International Flavors & Fragrances' CEO Hosts 2013 Investor Day (Transcript)

| About: International Flavors (IFF)

International Flavors & Fragrances Inc. (NYSE:IFF)

2013 Investor Day

June 05, 2013 8:00 am ET

Executives

Shelley Young - Director of Investor Relations

Douglas D. Tough - Chairman and Chief Executive Officer

Hernan Vaisman - Group President of Flavors

Nicolas Mirzayantz - Group President of Fragrances

Ahmet Baydar - Senior Vice President of Research and Development

Kevin C. Berryman - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Francisco Fortanet - Senior Vice President of Operations

Analysts

John Roberts - UBS Investment Bank, Research Division

Mark S. Astrachan - Stifel, Nicolaus & Co., Inc., Research Division

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

John D. Staszak - Argus Research Company

Shelley Young

Good morning. Welcome to IFF 2013 Investor Day. I am Shelley Young, the Director of Investor Relations. We have a very exciting day planned for you. Before we begin, we would like to remind everyone that during today's presentations, we will be making forward-looking statements about the company's performance. These statements are based on how we see things today, and actual events or results may differ materially from those reflected on our forward-looking statements. Forward-looking statements can be identified by words such as believes, estimates, expects or similar references to the future and include statements we may make regarding the company's future financial performance, business prospects and operating strategies. There are many factors that can result in actual performance differing from projections and forward-looking statements. These factors are set forth in our 2012 annual report on Form 10-K filed with the SEC on February 26, 2013.

Today's presentations 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 are available on our website at www.iff.com.

With that, it's my great pleasure to introduce Doug Tough, our Chairman and Chief Executive Officer.

Douglas D. Tough

Thanks, Shelley. Good morning, everyone. Welcome to IFF's 2013 Investor Day. I'm delighted that you are here with us today, and also good morning, and good afternoon to those of you who are listening to us over the webcast.

The theme of this year's event is innovation, the foundation of our success. It is our goal today to share the many things we are doing that set us apart from the competition, that drive our performance and position us for continued profitable growth. We take a holistic approach to innovation at IFF. I am not just talking about the new molecules we create in R&D or the regional flavors we develop in our creative and applications laboratories. We are talking about how our IFF people in procurement, in engineering, human resources, information technology, finance, marketing, communications and operations are finding new and better ways to deliver improved performance. You will have a chance to hear from some of our senior management team, as well as to meet IFF-ers from other areas in the organization. It is our goal to help you develop a better understanding of our business, as well as to gain increased knowledge of the initiatives that are driving our business. You will also have the opportunity to experience 4 of the technologies that are driving our growth and increasing our new win success rate. In case you can't tell, we are proud of what we have accomplished since our 2011 event and excited about the future of IFF.

I would now like to introduce our operating committee, which is made up of our senior managers who lead our business units and our functions. In some respects, these 8 individuals are as global and diverse as the regions of the world in which we do business. Six of them have either lived or worked in various countries around the globe. I'll ask each of our operating committee members to stand as I call their name. Many of you have already met Kevin Berryman, our Chief Financial Officer. Kevin will provide financial perspective on our progress; Hernan Vaisman, our Group President of Flavors who will provide an overview of his business segment and its strategy for future growth and profitability. Nicolas Mirzayantz, our Group President of Fragrance will update you on Fragrances and also discuss their strategy for continued growth. Dr. Ahmet Baydar, our Senior Vice President of Research and Development will shed light on our disciplined approach to R&D at IFF. Francisco Fortanet, our SVP of Operations will talk more about how we optimize our manufacturing footprint while reducing our cost structure. Francisco will also discuss sustainability and review the improvements we have made in some of our key sustainability metrics. We have us -- with us today 2 members of our operating committee who are not presenting, but they will participate in the question-and-answer session. They are Anne Chwat, our Senior Vice President and General Counsel; and Angelica Cantlon, our Senior Vice President of Human Resources.

As you can see from the agenda, we have planned an exciting day for you. For the next 80 minutes, members of the operating committee will provide you with an overview of what's happening with our business units in R&D and our operations functions. Then, we'll take a short break. Then, you'll have the opportunity to experience firsthand some of our winning technologies. We will then come back at 11:00 for more presentations, and following my closing remarks, we will open the floor for questions. I will ask you all to hold your questions until the end. We've also prepared box lunches for you, which will be available after the Q&A session.

We are excited about the technology demonstrations and hope you will enjoy them today. We have a few objectives with those demonstrations. Firstly, they will be presented in a way that will hopefully make the technology come alive. They will provide you with a better understanding of why we are confident about our position in the marketplace. You will be able to taste and smell these innovations, and we will also be providing you with samples that you can enjoy in the future in your gift bags.

Here is what I expect -- here's what you can expect. Upstairs, we have 2 Flavors technologies. In the front of the building, we have a FlavorFit exhibit, which is our portfolio of health and wellness solutions. Consumers have a need for healthier choices without compromising on taste, and we are satisfying that need through our technologies. We have also prepared a sample of our beverages using our Citrus Toolbox and expect you will be impressed with the authentic citrus flavors and understand how we are winning in this important business segment. Downstairs, you will experience the lasting freshness of encapsulated fragrances, learn about the birth of a new fragrance, which is on its way to becoming a classic and also experience some classic fragrances of IFF. We want to feel just as excited about our future growth potential as we do and gain insight into why we are winning business.

Turning now to our public profile, IFF is a member of the S&P 500 and is listed on the New York Stock Exchange. We have been in business for over 100 years and started trading on the NYSE in 1965. We have a current market cap of approximately $6.5 billion, and as you may know, the stock has appreciated nearly 47% in the past year. In 2012, we had $2.8 billion in sales and generated $488 million in adjusted operating profit. We are a leading innovator in the field of creating flavors and fragrances for food and beverage and beauty companies, and we create scents and tastes that people enjoy.

The next slide touches on the key components of IFF's investment thesis: Our strong geographic reach, diversified product portfolio and outstanding customer base. From a geographic perspective, we have approximately 5,700 employees working in 32 countries worldwide, working with customers who are serving consumers in more than 100 countries over the year at the end of 2012. It is important to note that the fast-growing emerging markets made up approximately 47% of our total sales in 2012. This represents tremendous progress, and we believe we are on track to exceed 50% on a full year basis by 2015. We also believe that we are -- we benefit from our diversified product portfolio, both within Flavors and Fragrances and across numerous subcategories. This diversity provides tremendous stability and opportunity for sustainable, profitable growth in almost any operating environment. On a business unit basis, Flavors represented 49% of our business, and Fragrance represented 51% of sales. Fragrance Ingredients represented about 9% of total IFF sales as of year end. The business has been facing additional pressure in the high-volume, low-margin part of the business, and we have put a plan in place to improve the performance of this business, and Nicolas will tell you more about it. Lastly, as an established partner with key global and regional customers, we are strongly positioned to support our stable customer base in both the developed world and the emerging markets, as they in turn are committed to growing their business.

Turning now to our business model. The IFF business model is really quite simple. We start with rigorous consumer research all around the world and across categories. We conduct over 400,000 interviews every year to come up with that database. Because of our geographic reach, we are interested in and collect research data on consumer trends in China, in India, in Indonesia, as well as the United States, which is very valuable to our customers who are looking to grow their global businesses. We use this research to create innovative solutions for customers. Our customers are looking for differentiated products with more value add for their consumers not only to capture market share but as a basis for charging a premium for their products. We invest our energies in innovation because it is a differentiator for IFF and also because it benefits our customers. The innovation needs to be tailored locally around the world since Flavors is a local business. You can appreciate that perhaps in this country, a barbecue chip is a wonderful concept. It does not play well in parts of Asia where the lead seller might well be a seaweed chip, which in turn may not be a hit in other parts of the world. My point is that our R&D allows our customers to adapt our products locally anywhere in the world.

The next component of our business model is operational excellence, which we define as improving efficiency in everything that we do. This leads to increased productivity and margin improvement. And the final component is customer intimacy. We want to know more about the customer than they know about themselves and anticipate what their needs are going to be 5 years from now and demonstrate that we can help them address those needs. The key component is our innovation, which differentiates IFF. Innovation may be superior scent, superior taste and all the elements that are captured in what customers are looking for all around the world.

But during our last Investor Day in 2011, we told you that we have put certain plans in place to better manage the business for improved growth and profitability. We did several things to provide ourselves with a roadmap for future profitable growth, which I will briefly summarize. Firstly, we created a process for targeted R&D spend. We spend approximately 8% of our sales on research and development, and we put a more rigorous process in place to make sure that we are focusing on those R&D platforms that we believe have the highest potential for success. Second, we ingrained the philosophy of investing resources behind advantaged product categories while fixing those businesses that are not carrying their investment either by lessening the investment in those businesses or raising their margin profile. Third, using economic profit, we created a roadmap for achieving strong financial results by maximizing the portfolio and hence, the profitability of our business. Fourth, we instituted a process for evaluating our portfolio and tracking and measuring the progress and improving the economic profit of our overall business. We did all this with the goal of maximizing our returns on investment.

What has changed since the strategic review presented in 2011? The strategic review confirmed that both Flavors and Fragrances are attractive businesses with long runways for growth and at the bulk of our portfolio is, in fact, economically profit positive. Some categories and customers needed remediation, and we put plans in place to address those situations.

We have substantial growth opportunities in the business. We also know that M&A can be used to accelerate our organic growth. Since our review, we made progress in spreading the concept of EP throughout the organization. Our top management team embraces it and uses it in their approach to evaluating new investment opportunities and also as a way to manage the business for everyday growth and profitability. With our more rigorous and targeted approach to R&D, our pipeline has strengthened, and it is the strongest it has been in over a decade. We formed a scientific advisory board comprised of 5 leading lines in their field to help guide our investment spend. We announced 2 biotech alliances. We are in a preproduction mode with Evolva, a Swiss biotech company to create a natural, cost-effective, sustainable vanillin. We also announced an agreement with Amyris, a United States biotech company, to create cost-effective, renewable ingredients for Fragrances.

We embraced the concept of open innovation and have increased the number of external partnerships for the purpose of accelerating our innovation. We invested in new creative centers and facilities in the emerging markets, and we also made difficult decisions like the closing of our facility in Sweden and the partial closing of a Fragrances plant in Indonesia and the recent decision to close our Augusta, Georgia plant. We believe these decisions were necessary to strengthen the long-term competitiveness of our company, and we expect to achieve operating efficiencies in the future. As a result of all of these actions, we improved our financial performance and achieved solid operating results, in line with our long-term objectives.

With that as a backdrop, there are 3 forward-looking strategic pillars that comprise our growth strategy. Firstly, we want to accelerate our growth in the attractive markets especially in the faster-growing emerging markets by leveraging our geographic footprint, increasing understanding of local customers and consumers and providing technical expertise to leverage our strong geographic presence all around the world. Secondly, we want to strengthen the innovation platform to drive profitable growth by focusing on consumer trends, commercializing new ideas and products and working with third parties to commercialize cost-effective, sustainable ingredients. And thirdly, we look to maximize the value of our product portfolio by focusing on margin-enhancing opportunities and the profitable growth categories while remediating or exiting lower margin businesses.

Now let me review each of those in a bit more detail. Firstly, leveraging our geographic reach. Our broad and diverse operating base enables us to work with customers on a global basis by providing them with advanced solutions that meet the needs of millions of consumers in both developed and emerging markets both IFF and our customers can grow profitably. On a long-term basis, we believe that the emerging markets, which we consider to be Latin America, Eastern Europe and Middle East, Africa and areas of Asia, will grow at a rate at least double that of the developed markets. By being in these markets for substantial periods of time, such as India for more than 80 years, we are able to better anticipate consumer and market trends and needs. This strategy has reached dividends for IFF where the share of emerging markets sales to our total portfolio has grown from 43% in the first quarter of 2010 to 49% in the first quarter of 2013. On the right, you can see that we are well balanced across the 4 regions with 75% of our sales outside the United States in 2012. Of our top 10 countries, 5 of them are in the emerging markets, and we have a leadership position in India, Indonesia and in Brazil.

Secondly, we believe that strengthening our innovation platform continues to be critical component of our future success. Innovation is a key growth driver and a cultural imperative for IFF. Throughout our history, IFF's patented technologies and captive molecules have been game changers for us, our customers, for the industry. Innovation is our lifeblood and is the lifeblood of any consumer products company. Importantly, these innovations create value for our customers and position us to improve our gross margins.

Two years ago, we presented the graphic on the left that shows that approximately 35% of our capital employed in 2010 was supporting business that was either EP negative or breakeven. We developed specific action plans for each area of the business supported by a series of profitability initiatives and mapped out our path for accelerated growth through 2015. We have been tracking our performance against these plans and profitability initiatives ever since. Two years later, we have made tremendous progress in a challenging macroeconomic environment. I will let Kevin tell you more about the progress we have made later in the presentation. This ensures that you will at least stick around to hear what we have accomplished.

All of the best strategies in the world are words on paper without the right people to execute the plan. IFF is in a fortunate position to have exceptional teams all around the globe. Continuing to attract, develop, engage and retain the right people is an ongoing focus for us. To help address this, we have had a regional recruiter model in place for the past 2 years. We are proactively engaged in talent mapping to ensure we are staffed with the [indiscernible] continue to drive IFF success well into the future. Growing talent internally is a critical focus. We have a three-pronged approach including: first, on-the-job development that allows our people to work on cross-functional and cross-regional teams; secondly, online learning through our mobile learning center, which is more than 80 programs and over 6,000 participants and growing; and finally, our structured learning approach. Through a partnership with NCAD, a leading business school, we created our managing business agility program for our high-potential emerging leaders. We more specifically have our technical perfumery and our flavor schools. IFF's investment in people enhances our employee engagement. Our numbers tell a story with a global retention of 94% inclusive of our emerging markets where double-digit turnover is the norm. And finally, our deeply held values of passion, creativity, empowerment and expertise are the bedrock of our employee value proposition and give us a distinct talent advantage to support our current and our future success.

At IFF, we are creating a competitive advantage, and you will hear from each of our business leaders how we are accomplishing that goal. We are increasing our R&D spend to improve innovation by investing in those categories that are growing the fastest and are the most profitable. We are developing superior products and delivery systems for our customers that address consumer needs. We are deepening our understanding of customers' brands, and we are using innovation to drive continuous margin improvement, and we are making investments in facilities, creative centers and people to support the growth. I believe the next few hours will support our own belief that we are creating a competitive advantage at IFF. I look forward to returning once again at the end of the day for some concluding remarks.

