our innovation and managing the portfolio are all our -- are opportunities that will allow us to continue to hopefully drive our gross margin progress going forward. So it's part of our strategic vision that, that happens. Having said all of that, Mike, we saw some great advancements in 2013. We would not expect to have that same level of improvement in 2014. So I think we're going to be looking at a more normalized level of gross margin improvement in 2014. And of course, that will require us to take some pricing actions into those specific areas where we're seeing some acceleration in input costs for our respective businesses. And I think that at the end of the day, there's an inherent dynamic relative to the innovation that the teams are bringing to their portfolios, which should afford us gross margin enhancement over the long haul. And so that's a critical part of our strategy. We still think that, that strategic pillar is well in place, and that is our intent, to try and drive that. But it will be at levels that are less robust in 2014 than in 2013 in terms of level of improvement.

[Michael J. Sison:]

Okay. And then, Doug, you talked about your return on capital being at very industry level -- industry high levels. That's certainly a great level to be at. But is there a way to deploy that capital a little bit more aggressively to maybe enhance growth? Or you start to get worried when your returns are too high, right, in terms of being able to generate growth. Any thoughts there and maybe using your balance sheet more aggressively, too, to add more growth to the company?

[Douglas D. Tough:]

Certainly, Mike. We look at a number of ways that we might be able to attack that issue. And we publicly stated certainly that the focus will be on continued growth and investment. But certainly, the balance sheet and the opportunities for capital, we look at M&A-type opportunities. We've done a small recent deal with Aromor. The company's aspirations would be greater than that, but they will also be well disciplined in the context of the financial rigor that M&A has to bring. Certainly, other capital issues, whether they're buybacks and so on, we've done small ones. But I'd say the overall earning objective here is how can we get growth, that profitable growth. So we hope we have more M&A opportunities ahead of us, and -- that would be deploying the capital.

[Operator:]

And your next question comes from Jeffrey Zekauskas from JPMorgan.

[Jeffrey J. Zekauskas:]

Of the 5.8% sales growth that you reported in 2013, was more than half of that mix or price mix?

[Kevin C. Berryman:]

No. In 2013, no.

[Jeffrey J. Zekauskas:]

Yes.

[Kevin C. Berryman:]

It was largely associated with new wins associated with the efforts by the BUs in driving innovation into the portfolio. So it's largely volume related. Now some of that is mix because you might have innovation that brings mix benefits to it. But we don't break that out necessarily separately. So think about it as volume-mix driven.

[Jeffrey J. Zekauskas:]

Right, because the puzzle is your cost of goods sold went up $15 million or less than 1%. And if your volume on a ratable basis, maybe your cost of goods sold was flat, raw materials would have gone up, I don't know, $65 million. And even with cost initiatives, it seems difficult to pull that much out. So there must be a very large mix benefit in 2013. Is that right or no? Or why is the growth in cost of goods sold so slow?

[Kevin C. Berryman:]

I think there's a variety of factors that are driving that. Certainly, the strategic initiatives that we talk about a lot, Jeff, are a driver to that. And if you think about the exit of the low-margin Flavors activity, that's worth probably 80-plus basis points to Flavors, 40-plus basis points to the company over that period of time. You have the mix benefits of our innovation coming out of that higher margin levels. We did -- we're able to realize a moderating level of input costs. All of those things add up to something that looks very attractive from a margin progressive. And we think that the thesis underlying that strategic kind of plank of innovation and margin enhancement is certainly going to play forward as well. There was also, and I would say this especially in Fragrance in 2013, a lot of productivity enhancements as well, which related to our ability to drive a reduction in ingredients that support those new opportunities of wins. As well, you know that Nicolas and his team have done some restructuring efforts over time to ultimately drive incremental margins as well. So a broad array of efforts, and it will always continue to be a broad array of efforts because we need to be efficient, productive and innovative in terms of driving the business going forward.

[Jeffrey J. Zekauskas:]

Yes. And then lastly, your Latin American results were very, very strong for the second successive year, and I imagine that, that's largely Brazil, Argentina and Mexico. Were there differences in the growth rates in those 3 countries? Or were they smoother? And in general, for many companies, the North American growth, with the growth in the economy, is really the strongest element. But for you, especially in South America, you've grown especially well with very, very weak economies. Can you talk about that feature?

[Hernan Vaisman:]

Okay, I'll take a stab, and it's Hernan here. You're right. I see the type of situation when you read the newspapers on the real economy there, that they are really -- almost all economies except Mexico and Brazil [ph], mainly, Argentina and Brazil. And really, we're performing really, really well, and this is basically from what I mentioned before, the high level of new wins that they have there in this area. In some countries, for example, you can think that Argentina we will never grow and there's a bit of pressure on this country, well, our growth is more on the 20%. And this is really coming from the new wins. So we -- usually, you can say that the economies and the growth of our business should be somewhere correlated. But we stated that the correlation will be a big difference between whether the country will grow and when you're winning by yourself. Organically, actually, we're not growing, but our new wins there should accelerate the growth in that region. And your question is almost in all countries, in Mexico, Brazil and Argentina.

