Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

International Flavors & Fragrances Inc. (NYSE:IFF)

Q3 2009 Earnings Call Transcript

November 4, 2009 10:00 am ET

Executives

Michael DeVeau – IR Manager

Kevin Berryman – EVP and CFO

Hernan Vaisman – Group President, Flavors

Nicolas Mirzayantz – Group President, Fragrances

Analysts

Silka Koopf – JPMorgan

Mike Sison – KeyBanc

Edward James [ph] – Oppenheimer

Lauren Lieberman – Barclays Capital

John Roberts – Buckingham Research

Eric Sjogren – Morgan Stanley

Susan McGarry – Granahan Investment Management

Operator

At this time I would like to welcome everyone to today's International Flavors & Fragrances third quarter 2009 earnings conference. Just as a reminder, today's call is being recorded. All participants will be in a listen-only mode until the formal question-and-answer portion of the call. (Operator instructions)

I would now like to introduce Michael DeVeau, Investor Relations Manager. Please go ahead, sir.

Michael DeVeau

Thank you, operator, and thanks, everyone for joining us this morning. We me on the call is Kevin Berryman, Executive Vice President and CFO, Hernan Vaisman, Group President of Flavors, and Nicolas Mirzayantz, Group President of Fragrances. Our call is being recorded and will be available for playback on our Web site.

Please keep in mind that this call we may make forward-looking statements about the Company's performance. These statements are based on how we see things today and may contain elements of uncertainty. For additional information concerning factors that could cause actual results to differ materially from forward-looking statements, I ask you to refer to the cautionary statement and risk factors contained in today's press release and in IFF's filing with the SEC.

Some of today's prepared remarks will exclude those items that affect comparability. These items are laid out in our non-GAAP reconciliation, which is also available on the Investor Relations section of our web site.

With that, let me turn the call over to Kevin.

Kevin Berryman

Thanks, Michael, and good morning, everyone. Before I begin, I would like to update everyone on our recent executive management changes. As you know, Doug Tough, current CEO of Ansell Limited, has been elected our new Chairman and CEO, effective no later than the end of the first quarter 2010. Until Doug is able to join us full time, we are thankful that he will be able to add value to his role as non-Executive Chairman of IFF.

Prior to joining us full time, Doug continues to work through his current commitment to Ansell and its shareholders, while devoting as much time as possible to IFF duties. He is not able to join us today as he is in Europe on Ansell business. We look forward to introducing him as soon as we have the opportunity.

Turning to our quarterly results, it is clear that the operating environment in which we do business has improved since the first half of 2009. Specifically, our worldwide local currency sales in Q3 turned positive, growing 2 plus percent year-over-year, an improvement versus our first half decline of 3%.

Our continued focus on cost and productivity initiatives has helped provide a year-over-year improvement in operating margin. We continue to manage controllable costs with discipline, which will help support enhanced margin levels as we look to future growth. This continued cost discipline demonstrates our ability to drive organizational efficiency while continuing to support key growth initiatives in each of our businesses.

We have improved operational performance, which has strengthened our foundation and set the stage for future success. The end result of the improved top-line dynamics, combined with the continued disciplined approach to our cost structure, has allowed us to report the highest adjusted quarterly EPS in Company's history.

I'm very proud of our team. We have the right combination of strategic initiatives, and extremely talented workforce, and a diverse geographic portfolio that will help us capture growth opportunities and create long-term value for our shareholders.

I'm now happy to introduce Hernan Vaisman, our Global President of Flavors. He will provide you with additional commentary and insight related to the Flavors business, which continues to deliver strong results.

Hernan Vaisman

Good morning, everyone. As Kevin has previously noted, it is clear that the operating environment in which we are conducting business has in fact improved versus the first half of 2009.

Flavor local currency sales increased 2% over the comparable 2008 quarter. All regions reported positive results.

Overall growth was driven by new wins in North America, particularly in Savory combined with stronger volumes and new wins in confectionary and dairy in the EAME regions.

Underlying demand in emerging markets remains strong. However, in beverage, the loss of non-strategic business in Latin America and customer-specific volume weakness in greater Asia did impact results.

In North America, local currency sales increased 5%, and we experienced double-digit growth in Savory, driven by new wins and strong demand. Our industry-leading efforts in R&D and creative expertise continue to drive our strong performance. Particularly, Savory has been our most consistent performer over the past few years and has been the main component behind our 17 consecutive quarter of consolidated local currency growth.

Looking at EAME, local currency sales were up 1% year-over-year. Stronger volumes growth and new wins in Confectionary and Dairy provided solid results. Our team has done a good job capitalizing on our strong share position in Confectionary to leverage new business opportunities. And while Dairy is a smaller activity for us, I am pleased with the progress our team is demonstrating.

We are tracking well against our objective to improve our market share positions as we continue to win new business.

Turning to Latin America, local currency sales increased 1%. We did experienced isolated weakness in the beverage category as we look some non-strategic business and we're dealing with the strong comparisons year-over-year. However, going forward, we believe we are better positioned from a margin perspective.

Finally, in greater Asia, local currency sales were up 1% as new win performance and solid demand in Savory drop results. Results were negatively impacted by specific beverage volume weakness as some specific customers managed through inventory reduction.

Before leaving this slide, I would like to point out that while we did see isolated weakness in the Beverage category, it was mainly due to customer-specific volume. Going forward, we expect this category to remain in strategic focus where we tend to be more of profit growth driven. Since 2007 we have made good progress and expect it will continue in the years to come.

In summary, our local currency top-line performance is a clear indication that IFF continues to perform well in the flavors industry. As we look at our cost structure, higher input cost and weaker mix negatively impacted profitability. However, margin recovery efforts, including price increase, cost discipline, and improved operating efficiencies more than offset this negative impact.