It is now my pleasure to introduce Hernan Vaisman, our Group President of Flavors.

Hernan Vaisman

Thanks, Doug. Hello, everyone, and welcome. I am Hernan Vaisman, the Group President of Flavors. It is my great pleasure to be here with you to review our strategies and tell you about how we are moving the business forward. And today, I want to share with you our Flavors growth story. Over the past 6 years, we delivered solid sales growth while also achieving consistent double-digit adjusted segment profit growth of 12%. Throughout this presentation, I will tell you how we are right here and what we are going to do to continue growing. But before doing so, I would like to talk to you about the total Favors market potential.

The Flavors market potential was estimated in 2011 to be at $9.6 billion. Our estimation is that the Flavors potential in the last 6 years grew between 3% to 5% CAGR. Over that same period, IFF's share of the market increased from 12% to 14%, growing on top line local currency on a like-for-like basis by a CAGR of 7%. Our business is segmented into 4 -- in 4 main categories. On the left-hand side, you can see the potential of each. Beverage is the largest category, and the one with more room to innovation. The second largest one is Savory, which represents 33% of the market potential. In this category, we have the opportunity to use our technologies in delivery systems and our capabilities in consumer understandings since food preference are very local. The third and fourth categories are Sweet and Dairy, respectively. The latter is the smallest but growing at a fast pace in developing countries. On the right-hand side, you can see our estimates of the market potential for each region. The largest is Europe, Africa and the Middle East with 33% followed by Greater Asia and North America. The smallest one is Latin America. The overall market is expected to grow 4% to 5% annually during the next 5 years, and IFF is expected to outgrow the industry by 2 to 3 percentage points.

Let me share the progress we have made since 2010. Let us start with the top line. Over the past 3 years, our local currency sales growth on a like-for-like basis has averaged 9%, ranging from 6% to 12%, contributing to this delivery of 29 quarters of consecutive positive growth. One of our strategic pillars, as you know, is to leverage our geographic reach. We believe our investment in emerging markets are succeeding as our sales to these markets were about 50% in the quarter of 2013, up from 47% in the first quarter 2010. Our health and wellness initiatives, naturals platforms and delivery systems are all contributing to the expense of our current portfolio, reinvigorating our growth in developed markets. These technologies are in line with our second strategic pillar, which is to strengthen our innovation platform. All these initiatives, along with our emphasis of reshuffling the portfolio by profitable growth, by investing in more advantaged areas, have resulted in improved profitability. These initiatives, combined with the hard work and determination of our talented teams, are the drivers of the 13% CAGR increasing our segment profit since 2010, delivering $298 million in 2012, which is an all-time high.

Moving on to sales. Local currency average growth for this 3-years period from 2007 to 2009 was 6%. As you may recall, we articulated and put our strategic plan into effect in 2010, which accelerated our currency sales growth to 9% CAGR on a like-for-like basis in the following 3-years period. This acceleration in top line growth is a result of the increased investment in the emerging markets of Asia, Africa and the Middle East. As part of this strategic plan, we consistently targeted growing countries, customers and profitable categories. Our investment behind health and wellness taste [ph] solutions, our authentic natural flavors in key business categories have resonated with our customers. At the end of the day, customers buy our products because our superior technological expertise supports their brand strategy. As I mentioned, IFF outperformed market growth in recent years by 2 to 3 percentage points.

To show our strength in the emerging markets, I'm highlighting the trends in our shifting sales mix from the developed to the emerging market over the past 3 years, in line with our strategic pillar to leverage the growth in emerging markets. As you can see, the percentage of sales to the emerging markets has increased for 47% in 2010 to 49% in 2012. What is most noteworthy is that during Q1 2013, about 50% of sales in our Flavors business were to the emerging markets. IFF has a presence in many of the emerging markets for multiple decades. We continue to invest in manufacturing capacity, creative applications and sales offices in this market to better serve global and local customers in these regions.

In 2012, we opened new facilities in Singapore, Delhi in India, and Chengdu and Beijing in China. Also, we recently announced a $50 million investment to expand our facility in Gebze, Turkey. And in March, we had the official opening of our new facility in Guangzhou, China.

Moving on to profit, we were able to deliver profit growth of 140 basis points despite the massive cumulative increase of input cost in 2011 and 2012. Unfortunately, our pricing did not fully cover the increase in input cost. In fact, the net impact pricing and input cost increases had a 60-point negative impact. We offset this unprecedented impact by implementing these strategic initiatives, including the exit of low-margin sales activities, operating efficiencies and other cost savings initiatives.

This last slide on performance captures the segment profit evolution since 2006 when we formed the Flavors business unit. Adjusted segment profit grew by a compound annual growth rate of 12% in the period from 2006 through 2009. From 2010 to -- through 2012, segment profit growth accelerated to 13%. Adjusted segment profit margin over sales improved from 16.7% in 2006 to 19.3% in 2009 to 21.6% in 2012.

So far, I walked you through our past financial performance. Now I will summarize our 3 strategic pillars and tell you how we have executed against them. To leverage our geographic reach, we have invested total of $150 million in additional capacity, for which I will give you more details the coming slides. To strengthen our innovation platform, we continue to invest in the key R&D programs such as naturals, flavors modulators, delivery systems and high-impact molecules. In term of maximizing our portfolio, we have exited approximately a cumulative $55 million of low-margin sales activities since 2010. Q2 2013 will be the last quarter that will reflect the impact of these exits. In line with the principles of economic profit, we have placed a greater emphasis on those more profitable categories, regions and customers. Lastly but certainly important, we were able to recover the large increase in input cost through pricing, as well as other strategic initiatives.

As emerging market expand, stands [ph] of living improve and poverty declines and real incomes rise with the corresponding expansion of the global middle class, which provide us with much greater opportunities. Based on this, we identify Greater China, India, Indonesia and Turkey as 4 emerging markets with great potential for IFF. We are investing in those emerging markets among the fastest growth and greatest market opportunity. As part of this commitment, we have invested $100 million in the emerging market of Asia. In 2012, we opened our Singapore plant, a state-of-the-art liquid flavors and fragrance plant. And in March of this year, we announced the formal opening of our facility in Guangzhou, China. We also have regional creative centers and satellite labs in Chengdu, Beijing and Dubai. Greater China, which includes Taiwan, Macau and Hong Kong has a market potential of $650 million. Our like-for-like sales CAGR over the past 3 years was 12%. India has a market potential of $250 million, which is expected to grow over 9% per year. We opened a creative and commercial site in Delhi to better serve key players in the Indian subcontinent. Our like-for-like sales CAGR over the past 3 years in India was 17%. In Indonesia, which has a market potential of $285 million, we are investing in creative and applications and resources and infrastructure. Our like-for-like sales CAGR over the past 3 years was 13%. Turkey has a market potential of $125 million. We announced in October of 2012 that we were investing $50 million in Gebze, Turkey to build out our facility in the strategic located hubs serving Eastern Europe, the Middle East and Central Africa.

To strengthen our innovation platform, we have invested heavily in 4 programs. I mentioned before, naturals, flavor modulators, delivery systems, high-impact molecules. But what is more important is that these programs are targeted at delivering against the current and future taste needs and preference of consumers. Our naturals program has targeted a need for freshness and around authenticity [ph] . Remember, we said all tastes are local. Our flavors modulators programs are addressing a mega global trend of health and wellness. These flavors mitigate the effect of sodium, sugar and fat reduction, production by our customers in their products. We can help people eat and drink healthier foods without compromising taste. Our delivery systems help consumers have the great taste experience they love at the right time. And finally, we help our customers deliver affordable products through our high-impact molecule programs. Later on through our upcoming technology demonstration, you will have a chance to taste a few example of our natural and health and wellness programs.

We have greatly improved our overall economic profit of our portfolio. In 2010, 80% of the capital invested was in positive economic profit sales activities. We put in place several programs that allow us to have 100% of the capital invested in positive sales activities by the end of 2012. All categories and regions show a significant improvement compared to 2010. Among these programs, we put in place 1 consecutive having shedding [ph] a cumulative $55 million low-margin sales activity since 2010. This is in line with our strategy of delivering superior products that expand our operating profit margin by excelling in targeted categories, customers and geographies while driving continuous improvement and investing back in people and capabilities.

Going forward, we continue to invest in the developed markets with special emphasis in Africa, Middle East, Central and Southeast Asia. Regarding the latter, Indonesia is carrying our agenda considering the current economic fundamentals, population and ongoing investment from our key targeted customers. We are in the process of better understanding the potential and opportunities of some ethnic and religious groups in the largest countries worldwide. Lastly, developed countries is still around 60% of the Flavors potential, providing us with a material upside opportunity to keep growing top line in a profitable way.

Moving on to innovation platform. We will maintain the strategic innovation programs that are delivering remarkable results, and we'll continue to improve them either with new technologies or with the lessons from the last 5, 6 years. Starting with naturals, we will leverage new biotech pathway and gene optimization. These expertise in proprietary chemistry capture biodiversity through natural products expertise. In flavors modulators, we will improve modulation tools through natural processing of specific targets from biodiversity. Many of the best-seller flavors modifiers have the roots in our research programs targeting biodiversity, discovering new game-changing flavors modulator through our in-house taste receptor programs. We are investing heavily in new capabilities such as people and molecule [ph] libraries that will allow us to accelerate findings of new molecules that trigger taste receptors. Considering the current economic uncertainty, we will keep investing in our high-impact, low-cost molecules to ensure that we are not only bring superb technology to the marketplace but at an affordable cost. We will do it using our unique analytical and organic chemistry expertise. We will continue to improve our delivery system capabilities to be able to provide our customers the taste preference and attributes they need at the right time. We will offer them an enhanced consumer experience that their brand deserve regardless of the difficulty of the production process.

Moving to our strategic priorities. Maximizing our most profitable portfolio will be priority in our agenda. We will place more focus on those subcategories where we currently have significant opportunity for growth. Finally, we will also focus on looking to improve our margin, especially through manufacturing efficiencies from their recent investment on our manufacturing footprints. Our production capacity will give us the opportunity to better absorb fixed cost.

In summary, our past performance is a real success story of growth and consistent profit driven by a sound strategy based on having the right footprint, superb consumer understanding and innovation pipeline to address the need of consumer and focus on profitable categories. And this strategy was executed by the most talented team in the industry. Throughout the last 6 years, we learned a lot. Going forward, this lesson will help us to be more assertive and more effective in execution. This will help us to be bullish about our future and expectations. Long term, we expect to keep gaining global market share, continue to expand gross margin and continue delivering share quality [ph] value by growing our segment profit at the high single digits.

And now I would like to introduce Nicolas Mirzayantz, Group President of Fragrances.

Nicolas Mirzayantz

Thank you, Hernan. Good morning, everyone. I am Nicolas Mirzayantz, the Group President of Fragrances. I am very pleased to be here today with you to update you on our Fragrance business. I will be sharing with you the strong progress we have made since our new strategy was implemented in 2010, the Ingredients strategy adjustment developed in 2012, and I will provide insights into our current strategic plans.

Before talking about IFF Fragrance business, I want to show you the total compound fragrance market in which we participate. The global category is estimated at $6 billion and is growing at 2% to 3% per year. By our estimates, our Compounds business has improved its market share by 2 percentage points since 2009, giving us a 19% market share. Looking at the end use categories, over 50% of the Compounds market potential is in fine fragrance and fabric care, and the remaining potential is split fairly evenly between beauty care, home care and personal wash.

In terms of geography, the largest market is Europe, Africa and the Middle East, EAME. It has 40% of the global market potential and consists of both developed and emerging markets. EAME is followed by North America, which accounts for 23% of the market, while Asia and Latin America comprise with more than 1/3 of the total market. We believe the majority of our opportunities lay in these emerging markets. The emerging markets have been growing and are expected to continue to grow at a rate 2x to 3x faster than the developed markets. These markets are the majority of the world's population and the rapid rise of a large consumer base with more disposable income and a growing interest in buying fragrance products. Our historically strong presence in emerging markets has allowed us to capture the benefits of the attractive population growth, and increasing income levels will continue to provide IFF with many growth opportunities. In 2012, our Compounds sales to emerging markets grew at 11%, accelerating to 18% growth in Q1 2013.

Now turning to our business results. Over the past 3 to 4 years, we have made strong progress in delivering input growth and segment profits. Our Compounds business delivered strong sales growth of 8% since 2009, driven by our increasing emerging market presence, strong innovations-driven win rate and increased core list participation. The strong growth in our Compounds business has been partly matched by top line pressure in Ingredients, a result of increased pressure from low-priced manufacturers. In light of this market pressure, in 2012, we revised our Ingredients strategy and have been taking action to rationalize our Ingredients portfolio and our manufacturing footprints. Although some of our high-volume external ingredients have been under pressure, the business continues to be of a strategic importance to IFF and is a critical component of our Compounds strategy.

Turning to profit. Since 2009, our adjusted segment profit for the Fragrance business has improved by an 8% CAGR. Our growing profit fairly speaks to the strong underlying momentum in the business and our ability to grow both sales and profits during a time when we face challenges both from Western Europe and significant input cost increases.

Turning to local currency sales growth. We have separated our Compounds and Ingredients business on this slide, so you can see their respective dynamic and performance. Between 2007 and 2009, Compounds were essentially flat, while Ingredients grew by 1%. Since 2010, Ingredients sales have been flat, but the competitive pressure that we just spoke about resulted in an average decline of 9% in 2011 and 2012. Compounds, which represents more than 80% of our total fragrance segment sales have accelerated to an 8% growth rate. The growth in Compounds reflect the successful execution of our strategy, which includes realignment of the Functional Fragrance business, which just delivered its 19th consecutive quarter of growth, investment in higher profit categories in keeping with the principle of economic profits, consumer insight-driven fine fragrance wins, increased core list participation, emerging market investment in capacity, technology and sales support and increased investment in innovation to continue to differentiate IFF from our competition.

We have greatly strengthened our presence in emerging markets by making strategic investments in our people, creative centers, sales office and manufacturing capacity, such as our new plant in Singapore, which just opened in 2012. In 2010, as you can see, 42% of our total sales were generating in the emerging markets. That has grown to 48% in the first quarter of 2013. Now if we focus specifically on Compounds, actually 54% of our Q1 sales are coming from emerging markets, which is an 8-percentage-point increase since 2010.

