International Flavors & Fragrances Inc. (NYSE:IFF) Q3 2023 Earnings Call Transcript
International Flavors & Fragrances Inc. (NYSE:IFF) Q3 2023 Earnings Call Transcript November 7, 2023
Operator: At this time, I would like to welcome everyone to the IFF Third Quarter 2023 Earnings Conference Call. [Operator Instructions] I would now like to introduce Michael DeVeau, Head of Investor Relations. You may begin.
Michael DeVeau: Thank you. Good morning, good afternoon and good evening, everyone. Welcome to IFF's Third Quarter 2023 Conference Call. Yesterday afternoon, we issued a press release announcing our financial results. A copy of the release can be found on our IR website at ir.iff.com. Please note that this call is being recorded live and will be available for replay. Please take a moment to review our forward-looking statements. During the call, we'll be making forward-looking statements about the company's performance and business outlook. These statements are based on how we see things today and contain elements of uncertainty. For additional information concerning the factors that can cause actual results to differ materially, please refer to our cautionary statement and risk factors contained in our 10-K and press release.
Today's presentation will include non-GAAP financial measures, which exclude those items that we believe affect comparability. A reconciliation of these non-GAAP financial measures to their respective GAAP measures is set forth in our press release. With me on the call today is our CEO, Frank Clyburn; and our Executive Vice President and Chief Financial and Business Transformation Officer, Glenn Richter. We will begin with prepared remarks and then take any questions you may have at the end. With that, I would now like to turn the call over to Frank.
Frank Clyburn: Thank you, Mike, and hello, everyone, and thank you for joining us. On today's call, I will begin by providing an overview of our performance in the third quarter and an update on our strong execution to position IFF for long-term success. I will then turn the call over to Glenn, who will provide a more detailed look at our third quarter financial results by business and discuss our outlook for the remainder of 2023. We will then open the call for questions. Moving to Slide 6. Our third quarter story is one of sequential improvement. As we've discussed, improving volumes has been a top priority, and we are pleased with the sequential volume improvements that we have achieved across the majority of our business.
On a total company basis, while our volume in the third quarter was down mid-single digits, it was a marked improvement from our Q2 lows where we saw a double-digit decline. Similarly, our enhanced productivity initiatives as well as favorable price to inflation led to strong adjusted operating EBITDA results. Sequentially, our adjusted operating EBITDA margin finished at 17.9%, which is a 50 basis point improvement versus the second quarter of 2023. And our focus on ongoing working capital improvements drove strong free cash flow generation. In particular, the continued execution of our inventory reduction program has resulted in more than a $600 million reduction in inventory since the end of 2022. This was the largest driver of our free cash flow, which improved $320 million versus the second quarter of '23.
The net result is that we delivered higher than our expectations on both the top and bottom line. At the same time, our commercial excellence initiatives in our R&D platform continue to drive improvements in our sales pipeline. In addition, in Functional Ingredients, as discussed on our second quarter call, we are implementing a targeted operational improvement plan to improve sales execution, strengthen our operating model and reshape the portfolio. As we shared previously, we expect this plan for Functional Ingredients will translate into low single-digit comparable currency-neutral sales growth in line with the market and a mid-teen adjusted operating EBITDA margin over the next 3 years with a strong improvement in 2024. And while this will take time, we are seeing improvements in our volume performance, where we finished the quarter down mid-teens versus low 20% declines in Q2 of 2023.
With this momentum, we have increased confidence in our ability to deliver within our previously announced full year '23 sales guidance range and we are now targeting the mid- to high end of our full year 2023 adjusted operating EBITDA guidance range. As Glenn will highlight, we are seeing signs of green shoots in the fourth quarter, with stabilization and improvements across several parts of our business. Lastly, we've made important progress against our portfolio optimization initiatives as we are rapidly addressing our capital structure. Most notably, aligned with our best owner mindset, we announced an agreement to sell Lucas Meyer Cosmetics to specialty chemical company, Clariant, for $810 million, which is equivalent to a high teens multiple based on our projections.