In fact, gross margin percentage improved approximately 100 basis point year-over-year. This helps support the Flavors operating profit margin as it increased by 100 basis point year-over-year to 20%.

Despite the challenging operating environment, the Flavors business has continued to perform consistently well. While we are early in Q4, we have started the quarter on a positive note. Consistent with the Q3 results, we continue to see solid local currency growth that when combined with our increased focus on cost productivity initiatives should result in improved margins versus the year-ago period.

Overall, I am very pleased with the performance of our Flavors business. While we have had some (inaudible) pressures that we work through in the emerging markets, our diverse geographic portfolio and product mix has allowed us to more than offset any isolated weakness and deliver solid results. Looking forward, our project pipeline remains very healthy, and I believe we are in good shape to continue our track record of local currency sales growth.

I would now like to turn the call over to Nicolas Mirzayantz, our Global President of Fragrance, who will provide an update on the Fragrance business.

Nicolas Mirzayantz

Thank you, Hernan, and good morning, everyone. Similar to the comments my colleagues have made, we are in fact seeing an improvement in business conditions during the third quarter of 2009. Specifically, our Fragrance business unit has reversed its recent downward trend, and posted local currency sales growth of 3% in the quarter.

Importantly, our total local currency sales growth represents the first quarter of year-over-year improvement since the second quarter of 2008. Our team has done an excellent job at managing through a very challenging environment to deliver much improved results.

The Fragrance business unit delivered sequential local currency sales improvement in every category except for Fine Fragrance. We specifically saw strong double-digit growth in Fabric Care, in Europe, Greater Asia and Latin America.

In addition, toiletries and hair care performed very well in the emerging markets. In Fine Beauty Care, local currency sales decreased 6% as weakness in Fine Fragrance more than offset low double-digit growth in Beauty Care. Within Beauty Care, toiletries and hair care posted solid results, driven by new win performance. Fine Fragrance in the developed markets of North America and Europe, although still declining showed significant improvements compared to first half 2009 results.

This change reflects strong new win performance, a significant reduction in customer destocking, along with some underlying improvement in consumer demand. While this is much improved, we do not foresee a recovery to normalcy in the Fine Fragrance market in Q4.

As consumers continue to be prudent, and the economy remains (inaudible), we continue to be cautious on the outlook for this part of our business. We did have a stellar performance in Functional Fragrances as local currency sales grew 10%. Importantly, not only did every category within Functional Fragrances post solid results, but we also delivered positive growth in every single region.

This performance was driven by solid Personal Wash growth, new product wins and volume gains in Fabric Care, our largest Functional Fragrance category. This reflects our strategic commitment to this category and the investments made over the past few years to strengthen our position. Indicative of our Q3 results, we have made terrific progress against this initiative.

Finally, Fragrance Ingredient sales improved significantly compared to first half 2009 as local currency sales increased 3%, largely driven by a reduction in customer destocking activity. Sales were also supported by cost driven price increases versus the year-ago period.

This stronger top-line growth translating to further improved operational performance in the third quarter. From a profitability standpoint, adjusted operating profit margin increased 60 basis points year-over-year to 16.8%, excluding the gross restructuring cost of $10.5 million related to our European Fragrance facility rationalization.

The increase in margin was driven by cost reduction efforts and price increases that more than offset the effect of unfavorable mix, higher input cost, and unfavorable foreign exchange.

I believe the recent announcement outlining the conclusion of the European consultation process and our decision to proceed with our restructuring plan is a clear indication of our commitment to continuous improvement. As difficult as these decisions are we must do what is ultimately best for the Company and our customers. We continue to be grateful for all the contributions our employees have made at these locations.

As we look at Q4, business is off to a good start. Functional Fragrances continue to build momentum and we expect local currency trends to be positive once again in Q4. I am confident that we are moving in the right direction and taking the necessary steps in order to be stronger in the future.

Our Q3 results reflect our organizational capability to deliver solid results despite very challenging business conditions. When a normalized operating environment returns, I believe our Fragrance business will be in a much better position to leverage future growth as a result of our continued focus on margin improvement initiatives. With that, let me turn it back to Kevin.

Kevin Berryman

Thanks, Nicolas. On our Q2 Conference Call, we outlined our expectations on four key trends. I would like to now update you on how we measured up versus these previously communicated objectives.

First, we communicated that local currency sales trends were expected to improve. Both the Flavor and Fragrance teams delivered improved commercial performance, including continued strong new win success, resulting in 2 plus percent consolidated local currency sales growth.

Second, we highlighted that we would see an improving margin picture. This did happen as both the adjusted gross margin and adjusted operating profit margins improved versus the year ago period in the second quarter.

Adjusted gross margin improved 70 basis points to 40.7% as price increases, moderating input cost, and cost-recovery and margin improvement initiatives aided results. When combined with strict discipline in the management of our research, selling, and administrative expenses or what we call RSA, and despite the continued currency headwinds, we still managed to deliver 20 basis points of adjusted operating margin improvement.

Third, we said we would continue to challenge every aspect of our business in order to improve our business model and cost footprint going forward. And our recent announcement regarding the European facility rationalization confirms that commitment.

Fourth, we noted that we would be able to grow EPS sequentially versus the second quarter of 2009. The combination of our improved operational performance as well as some below the line leverage allowed us to do just that.

Specifically, interest expense decreased $5 million year-over-year, principally due to the elimination of cost currency interest rate swaps and lower borrowing costs. The effective tax rate, excluding the tax implications related to the European facility rationalization and the executive management change, decreased approximately 110 basis points to 26.8% versus the year ago period. As a result, adjusted EPS grew 26% from the second quarter and grew 11% year-over-year to an all-time company high of $0.82.