Turning to our segment profits. From 2010 to 2012, our segment margin decreased 80 basis points due to the unprecedented increase in our input costs. We partially offset the increased input costs through pricing. But as you can see, the net impact of pricing to input costs was still negative, a 280-basis-point impact. We are, however, very pleased that during this time our focus on strategic initiatives designed to improve our margins contributed 200 basis points to margin expansion. We focused our investment in our higher-profit businesses. We took corrective actions to improve lower or negative EP businesses and implemented EP-based principle to our investment and spending decision throughout the entire organization.

Another way to look at this is, between 2007 and 2009, we had a negative 5% CAGR in our segment profits. We reversed that trend by investing behind our advantaged categories, countries and customers, resulting in an 8% positive CAGR from 2010 to 2012.

As Doug introduced, we have 3 strategic growth pillars: leverage geographic reach, strengthen innovation platform and maximize our portfolio. Studies show that the population is forecasted to grow by 800 million people by 2020, with 95% of this growth coming from emerging markets. The studies also show that there will be approximately 1.4 billion new middle-class consumers in developed markets by 2020. The strategies of our global and regional customers are focused on these markets, and they are building strategies to take advantage of additional disposable income. We are well positioned to support our customer strategies and expect to benefit from the positive market dynamics as they leverage our fragrance expertise to sell consumer-preferred fragrance products.

IFF has a long-standing presence in the emerging markets. And of the top 10 countries we sell into, 5 are in the emerging markets. To support our growth, since 2010, $54 million of our capital spending has been in emerging markets. In Asia, the market with a $1.2 billion Fragrance potential and anticipated growth that is 3x to 4x higher than the growth outlook of the developed markets, we are investing in a new technology center in Mumbai and expanding our creative and application resources in Singapore. And we have recently opened a new state-of-the-art manufacturing facility in Singapore to address the growing needs of the entire Asia region. In Latin America, a market with a $1 billion of Fragrance potential and anticipated growth of close to 5%, we are leveraging our historical, long-standing leadership position in Brazil and our 2009 investment in our creative center in São Paulo to capture the exceptional growth in Brazil, which is today the #1 global market for fine fragrance and deodorants and the #2 global market in hair care and bath and shower. As part of a functional fragrance reorganization, we have been expanding our creative and application capabilities in Mexico.

Our innovation platforms are the result of in-depth consumer insights. All 6 of our Fragrance innovation platforms are designed to meet current and future consumer needs. From the consumers' point of view, we're addressing the fundamental needs in the areas of seeking additional multi-sensorial experiences, where consumers look to enjoy every moment. It's supported by our new molecules and delivery system providing a new level of consumer fragrance experience across categories. Health and wellness, where consumers say, "I take care of myself," here again, our new molecules and performance insights are providing new level of freshness, cleanliness and malodor coverage across categories.

Sustainability, where consumers look to take care of our planet, is supported by applying green chemistry principles to all molecule development and by driving sustainable natural initiatives. And under affordability, where consumer is asking themselves, "Can I afford it?" we are designing new low-cost, high-impact molecules for our perfumers to create winning fragrant solution for the $1-a-day consumers.

We are excited about our increased molecule pipeline, which is critical to win fragrances and to create new winning solutions for the brand of our customers. You will have a chance to experience some of our innovation at the technology station this morning when we demonstrate to you the power of our leadership in encapsulation technology in fabric care. And you will also experience our use of consumer insights and natural ingredients in the technology booth, where we talk about the creation of classic IFF Fine Fragrances.

Part of our strategic framework is to improve EP for the Fragrance business units. And we have made very good progress in improving the EP of our portfolio since our last Investor Day. We executed our strategic realignment in 2012 and have been focusing our efforts on improving the profitability of our business by allocating our resource based on economic profit and investing in the areas where we are advantaged. We also took actions to restore profitability through pricing and other margin initiatives. You can see the results on this chart. In 2010, 50% of our invested capital was directed towards positive EP parts of our business. And as of 2012, this number improved from 50% to 78%. Our strategic review indicated that fixing the remaining unprofitable part of our portfolio will create more value than exiting. So we put plans in place to improve them. We are still working on improving the economic profit of all parts of our portfolio, including the part that we are most challenged from input cost pressure.

Now turning to our ingredients. While our Ingredients business has been challenged in recent years, it continues to be the bedrock of our growth in Compounds and provide us with a competitive advantage. I want to underscore the critical importance of our Ingredients business as it is primarily focused on supplying cost-advantaged ingredients to our Compounds business, and it still continues to generate positive EP results for our external sales. As you can see on the pie to the left, more than half of the raw material used by our Compounds business is provided by our own ingredient plants, and this give us a distinct advantage both in terms of costs and in terms of the differentiation and performance of these ingredients. We are our own #1 supplier. And with the successful execution of our innovation programs and cost reduction programs, we expect our ingredients to continue to be an increasingly larger share of our Compounds raw materials. While our Ingredients business is focused on supporting our Compounds business, in order to maintain our low-cost structure, we leverage our capacity to sell ingredients externally to both customers and competitors. As you can see to the right, our external sales, which represent less than 20% of total sales, have appropriate margin and generate EP positive results.

Our Ingredients business provides our Compounds business with unique new molecules, so we are increasing the number of IFF ingredients used in new wins in our Compounds and are increasing the pipeline of new molecules for our internal use. Our backward integration in this business provides for rapid speed to market from innovation by R&D to creation by our perfumers. We continue to rationalize our lower profit portfolio and our manufacturing footprint to improve return on assets. And we have recently announced the June 2014 closure of our plant in Augusta, Georgia, which will save $6 million to $8 million annually. We recently announced our new and exciting strategical collaboration in the area of biotechnology with Amyris to jointly develop a sustainable, cost-effective and reliable source of key fragrance ingredients. Within manufacturing, we're investing in a new pilot plant in -- within the structure of existing facility to accelerate our innovation pipeline and increase speed to market of our new molecules for our perfumers to use in new fragrance creations as they are developed.

Going forward, we will continue to focus on our 3 strategic pillars. The majority of our investments will be in fast-growing emerging markets, in particular, India, China, Southeast Asia, Brazil, Mexico and the Middle East. And we will continue to strengthen our consumer insight expertise in these markets to provide winning fragrance solutions to our customers. As I mentioned earlier, in Q1 2013, 54% of our Compounds sales are to the emerging markets, and we plan to continue to capture more growth opportunity in this region. As I also mentioned earlier, there continue to be big growth opportunities in the developed markets that we will pursue as well.

One of our differentiating strengths is our knowledge of the consumers, and this insight into consumer trend is driving the choice of our innovation platforms. In Fragrance, we have 6 platforms. I will now discuss only the last 3, as Dr. Ahmet Baydar will describe the first 3 during his presentation. In process engineering, we have introduced novel engineering technologies for our Ingredients operation, reducing waste, energy, but more importantly, cost. Performance insight, where we have established a diffusibility model for our perfumers, which we believe will provide a competitive edge in perfume creation. We created an in-house modeling capability to obtain deeper insight on substantivity and diffusibility, which are 2 of the critical elements for driving consumer preference. Malodor control has become a key platform with novel ways for counteracting malodors using a variety of IFF developed technology.

Improving our overall EP profile is a top priority. We have made solid progress, but as I told you, there is more progress to come. The EP concept is embedded throughout our entire organization, and it has helped us to bring financial discipline to a new level. And it is a key consideration for all the major decision that we make, from core list participation to major investments. As we continue to grow our higher-profit businesses, we will also restore profitability to those remaining products that have negative and neutral EP, all while continuing to drive proven cost productivity program.

In summary, we have made good progress and gained strong momentum in Fragrance Compounds. We remain committed to our 3 strategic priority in leveraging geographic reach, strengthening our innovation platform and maximizing our portfolio. Long term, we expect to grow our Compounds local currency sales at 2% to 3% above the market. We expect to stabilize our external Fragrance Ingredients sales, we expect to improve margin, driven by technology and also by allocating our resource to do these initiatives that offer the best value proposition for IFF, for our customers and to our consumers, all resulting in the delivery of high single-digit segment profit growth.

We have the rich talent pool at IFF. And after Ahmet Baydar's presentation, you will have an opportunity to meet some of them as they explain the technologies that differentiate us in the marketplace and help to support our customers' brands. We have with us today perfumers, scientists, marketers and fragrance development experts. A highlight of your meeting will be spending time with one of our master perfumer, one of the most iconic perfumer in the world, Carlos Benaim, the creators of classics such as Polo and Polo Blue for Ralph Lauren, Eternity for Calvin Klein and today continues to contribute in a major way with the recent successes in Fine Fragrance, like Euphoria for Calvin Klein and Flowerbomb and Spicebomb for Viktor & Rolf, that are on their way to become the classics of tomorrow.

Thank you very much for your time and interest in our business. I would like now to introduce Dr. Ahmet Baydar, our Senior Vice President of R&D.

Ahmet Baydar

Hello. Innovation. We have heard from Doug how innovation is the lifeblood of our business. Nicolas and Hernan have highlighted how innovation is driving our business results. But what is innovation? Innovation is having superior flavor and perfumery creation. Innovation is building superior process discipline and cost efficiencies. But innovation is also having superior technologies, superior intellectual property and superior science. This is the innovation that R&D provides, differentiating IFF today and into the future.

Good morning, everyone. I'm Ahmet Baydar, Senior Vice President of R&D, and I'm very pleased to be with all of you today to discuss how R&D is driving innovation. At IFF, we are passionate about our R&D, which we believe is the heart and soul of the company. So I'm thrilled to share with you how over the past 2 years we have built the strongest innovation pipeline in recent IFF history. As mentioned earlier, after the break, we will be bringing some of these innovations to life through a series of technology demonstrations, where you'll be invited to experience the impact of innovations for yourself. And our scientists are very passionate in what they do, and we hope you have time to go through all the 4 stations.

Before we commence, I should highlight that our need for confidentiality in R&D presents limits to what we can discuss today. However, I am very excited to be able to provide all of you with insights into our R&D activities.

Let us begin by considering the role that R&D plays in driving our strategy. Here, we see our 3 strategic pillars. R&D's primary role is helping support the central pillar, accelerating innovation. But through that pillar, R&D supports the other 2 strategic pillars, allowing us to leverage our geographic reach and maximize our portfolio. As a reminder, in the 2011 Investor Day, we introduced our refreshed go forward research strategy. This strategic approach was built on a better understanding of our customers and consumers, building a pipeline of differentiating ingredients and technologies and extending the boundaries of our internal research to make us future ready while strategically leveraging open innovation.

Over the past 2 years, we have continued to strengthen knowledge of our customers and consumers through direct consumer testing, customer collaborations and local market penetration. The 8 bubbles you see here represent the 8 long-term customer objectives and consumer need states. That will be driving purchasing decisions today and well into the future. We have used our deeper understanding of these 8 customer and consumer needs to drive the 10 platforms that represent the broad research fields we're working on to provide our customers and consumers with novel solutions to the 8 long-term needs you saw on the previous slide. I will elaborate on a selection of these platforms, 3 from Flavors and 3 from Fragrances, in this presentation.

Two years ago, we also rolled out and enhanced the portfolio management approach. As Doug highlighted earlier this morning, we have implemented a 5-step economic profit-based evaluation process for all our research projects to review and to make priorities on the R&D investments. This process begins by understanding the market opportunity and likelihood of success to determine the value for IFF. Based on this, we prioritize and resource our individual research programs and then execute. The process requires a structured Stage-Gate approach for all research projects and includes quarterly reviews with all our full operating committee to track progress against a plan, make regular go, no go or redirect decisions. And then we can re-prioritize our investment to speed innovation. In the past 2 years, as a result of these processes, we have stopped investing behind underperforming research programs to accelerate our existing portfolio and launch new programs.

As you've seen since our last Investor Day discussion, we have strengthened our understanding of our customer and consumer needs, built out our research platforms to address these needs and put in place processes to manage and support our growing investment behind R&D.

What is the result of these strategic efforts? We are accelerating the rate and impact of innovation. Our flavor molecule pipeline has grown 56%. Our fragrance molecule pipeline has grown 75%. Our delivery systems portfolio includes multiple technologies to extend our market leadership. Cost innovation continues to deliver steady benefits, offering opportunities to improve margin and increase creative flexibility. In total, our innovation pipeline is the strongest it has been in recent IFF history. I will now take you through some of the research platforms that are driving this strengthening innovation pipeline.

We will begin our flavor research platform with health and wellness trend Hernan highlighted earlier this morning. Flavor modulation is critical to the Flavor business unit. This technology allows us to provide healthy flavor options for our favorite foods, maintaining the taste we all love. The technology has brought category applicability, playing a major role in the Beverage, Savory, Dairy and Sweet categories. Last year, we launched FlavorFit, which offers our customers a portfolio of proprietary healthy flavor solutions. These are obtained by a high-throughput analytical screening. This FlavorFit portfolio includes tools with modifying properties to modulate the perception of sweetness and saltiness, mask sour, bitter or off notes, improve mouth feel and creaminess. Creative use and application of these tools has been a key driver of our commercial success in the Beverages category, and both have significant new business. For example, at the end of last year, our flavor modulator program resulted in the largest order for a single flavor ever received at IFF. It will be the focus of our technology. And in the demonstrations, you will see FlavorFit as well. We have a lot of people from R&D who are going to show you that. As we look to the future, we're building a strong pipeline of novel flavor modulators via isolates from biodiversity and receptor research done internally. These new tools will help expand our regional and category participation.

Another significant element of R&D's efforts to address health and wellness needs is over Flavors natural platform. We are continuing to expand our portfolio of unique naturals, which provide healthier cost-effective flavors that have an authentic taste profile. Our research program utilizes the state-of-the-art analytical techniques, a key area of strength for IFF, to identify flavor molecules from natural products. This enables IFF to create novel high-quality extracts, essences, oils and absolutes that are all natural. This research program has led to significant wins in Europe, where the new regulatory regime has made natural crucial to deliver against stringent, natural label requirements. And this is particularly true to savory flavors, in which we have created and continued to expand unique competencies. Looking ahead, we are leveraging biotechnology to create new paths to sustainable and natural ingredients.

The final platform I will highlight today is flavor delivery, which is critical for addressing our performance and cost innovation needs. IFF is developing a variety of encapsulation technologies to deliver specific flavor attributes required by our customers, including the ability to produce a flavor in a particular physical form, for example, as a powder, emulsion or granule; the ability to protect the flavor of substance until the flavor release is required, for example, heat stability; or the ability for a controlled flavor time release, for example, long-lasting taste. This strong portfolio of flavor technologies have resulted in IFF winning business across geographies and categories. Our delivery system technologies have now been validated in the market with major customer launches. These encapsulation technologies are bringing significant advantage across all categories, but particularly in powdered beverage. And these novel delivery systems have the potential to capitalize IFF's capture of significant business, specifically in developing markets. To expand our technical expertise in this field, we continue to add new technologies to our portfolio. One example is biopolymers, which would allow us to use natural, biologically-sourced materials for delivery systems.