[Nicolas Mirzayantz:]

It's Nicolas here. Very similar to what Hernan was saying, we -- well, we've been saying that first of all, emerging markets, especially in Latin America, is that -- where we had a leading position for many decades already. So it speaks to not only the strengths of our portfolio, the strengths of the relationship, very high market share, very, very strong consumer insight and really understanding what is driving consumer preference. So we engage on a position of strength and knowledge and expertise, which is augmented by our innovation pipeline. And the growth was really driven by new wins. So very, very strong growth for the portfolio and a very strong growth last year. Yes, the economy is where we're seeing some signs. We have to monitor the situation. But at least the pipeline of introduction for the Q4 was very strong, and we will have to keep monitoring as the situation progress. And as far as countries are concerned, very, very strong growth in Brazil and Mexico, Argentina and Colombia, really driving the growth in Latin America.

[Operator:]

Your next question comes from Rohini Nair from Deutsche Bank.

[Rohini Nair:]

I just wanted to touch on Fragrances. And I'm wondering whether you can give us a bit more color around what you're seeing there. Functional seems to be doing pretty well uniformly across your markets. Fine fragrance growth also good but maybe limited to certain regions. So if you could address those dynamics. And then along with that, do you have a sense that you may be benefiting from new product wins maybe more so than your competitors?

[Nicolas Mirzayantz:]

It's Nicolas here. First of all, I would like to provide a perspective. There's 2 components to take into account. First, comp versus last year. So if you take here North America [indiscernible] minus 6, but it was on the heel of plus 17%, which was significant growth and far higher than what the market was experiencing. So I think that the comp is playing an element. And then if you look at our growth of 24% in the EAME, one thing that is important to take into consideration is a large majority of our customers, while European based, are manufacturing in Europe for the rest of the world. So probably definitely, as we know, part of the 27% growth in Europe, which is far above the market growth, is also then being exported to the U.S., but we cannot record it as U.S.-based sales. So it's difficult for us to track. But definitely, the 24% in Europe were from very strong -- new wins, a pipeline that are shipped in different parts of the world. And then there are things about Latin America. Minus 1. I just would like to remind everyone that last year, in Q4, we grew 59%, which is also very far in excess of what the market was going. So if you look at the 2-year average, it's still a double-digit growth and above the market growth.

[Rohini Nair:]

That's great. And just to follow up on that, if we think about profitability on the Fragrance side, it seems that with the increased specialization you're getting from Aromor, your ingredients rationalization, you have good opportunity for improvement over time. So I just want to get a sense of how you may be thinking about those margins longer term, whether we might eventually see those margins approaching the level of Flavors at some point.

[Kevin C. Berryman:]

It's Kevin. I'll take a crack at that. Look, I think that certainly, both of our business units are very strongly economically profitable, and both represent fantastic growth opportunities. We do think that there were some significant opportunities to enhance economic profit within the context of the Fragrance business. And you can see, given their margin profile, well, some of that improvement is coming to light. Whether or not we openly get to a level where those 2 businesses are equal in terms of margins, we don't think about it that way necessarily, but we do believe they both represent very, very strong opportunities to have profitable growth. And specifically, because of the things you called out in your question, there are some things which will afford us perhaps an ability to further reduce the difference between the 2 margin profiles of the business units. And of course, depending upon, at the end of the day, our ability to drive innovation into our portfolios, that will ultimately determine where we fall out in terms of margin profiles in my mind.

[Douglas D. Tough:]

And certainly, Aromor brings us strength with the opportunity to use those molecules. You can see, we're, using more of them in order to win new businesses will give us perhaps long-term margin improvement, not necessarily short term. But I'd echo what Kevin said, both businesses are attractive. But while we look at the comparisons to each, the real comparison needs to be within the BU and the comparisons to their competitors and what we need to do to win against competitors, not to win against each other. But both are attractive, and we pointed that out both at the Investor Day and in the overall financial results.

[Operator:]

Your next question comes from Jonathan Feeney with Janney.

[Jonathan P. Feeney:]

I wanted to ask specifically, just having gotten off a few of the CPG calls, specifically as it relates to Flavors, do you -- or is there any concern about in -- a slowdown in developing markets affecting innovation plans? And I know you made some comments about this, but just more detailed specifically about how specific customers, like Monde at least, talked about a little bit less spending in emerging market this year. If you had a customer that was in that situation, how does that affect your business? On what kind of lag? And are you seeing any kind of that activity right now even upstream from what you might be feeling directly at the revenue line?