Looking at the recent sales trends, we believe that there is an indication that Q2 represented an inflection point. It is encouraging to note that every category has improved in Q3 and as a result, the Flavors, Functional Fragrances, and Fragrance Ingredients categories all realized positive local currency sales growth.

We remain cautiously optimistic on our outlook going forward. However, we believe we have turned the corner versus the very weak conditions reported in the first half of 2009.

I would now like to provide you with an update on other key drivers in our financial performance, specifically, input costs, RSA costs and currency. Turning to input costs, we continue to see year-over-year increases in the P&L, driven primarily by the fluctuations in raw material costs.

As a reminder, raw material costs have a large impact on the gross margin of the business as around 70% of our total cost of goods sold is made up of raw materials. In the third quarter, our input costs increases represented a 2% increase in our cost of goods sold, adding approximately $7 million to our cost base.

As communicated in Q2, we expected this cost increase to moderate. In fact, increases versus the year ago period were less than half of what we had seen in Q1 and Q2. Despite this increase, we did realize gross margin expansion for the first time in 11 quarters as margin recovery efforts including pricing, manufacturing efficiencies and cost reduction initiatives offset this cost increase. Importantly, we are seeing our current purchases of raw materials at lower price levels, so it is clear that this favorable trend will continue as we work through our higher cost inventory. Notwithstanding this continued positive trend, we still expect input costs to remain at elevated levels, above those, which we saw before the increase is seen in 2008.

From an overhead cost standpoint, we continue to make progress. In the quarter, adjusted RSA, which excludes the $5 million charge associated with the change in executive management, increased $2 million year-over-year to $145 million as a result of higher incentive compensation, offset by the effects of a stronger U.S. dollar. As you may recall, last year's incentive comp booked in Q3 was abnormally low.

For a more appropriate comparison versus the year ago period, if we exclude the additional incentive comp expense of $10 million and the $4 million benefit related to currency, RSA actually declined $4 million year-over-year, reflecting the benefits of our ongoing cost reduction efforts and restructuring initiatives in the Fragrance business. Within RSA, R&D expenses as a percentage of sales increased slightly to 8.5%.

I'm very pleased with the way our organization has responded to the current operating environment, as this performance is a clear indication of our continued disciplined approach to managing costs.

Moving to currency, it is important to note that in the third quarter, currency parity continued to negatively impact our results. Looking at the table to the left, while it is clear that the second quarter was our most difficult comparable from the foreign currency perspective, currency parity in the third quarter still represented a headwind.

From a sales standpoint, it had a negative $19 million or 3 percentage point impact. From an operating profit standpoint, it represented a $5 million negative impact.

As a reminder, we have shown the Euro changes versus the dollar as representative of our currency exposure, as a material portion of the portfolio is Euro-based.

Looking ahead to the fourth quarter, our comparisons should become more favorable. If rates stay where they are today, our fourth quarter results should actually benefit from the year-over-year comparison, resulting in a positive impact to both our sales and margins.

Continuing with foreign currency, the dollar strengthening versus the year ago period over the first three quarters of this year has continued to pressure margins, masking a fundamental improvement in the operations of the business. I have tried to illustrate this issue by highlighting the drivers of change in operating margins in the previous three quarters versus year ago results. I showed this analysis in the second quarter and have updated it to highlight the continued improvement in margin, and more importantly, the improvement in margins excluding the impact of currency parity.

In Q3, we have continued our trend of operational improvement. As you can see, the margin improvement due to operations improved 50 basis points versus the year-ago period as a result of price increases and cost reduction efforts. Operating performance is now more than offsetting the negative currency impact, which has been reducing over time. As we look forward, we expect that operational improvement will continue to gain traction, and again that currency will become a tailwind.

Turning to our EPS reconciliation, I will not spend a lot of time going through the details; I have already covered all of the topics earlier in this presentation. I would, however, again like to reemphasize the operational performance of the group.

As highlighted on the slide, in a challenging operating environment, the IFF team drove strong operational performance, improving EPS by $0.07. When including a net $0.01 benefit associated with interest and other items partially offset by foreign exchange, adjusted EPS grew 11% versus the year-ago adjusted figure.

I would also like to provide an update on the recent European Fragrance facility rationalization plan. As we constantly challenge all aspects of our business to improve customer service and enhance profitability, we announced during Q3 that we had initiated a collective consultation process with employee representatives regarding the potential closure of our Fragrances compounding facility in Drogheda, Ireland, as well as the potential partial closure of a portion of a Fragrance Ingredients chemical plant in Haverhill, United Kingdom.

More recently, we announced that we have concluded the consultation process and have determined that we will in fact proceed with the facility rationalization plan. As a result, we have concluded negotiations with our Haverhill employees, and entered into negotiations with our Drogheda employees regarding severance packages.

We have recorded a $10.5 million provision for severance based on our best estimate of the outcome of these negotiations. We expect to conclude our negotiations in the fourth quarter 2009 and we'll record any adjustment, if necessary, at that point in time.

As a reminder, we expect to fully deliver our targeted annual cost savings for the strategic project of $17 million to $20 million annually by 2011.

Lastly, turning to our cash flow, we continued to strengthen our financial position as we ended September with $155 million in cash and $92 million in free cash flow, $60 million above the year ago figure.

We saw a significant reduction in working capital in the first nine months versus the year ago period, as a reduction in inventories combined with better operating discipline over receivables and payables continued to gain momentum. As a result, cash flow from operations improved by $64 million to $200 million for the first nine months of 2009. Importantly, we were able to more than offset the $33 million decrease in net income to deliver the strong cash flow improvement.