Now moving over to Fragrances. We will begin with our new molecule platform. New and differentiating fragrance molecules are the lifeblood of a successful and profitable fragrance business. The current pipeline of new molecules has been designed to address all categories and regions, with special emphasis on filling gaps in our portfolio and addressing the needs of fast-growing emerging markets. Over the next several years, we will be commercializing the strong portfolio of hedonically unique, high-performing patented molecules to strengthen IFF's Fragrance business. This pipeline of new molecules contains new ingredients to be launched over the short, mid, but also long term. In our Compounds business this portfolio of captive IFF molecules will allow us to expand margins and offer our perfumers new and unique creative capabilities. And long term, these molecules are expected to become a key driver for the growth of our Ingredients business.

Naturals, like in Flavors, are a key driver of our Fragrance business, particularly in the highly profitable Fine Fragrance category. We have been a leader in this area over the past decade. In order to maintain this leadership, our focus has been on maximizing the yield of crops and increasing the active principal component, lowering harvesting costs by optimization of cultivation and agricultural techniques, improving the yields of transformation from precursors by proprietary in-house extraction and distillation techniques. And our nature-inspired technology benefits from our new state-of-the-art proprietary analytical tools, drawing inspiration from our award-winning IFF greenhouse. We have leveraged these technologies to great effect in recent years, achieving a record number of wins in Fine Fragrances that utilize our natural technologies. Going forward, we will continue to expand our exclusive global sourcing and extend synergies between Flavor and Fragrance natural programs. And once again, you'll be able to learn more about the role that Naturals play in the Fine Fragrance creation in our innovation station.

Now moving over to Fragrances. We will begin with our new molecule platform. New and differentiating fragrance molecules are the lifeblood of a successful and profitable Fragrance business. The current pipeline of new molecules has been designed to address all categories and regions with special emphasis on filling gaps in our portfolio and addressing the needs of fast-growing emerging markets. Over the next several years, we will be commercializing the strong portfolio predominantly [ph] unique, high-performing, patented molecules to strengthen IFF's Fragrance business. This pipeline of new molecules contains new ingredients to be launched over this short, mid but also long term.

In our Compounds business, this portfolio of captive IFF molecules will allow us to expand margins and offer our perfumers new and unique creative capabilities. And long term, these molecules are expected to become a key driver for the growth of our Ingredients business. Naturals, like in Flavors, are a key drivers of our Fragrance business, particularly in the highly profitable Fine Fragrance category. We have been a leader in this area over the past decade. In order to maintain these leadership, our focus has been on maximizing the yield of crops and increasing the active principal component, lowering harvesting costs by optimization of cultivation and agricultural techniques, improving the yields of transformation from precursors by proprietary in-house expansion and distillation techniques and our nature inspired technology benefits from our new state-of-the-art proprietary analytical tools, drawing inspiration from our award-winning IFF greenhouse. We have leveraged these technologies to great effect in recent years, achieving a record number of wins in Fine Fragrances that utilize our natural technologies. Going forward, we will continue to expand our exclusive global sourcing and extend synergies between Flavor and Fragrance natural programs. And once again, you'll be able to learn more about the role that naturals play in the Fine Fragrance creation in our innovation station.

The final research platform we wanted to review is our Fragrance delivery platform, which has been a game-changing technology in the Fragrance business. This innovation allows us to improve impact, aroma quality and longevity of the scent while addressing performance and mellow counter interaction [ph]. IFF was one of the first movers with this technology. We have experienced double-digit growth since its launch, and we remain industry leaders. The first generation of delivery systems have primarily been used in the Fabric Care category. Over the last 2 years, we have adopted this technology for Personal Wash and Hair Care where it is demonstrating potential to offer breakthrough consumer preference. Looking forward, we are building novel proprietary systems to continue growing into new categories while expanding and extending our IP coverage in this field. Today, you can also experience this technology firsthand at another one of our technology demonstrations.

Within our research platforms, additional initiatives are expanding the boundaries of innovation in R&D. One key example is green chemistry to support our sustainability mission. Over the past several years, IFF R&D has been introducing novel green technologies to our manufacturing, eliminating waste, harsh raw materials while reducing costs via micro-reactors and our proprietary catalysts. As an example for one critical IFF ingredient, our chemists and engineers were able to cut 3 synthetic steps into one and decreasing waste over 20% through the use of micro-reactors. As we look to the future, the next generation of new molecules being created by our scientists are designed and will be designed with proprietary green chemistry technologies in line, using renewable raw materials, developing more energy-efficient pathways and designing molecules that are biodegradable.

Another key initiative which was mentioned earlier is open innovation, which has become a critical component of our research strategy. Over the past 2 years, we have more than doubled our investments in strategic partnerships. Our collaborations drive value in 3 ways. One, they provide guidance. In this first type of collaborations, we reached out to our external experts to provide their perspective on our research approach. Two, they augment, accelerate internal innovation. In this second type of collaboration, we bring in external partners on specific ongoing internal programs that enhance and accelerate our ongoing research efforts. And three, they expand innovation horizons. And in this third type of collaborations, we create new technical platforms not available internally via these strategic partnerships.

Let me provide you with a couple of examples. In early 2012, we founded the IFF Scientific Advisory Board comprised of 5 R&D leaders both from academia and industry. Over the past 1.5 years, the Scientific Advisory Board's perspectives have been invaluable to our R&D efforts as they provide guidance and insights on the technical approach for our R&D programs, help us identify appropriate research partners, raise scientific issues and highlight potential opportunities.

Biotechnology is becoming a key area of research for IFF. Over the past several years, we have secured 2 industry-leading partners. In 2011, IFF entered into a partnership with Evolva, a Swiss biotechnology company, to implement a commercially viable biosynthetic path to the production of vanillin. To offer you perspective on the project, vanilla is a complex blend of fragrance and flavor molecules extracted from the seed parts of vanilla orchid. Commercially, the most widely used molecule in these plant is vanillin. Because of the cost and supply chain variability of natural vanilla, those products containing vanilla, in fact, just contain synthetic vanillin made from petrochemical or other feedstocks. In contrast, our vanillin will be naturally derived via fermentation. With this competitively priced sustainable natural vanillin, we expect IFF be uniquely positioned to accelerate performance in this key area. Early this year, we achieved the yield and productivity that we believe will allow for commercial launch for vanillin next year. Based on our progress with the vanillin project in May 2012, we expanded our collaboration with Evolva to encompass additional flavoring ingredients. To further strengthen our biotechnology platform, as Nicolas mentioned, in April of this year, we entered a multi-year collaboration with Amyris, a San Francisco-based industrial synthetic biology company, to jointly develop sustainable, cost stable routes for essential Fragrance Ingredients in our portfolio.

As we wrap up the R&D portion of our discussion today and we -- also if you go and see all the 4 technology demonstrations, I wanted to leave you with a few key takeaways. The new R&D strategy we laid out 2 years ago is accelerating the rate and impact of innovation, driving value for IFF shareholders today and to the future. Our R&D efforts are well aligned to address the long-term needs of our customers and consumers. Open innovation is growing in importance and becoming a critical driver of our research efforts. Finally, our innovation pipeline is the strongest it has been in recent IFF history, providing us with the pipeline of molecules and technologies over the short, mid and long term, creating IFF's long-term sustainable competitive advantage.

I thank you all for your attention this morning. And now I will introduce our Chief Financial Officer, Kevin Berryman. Thank you again.

Kevin C. Berryman

Okay. Good morning, everyone. Very glad that you're here joining us today. Just a couple of housekeeping points that we'll work through in terms of the technology demonstrations. First, for those of you that are listening via webcast, we're going to actually not unfortunately be able to have you engaged on the technology demonstrations since we're touching and feeling and tasting. So we're going to basically leave you. There will probably be about 1 hour and 15 and 1 hour 30 minutes from now before we reengage. We'll have a slide up on the webcast, which allows you to understand when we will get back to you and when we will reengage in the formal presentation here in the auditorium.

For all of you that are lucky enough to be here to have a little bit of experience relative to our technology demonstrations, we're first going to do a short little break here, and then we will have 4 technology demonstrations, which have already been described to you. When you checked in, you got a color on your badge. So that is going to determine where you end up going, and then you are going to stay with your group as you go amongst each of the 4 technology demonstrations. Probably each one will take about 15 minutes or so.

So if you have a green badge, you're going to start at the FLAVORFIT technology demonstration, which is out here at the front of the building. If you have, I guess it's pink, looks a little bit more darker than pink to me, but you will then be at the Citrus Station, which is out here on the top level to the right as you exit the auditorium. If you have a dark blue badge, you're going to actually start downstairs at Fine Fragrance, which is in this corner downstairs. And finally, the orange group will begin at the Encapsulation Station technology demonstration, which is down to you're right as you exit the auditorium.

So again, feel free to take a quick 10-minute break or thereabouts. We're going to have support staff out there to direct you in case you have any problems trying to find your way. Hopefully, it won't be too difficult. But only about 10 minutes or so. We're a little bit behind, but that's okay because we're going to be catching up over the course of the balance of our presentations and whatnot. So we're fine as it relates to getting through the agenda for the day.

Okay. So those on the webcast, we'll welcome you back 1 hour 15, 1 hour and 30. And for all of you, enjoy the break and then certainly enjoy the technology demonstrations.

Operator

Ladies and gentlemen, we will now take a short break to allow you to move to the technology demonstrations. Please proceed to the lobby and locate the colored flag corresponding to the color on your badge. There are 2 demonstrations on this floor and 2 downstairs. The demonstrations will begin in 15 minutes.

[Break]

Operator

Ladies and gentlemen, please welcome Francisco Fortanet, Senior Vice President, Operations.

Francisco Fortanet

It is always good to start with this video. Good morning, everyone. My name is Francisco Fortanet. I am responsible for global operations at IFF. I am the newest member of the IFF operating committee, so briefly, let me introduce myself.

I have been with IFF for 17 years. I started in Mexico as a planning manager, then transferred to the U.S. as a plant manager in our facility in New Jersey. Then ran both Flavors and Fragrances as a regional operations manager. I was deployed to Europe twice for more than 4 years. I have responsibility for global manufacturing before I received this opportunity over a year ago.

I hope you enjoyed the technology demonstration and they gave you good insight into our priorities, challenges and direction of our product offerings. You may be wondering how we take that technology, those solutions and transfer into Flavors and Fragrances products that our customers use and our consumers love and trust. The answer is operations. We are responsible for the supply chain. We work very close with the entire team to deliver strong results to our shareholders.

I would like to start by speaking about our operations strategy. Our strategic mission is to support the growth of the business with reliable service and reliable quality. Our #1 priority, my #1 priority, is to have satisfied customers. Our goal is to exceed customer expectations and enable our commercial teams to discuss innovation, creativity, new solutions for our customers' brands instead of dealing with supply chain issues. Our second objective is to reduce costs. We achieve this by having a clear productivity and quality agenda, driven by continuous improvement. My objective for the balance of the presentation is to discuss these 2 dynamics. First, how to improve service; two, how to reduce costs.

One of the main drivers of service and costs is certainly the main driver of capital investment, is the global manufacturing network. So let me just spend the next 3 slides on this subject. While we currently have 29 sites, with presence in all regions, this number is not fixed. We are in constant evolution. This evolution follows our corporate strategy of leveraging our geographic reach and maximize our portfolio.

First and foremost, our mission is to support the growth of the business in all regions with a greater focus on the emerging markets. Our second, to reduce our cost structure in all geographies, particularly in the more mature markets.

Capital investment is a very important part of how we support the growth of the business. Historically, our capital spending was approximately 3% to 3.5% of sales. In 2010, we made the decision to ramp up spending. So over the past 2 years, we increased our capital spending to approximately 4% to 5% of sales, and we expect to continue at this rate for the next 2 years. However, we anticipate returning to our historical rates of 3% to 3.5% by 2016. The bulk of the increase in the investments we are making is for new manufacturing sites. For example, in 2012, we opened a new plant in Singapore. This year, we announced the formal opening of a new site in China. And by 2015, we will significantly expand our facility in Turkey. I will use these 3 examples, 3 investments, to provide you with insights on how and what is the rationale of how we make investments at IFF.

Our first example is Singapore. The new liquid compounding plant replaces a 30-close years old plant. The new plant was designed with industrial best practices, lean manufacturing principles and state-of-the-art equipment, including significant levels of automations. With this new capacity, we consolidate the entire portfolio of the Asian business for Fragrances and a good percentage of the Flavors liquid portfolio. Although the new facility was built to mainly serve the Southeast Asia market, it will also support other countries in Greater Asia, including the mature markets of Korea, Japan, Australia and New Zealand. The liquid technology employee at the plant uses raw materials from all around the world. We pay no duties on these raw materials. Finally, and as you know, in Singapore is supportive of commercial enterprise and is business friendly.

Our second example is China. Our investment in China was driven by the robust growth that we have experienced in the region. The new plant allow us to handle the additional demand and will enable us to grow with our customers in the region. Food regulation in China has increased dramatically in the last years. The regulatory landscape changed in increasing complexity. These investments will allow us to fulfill those requirements and offer services to our customers. We believe this will be a competitive advantage for us. We also introduced new technologies in this facility and will allow us to offer new products to our customers and minimize raw material import costs and expensive tolly. [ph]

Our third example is in Turkey. Our investment in Turkey is strategically located and allow us to have access to the Middle East, Central Asia, North Africa and parts of Eastern Europe, Russia, and of course, the Turkish market. The cost structure in this new plant is very competitive, especially when compared with our plants in Europe. Like China, this investment also introduced new technologies to those regions.

As you can see, the capital deployed is mainly driven by long-term growth, but as I have explained, these investments have allowed us to reduce our operating costs in the short term, resulting in solid return investments.

Now, I will talk about the second objective of our manufacturing footprint strategy, cost reduction in all geographies, particularly in the mature markets. You have heard from both Hernan and Nicolas that the revenue in the mature markets is now below the 50% mark in the Compounds business. In contrast, the labor cost to operate our sites in those regions is approximately 75% of the global employee cost and subject to several pressure points like pension. This is why manufacturing optimization in this case, plant consolidation in the mature markets, is imperative. In the last IFF investors meeting in 2011, we communicated a major consolidation of Fragrances in Europe, which is now fully implemented. We are now in the process of closing our small Flavors site in Sweden, and have announced our decision to close our Ingredients facility in Augusta, Georgia. These difficult decisions allow us to structurally reduce our fixed cost and improve profitability for IFF.