[Hernan Vaisman:]

Thank you for the question. I just came -- it's Hernan here. I just came from Asia, and it's been a long trip there. And as I was mentioning last call, we saw some slowdown in India. I mean, definitely, the economic situation is impacting the overall of the business. But I just came and I -- even now, the sentiment is, in some ways, different. I mean, they see may see some, they say, light at the end of the tunnel by the second [ph]. So our real concern in the third and fourth quarter was India. We see some improvement. Having said all that, I mean, the incentive is clear. I mean, the pace of growth that they used to have, I mean, the developing markets in Asia, the one we're focusing, is different. I mean, when we talk about 2 or 3 years ago, the growth was almost in the double digits, and now you're talking in China 10%, India 6%. So there is a kind of slowdown there. Having said that, the potential is huge. I mean, we've got so many consumers, they -- buying and getting the new cars. So the [indiscernible] the timing [indiscernible]. How it's impacting, I mean, the customers, yes, in some customers that's really impacting in those markets. But again, I mean, we are not only working with one customer, we are working with many customers in one of these markets. And as I mentioned before, domestically [ph], it has a perfect correlation between a customer, between countries and our, I mean, growth. If we are really putting effort there, as what we are doing, a lot of investments, they are really creating good products, that they are really gaining the consumer preference. We can have -- even though it's kind of a lower base in growth [ph], we can have the possibility to grow faster than even of many of the customers in the countries. So in short, the pace of growth in emerging markets is down, but we have the fundamentals in place really to keep on outperforming the market growth.

[Operator:]

Your next question comes from Edward Yang from Oppenheimer & Co.

[Edward H. Yang:]

Just following along the other questions on emerging markets and your ability so far to decouple from some of these more troubled economies, are there any sort of canaries in the coal mine or leading indicators that you would look to, to let you know that trouble is coming down the pipe?

[Douglas D. Tough:]

Well, I mean, I guess the comments we get from customers, the customer interaction we have is ongoing across both sides of the business. I think the one thing that -- there is what we would call defensive and offensive briefs. And the opportunities to go forward to customers with a view to understanding their portfolio and providing solutions to them and recommendations on innovation has really been well received on a number of the globals. So the leading indicators, the way you've called them, can be some softness, which Hernan has just touched upon. But the way we have to deal with that is our customers are still looking for innovation and the opportunities for innovation. And we've ramped up our game, continued to do so. So not withstanding there may be some slowing down, we've been able to counteract some of that through proactive activities. And that would continue to be the thrust that we would do.

[Edward H. Yang:]

Okay, and thanks for that color, Doug. Kevin talked about how although you have half your sales from emerging markets, only about 1/3 of that half is non-dollar or non-euro denominated. Do you have any plans to hedge out that remaining exposure? And in markets like Indonesia or Argentina or you hear nowadays about Venezuela having some -- putting into effect some capital controls and your ability to repatriate that cash, when you do have sales in the local markets, how frequently do you bring that cash back? Or do you wiggle in those markets?

[Kevin C. Berryman:]

Well, to a large extent, Ed, that's -- that was a mouthful of a question because as you know, it's a complex area. But I will tell you that certainly, in general, we have a belief that we'll continue to reinvest back into the emerging markets. And so to a certain extent, there is an ability for us to use that cash by reinvesting back into the businesses. And that's good for us. That's good for our customers. That's good for their consumers ultimately. Having said that, we do need cash back in the U.S., and we look at all available means to provide opportunities to bring that back to help fund our needs on debt service, share buybacks, dividends, whatever the case may be. So we have very proactive discussions ongoing with our teams around the globe, and the treasury group does a very, very nice job of working out with our teams to facilitate our ability to get the cash where we need it and when we want it. There are challenges. Clearly, Argentina is one. There are others that I would call out, which are bigger challenges actually just because of the magnitude of it. But at the end of the day, some of our FX structures that we have in place and its ability to match our costs with our -- with the more harder currencies is a benefit to us probably versus many of our competitors and/or customers.

[Edward H. Yang:]

Okay. And on reinvestment, just finally, you talked about R&D spend. What's your expectation for CapEx for this year?

[Kevin C. Berryman:]

We've continued to say that we're in the neighborhood of 4.5% to 5% probably until the year 2016 when we will probably start to trend down to, let's call it, a lower level, more consistent with history.

[Operator:]

Your next question comes from Lauren Lieberman from Barclays.

[Lauren R. Lieberman:]

It was just a quick clarification. Hernan, when you talked about the growth rate you were seeing in Argentina north of 20% and that's attributable to new wins, I just want to be very clear that, that does not include any kind of inflationary -- material inflationary pricing.

[Hernan Vaisman:]

You're correct, this is through dollars. It's not including any kind of inflationary impact.

[Operator:]

At this time, there are no further questions.

[Douglas D. Tough:]

Well, thank you all for your participation. I think this morning, you got a sense of the -- how IFF needs to operate and the diversity of the business, whether it's the 2 business units, the regions, the categories. But managing that diversity, we think, leads to our success. We look forward to talking with you in early May for the Q1 results. Thanks for your participation.

[Operator:]

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