In the third quarter alone, I would like to add we experienced a significant improvement in working capital versus year ago performance. Every element of working capital helped support this strong performance.

Looking at capital expenditures, I would like to note that we are trending below the $70 million number we communicated in Q2. As a result we now expect capital expenditures to be approximately $65 million.

Importantly, we still expect higher spend levels over the next few years as we will focus our investments behind supporting strategic growth with focus in the emerging markets and driving efficiencies by strategically improving our manufacturing and supply chain footprint.

As a result, we would expect our future capital expenditures to grow to levels near 4% of sales. Finally, our improved cash flow will also give us some flexibility to consider an additional contribution to our pension plans in Q4 of this year.

Looking ahead to the fourth quarter, we expect positive trends as external conditions improve that we gain traction against our business initiatives. While predicting near-term economic conditions remain difficult, we believe that we are well-positioned to deliver positive local currency sales growth in the fourth quarter.

Both the Flavor and Fragrance teams are expected to drive positive local currency growth, driven by strong new win performance, which will result in solid worldwide performance Regarding input costs, we will continue to see an improving picture. Regarding RSA, we remain committed to driving organizational efficiency in all that we do.

Finally, it is important to note that stronger U.S. dollar had one of the single largest negative impacts on our bottom-line results through the first three quarters of 2009. If rates remain where they are today, foreign exchange should now prove to be a positive in the fourth quarter.

As a result of the above-mentioned items, we expect adjusted EPS in the fourth quarter to show improvement versus our year ago figure. It is reasonable to expect EPS growth in Q4 to be more in line with our long-term strategic financial goals.

Before making some final comments and taking your questions, I do want to spend a moment and reemphasize our strategic priorities. There are three strategies that we pursue in order to increase shareholder value. First, we focus on investing and research to develop innovative materials and delivery systems. Second, we develop a deep understanding of consumers’ preferences and values. And third, we deliver creative expertise to support our Flavor and Fragrance customers.

Importantly, we will continue to drive the creation unique, superior, and economically competitive products for the world-class integration of these strategies via executional excellence. An important part of driving that excellence will be our continued commitment to drive manufacturing and supply chain efficiencies throughout our global infrastructure.

As an established partner with key global and regional customers, with whom we collaborate to build their brands, we are strongly positioned in the consumer markets of the developed world and the emerging markets. Going forward, the opportunities that lie ahead are real and we have an opportunity to further leverage our strong position in the emerging markets.

By focusing on our core competencies of R&D, creative expertise and consumer insight, we are outperforming the industry and have shown an ability to grow faster on a local currency basis. Our organizational culture is one of innovation and continuous improvement, which will provide us with the foundation to achieve our long-term financial objectives.

In wrapping up, we are excited that our strategies and focused execution drove a record EPS quarter for our shareholders. This performance is a testament to the passion and commitment of our teams here at IFF. The combination of our global presence and diversified product portfolio, both within Flavors and Fragrances, offers us great growth opportunities that position us well for future success.

We continue to be disciplined in driving efficiencies in all that we do, thus ensuring that we will have the ability to improve margins while continuing to support our growth initiatives.

Our organization remains strategically aligned and committed to become better tomorrow than we are today. This commitment will ensure that our company will be able to win in a marketplace regardless of what the future might hold.

With that, we would be happy to take any questions that you might have.

Question-and-Answer Session

Operator

(Operator instructions). Jeff Zekauskas of JPMorgan has our first question.

Silka Koopf – JPMorgan

Good morning, this is Silka Koopf for Jeff. How are you?

Kevin Berryman

Good morning, Silka, how are you?

Silka Koopf – JPMorgan

I'm doing okay.

Kevin Berryman

Very good.

Silka Koopf – JPMorgan

It seemed there was a lot of emphasis on price this quarter, which also benefited margins. Can you outline what the pricing benefit was in the quarter when we look at your organic 2% improvement in volume on pricing?

Kevin Berryman

Silka, we actually highlighted some of the pricing activity in our second quarter as well. So I don't know that there is an incremental focus on it in this quarter. And as a matter of fact, as we have communicated in the past, our pricing actions that we took, which were kind of at the end of 2008, and in the beginning of 2009, we're starting to lapse some of that. So actually the pricing benefit associated with our Q3 results are starting to decelerate versus the first half of the year. We actually saw volume growth in both of our businesses. And so you can imply from that that the pricing activity is actually declining over time.

Silka Koopf – JPMorgan

When I look at like a 2% organic growth year-over-year, is that then 1% volume, 1% price?

Kevin Berryman

Well, I would say we talked about a 2 plus percent number, and I would say that we had talked pricing in the neighborhood of 2.5% in the past. We're down from that level, and we did see relative volume growth versus year ago period. So we're declining in terms of the impacts of price, specifically in the third quarter. And we would expect that that would continue to be reduced in the fourth quarter of this year and again in 2010 as well. So, yes, some slight volume growth for both of the businesses, with the balance being some pricing.

Silka Koopf – JPMorgan

Okay. In terms of the food flavor sales in North America, which are very strong, up 5% this quarter, is that sustainable that rate given that fourth quarter trends may be more difficult?

Kevin Berryman

And Silka, you are specifically talking in North America?

Silka Koopf – JPMorgan

Yes.

Kevin Berryman

Flavors. I think ultimately it is the level of performance that we have seen in Flavors in North America, specifically, there is a long track record of very, very strong performance. So whether or not this is that much higher than what we have been able to show historically, I'm not sure exactly that's the case. But I think we have a long track record of performing very well in North American Flavors, driven specifically by some strong performance in Savory. I would ask Hernan to add any insight if he feels appropriate. But I think we actually have a strong track record of good solid growth in that particular region in Flavors.