Finally, our IT system is robust and mature. We implemented our single-instance global enterprise systems 13 years ago. We are in an excellent position to leverage this technology and move task from high-cost to low-cost environments. We see this a real point of strength for us.

Now the question is, is our strategy delivering value for our shareholders? We believe the answer is yes. Our capital investment strategy is highly efficient, and we measure that by looking at our fixed asset turnover. In fact, our invested capital -- our return on invested capital is the highest in the industry. The allocation of capital investment, especially the decision involving opening and closing plants, is a big deal, and we take these decisions very seriously. One of the reason for our success is our disciplined approach to making investment decisions that are based on the principles of economic profit.

Now let me turn to our productivity and quality agenda, that is the cornerstone of our operations strategy. As you have heard from Doug, innovation is an essential building block of our DNA and it defines the way we approach opportunities in all parts of the business. In the context of R&D, it means patented technologies and captive molecules. In the context of operations, we are finding new and better ways to deliver improved services and shareholder value every day. The intersection of these 3 circles, these 3 concepts, people, process and tools, is what create the conditions for continuous improvement. We constantly review our processes and tools in order to increase efficiency and reduce all forms of waste. But it is our people who are at the center of the agenda, and the source of creativity and innovation with their passion and expertise. We are truly a global enterprise, and our team is a clear reflection of that. For instance, every plant manager in a medium or big site has won at least 2 manufacturing sites in different countries. Let me give you a few examples. The plant manager in Singapore started with IFF and was previously the plant manager in India. The plant manager in Argentina was the production manager in Mexico. The plant manager in the Netherlands was the plant manager in the U.S. The plant manager in China was the plant manager in Egypt. And the list keeps going and going and going. This is truly an x-ray of IFF and our global vision. And it is precisely this environment, this mobility that has created the conditions for new ideas, new processes, new methods, new techniques, new tools, learning successes and things that we have to do differently. In summary, allowing best practices and continuous improvements to flow naturally in our global network.

The results of our efforts are encouraging. From 2008 to 2012, our sales from the Flavors and Fragrances Compounds has a CAGR of 5.8%, while our manufacturing cost only experienced a 3.7% CAGR. This is very good especially in light of the pressure points we have in our cost structure, that includes volumes, inflation, new regulation, pension costs, et cetera. Manufacturing has contributed 110 basis points in gross margin expansion helping to offset ongoing cost inflation. We believe that this 110 basis points increase has driven by the success of our productivity initiatives.

We are also very pleased with our superior performance in quality, which directly impact service to our customers and to the bottom line. We had a significant reduction in both external and internal quality rejections. As you can see in this graph, we have had a constant yearly reduction of our customer rejections for many years for long term. We have had the same level of success in decreasing our internal rejection rate. This decrease in internal nonconformances reduces waste, waste of raw materials and finished goods. As I compare to our 2006 levels, this reduction has contributed over 100 basis points in gross margin expansion which is also helping to offset ongoing inflation cost.

For many of our customers, our products are the signatures of their brand. This is a great honor and responsibility. Our commitment and success in continually improving the productivity and quality of our operation is a cornerstone of how we earn, every day, our customers' trust.

Our global procurement strategy has 3 components. Again, first our people. Our team is globally organized with key resources in sourcing regions. Spending is split in several categories. Each category managed by a team with a global leader. The most important job of the category manager is to understand the market dynamics and bring that intelligence to IFF. They then work together with the business units and the finance teams and develop action plans. We are fortunate to have an incredible deep bench of category managers and directors with an average industry experience of 25 years. We believe that our organization and our people are the reasons that we were the first to catch the inflation wave back in 2011, which put us in position to act quickly.

Second, our process and systems, we use a 7-step sourcing methodology. We have used a well-known global consultant, one of the best in the procurement area, to help us to introduce these techniques to IFF. We have a one-instance global systems that allow a fast review of the spending information.

Finally and third, our sourcing strategy. Let me explain just a couple. First, forward-buy strategy. We go in and out of the market with high degree of discretion. The combination of market intelligence and good cash flow allow us to buy or contract a significant amount of coverage up to 18 months if we see the right conditions, or hold our positions if conditions are not favorable. Second, our vertical integration, particularly in Fragrances, allow us to constantly review make versus buy opportunities. In summary, I believe our global procurement approach is ensuring supply, achieving price and providing transparency to the process.

Before I close, I would like to share with you our sustainability strategy. Our approach takes into account social, environmental and economic factors, commonly refers as the triple bottom line. This means we consider what matters most for our shareholders, customers and employees, and the consumers whose life we touch every day. Our strategy is divided in 4 pillars. Our first concern, our products, where we focus on creating innovative solutions -- customer solutions, combining creativity with scientific expertise to support both our customers and consumers' future needs. The second pillar is about impact on the environment, where we are focused on reducing the waste, water and energy within our operations. The third pillar name our sources refers to where and how we acquire materials and product ingredients so it is socially and environmentally responsible and appropriately secure our supply chain. All of these pillars are supported by our fourth pillar, our people. As I mentioned earlier, we seek to attract, develop, engage and retain the best talent globally. A recent highlight of our progress includes key external measures such as the Carbon Disclosure Project for S&P 500 companies. We have now earned a B in performance and an 86 in disclosure and we expect to improve.

Through the effort of our global teams, we have made excellent progress in our metrics. Reduction in energy, water, waste, hazardous waste and safety incidents has helped our people, the communities where we operate and our business. As you can see, we have reduced these factors substantially since 2010. More details will be available by the end of the month upon the publication of our 2012 sustainability report, which will be available in our webcast -- website.

In summary, we understand -- I understand that my job #1 is to satisfy our customers. Productivity and quality are the cornerstone of our operations strategy. People are our best asset, and I am convinced we have a great team. We are delivering results, a strong manufacturing leverage, excellent reduction in waste and the highest industry return on invested capital. I strongly believe that the efficiency of our operations, right now, make us well-positioned to capture future growth.

Thank you very much. And now, it is my pleasure to introduce Kevin Berryman, our Chief Financial Officer, who will take you through the progress we have made in our strategy and how it is resulting in improved the financial performance.

Kevin C. Berryman

Okay. Good morning, everyone. And a good afternoon or maybe even evening for those that are listening in via the webcast. And for those of you on the webcast, we certainly appreciate you sticking with us through the morning's presentations and actually the break that we had on the technology demonstrations. Solely, our goal has been to help you understand why we believe we are winning businesses and building strong momentum in the company. We believe we are on the right track, and that the progress we have made in executing our strategy is reflected in our operating results.

As we have been reporting, every quarter, we have made great progress on executing against our 3 strategic pillars. I will only highlight some of the initiatives you have heard about this morning, but let me talk about them. Regarding leveraging our geographic reach.

Over the past 3 years, we have made significant investments in the emerging markets. As noted earlier, we have spent or will be spending over $150 million in expanding or creating new facilities that will support our growth objectives in the emerging markets. These facilities include the ones mentioned by my previous colleagues: Singapore, China and Turkey. In addition, we have or will be closing plants, including plants in Ireland, the United States and Sweden, and transferring the production from those plants to larger, more efficient plants in the network. We have augmented our creative and satellite laboratory network by opening new facilities in Delhi, India; Chengdu, China; Beijing, China; Dubai, and we're expanding others.

Regarding strengthening our innovation platform, we have instituted a more rigorous review of R&D and our processes. As an organization, we are focused on our 10 key platforms that address current and/or future expected consumer need states. We have formed outside alliances with biotechnology firms in the U.S. and Europe to advance our agenda for developing cost-effective, sustainable ingredients. We have strengthened our innovation pipeline, and we expect to release new molecules and delivery systems to the market in the near-term, the medium-term and the longer-term.

Turning to the last part -- pillar, regarding maximization of our portfolio. We are executing against our disciplined approach to analyzing and investing in our portfolio, using the tool of economic profit to guide us in making good, value-enhancing decisions relative to our portfolio. We have been and will be prepared to make difficult decisions such as exiting approximately $55 million of low-margin sales activities in the Flavors business. We have reshaped the portfolio towards higher profit businesses, while also improving the performance of underperforming parts of the portfolio and as a result, we have further expanded our margins. We have improved our growth prospects and cash flow for reinvesting back in the business supporting a bright future for the company.

So to give you a sense of the improving growth momentum that we have seen. This chart indicates, in 3-year buckets, our local currency sales growth, and over the past 9 years, clearly, there has been a clear indication of an improved amount of momentum in local currency sales growth. Prior to 2010, our local currency growth rate was, on average, approximately 2% per year. After 2010, our 3-year average local currency growth was 7%, even above our long-term financial targets of 4% to 6%. This accelerating top line growth has been supported by our increased investment in support of the emerging markets where industry growth rates are continued to be expected to be 2 to 3x the rate in the developed markets. In addition, our focus on value-added innovation and our disciplined approach to investing behind our growth initiatives has supported this acceleration. Going forward, certainly, because of the good momentum, we believe that we will be able to continue to deliver against our long-term, local currency sales growth objectives of 4% to 6%.

You've seen other versions of this chart for Flavors and Fragrances, but let me turn to it on a consolidated basis. And this is relative to our growth in the emerging markets and our increased index and exposure to those areas. This slide highlights our increasing sales, exposure to the emerging markets over the last 3-year period. A key component of our growth plan is to capture the benefits of attractive population growth and wealth creation in these fast-growing emerging markets. Our percentage of sales in the emerging markets increased from 44% in 2010 to 47% for the full year 2012, and actually further increased to 49% in the first quarter of 2013, reflecting our success in high-growth -- these high-growth markets. We believe our recent 49% index to the emerging markets is the highest in our industry and is reflected in our improved organic growth rates.

Interestingly, the percentage of our sales of the emerging market is even more dramatic if you look at only our Compounds business. Our Compounds business is that business which excludes our Fragrance Ingredients part of the portfolio. By excluding Fragrance Ingredients, it is actually likely a more accurate representation of our index to the emerging markets. Our Ingredients are sold primarily to global customers in the developed markets, who then, in turn, sell their products all over the world, including the emerging markets. So importantly, the percentage of Flavors and Fragrance Compounds sales to the emerging markets represents an even greater percentage, and has increased from 47% in 2010 to over 50% in 2012 and further expanded in the first quarter of 2013. As a result, for the total company, we believe that we are well on track for the emerging markets to represent a greater percentage of our sales than the developed markets by the year 2015, especially when noting the strong trend in our Compounds business.

So while it is clear we are gaining momentum against our first strategic pillar, what has been realized in terms of innovation? To do this, I'm going to focus on our gross margin performance over the last few years, as we believe it is a good proxy to show what kind of innovation is being driven into the portfolio. All else being equal, higher gross margin levels imply higher-valued products, higher value-added products imply higher levels of innovation and technology. Before doing this though, I think it important to first put context around the cost pressure we have faced over the last few years. As you know, and which has been discussed widely and often on our earnings calls over the last 2 years, we have seen unprecedented increases in our raw materials.

After 2010, our 3-year average local currency growth was 7%, even above our long-term financial targets of 4% to 6%. This accelerating top line growth has been supported by our increased investment and support of the emerging markets, where industry growth rates are continued to be expected to be 2x to 3x the rate in the developed markets. In addition, our focus on value-added innovation and our disciplined approach to investing behind our growth initiatives has supported this acceleration.

Going forward, certainly because of the good momentum, we believe that we'll be able to continue to deliver against our long-term local currency sales growth objectives of 4% to 6%.

You've seen other versions of this chart for Flavors and Fragrances, but let me turn to it on a consolidated basis, and this is relative to our growth in the emerging markets and our increased index and exposure to those areas. The slide highlights our increasing sales exposure to the emerging markets over the last 3-year period. A key component of our growth plan is to capture the benefits of attractive population growth and wealth creation in these fast-growing emerging markets.

Our percentage of sales in the emerging markets increased from 44% in 2010 to 47% for the full year of 2012 and actually further increased to 49% in the first quarter of 2013, reflecting our success in high-growth -- these high-growth markets. We believe our recent 49% index to the emerging markets is the highest in our industry and is reflected in our improved organic growth rates.

Interestingly, the percentage of our sales to the emerging markets is even more dramatic if you look at only our Compounds business. Our Compounds business is that business which excludes our Fragrance Ingredients part of the portfolio. By excluding Fragrance Ingredients is actually likely a more accurate representation of our index to the emerging markets.

Our ingredients are sold primarily to global customers in the developed markets, who then, in turn, sell their products all over the world, including the emerging markets. So importantly, the percentage of Flavors and Fragrance Compounds sales to the emerging markets represents an even greater percentage and has increased from 47% in 2010 to over 50% in 2012 and further expanded in the first quarter of 2013.

As a result, for the total company, we believe that we are well on track for the emerging markets to represent a greater percentage of our sales than the developed markets by the year 2015, especially when noting the strong trend in our Compounds business.

So while it is clear we are gaining momentum against our first strategic pillar, what has been realized in terms of innovation? To do this, I'm going to focus on our gross margin performance over the last few years, as we believe it is a good proxy to show what kind of innovation is being driven into the portfolio. All else being equal, higher gross margin levels imply higher valued products, higher value-added products, imply higher levels of innovation and technology.

Before doing this, though, I think it's important to first put context around the cost pressure we have faced over the last few years. As you know, and which has been discussed widely and often on our earnings calls, over the last 2 years, we have seen unprecedented increases in our raw materials, which have -- had been a significant headwind for both our Flavors and Fragrance business units. Starting in the fourth quarter of 2010, raw material costs actually started to escalate and continued to stay at escalated levels over the next couple years. In 2011, our raw material cost increased a total of 10%. And again in 2012, they increased another 4%. Over the combined 2-year period, our raw material costs increased 14%.

Looking at the cumulative gross margin impact of these raw material cost increases over the 2011 and 2012 years, the inflation negatively impacted our gross margins by an astounding 560 basis points.

So how do we do in terms of protecting our gross margins in this extraordinary inflation environment? As evidenced by the chart on the left, even though we experienced this 560-basis-point drag on our margins due to the inflation, we successfully protected our gross margins over the period from 2010 to 2012, basically maintaining a gross margin level of 41.7%. Importantly, a large benefit was accomplished through proactive, successful discussions with our customers regarding additional pricing. It was a great effort by our business unit teams, it was substantial in terms of the efforts, it took fact-based discussions and lengthy discussions with our customers to drive that pricing through.