We expect to complete the transaction in the early part of the first quarter of 2024, and all proceeds will support our deleveraging priorities. Moving forward, we continue to pursue strategic noncore divestitures that will drive further deleverage and enable us to further prioritize our fastest-growing margin-accretive businesses and deliver long-term value for shareholders. Moving to Slide 7. In the third quarter, IFF generated $2.8 billion in sales, representing a 3% decline on the comparable currency-neutral basis. A strong performance in Scent and Health & Biosciences was more than offset by softness in Nourish and Pharma Solutions. As I mentioned, volumes improved sequentially across nearly all businesses with particularly strong performance in Scent and Health & Biosciences.
Excluding Functional Ingredients, which continues to disproportionately impact our results, overall volume declined low to single digits in the third quarter. Adjusted operating EBITDA for the quarter was $506 million, down 10% year-over-year on a comparable currency-neutral basis. Our favorable net price to inflation as well as enhanced productivity gains were more than offset by lower volumes due primarily to temporary customer destocking and unfavorable manufacturing cost absorption. Adjusted EPS, excluding amortization, was $0.89, primarily impacted by lower profitability. Now I'll turn it over to Glenn to provide more detail on profitability and our performance by business segment.
Glenn Richter: Thank you, Frank, and good morning, good afternoon and good evening, everyone. Taking a closer look at our profitability performance on Slide 8. As Frank mentioned, we delivered higher-than-expected EBITDA of $506 million in the third quarter. While we continue to benefit from favorable price to inflation and productivity gains, as you can see from the slide, ongoing volume pressures impacted our profitability in the quarter. While we are encouraged by the sequential volume improvement, we have seen across most of our portfolio, it remained the primary pressure in Q3. If we look at our profitability performance, absent the unfavorable manufacturing absorption related to our inventory improvement program, adjusted operating EBITDA would have declined 6% year-over-year on a comparable currency-neutral basis.
Note that our negative absorption in the quarter was less than expected as our inventory reduction program for the year has run its course and volumes have improved. We have done a good job at driving working capital improvement through our inventory reduction program, driving more than $600 million reduction in inventory since the end of '22. As a result, at this time, we are now expecting approximately a $165 million impact from negative absorption to profitability for the full year, down from $180 million. This could also flex further as the fourth quarter unfolds. To reiterate, this is a onetime transitory impact to the P&L in order to maximize cash flow moving forward. Turning to Slide 9. I'll provide a closer look at our Q3 performance by business segment.
In Nourish, sales declined 7% on a comparable currency-neutral basis, driven mainly by the continued weakness in Functional Ingredients. While Functional Ingredients remained a main driver of weakness in Nourish in the third quarter, we did see sequential improvement and expect this to continue as we move into the fourth quarter. Good growth in our Flavors business and the positive impact of IFF's ongoing pricing actions and productivity initiatives were more than offset by lower volumes and unfavorable manufacturing absorption. Together, this led to a 26% year-over-year decrease in comparable currency-neutral adjusted operating EBITDA. Health & Bioscience continued to deliver strong results in Q3, led by meaningful growth in Cultures & Food Enzymes, Grain Processing, Home & Personal Care and Animal Nutrition leading to comparable currency-neutral growth of 2% year-over-year.
Price increases and productivity gains led to a 12% year-over-year increase in comparable currency-neutral adjusted operating EBITDA. Scent was once again our strongest performer, delivering 7% growth in comparable currency-neutral sales driven by double-digit growth in Consumer Fragrance and high single-digit growth in Fine Fragrance. Like Health & Biosciences, Scent also saw strong 19% growth in comparable currency neutral adjusted operating EBITDA with profitability driven by favorable net pricing and productivity gains. Pharma Solutions growth rate was pressured this quarter, in large part due to a very strong prior year comparison with a 28% 2022 sales growth comparison and a 76% '22 adjusted operating EBITDA comparison. Price increases and productivity gains for this business were more than offset by lower volumes and comparable currency neutral sales declined 9% and comparable currency-neutral adjusted operating EBITDA declined 34% in the quarter.