Hernan Vaisman

Thank you, Kevin. Yes, I agree with Kevin and we have a very good track record. Specifically, I mean, these track records are coming from new wins as I explained before. So in some way I expect to keep on I mean this trend going forward.

Silka Koopf – JPMorgan

Okay. And if I can ask a last question on cost savings and I'll get back into queue. How much of the $17 million to $20 million run rate do you expect to achieve in 2010? I understand that you try to get the full amount by 2011, given that the plants are being shut down and the people will roll off, there should be benefits in 2010 that are measurable? And you can achieve half of that or can you explain if there are any offsets, why you wouldn't see some of these benefits in 2010?

Kevin Berryman

Yes, the bulk of the savings obviously is driven by the plant closure and that ultimately doesn't fully occur until the end of next year. So the bulk of the savings really are going to be realized over the course of the 2011 year. What we said is that we will realize the full benefits in 2011 specifically. There may be some incremental benefits over the course of 2010, but we will have some transition costs as well that could potentially offset those. So we're not calling for a significant improvement in 2010. As we get closer and we see how the transition is playing out, we could provide some better insight. But I wouldn't necessarily count on some substantial improvements in 2010, as it relates to that restructuring, given that the plant closure ultimately happens near the end of the year.

Silka Koopf – JPMorgan

Thanks. I'll get back in the queue.

Kevin Berryman

Thanks, Silka.

Operator

(Operator instructions). We'll go next from KeyBanc we'll go to Mike Sison.

Mike Sison – KeyBanc

Hi, guys, nice quarter.

Kevin Berryman

Good morning, Mike. Thank you.

Mike Sison – KeyBanc

In terms of Fine and Beauty, you started to see, looks like in most of the regions except for Europe, some pretty good improvement year-over-year. Has the inventory destocking in Europe started to abate? And then to some degree, what are your customers there talking about in terms of the holiday season? And then when organic sales growth turns positive for Fine Fragrances, how much of a profit impact is that on the business? That's my one nice question.

Kevin Berryman

Okay. Well, look, let's take the European discussion first. Look, in terms of the Fine and Beauty Care part of the business, specifically, Europe and North America were those regions most impacted by the Fine situation. That's where the large customer base is, and so clearly that is where we have seen the biggest pressure points in terms of the Fine Fragrance business. I think clearly the improvement in the Q3 performance is certainly potentially some underlying demand, but certainly a big part of an elimination of destocking.

Our customers have continued to act in a way that it appears that there's not much inventory left in the system, and so whether or not there is still an ability to drive down inventories or not is we're not exactly clear. But I think that at the end of the day, we're not necessarily counting on our Fine Fragrance business returning to normalcy for us to be successful. I think Nicolas talked about that in his comments .It's still a fluid situation; it still has implications as it relates to the Christmas season, and what's going to ultimately happen from that perspective.

And so it's unclear that we're going to get back to any kind of normal growth environment from that perspective. So I think that would be a high-class part at least from our perspective if we're able to realize growth in that business in the very near future. It does impact our margin profile. It is one of our highest margin businesses. We haven't gone into specifically the implications on what the margin profile is. But as you have seen the mix dynamic over the course of the last 18 months be negative, if Fine would start to become positive in terms of its business, we'd see a positive mix going into different direction. Nicolas any other comments to add?

Nicolas Mirzayantz

Good morning, Michael. As Kevin was saying, it is very difficult to predict at this time. We know that the outlook is uncertain at this moment. And Christmas being such a big part of the total year revenue for partners, I think it will be a mixed milestone or barometer to understand the strength of consumer demand in that category. We probably see more destocking happening in the U.S., which is more centralized in terms of the retail landscape than in Europe. So we saw some improvement because of the destocking in Fine Fragrance.

Mike Sison – KeyBanc

Okay. Thank you.

Kevin Berryman

Thanks Mike.

Operator

We'll go to Oppenheimer's Edward James [ph].

Edward James -- Oppenheimer

Hi, good morning, Kevin.

Kevin Berryman

Good morning, Ed. How are you doing?

Edward James -- Oppenheimer

Good. On Functional Fragrance, local currency up 10%. What drove that? Was that market share gains or a big product launch? And would there be any similar lumpiness on the upside in the upcoming quarters?

Kevin Berryman

Yes, I think Nicolas commented a little bit on that in his commentary. I'll turn it over to Nicolas to provide some reemphasis on some of the key drivers.

Nicolas Mirzayantz

Good morning. What is important is first of all across all the regions, across all the subcategories within Functional Fragrances, and we had a strong pipeline of new introduction across the board. So I'm pleased to see that it's really across the different categories and across different regions, and across different segments of customers.

Edward James -- Oppenheimer

Nicolas, just to follow up. I mean the category itself isn't growing 10% local currency. Is it globally?

Nicolas Mirzayantz

No, it is not. But we're gaining a lot of market share in that category at the moment.

Edward James -- Oppenheimer

Okay, great. On the Flavor side, you mentioned some isolated weakness in Latin America and Asia, would like some additional detail there. And one of your competitors I think previously noted that there were some delayed product launches, especially within Beverages. Are you seeing that as well?

Kevin Berryman

Ed, just a couple of quick comments before I turn it over to Hernan. Look, I think that you have to put certainly the third quarter performance also within the context of a long-term historical level of growth that we've been realizing in this business. And there were some isolated pieces that Hernan has alluded to, which impacted the numbers for Q3. We fundamentally believe that the underlying strength of our portfolio and our position in new win performance is going to translate into continued strong growth going forward. Perhaps, Hernan, I don't know if there is any other things to add, but certainly, we're feeling good about our position in that particular part of the world.