We certainly believe we were one of the first flavors and fragrance companies to go to market with these price increases. However, that move, in and of itself, did not initially cover the higher level of input costs primarily because the pricing lags input costs in an increasingly extraordinary inflationary environment. Of course, our pricing efforts were critical, as it allowed the company to reduce the input cost pressure from the 560 basis points I previously mentioned down to 270 basis, which is shown -- 270 basis points, which is shown on the left-hand chart.

But that's only part of the story as it relates to us driving the margin profile. We also began to execute against our strategy and our initiatives supporting our strategy in 2010 and continued to then executing against them through 2012 and now into 2013, including exiting low-margin sales activities, driving innovation, increasing investments behind growth, implementing numerous cost savings initiatives and being more efficient and productive in our manufacturing network.

In all, these strategic initiatives had a 270-basis-point improvement, positive impact, on our gross margins over the full year period from 2010 to 2012 and effectively offset the net pressure of pricing and input costs, thereby protecting our margins.

Importantly, looking at the chart on the right side, with the first quarter of 2013, which includes an additional quarter of the benefits associated with prior pricing actions and another quarter of year-over-year strategic traction against our strategic initiatives, our gross margins increased by 160 basis points versus the most recent comparable period before the input costs rose over the first quarter of 2010.

And in 2013, we continue to believe that the input cost environment will remain benign. In short, the takeaway of this slide is that we are exiting the extraordinary period of inflation with actually higher gross margins than what we had before this period. We believe this is a strong testament to the traction we are gaining against our strategy.

So while I will not comment in any additional detail on our innovation efforts, as I certainly feel it was covered well by my colleagues before me, I would like to turn to our last pillar, to maximize the portfolio. As Doug mentioned in his opening comments at our last Investor Day, we presented the slide on the left. We did this in 2011, as you'll recall. At that point in time, approximately 35% of our invested capital was supporting either breakeven or negative EP businesses. Further, we estimated that there was a $50 million opportunity, profit opportunity, by the year 2015 in bringing these businesses back to EP positive territory when compared with the initial period of 2010. The pie chart on the right now is an update to that picture and shows that, as of 2012, we have made significant progress on improving the portfolio, with only 21% of our invested capital now supporting EP neutral or EP negative categories.

And importantly, only 6% of our invested capital is supporting negative EP businesses versus 15% in 2010. We actually now estimate that we have realized approximately half of the $50 million profit opportunity that we had identified in 2010, while specific efforts to improve positively, profitability has actually probably delivered more the specific action steps taken by the teams. Some of that actual benefit was reduced by some of the strong input cost pressures that we saw, and that is certainly, specifically true for the part of the portfolio that continues to show a negative EP position.

Nonetheless, given our strong traction in improving the portfolio, we believe that we will be able to continue to deliver improvements in profitability in the more challenged areas of the portfolio going forward. This will allow us to deliver the remaining 50% balance of that previously identified $50 million opportunity over the next 3 years.

We are pleased with the improved picture that we have been able to deliver. But clearly, we have some more work to be done.

So what does this mean to some of the other financial metrics that we certainly cover and monitor and continue to drive going forward? Specifically, one is very important, our adjusted operating profit growth. Over the last 9 years, the growth of our adjusted profit has greatly improved. Again, using the 3-year buckets that I talked about earlier for the years 2004 to '06 and '07 to '09 periods, the 3-year CAGR was less than 1% and 4%, respectively. However, in the years 2010 through 2012, the 3-year CAGR of 10% actually exceeded our long-term financial target growth objectives of this important metric of 7% to 9%. We expect, because of our strong performance, to see continued operating profit growth over the next 3 years, certainly in line with our long-term adjusted operating profit growth targets.

We have also been able to drive below-the-line leverage by making improvements in our adjusted effective tax rate position. Over the last 9 years, our effective rate has been reduced by 400 basis points. The improvements are attributable to both efforts on the part of our teams around the world, as well as changes in where and how we operate as a global business. It is important to note that while achieving reductions in our effective tax rate has been one focal point, we have also been able to significantly reduce our risk profile through the Spanish tax settlement that was announced in 2012.

Going forward, we believe our disciplined approach in this area will continue to provide improved effective tax rates in the long term, absent, of course, fundamental governmental shifts in tax policy.

So clearly, an accelerating rate of growth in adjusted operating profits, combined with an improving adjusted effective tax rate, this is translated favorably into a 2010 to 2012 3-year CAGR in adjusted EPS growth, well above our 10% long-term strategic goal and certainly, also, well above the figure that we were able to realize in the previous 2 3-year periods. Going forward, again, we believe that we will be able to deliver EPS growth in line with our long-term growth targets.

So we've been focusing a little bit on our profit. Let's talk about the balance sheet investment behind our business. The single largest component of our capital employed is the core working capital needed to support our business on a day-to-day basis. We define trade accounts receivables, inventories, including raw and finished goods, and trade accounts payable as core working capital. By incorporating working capital into our performance management metrics, assigning clear responsibilities and setting aggressive improvement goals across the organization, we have been able to reduce the ongoing burden of core working capital by 330 basis points as a percent of sales since 2008.

On approximately $2.8 billion in sales in 2012, this has freed up roughly $90 million in cash compared to our 2008 working capital levels. We, again, expect to continue to realize improved efficiencies in this area in working capital as a percent of sales as we go forward into the future.

So -- and of course, if you look at our working capital, combined with strong P&L gains, certainly, all of this has translated and resulted in strong improvements in our return on invested capital, a metric certainly very aligned with the principles of economic profit.

Looking at our historical performance, since 2004, there are several key takeaways: first, our average return on invested capital in every period is consistently at a double-digit level, well above our estimated cost of capital; second, we have been able to show steady improvement in each 3-year period despite having made significant capital investments during the last 2010 to 2012 period; third, if we continue to execute consistent with our recent past, we expect this positive trend to continue for the longer term; and fourth, and as already mentioned by my previous colleagues, we have an industry-leading ROIC level versus the rest of our flavors and fragrance competitors.

And finally, all of our performance improvements have translated into a steady improvement in our adjusted operating cash flow generation, with 2010 to 2012 adjusted free cash flow levels approximating or nearly $1 billion or 29% higher than the cumulative amount of nearly $750 million in the first 3-year period of 2004 to 2006. And again, going forward, we expect to continue to drive improvements in this key operating metric going forward.

So as you have now seen, the health of our business has and is expected to continue to deliver robust levels of free cash flow. So what does this mean relative to our use of cash strategy? First, our most important use of cash will continue to be focused on making the capital expenditure investments necessary to support the future growth of our business and provide for greater efficiencies. Second, we have and will continue to execute a policy of a disciplined return of cash to shareholders, and we expect to continue to grow our dividend in line with our earnings growth. Third, we believe that M&A and other corporate development opportunities can play a role in augmenting our organic growth strategy, and we continue to routinely evaluate M&A opportunities. And finally, a guiding principle across all 3 areas of capital allocation will be our goal to maintain a healthy balance sheet and solid investment-grade credit rating, thereby ensuring high degrees of financial flexibility.

So let me talk briefly on capital expenditures. Francisco already talked about it a little bit. We have taken key steps to support our aggressive long-term growth and profit improvement objectives. We expect to remain at a level between the 4%, 4.5% to 5% for the next couple of years and thereafter, return to levels more commensurate with the 2003 to 2009 period.

Despite the increased level of capital spending, over the last few years, the company remains committed to a disciplined return of cash to shareholders. Our history has proven our willingness to return cash, and executing this philosophy going forward remains a priority for the company. We expect to continue to grow our dividend in line with our earnings growth at minimum. Over the last 3 years, we have increased our quarterly dividend by 36% or 11% per year on average.

In addition, last year, we authorized a $250 million share buyback, a clear indication of our board's belief in the strong fundamentals of the business and its future outlook. This buyback is certainly consistent with the company's historical commitment to return cash to shareholders, as is evidenced by the $1.9 billion that has been returned to shareholders over the last 10 years.

We also believe that M&A and other corporate development initiatives and opportunities can play a role in augmenting our organic growth strategy, and we routinely evaluate opportunities. We look for those opportunities that would enhance our strategic initiatives to drive increased shareholder value. We will prioritize those acquisitions that are aligned with our organic growth strategy and look at those companies that would provide us with access to new technologies, regions or customers or would fill in or complement our existing infrastructure. Of course, any opportunities will be evaluated consistent with the disciplined principles of economic profit. In addition, I should note we will also consider adjacencies that could provide opportunities to bolster our long-term, value-added growth objectives.

We're getting close to the end of my comments. And before turning it back over to Doug, one of the things I think is important to do is to reconfirm that our financial performance has been accelerating. And as a result, we believe it's appropriate to reaffirm our long-term financial targets.

I, herein, then talk to and reaffirm the numbers that we have been talking about for a few years: 4% to 6% in terms of local currency sales growth; 7% to 9% in terms of adjusted operating profit growth; and 10-plus percent in terms of adjusted EPS growth.

Before wrapping up, finally, I thought it would be a good thing to talk about how our strategy is being understood and appreciated by what appears to be an improving fundamental in our shareholders and their belief in our future. Our executive compensation programs also reward our management team for delivering total shareholder returns above the S&P 500 average. By delivering on our long-term financial targets of 4% to 6% local currency sales growth, 7% to 9% adjusted annual operating profit growth and double-digit adjusted EPS growth, we believe this will translate into first quartile S&P 500 returns for our shareholders. We are proud of our financial performance over the last 5 years and certainly, particularly, the acceleration that we have seen in each area during the 2010 to 2012 period.

We believe that our shareholders and the markets have looked favorably on our results, as evidenced by the total shareholder returns over the 5-year period ended December 31, 2012. During this time, IFF total shareholder return of approximately 55% is well above the S&P 500 average and our peer group.

So in summary, we are a diversified company with a stable, growing portfolio. This is certainly well demonstrated from a geographic standpoint, where, in 2012, 47% of our business was in the emerging markets; from a business diversity perspective, where 51% of our business is fragrance and 49% is flavors; and finally, from a customer base, where we work with many of the multinational consumer products companies around the world, as well as strong regional and local players. We have invested and will continue to invest in manufacturing capacity, research, creative and commercial resources to support future growth in the emerging markets and in higher-growth market categories. The business generates strong cash flow, and our quarterly dividend and the recent authorization of a $250 million share buyback program are indications of our confidence in our future.

In summary, by leveraging our geographic reach, driving innovation into our portfolio and improving the overall profitability of the portfolio by making faster and better business decisions, we believe we can improve our business performance and offer our shareholders returns -- strong returns long-term.

Again, I thank you for your attention, and I'll now hand it back over to Doug for his closing remarks. And then after his remarks, we'll open it up, the floor, to any questions.

Douglas D. Tough

Well, we're in the home stretch. I hope that by now, all of you, whether you're in the audience or on the webcast, have a deeper understanding of where IFF had been and, more importantly, where we are going. I hope that with all you have seen and heard, you also believe that our technology provides us with a competitive advantage and that we are well poised to continue to achieve high win rates. I also hope that what you've heard today underscores the commitment of everyone on our team to an organization that fully understands consumers and anticipates their needs and uses innovation to create superior products that touch people's lives all over the world.

I'd like to highlight some of what you've heard today and leave you with a few thoughts. Innovation is the foundation of our success now and into the future. It is the lifeblood of the company and of any consumer products company. As an organization, we are using innovation to discover new ways to create unique experience that enhance consumers' lives. Our definition of innovation is not just about R&D platforms but about everything we are doing to operate more effectively as an organization to make advances in the business and in the way we approach opportunities for growth. Innovation is truly the foundation for IFF's success.

At every level of our organization and in the 32 countries in which we operate, innovation helps us find efficiencies and streamline processes, more deeply understand consumers and create exceptional products for our customers to help them capture market share and build their brand equity. We believe that our commitment to innovation will set us apart from competition, help us drive performance and position us for continued profitable growth.

Consistent with the principles of economic profit, we will continue to allocate resources in line with where we see the most potential for growth and profitability, both in the emerging markets and the developed markets as well. We're aligning our R&D spend with the opportunities in our industry based on category growth and the expected profitability of the product.

In keeping with our goal of maximizing the portfolio, we will continue to use economic profit to develop a stronger portfolio that delivers a higher return on investment. We will continue to shift investments to advantaged regions, advantaged customers and categories, while remediating the less profitable areas.

Going forward in the future, we will continue to, first, leverage that geographic reach. Growth rates in the emerging markets are 2x to 3x the developed markets, and our anticipated growth rates reflect our strong index in the emerging markets. We are supporting our emerging market presence with new manufacturing facilities and capacity so that we can grow with our customers in those regions. We are also increasing coverage in these areas by expanding our laboratories and our commercial offices.

Secondly, we will work towards further strengthening our innovation platform. Our R&D pipeline has significantly strengthened. We have a well-defined set of R&D platforms, which are well aligned with the business unit strategies. We are accelerating the rate and the impact of innovation for the near term, medium and long term.

And thirdly, we want to maximize our portfolio, where we have exited accumulative $55 million of low-margin sales activities since 2010. We expect that Q2 2013 will be the last quarter that will reflect the impact of those exits. We realized approximately 15% of the $50 million operating profit opportunity as of the end of 2012, and we'll look to deliver the balance over the next 3 years. We have made significant progress in driving economic profit across the organization as a management tool for decision-making and resource allocation.

And finally, we have improved our return on invested capital 220 basis points over the last 3 years, and we will look to further improve this important metric.

Looking forward, our 2 business units are strong and profitable, and the fundamental strategies set forth for each remain valid. We will continue to invest in and support those markets, categories and customers to offer attractive growth and profitability potential. Near term, that includes building out our Gebze facility, which is a $50 million investment to expand our existing facility, including adding a new creative center to provide improved commercial and distribution coverage in the Middle East, Central Asia, North Africa and parts of Eastern Europe; leveraging our Singapore fragrance and flavors plant and ensuring that Southeast Asia capacity needs are met, as well as some countries in the Middle East; and finally, leveraging our Guangzhou, China plant, as well as satellite labs in Chengdu and Beijing to serve our important customers in the region.

We will continue to invest in R&D and innovation to drive differentiation in the marketplace and provide value-added solutions that meet our customers' and our consumers' needs. Our innovation priorities in the near term will focus on building a strong pipeline of molecules, continuing to develop high-impact molecules, extending encapsulation to other categories, such as hair care, and leveraging our expertise in natural ingredients and leveraging our flavors modulation toolbox, and leveraging the experience and the relationships of the Scientific Advisory Board to support our R&D efforts.