Now on Slide 10, I'll discuss our cash flow and leverage position. Cash flow from operations totaled $795 million, a significant increase, reflecting a strong improvement in inventory levels. CapEx year-to-date was $390 million or approximately 4.4% of sales. Our inventory reduction program and working capital improvements have also greatly contributed to IFF's improved free cash flow performance, which totaled $405 million, a significant increase of $320 million from the second quarter. Year-to-date, we also distributed $619 million in dividends to our shareholders. Our cash and cash equivalents totaled $652 million, which includes $23 million in assets held for sale. Additionally, gross debt for the quarter totaled approximately $10.3 billion, with a net debt to credit adjusted EBITDA of 4.6x.
Our trailing 12-month credit adjusted EBITDA totaled approximately $2.1 billion. We are making good progress on working down our debt levels. And as Frank mentioned earlier, portfolio optimization remains a near-term priority as we work to reduce our leverage position and ensure our resources are focused on the businesses that will carry our success into the future. The sale of our Cosmetic Ingredients business, which is expected to close in the early part of the first quarter 2024 will further support our strength in capital structure as we pay down debt in line with our net debt to credit adjusted EBITDA targets. Now on Slide 11, I would like to focus on our consolidated outlook for the rest of the year. First, we are reaffirming our full year revenue guidance range of $11.3 billion to $11.6 billion, which reflects the improved momentum we are seeing across the majority of our business and accounts for the macroeconomic environment and foreign exchange impact, which we expect will persist through the end of the year.
On the bottom line, we are now expecting to deliver full year 2023 adjusted operating EBITDA at the mid to high end of our previously announced guidance of $1.85 billion to $2 billion, driven primarily by favorable price to inflation and improved productivity. We also now expect full year interest expense to be slightly higher at approximately $450 million. Our projected effective tax rate for the year is expected to be approximately 21%, the same estimate we provided last quarter. Finally, as we look to the fourth quarter, we continue to expect an improving trend in the majority of our businesses as we navigate the macroeconomic challenges impacting our industry. We are seeing signs of green shoots in the fourth quarter, with stabilization improvements across several parts of our business.
As we near the end of the year, I know many of you have questions on 2024. While the macroeconomic environment remains volatile with low visibility, we are optimistic heading into the new year. We have several known one-off items that we have high level of confidence will be tailwinds, including significant negative absorption related to our successful inventory reduction program and onetime Locust Bean Kernel inventory write-down. Also, we will continue to execute on our cost and productivity initiatives and have a carryover benefit from this year's restructuring program. These, of course, will be partially offset by a reset of our annual incentive compensation program where we have reduced payments in 2023 related to our performance versus target.
In the end, improved volume performance will be critical to our success, and we believe that destocking will largely be done as we exit the year and we also believe we will benefit from acceleration of our strategic transformation initiatives. We will provide our 2024 guidance with our fourth quarter results, which we expect to be towards the end of February. With that, I'll turn the call back over to Frank for closing remarks.
Frank Clyburn: Thank you, Glenn. Let me start by saying that I am tremendously proud of what our teams have accomplished in the last quarter to advance our focused strategic initiatives and build a stronger, more resilient IFF. Our improved performance, productivity gains and reaffirmed financial guidance reflect the hard work of our global teams that continue to support our long-term vision. We executed against our strategic priorities in Q3, and we'll continue to take action in Q4 to build a stronger IFF, better positioned to accelerate growth, expand margins and deliver value for shareholders. Finally, looking at our business more broadly, we will continue to pursue portfolio optimization initiatives to strengthen our capital structure.
As we've discussed previously, we are laser-focused on investing in our highest-return businesses while positioning our less margin-accretive businesses for success, either through new ownership or through focused improvement plans, such as those we're pursuing for Functional Ingredients. Our goal, as we move through the end of 2023 and beyond is to ensure that each of our businesses has the resources and where appropriate, the ownership most conducive to accelerating our growth, expanding our margins and maximizing our long-term returns as we continue to innovate for customers worldwide. With that, I will now open up the call for questions.
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