Hernan Vaisman

In fact, I mean, you explained very well, Kevin. Basically was two isolated cases, one in Latin America, where we decided to walk away from non-strategic business, I mean low-margin business, we decided not to compete in this business. And the other one was specifically in one country in Asia. It was the first time that over-stocking and this customer which is a key for us in Asia, went through de-stocking process. But I think the key elements in this is what Kevin mentioned. I mean we have been growing very fast in the last two years, three years in the Beverage category. It's a key category for us. We were growing at double-digit growth in almost all regions. So the key element here is that (inaudible) to keep on growing.

Edward James -- Oppenheimer

That's very helpful. What about just the overall market? Are customers delaying any product launches?

Kevin Berryman

Look, I think that our customers have continued to be prudent in terms of the current economic environment of which they've been operating. However, we continue to be seeing a lot of activity as it relates to requests for innovation, requests for innovation relative to becoming more efficient in terms of how we're interacting with them. So, there is a desire for our customers to continue to win, and win ultimately means some level of innovation. Whether or not there is a marked change as it relates to delays, I'm not so sure we could say that in a total affirmation basis, but there are one-off examples of certainly that happening.

Edward James -- Oppenheimer

Thank you for your help.

Operator

(Operator instructions). We'll move next to Lauren Lieberman of Barclays Capital.

Lauren Lieberman -- Barclays Capital

Great. Thank you. First, just following up on the questions around Flavors in Latin America and Asia. So first-off, Asia didn't really seem like much of a change in trend to begin with it. So I wanted to know if this sort of isolated weakness has already been in play for several quarters so we're nearing the end of it. And then with respect to Latin America, where there was a significant sequential change in trend, should we think about that as sort of lasting through the flow of top line for another three quarters, until you lap that decision to walk away from the business?.

Kevin Berryman

Thanks for the question, Lauren. I think the actual discussion on Greater Asia is the fundamentals are very strong there. And there just was this one particular issue that has impacted our results. So if anything, we would have been reporting a stronger robust picture for Q3. So that's what we're trying to communicate there. In terms --

Lauren Lieberman -- Barclays Capital

I'm sorry, Kevin, but I'm understanding is that in Q1 and Q2, and broadly speaking, demand in Asia has still been pretty strong, right? Recession or no recession, it's been strong sort of throughout. So that business also only posted 1% or 2% growth in the first half. So to what we can see it doesn't look like a change in trend.

Kevin Berryman

And what we're trying to communicate is that there really is a change in trend.

Lauren Lieberman -- Barclays Capital

Okay.

Kevin Berryman

This was the last most recent periods because there was unique aspects of Q3. That's what we're trying to communicate.

Lauren Lieberman -- Barclays Capital

And then Latin America, should there be that similar kind of drag for the next three quarters?

Kevin Berryman

No, I don't think we're expecting that kind of drag. There are some one-offs that Hernan has alluded to, but we're also seeing good win performance as well. So while we certainly will have some implications of those businesses kind of going forward, they are being quickly replaced and then some.

Lauren Lieberman -- Barclays Capital

Okay. And then in terms of margin expectations, gross margin specifically, should we think of this sort of rate of gross margin improvement in the quarter when we look forward, should that be increasing because the benefit of inflation turning to deflation is greater than the winding down of pricing?

Kevin Berryman

Let me talk about Q4 specifically. Q4 tends to be one of our smaller quarters in terms of sales as you know. Let's call the gross margin, at the gross margin line there is some fixed cost absorption issues you need to think about. So the fact that there is less flow through on the top line will have some negative impact vis-à-vis other quarters in the year, just because we have less money flowing through the pipes so to speak. So there is going to be a dynamic there.

There will be a positive associated with certainly the input cost continuing to be down, but again, that's going to be offset to some extent by the continuing reduction in the benefits of the pricing as we've talked about. So I'm not so sure the fourth quarter is one where we would be able to say there's a significant acceleration in gross margin improvement versus year ago, although we would expect that we will continue to show improvement.

Lauren Lieberman -- Barclays Capital

Okay. And then finally, I was actually going to ask about the traditional seasonality in revenues. Might Q4 be I guess not quite as smaller percentage of the full year as usually is, because retailers and then thus manufacturers are delaying some of their Q4 purchases, right? Everything we hear about is that everyone is sort of being cautious, so orders are getting placed closer to the actual holiday season versus in Q3? And that should also impact your business, and I would think even at this point in the quarter you may be seeing some of that? So --

Kevin Berryman

I think that the bulk of kind of the business that we see that is impacting the fourth quarter actions associated with our customers, specifically in the Fine area, the very, very large majority of that is occurring in the third quarter. There may be some minor stuff that occurs in the fourth quarter, but I would not give you an indication that there's going to be a significant rollover into the fourth quarter as there has been a delay of purchases from our customers. Given the supply chain, most of that is happening in our third quarter. And so I wouldn't necessarily give you a direction that there is a corresponding kick in the fourth quarter as it relates to this delay mechanism, relative to the upcoming holiday period.

Lauren Lieberman -- Barclays Capital

Okay, great. Thank you.

Kevin Berryman

Sure.

Operator

We'll move on to John Roberts of Buckingham Research.

John Roberts -- Buckingham Research

Could you give us an update on the timing of when Doug Tough becomes fully focused on IFF?

Kevin Berryman

Sure, John. Good morning. How are you?

John Roberts -- Buckingham Research

Good, thanks.

Kevin Berryman

We made the announcement in the beginning of September, and at that point in time, Doug had a commitment with his existing company that he had to give a six-month notice period. And so we are abiding by that process. What Doug is doing is working with the Ansell Board in a deliberate and thoughtful process to ensure that they have an appropriate transition and to help support their shareholders and the dynamics associated with that company. We're abiding by that. We hope that, that process will translate into an ability for Doug to get here sooner as opposed to later, but that's still being worked through. And we respect the requirements that Ansell, the Ansell Board and their shareholders have, as it relates to making sure they are taking care of business, as it relates to the transition.