Delivering on the first 2 pillars is important, but there remains a lot of potential value creation with a continued focus on maximizing our portfolio. We have made a lot of progress since 2011, but our focus in this area going forward will be to gain momentum in our execution by focusing on innovation, profitability and return on investment, continuing to realize strong improvements in the portfolio through a disciplined approach to investing and resource allocation and leveraging our strong margin profile and cash flow generation to provide flexibility to meet our growth, capital expenditure, acquisition, development and shareholder needs.

Here then is a summary of our strategic priorities going forward: to invest in innovation, both in R&D and across all IFF functions; to grow our footprint in the emerging markets and improve coverage with laboratories and offices and creative centers; and improve the value of our portfolio by prioritizing higher-margin business. By driving greater operating efficiencies in manufacturing and in purchasing, our expectation is for a continued strong financial performance and delivering on our long-term growth targets: local currency sales growth of 4% to 6%; our adjusted operating profit growth of 7% to 9%; and our adjusted earnings per share growth of 10% plus through portfolio mix, product innovation and manufacturing leverage.

I thank all of you for your participation today, both in the audience and in the webcast, and I hope you have benefited from all you've seen and heard about IFF. I will now ask the operating committee to join me on the stage, and we will look forward to having a good Q&A session. While we bring out chairs for them, I'd just lay a couple of ground rules, one of which is that we'll take one question at a time from anyone who has it, and we'll keep rotating until you get a chance to come back and ask a second question, if you have one. And we will have microphones that are roaming in the audience in order to help you ask your questions. So if you'd please join me. We'll start over here. The lights are kind of bright, so raise your hands. Is there a microphone -- can we get a microphone over here? For here in the white shirt. We'll then go that way.

Question-and-Answer Session

John Roberts - UBS Investment Bank, Research Division

Back in the bleacher seats, John Roberts from UBS. Given the importance of the emerging markets, could you talk a little bit about whether you're gaining share with emerging market customers? Is it your global customers gaining share and just pulling you through? Does it vary by Flavors versus Fragrances? And do you have any competitors in the emerging markets you think might break through into the majors over the next 5 years?

Douglas D. Tough

Okay, John, thank you for the question. And because it's touching both business units, I'll maybe ask Nicolas, if you will, start, and then Hernan -- you got the microphone, Hernan? Okay.

Hernan Vaisman

I would just start then. So let me see if I got your really good questions. So if there in Asia on the emerging markets, if the global accounts are gaining share or they're local accounts or regional accounts, this is the first question. I think it depends in countries. In some countries, global accounts are making good inroads, and they have already for many, many years. I would say, in the case of Brazil, I mean, there is in the food & beverage customers that have been -- so they were down for many, many years, and they have very strong position. In India, also, you have global customers really having a strong position. But they are also coming up very strongly in the local ones. In China, you have both -- I mean, the globals -- some globals are doing well, but also the locals and regionals are also growing really, really fast. So I cannot give a kind of rule of thumb. Definitely, in each country, you have a different, I mean, situations. What I could say, that is a very tough battle for both. I mean, while you have in some countries the local ones have a very good distribution, they also have met [ph] pretty well the consumer needs. So it is difficult, really, answer to say or to comment, to clarify. So I think that is a -- I could say, overall, it just depends on each countries. The second question was -- if you can repeat, there was another question?

John Roberts - UBS Investment Bank, Research Division

Any global competitors that are going to emerge, you think, in the next several years?

Hernan Vaisman

The global competitors from the...

John Roberts - UBS Investment Bank, Research Division

Emerging market competitors that will emerge on the global scene. I mean, the emerging markets seem to be led still by the developed Flavor and Fragrance companies.

Douglas D. Tough

So you're talking about emerging market, Fragrance and Flavors locally?

John Roberts - UBS Investment Bank, Research Division

Suppliers that compete against you.

Hernan Vaisman

Our competitors you're talking or our customers? Competitors, I frankly don't have this information. This is something that might happen.

Douglas D. Tough

I mean, let me just briefly touch upon that and then ask Nicolas to comment from a Fragrances point of view. I mean, we think there are -- we have some competitors in the commodity ingredients business, which have impacted our business. But we have not seen significant challenges from local F&F companies in the more advanced parts of the business. And we frankly think, John, there are some pretty compelling barriers to entry now all the way from the scientific community, the R&D element, as well as the regulatory environment. So we're always mindful of competition but don't see anyone right now breaking into that -- the forefront. Nicolas, maybe you can talk first?

Nicolas Mirzayantz

Yes. Regarding competitors, what I call your comments, it's mostly in the ingredients business but not in the compound business. We have not seen that so far. Regarding the balance between global player and regional players, similar answer to Hernan. But I would like just to mention that we've seen obviously the focus of global players entering into this market and most of our global customers have announced their intention to reach the next billion consumers and are making significant investment. But we have seen also and we have benefited from the increased market growth from the strong regional players. And if you look in Brazil, if you look in India, if you look in China, you have few regional players that are gaining significant market share as well, leveraging their consumer knowledge, their distribution infrastructure and manufacturing facility. Some of them are pure-play Flavors or Fragrances, and some are actually leveraging their current infrastructure in other categories in order to gain market share and traction in their local market. And we see these regional players not only growing in their own country but expanding into new countries and expanding into new product categories.

Douglas D. Tough

Next question? Mark?

Mark S. Astrachan - Stifel, Nicolaus & Co., Inc., Research Division

A question on segment margins. So Fragrance margins are materially below where Flavors margins are. And if you go back to what you guys had put up in the presentation, pricing was -- pricing strategic -- maybe strategic benefits were pretty similar. But the net benefits of pricing offset by input costs were more pronounced in Fragrances. I guess on a go-forward basis, should we be thinking the Fragrance margins narrow that gap or close that gap? And then what about the longer-term opportunities to close the bigger picture gap between Flavors and Fragrance margins?

Douglas D. Tough

You want to talk to Flavors -- Fragrances margins?

Nicolas Mirzayantz

Thank you for the question. If you look back at what we have shared so far regarding the input cost pressure, it is fair to say that the input cost pressure have been significantly higher on the Fragrance side and on the Flavors side. And therefore, the gap to -- from input cost to pricing was far greater to reach. And that's why they're focused on all their strategy initiative and margin improvement initiative was so critical to be able to offset in addition to pricing. That's why when you look at the -- really maximizing our portfolio, to focus and shifting resource to higher profit categories is critical for us. We have more to do. We're pleased about the progress that we have made, but we recognize that there is more traction to be gained.

Mark S. Astrachan - Stifel, Nicolaus & Co., Inc., Research Division

So maybe just to follow up on that then. So it sounds like it's getting better but maybe touch specifically on some of those impacts that you've had into the business and how we should think about that sort of reversing out, as Kevin has talked about, input costs being, I guess, moderating is what you've been saying, Kevin.

Nicolas Mirzayantz

And that's why if you see the progress we've made in Q1, we recognize that the input costs has remained at very elevated level. But because of mix, because of volume growth, because of margin and improvement initiative, strict cost discipline, we've been able to continue to regain. But the input cost, as I said, had remained at a level cost.

Kevin C. Berryman

Maybe a couple of other comments to address your question, Mark. Yes, you're right, there is a margin differential between the 2 business units and certainly, the pressure points in the Fragrance business were more pronounced because of the input costs. So if you think about the number we quote at the corporate level of 14%, it was higher than that for Fragrance and it was lower for Flavors. So the lag impact associated with that is certainly greater for the Fragrance business, and they had more work to be done. I think at the end of the day, it's clear that both of the businesses have an economic profit profile that's very attractive, clearly. And that the growth opportunities and margin enhancement opportunities are -- still exist for both of them. And so consequently, the team in Fragrance is executing against that. We actually like the fact that there's growth opportunities in both, the fact that Fragrances has a lower margin today. We like the fact that they're growing as well because it's economically profitably enhancing our shareholders. So it's positive in a lot of ways and certainly probably more to do -- I talked about that piece of the portfolio, where it was still under water from an economic profit perspective. That team actually did some great work in terms of executing against our plans to improve it. It was also the piece of the business that faces the greatest levels of input cost pressures. So as we go forward, they're confident that the steps that they took, it's gaining traction, it's working, so there is an ability to improve the margin profile going longer term.

Douglas D. Tough

I think it also touches upon the diversity of the company. When I joined and looked into the history and trying to understand it, went back and saw the margins in 2005, and it was extremely unattractive for Flavors and the reverse was true. So both the diversity in watching the portfolio modulate itself has been really quite beneficial. Kevin's right. We're kind of agnostic to where the growth comes from, we'll look for improvements. And I think the one thing that we touched upon are some very good categories in Fragrances that there's now work underway, I want to say very good categories but a very high profit margin categories work underway to try to bolster the business not only the very good work that's happened in the Flavors business on some very attractive categories, which have helped their margins. Laura?

Unknown Analyst

So the margin expense you guys have seen and now you're earning margins that are well above anyone else in your Flavor and Fragrance competitive set. Not questioning at all that you've earned those margins, it's mix, it's productivity, it's all the good stuff you can control. But are you starting to get any kind of pushback at all from your customers about the profitability that you're seeing because as they're looking to push more and more of their own profitability and looking for cost savings. It's been well documented they're aggressively looking for ways to save on their end.

Douglas D. Tough

Well, let me just briefly give some overview comments, and then I think Nicolas and Hernan should both talk about it. I mean, customers are always in conversations about relative profit margins regardless of whether ours have improved or not. So I think that's kind of a given. One of the things which has helped in the last couple of years and Kevin's slides were very precise and very good in showing margin improvement against cost, what we've recovered or not. So the basis for a fact-based conversation showing in fact we still not fully recovered the margin we had before the advent of the inflationary increases is something we openly share with customers and as it relates to their particular portfolio, too. So while they will come back, and Kevin and Nicolas -- or Nicolas and Hernan will talk to it, we're in a position of sharing with them, we've not fully recovered yet. Hernan, you want to go first?

Hernan Vaisman

Yes, in fact, yes, we have some pressure from customers, but then, we -- I think we have improved a lot having a transparent discussion with them, explaining clearly which are the key drivers of our cost on one side. Secondly, as we explained throughout the day today, we are working very hard in looking for efficiencies. So in some ways, sometimes, we have to share with them. But definitely, something that we have high in our agenda and we try always to be very open, transparent and this comes fairly with the customers to really avoid [ph] and to prove but also they are paying for a good technology that we are providing to them, but in fact, yes, we have some pressure.

Nicolas Mirzayantz

Yes, a similar response, Lauren. One thing which is important is that not all the categories have been affected by input costs and not all the customers, because of the diversity and the portfolio that we're delivering to our customers. We've learned a lot from the increase, and we've shared a lot. So now together, we are monitoring the evolution, trying to understand the trends for the future and some where we have not yet completely recoup, as you could see at the end of 2012, 200 basis points of GAAP. So our customers understand, and we're trying to find solutions, give additional visibility and finding some savings, common savings opportunity together in order to drive better efficiencies for both our customers and ourselves. So it's an ongoing discussion and we're monitoring the market together.

Douglas D. Tough

Jeff?

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Jeff Zekauskas with JPMorgan. I have, I think, a 2-part question, there may be 3 parts, but I can't exactly keep track. It sounds like you think that the Flavors market will grow faster than the Fragrance market. And so I'm curious as to why you think that. Or what you think the relative growth of the markets are. In your presentation, you say that you expect high-single-digit operating profit growth from both divisions. And so given that Flavors seems to grow faster, one would natively expect -- and they have higher margins, one would expect that Flavors' operating income should grow faster over a longer period of time than Fragrance operating income. And so I want to know why you think that they should be the same, if that's what you think. And then there's the last part and then the last...

Douglas D. Tough

In liberty of one-question policy but go for it.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

Okay. And then the last thing is you were kind enough to point out that raw materials went up about 4% in 2012. But actually, your cost of goods sold in 2012 went down. It went down by about $40 million. So I was wondering if you could sort of reconcile the raw materials at 70% of cost of goods sold, growing at 4%, but cost of goods sold going down? Okay, I'm done.

Douglas D. Tough

Okay. Let me kind of try to deal with the first question. As I reframe the question, I'll kind of ask Nicolas and Hernan to talk to the market growth and then we've just come out of a long-range plan discussion. So I think I'm going to ask Kevin to kind of shepherd question 2 and maybe 3. But question 2, particularly, as related to why can -- why will they both grow strongly in one of them. And I think the answer is we shared with those today. But on the market performance and -- you've got the microphone?

Nicolas Mirzayantz

Regarding market growth expectation, the growth that we're giving about 3% moving forward is really a blend of 1% in developed markets and 5% in emerging markets. So when you combine the 2, that's where you get to a 3% market growth expectation moving forward. And this has been historically the average. If through additional distribution in emerging market, we might see an evolution, but we have not seen that so far. So that's what the history is telling us, and that's what the different projection from the different region is also telling us.

Hernan Vaisman

Let me try to [indiscernible] in Flavors. Let me start with the developed market. As we mentioned many times, we have this health and wellness trend, and this health and wellness trend for Flavors is bringing in a lot of new opportunities. We are talking about -- we can create taste modulators, and this is additional to the normal potential of the Flavors and also allow us to consider the developed market that they are very well penetrated growing between 2%, 3%, when previously we're growing to 1% to 2%. So this is a new value added to the Flavors business. That's why we will -- it's growing faster than the developed in the Fragrance side of the business. And on the other hand, and this is what we believe, when we say we have the information, in the emerging markets, as long as the disposable income are growing, I mean, people were only eating, I mean, vegetables, fries and so on, they start consuming more packaged good foods. So that's why you have more tractions that the market was, like Fragrance, more penetrated before. So this is why our belief is that the Flavors market will be growing than the Fragrance market.

Douglas D. Tough

Okay. Kevin, do you feel -- you've got the facts surrounding equal growth for margins?

Kevin C. Berryman

Regarding the margin discussion, look, I think that clearly, Hernan has talked about the fact that there is perhaps a little bit higher level of growth in the Flavors business just because of the industry dynamics relative to food versus personal care and household care products. And the margin profile, perhaps there is going to be a difference, but it's going to be because of the fact to your point that there is perhaps a little bit higher growth on the Flavors side than the Fragrance side. But they're both going to be good. And so perhaps Flavors ends up being a little bit higher in terms of the profit growth but they're still at a high-level single-digit, 7% to 9%, either one, I'll take. So I think that it's just the fact of how the margins are working going forward. And clearly, we do believe there's opportunity to improve the margin profile in Fragrance business.