So Doug is currently our Non-Executive Chair, as I mentioned in the preliminary comments, and we're happy that he is here in that capacity. So he is adding value from that perspective, and we would hope that he will certainly be able to be here before the end of the first quarter of 2010. But that's all we can really say at this particular point in time, as they work through that process.

John Roberts -- Buckingham Research

Secondly, I don't know if you can tell us, but are there any major strategic studies underway? Do you have the McKenzie guys inside doing any focused work or anything like that?

Kevin Berryman

Well, look, let me answer the question in the following manner. The change in executive management is not driven by a fundamental difference of opinion, as it relates to our strategies. Our strategies are well-defined. Doug has been a Board member over the last year. He has been involved in those strategic discussions, and so as we sit here today, we're not providing any indication that there is a strategic redirection that's being considered. Organic growth is going to continue to be a very important part of our value proposition to our shareholders.

We certainly have shown an ability to do that in the past, and we expect that we will continue to do it in the future. So, clearly, as Doug comes on board and becomes more integrated into our business, we'll be able to work through any potential adjustments as necessary relative to that. But certainly where we are right now and as we have communicated in this call, we're aligned and we're executing fully against that aligned strategy.

John Roberts -- Buckingham Research

Okay. And then maybe a more detailed operational question. The strength that you had in Savory, is that in meat products, or is that in snack foods that have meat flavoring? And I ask that because there has been a lot of volatility in the meat supply chain and I don't know whether that is somehow backing up or affecting Savory flavors.

Kevin Berryman

I would say that Savory flavors has been strong for an extended period of time, but I will say that we've actually seen some strength in some of the meat based as well. We have done some new work in that particular area on beef notes and chicken notes and then we're seeing good traction as it relates to those specific initiatives. So Savory is certainly a big part of the drive, but we have actually seen some success in the other area as well.

John Roberts -- Buckingham Research

Okay. Thank you.

Operator

Silka Koopf in line has another follow-up question and they are from JPMorgan.

Silka Koopf – JPMorgan

Yes, thank you. So in fragrances if I look year-over-year, I think the sales were down $2 million, and the profits were up $2 million. And what you have told me previously is that your pricing is beginning to weaken and that raw material costs are up, and that there are no benefits from the shut down of these compounding plants until the end of 2010. So how did you do it?

Kevin Berryman

How did we do the margin improvement?

Silka Koopf – JPMorgan

Yes, your sales were down, and your profits were up.

Kevin Berryman

Well, we were diligent in terms of some of the restructuring initiatives that have already been discussed in previous quarters. Those are coming through in terms of reduced levels of research, selling, specifically, administrative costs. We have seen continued efficiencies in terms of our factories. We are continually trying to drive efficiency and productivity in that area. And of course, we have some benefits associated with a proactive stand taken relative to pricing in late 2008, early 2009.

So all of that translated into us being aggressive and proactive in terms of recognizing the environment, which we were operating in, and ensuring that we had the appropriate cost structure and base to make sure that we competed appropriately, and we're able to deliver margin enhancements in that environment. It hasn't been easy, but it has taken strong effort through the organization.

Silka Koopf – JPMorgan

Is this sort of like a target of cost savings from previous restructurings that you are trying to achieve in 2009 that you may have taken out this year?

Kevin Berryman

Yes, I think if you look at the RSA expenses, we keep talking about this $4 million reduction versus year ago kind of numbers. And on a quarterly basis it's $4 million versus year ago. That adds up to some pretty big numbers on an annual basis. And so those kind of expectations we are holding ourselves to in terms of delivering incremental efficiencies into the organization.

Silka Koopf – JPMorgan

Like on an annualized basis, that sort of like $16 million, which is similar to what I guess tried to achieve with the new efforts as well.

Kevin Berryman

Yes.

Silka Koopf – JPMorgan

Okay. And one question of clarification. Were there any pension contributions in the third quarter? And how much do you expect to contribute in the fourth quarter?

Kevin Berryman

As we noted in the presentation, Silka, we have a very strong cash flow that we've been able to realizing over the course of the first nine months. It's putting us in a position where we're feeling comfortable about some incremental contributions to the U.S. plant specifically. We're in the evaluation process as it relates to that, but we're thinking in the neighborhood of $20 million incremental contribution in the fourth quarter.

Silka Koopf – JPMorgan

That's all I have. Thanks very much.

Operator

Mike Sison of Keybanc has a follow-up question as well. Please go ahead.

Mike Sison – KeyBanc

Hey, guys, quick follow-up. Kevin, in terms of your outlook for the fourth quarter, you talked about sort of returning back to the long-term goal in terms of EPS growth and that has historically been 10% plus. For the fourth quarter of '08 you did $0.62, but at $0.12 sort of special items. So are you using the $0.62 or the $0.50 to grow that sort of that outlook in earnings for the fourth quarter?

Kevin Berryman

When we talk we're always talking on an adjusted basis, Mike.

Mike Sison – KeyBanc

Okay. So the $0.50. Then in order to hit that 10% plus growth, you've talked about historically that you need to grow local currency 4% plus. So is that sort of the general outlook for growth for the fourth quarter, to achieve type of earnings growth?

Kevin Berryman

No, we didn't specifically give an indication of growth other than it was going to be positive. But we think that those objectives that we've talked about in the past are kind of longer-term dynamics and objectives that we are pointing to, Mike. They don't necessarily mean that that's what’s going to happen in the fourth quarter specifically. And given the dynamics of reduction in our cost structure and the pricing activities that have been taken, there are some unique circumstances that are occurring in the fourth quarter versus kind of what be historically the norm. So don't necessarily assume that, that kind of falls into the longer-term picture.

Mike Sison – KeyBanc

Okay. Great. Thank you.

Operator

Eric Sjogren of Morgan Stanley has our next question.

Eric Sjogren -- Morgan Stanley

Yes, hi, this is Eric Sjogren from Morgan Stanley here.

Kevin Berryman

Hi, Eric.

Eric Sjogren -- Morgan Stanley

Hi. I had three quick questions. First, could you comment a bit on customer behavior if you split it between your global (inaudible) national customers and your local ones, in terms of stock levels and innovation trends et cetera? Is there a valid split between those two?

And secondly, on your cost realignment plans, is there also within this an intention to move towards kind of a product realignment? I'm thinking here more specifically about Fragrance Ingredients which has been volatile. Are you moving away from lower-margin products here? How should we some kind of portfolio rationalization impacting the sales over the next couple of quarters? Would there be any margin impact from that? And then finally, I just wanted to know on the working capital improvement, to what extent, is this driven by low raw material costs and/or actual volume decreases in the actual inventories? Thanks.

Kevin Berryman

Okay. I'll take your three headed question in the order. As it relates to customers, I don't know that we would distinguish specifically between how some of the global players are playing versus the regional players other than the fact that it's very clear in our mind that many of the large consumer packaged goods companies as they are approaching their business today are rethinking about how to drive volume. Certainly, they benefited from taking pricing actions, historically speaking, and they feel as if it's important given the economic environment, which they are competing to be probably a little bit more focused on driving volume growth. We think that actually bodes well for us as we continue to work with them to help support that volume growth.

In terms of the product realignment, we do that all the time actually. We're always focusing on evaluating our current portfolio of materials and whether or not there is lower margin items that we should consider exiting. And so that's an ongoing process that we have. So I'm not so sure that there's an incremental piece that we're facing. And then finally on working capital, certainly, the costs of raw materials coming down and help support. But as a matter of fact, at the end of the day, the material driver to our inventory levels are actually lower volumes in terms of the actual levels inventory.

Eric Sjogren -- Morgan Stanley

Okay. Great. Thank you very much.

Operator

Go back to Lauren Lieberman of Barclays Capital.

Lauren Lieberman -- Barclays Capital

Thanks. Just a quick one. Ingredient sales, I had sort of asked this offline when you guys talked about ingredient sales being one of the expected contributors to this quarter's better performance. So, looking forward, I have always wondered if seeing Ingredient sales pick-up can be thought of a precursor to a pick-up in compound sales. I know that business is generally lumpy overtime. But I thought maybe in this environment it may actually be a sort of leading indicator. So can you comment on that and sort of what you are seeing in terms of Ingredient sales at this point of the fourth quarter?

Kevin Berryman

I would say I hope you are right in terms of the precursor. I think that in general, our businesses, as both Hernan and Nicolas have described, are started from a strong perspective off to a good start. And hopefully that will continue. But whether or not that's going to be ultimately a precursor, I certainly hope you are right. But I'm not exactly sure that that will be the case. I think at the end of the day, we're seeing is that destocking in the categories of our customers is certainly coming to an end, and that's having an ability for us to have a more reasonable kind of growth dynamic going forward. So there's still a lot of noise in those numbers, Lauren, because of that destocking versus non-destocking issue.

Lauren Lieberman -- Barclays Capital

Okay. Great. Thanks so much.

Kevin Berryman

Sure.

Operator

From Granahan Investment Management, we'll go to Susan McGarry.

Susan McGarry -- Granahan Investment Management

Hi, I just want to revisit a previous question, and that was about product launches, Because a couple of companies in your space are serving similar customers have made a distinction between product development activity and product launches. And they have said that they definitely seen their customers being much more conservative on product launches. So I just wanted to be clear about what you have been seeing about launches versus product development. And then second part of the question is about competitive wins, and I'm curious about who you are gaining share from? Thanks.

Kevin Berryman

Look, let me make the point in terms of the customer activity and level as it relates to their product launches. Clearly, as we said, they are being prudent in terms of their introductions. There's no doubt about it. And I think that there has long been a desire to throw out innovation out there and have new items every other moment. And I think that there is certainly a belief that they need to be thinking about being a little bit more thoughtful as it relates to that.

I do think though that there is still continuing to be innovation and a desire to drive business, so I wouldn't necessarily disagree. I guess maybe the context of your question is effectively there's a nuance associated with it, but certainly customers are being thoughtful. I'm going to say (inaudible) word I would use as it relates to how they are approaching the environment in which they are competing today.

Susan McGarry -- Granahan Investment Management

Okay. And on market share competitive wins?

Kevin Berryman

Well, look, at the end of the day, it's difficult to say because there is not exactly great information as it relates to the industry information. But given the number of opportunities that are presented to us and given our win rates as it relates to those opportunities, the percentage is certainly greater than our current expected levels of share. So that's translating into us winning longer-term.

Michael DeVeau

We have time for one more question.

Operator

And actually it appears that was our last question. I will turn the conference back over to you for closing remarks.

Kevin Berryman

Great. Well, look, thanks everyone for spending some time with us this morning. As you can tell we felt pretty good about the ability for us to drive some improvements in our margins and growth for this Q3 and we hope it's a harbinger of things to come. So we look forward to following up and seeing you soon as it relates to further discussions on IFF. Thanks for the time.

Operator

And again, that does conclude today's conference, and we thank you all for joining us.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: International Flavors & Fragrances Inc. Q3 2009 Earnings Call Transcript
This Transcript
All Transcripts