Hernan Vaisman

Yes, the positive factor is the change in the categories. We are really winning in the case of Flavors with more higher-margin categories, and that's why you can see these kind of reversal approach of going up from materials while the cost of good going down. I mean, you have better markup. And the other one, as we mentioned before, I mean, we exited lower margin business. And this is also impacting in the way that you are seeing kind of a not a logical approach. I mean, going up from materials and going down on cost of goods sold.

Douglas D. Tough

And then question 3, I'm trying to reconstruct -- if I can't do it, we'll take it offline, I'm trying to reconstruct. I think the point was if you felt that costs were going up 4% in 2012 vis-à-vis our raw materials or COGS and yet, our, I guess, on our P&L, you've somehow figured out that actual costs went down. And I'm kind of thinking -- all I can think of was whether it was receipt of inventory or timing, when it might have been or -- Kevin?

Kevin C. Berryman

I think clearly, part of the answer is when we talked about in terms of driving the strategy going forward. We have a higher margin businesses that are coming into the portfolio. And consequently, they have lower costs as it relates as a percent of sales. Now the absolute drop is probably a certain amount of a variety of things. Certainly, one of them will be currency. Currency, if you look at our top line reported, it wasn't as great in 2012 as some of the local currency sales growth. So there was a dampening as you filter down the P&L, some of that will be currency. But at the end of the day, it's a function of a lot of things we talked about over the course of the morning. It's about innovation, it's about bringing higher margin business in, it's about fixing some of the lower margin and cost reduction initiatives. So they all add together, and it's not just one thing that's driving the agenda. They all have to work. And if they're working in a way that provides us margin enhancement, which certainly we had a low level at the end of 2011, we're exiting in 2012 in a much better level. So your comparison periods are from the low to kind of getting back to where we would like to be. Next question?

Douglas D. Tough

Sorry, before you go back to John, anybody else wants a -- okay, John, we'll, I'll come to you next after one.

Unknown Analyst

A quick question. During your technology presentation, you talked a lot about the new innovations, but can you help us quantify those innovations? Can you talk about maybe the win rates and the difference in win rates that you're seeing in both the divisions on the back of some of these? The encapsulation technology, some of the Flavor technology that you've come up with, just trying to quantify a little bit the innovation.

Hernan Vaisman

So if I captured your question, you say is the impact of the technology and the success rate this was...

Unknown Analyst

Yes, can you talk about the win rates that you're seeing, how those evolved and if you have any specific examples of a technology that you've developed and that has led to a significant jump in win rates in certain product categories.

Hernan Vaisman

Okay, great. I mean, definitely, in the last 2, 3 years, we -- our success rate has been increased year-on-year. That's why you have these kinds of performance in the top line. I cannot give you exactly one example, but I can, for example, give you some data that says in our, I mean, data house is that the -- for example, if you opt for different platforms in terms of naturals, in terms of modulations, in terms of R&D molecules, in the first quarter 2013, the last -- the previous quarter, 20% of our sales, our total sales contains new molecules coming from those programs. So this is one indication that definitely the output that we have for innovation is really giving us a clear advantage. This is one data. In terms of the delivery system, we have a different delivery systems in the company. As we mentioned, the delivery system you have for a powder of -- other format or liquids, which are really, really, I would say, innovative. They're very effective but just to make it very clear, I mean, just having only delivery system will not give you a win approach. You have to have the delivery system but also a good Flavors that they can really make the right expression at the right time. So we are winning in, we say, liquids delivery system, with powders, I mean, almost in all, I mean, new wins, you can have this kind of technology. It's just coming from the molecule side part of the business or coming from the delivery systems. But definitely, the bulk of the win rate or the increase of the win rate today in Flavors are coming from the new innovation that we have in-house.

Nicolas Mirzayantz

Regarding encapsulation for Fragrances, you saw that for 19 consecutive quarters, we have growth in what we call, function Fragrances, and the key driver behind that growth in Fabric Care was encapsulation, where we're growing at a rate of 2 to 3x higher than the industry. Therefore, we have significant win rate and much stronger than in the past. But as Hernan was saying, you need to couple the innovation with superior consumer insight because a great capsule, if you don't have a Fragrance that is driving consumer preference is not going to be able to generate the type of growth that we've been able to enjoy. One important component, as well is that we saw that we were part of a significant portion of the innovation platforms of our customers because of the encapsulation. So the more we work together, the more we have success together, the market share gain that they've been able to enjoy because of our encapsulation technology were above historical levels. And therefore, we are exploring more opportunities to bringing encapsulations to more regions, to more countries, as well as to new categories.

Unknown Analyst

And just actually, just to follow up on that, just to ask a different way, can talk about the market share gains and some of the subcategories in both segments?

Douglas D. Tough

We don't have -- I'll let them take a stab at that. We don't get the precise information that you might expect through a Nielsen or an IRI. So it just tends to be -- you get a sense of anecdotal information when you win a business. But precise market share is very difficult. But you want to talk to certainly...

Hernan Vaisman

Okay. Well, as I mentioned, we don't have this kind of information. But basically, if you go, for example, in Beverage, we have a very good success rate, I can say, in the last couple of years. What Mauritio was presenting in term of citrus, taste modulators, encapsulations are the key drivers of this improvement. Definitely, if your Beverage category grow in a double-digit and usually, the Beverage category growing at 8, 9, you're gaining some share but we're not managing it exactly, I mean, this kind of information. But once again, I would say the bulk of all the new wins are basically supported, you can find the roots in all what we are doing in innovation in the last 4, 5 years.

Nicolas Mirzayantz

And regarding encapsulation for Fragrances, e-customers where we're engaged with the technology and we've been able to develop the technology together, our level of performance is above the market growth and above the category growth. So we see a direct correlation between the use and leverage of encapsulation with our performance, with our customers and the performance of our customers in the market.

Douglas D. Tough

And, John, we'll come to you and then this gentleman.

John D. Staszak - Argus Research Company

Kevin, what did you mean by adjacencies when you were talking about M&A? And then I have an economic profit, just clarification.

Kevin C. Berryman

We haven't classified exactly what that means. But certainly, we would be interested in those areas where we can leverage. And certainly, the closer end would obviously translate into the most obvious opportunities. But there are things that our customers use have similar capability sets in terms of creation and these types of things, which could potentially make sense for us to augment what we believe is already a very strong organic growth strategy. I don't know, Doug, if you'd like to add any comment.

Douglas D. Tough

I think it really flows out of -- the company has a very strong footprint in both Flavors and Fragrances. I think it's well documented and understood. A lot of our customers are talking about penetrating the emerging markets for the next billion consumers, and you can see that's part of the current strategic plot we have. Certainly at the board level, when you're looking a long ways out, and there's -- we think there's an awful lot of organic growth there, the board is saying, from a position of strength, are there other opportunities you should be contemplating in adjacent categories. Some of our competitors are in adjacent categories. Obviously, the concept of adjacency flows out of what is your chord of confidence? What is chord of confidence fees? Where are you good at? And we think we're good in certain areas and can we leverage those outside of Flavors and Fragrances. That's the germ of the idea, the current thrust very much is confidence we have in the organic growth strategy, including potential M&A opportunities in our existing field. But having said that, from position of strength, we will be looking at conceivably what are other opportunities, not necessarily in the short term, but the long term, because I think there's a lot of runway for the next billion -- awful lot of runway for the next billion consumers, but it's an appropriate question for our board to ask us, then what? That's the germ of the idea.

John D. Staszak - Argus Research Company

Two clarifications on EP. You said the external Fragrance Ingredients business is actually economically profitable, so that's -- it's above its hurdle rate at least. And then secondly, I think you said the remaining 6% that's below would not be below if it wasn't for the raw material cost increase. So that was something where you've made progress, but you got set back by the raw material cost increases that occurred while you were making progress?

Douglas D. Tough

Those are fair conclusions, yes. And Kevin touched upon -- really, there may be some people in the audience, the Functional Fragrance, the [indiscernible] duty in making the progress they did, they just were hit by a tsunami. This gentleman?

Unknown Analyst

At the FlavorFit demonstration, it was described how a customer had approached you with the desire to have a tropical-flavored cookie, I think, it was. I'm just curious, how much of the business that you do is a result of inquiries from your customers, that sort of request to prepare a new formula for them? And how much of it is a result of you taking your own innovation and research and going out and trying to pull customers in first, that was my first question. Secondly, when you talk about economic profit model with regard to research, it's customary to think economic profit with regard to capital spending or working capital. But most companies that are targeting something like 20% to 30% returns on their research spending, and I'm curious how specifically do you apply this model to the way you would allocate your research dollars?

Douglas D. Tough

Okay. You want to go ahead -- you want to take that -- question 2, first? Sure.

Kevin C. Berryman

Let me go #2 first. As it relates to the EP question, certainly, investments in innovation and technology don't necessarily come to fruition, as we all would like. The key in the challenge and the opportunity is to be better at it than anybody else in terms of making the right choices and investing behind where really are the opportunities. We have a very disciplined process, which really talks about risk adjusting to a common denominator. So we effectively, even though there may be opportunities that have significant potential EP benefits, the reality and the opportunity and the challenges associated with that could translate that into a risk-adjusted opportunity of a very de minimis amount. So we go through that process, which allows us to basically compare these a risk-adjusted opportunities against our cost of capital, which is effectively doing the same thing as what you're suggesting with saying, look, if you got an opportunity and you use a 30% discount rate against it, what does it look like? We're doing a risk adjustment and factoring in the risk profile associated with all those things that get to a common denominator, what all of those environments or opportunities look like. And then we make the decisions on how we drive our investments against those opportunities in a consistent way.

Douglas D. Tough

And let me try to reshape question one and pass the microphone to Hernan because you asked it in the context of citrus, which was, I think -- the germ of the idea was ideas that either come from the customers to us or we take to the customers for development, what's the ratio, how does that work, proactive versus reactive?

Hernan Vaisman

Okay, thank you for the clarification. We have internal statistics that we follow up and we really monitor these kinds of, I say, entrance of breeds, whether we pull it to the customers. If you go for the customers or for the amounts of the briefs that they are asking from the customers' point of view that they help us to develop something different, special or helping them in that way, where almost 90% of the briefs start with the customers. 90% are coming from them, asking specific solutions for whatever the problem would be. This, of course, these problems will be different and will vary from a different regions. I mean, when you go to the developed markets it's more of the health and wellness, more on the natural approach. In the emerging markets, you will opt sometimes for cost of probability and so on. So 90% are coming from their needs. 10% is what we call it as -- was referring by Doug, proactive. We go, we bring to them a new technology, new things and may be this 10% of the proactive that is initiated by us, we can rate it afterwards, proactive. But I could say, as a rule of thumb, 90% are coming from needs that are generated in the customers.

Nicolas Mirzayantz

Can I have just added dimension to this. Yes, the majority is coming from requests from our clients but at the same time, Doug has expressed earlier that customer intimacy and really understanding the brand strategy and by becoming an strategic partner, you have good visibility on what are there. Growth aspiration, the category in which they want to play, the market in which they want to enter. So before the brief is being issued, you can actually be ready. So when you receive the actual request, you have already reinvested knowledge inside to be ready. And that's also was a change and when we spoke about creative excellence model in the past about how do we create and how do we bring this consumer insight. So you can help you partner, your strategic partner, to develop the brief with you, so you can play a role in driving also the creation of the brief.

Douglas D. Tough

Please?

Unknown Analyst

What's the growth in the emerging markets? I was wondering if you can describe how your profits growth around regionals has changed. Are the margins in the emerging regions different than they are in the developed regions? Are they higher? Are they lower? Maybe you can shed some light on that.

Douglas D. Tough

Kevin?

Kevin C. Berryman

Yes. So we're excited about the margin profile of both the developed and emerging market regions in which we are doing business in. So we're actually, from a margin perspective, rather different between whether we are in the -- doing something in the U.S. or the developed areas versus some of the emerging. The challenges may be different, as was discussed a little bit earlier in terms of having a different price point for our customers' products and whatnot. But the margin profile that we're able to get on average is effectively in the same neighborhood as what we would see in the developed.

Douglas D. Tough

Jeff? Mic.

Jeffrey J. Zekauskas - JP Morgan Chase & Co, Research Division

For those who have to leave, we totally understand and please pick up a lunch box on the way out, and we hope you've enjoyed the day. But we'll keep going but I see a few are trickling, and please pick up your lunch on the way.

Unknown Analyst

I have a question on R&D. I'll try to keep it to one, but it will have many parts. I don't know how much vanilla you buy. So if it turns out that the guys at Evolva can make some kind of synthetic vanilla, is that an opportunity that benefits you by less than $10 million, by more than $10 million? How big is the order of magnitude? And then secondly, with Amyris, I assume that what you're doing is you're using more renewable materials to get a more regular product or regular and lower-cost product. Is this a relatively narrow effort that is your working on 2 or 3 or 5 molecules? Or is this something which is broader, where you feel that you can really lower your cost base or increase the quality of the materials that are coming in, in a really global way? That is, can you just give us some parameters as to whether if this stuff works, it really matters a lot more, or it matters some, or it doesn't matter at all?

Ahmet Baydar

I've got my lawyer next to me so if I give any confidential figures, she's going to nudge me. I'll take question 2 and then go to question 1, but let me answer you on question one. And then Hernan could probably add to it. The vanilla we make and the vanilla will actually be natural, it will be made by fermentation. And we will have a sustainable source of it because today, that is not sustainable. Going back to the collaboration we're doing with Amyris on biotechnology now, biotechnology could -- we could use biotechnology to get the end product, the end ingredient. But we can also use it to make intermediates than through chemistry, make many, many derivatives from them. So to answer your question, it could be many, many different ingredients we end up with through the collaboration. But we take one ingredient at a time when we start. But it will be multiple.

Hernan Vaisman

I think, Jeff, kind of the answer to one collective group would be it's a meaningful opportunity as it relates to vanilla. If you're looking for a number, we probably can't do that, but it's meaningful. Anything else?

Well, listen, you've been a very good audience. I do want to thank particularly my team. Are you sure no one has a legal question or an HR question? Because they're all prepped. But I want to thank the team, the presenters, I want to thank all of you listening in the webcast for your participation today and all of you in the audience. We're very grateful, and hope you've benefited from the day. And there's lunch on the way out. Thank you.

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