International Flavors & Fragrances Q4 2023 Earnings Call Transcript

Participants

Corporate Executives

• Michael DeVeau, Senior Vice President, Corporate Finance and Investor Relations
• Erik Fyrwald, Chief Executive Officer
• Glenn Richter, Chief Financial and Business Transformation Officer

Analysts

• Ghansham Panjabi, Robert W. Baird
• Josh Spector, UBS Group AG
• Gunther Zechmann, AllianceBernstein
• David Begleiter, Deutsche Bank Aktiengesellschaft
• Lisa De Neve, Morgan Stanley
• Nicola Tang, Exane BNP Paribas
• John Roberts, Mizuho
• Kevin McCarthy, Vertical Research Partners
• Laurence Alexander, Jefferies Financial Group Inc.
• Patrick Cunningham, Smith Barney Citigroup
• Adam Samuelson, The Goldman Sachs Group, Inc.
• Michael Sison, Wells Fargo & Company
• Mark Astrachan, Stifel Nicolaus
• Salvator Tiano, Bank of America Co.

Presentation

[Operator]

At this time, I would like to welcome everyone to the IFF Fourth Quarter and Full Year 2023 Earnings Conference Call. [Operator Instructions]

I would now like to introduce Michael DeVeau, Head of Investor Relations. You may begin.

[Michael DeVeau, Senior Vice President, Corporate Finance and Investor Relations at International Flavors & Fragrances]

Thank you. Good morning, good afternoon and good evening, everyone. Welcome to IFF's fourth quarter and full year 2023 conference call. Yesterday afternoon, we issued a press release announcing our financial results. A copy of the results 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 will 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, both of which can be found on our website.

Today's presentation will include non-GAAP financial measures, which exclude those items that we believe affect comparability. A reconciliation of these non-GAAP financial measures to their respective GAAP measures is set forth in our press release that we issued yesterday.

With me on the call today is our CEO, Erik Fyrwald; 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 that you have at the end.

With that, I would now like to turn the call over to Erik.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Thank you, Mike, and hello, everyone. I'm excited to join you all today. I would like to begin by sharing some initial perspectives since joining IFF. I will then turn the call over to Glenn, who will provide a look at the fourth quarter and full year 2023 financial results before providing commentary on our current outlook for the full year 2024. After that, we'll open the call for Q&A.

Now, I officially joined IFF on February 6, and I have been impressed by the world-class teams globally and the strong innovation across our company. I spent the last few weeks visiting our operations and teams in some of our U.S. and overseas businesses. I spent that time listening to our teams, meeting many of our customers and assessing the current status of our businesses. IFF has a proud history as a global leader in high-value ingredients and solutions and a great platform from which to build and expand our partnerships with customers across the value chain to help them create leading consumer products. I believe in our purpose to help create a better world through science and creativity applied to sustainably meet customer and consumer needs.

The opportunity we have ahead of us is very big and that is why I joined IFF. We have solid businesses and will take the actions needed to unleash our full potential to start to deliver profitable market share gains by bringing great innovation to win with our customers. A perfect example of this is in our Scent business where we have been outperforming competition, something we must do also across our other businesses.

IFF also has other high-quality businesses such as Flavors and Health & Biosciences, where we will leverage our innovation to deliver higher growth rates with very attractive profitability. And in some of our challenged businesses, such as Functional Ingredients, with focus and attention, we can significantly improve performance. In both instances, we will do so by putting the business first, eliminating unnecessary processes and overhead, driving empowerment and strong leadership. And by doing so, IFF will be a more innovative and customer-centric organization that will be effective and efficient.

We also must be better executors, focus the IFF team away from distractions to continuously grow market share across all our businesses, put more of our investments into our high-return businesses and transformative R&D initiatives and our IT infrastructure and achieve our capital structure targets by reducing outstanding debt. Now, when we do this, over time, I see strong upside and value creation for all IFF's stakeholders.

Moving to the next slide, I'll walk through the achievements and factors that marked IFF's progress through the fourth quarter and full year 2023. Now, throughout the past year, IFFers have continued to take important steps to strengthen our financial and operational foundation and position this company to deliver value for the near, mid and long term. Our performance in the fourth quarter demonstrates progress. While reported sales were down, comparable currency-neutral sales increased 1% and comparable currency-neutral EBITDA grew 17% with an adjusted margin expansion of 260 basis points.

We've also seen notable improvements in volume trends across the majority of our business segments in the second half of the year, enabling us to perform within previously stated guidance ranges for full year 2023 sales and adjusted operating EBITDA. Now, with this progress and the improving performance through the second half of 2023, we exited the year on solid footing, and we are optimistic about our ability to build on this momentum and are targeting getting back to year-on-year growth for the full year 2024, while strengthening for 2025 and beyond.

Now, as I said earlier, we are committed to reducing our level of debt. We have, therefore, announced an update to our dividend policy to reduce the quarterly dividend by approximately 50% to share. This is not a decision the Board and management have taken lightly as we know the dividend is important to shareholders. However, it will enable us to reduce debt faster, strengthening our capital structure, which will create additional long-term value. This will also give the company greater financial flexibility, which will, when required, give us the ability to make more high-return growth investments.

I'll now turn it over to Glenn. Glenn?

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Thank you, Erik, and hello, everyone. Moving to Slide 7, as Erik mentioned, the Board and management have taken this opportunity to accelerate the improvement of our capital structure as we work towards our deleveraging target of 3 times net debt to credit adjusted EBITDA. Consequently, we have reduced our quarterly dividend to $0.40 per share. We believe this dividend change provides a dividend yield that is consistent with industry peers and is aligned with IFF's long-term cash flow generation and target payouts. The dividend remains an important part of our capital allocation framework and we expect this new base to grow alongside our profit over time. IFF remains committed to providing competitive returns to our shareholders and firmly believes that these actions set us up for more durable value creation in the long term.

Now on Slide 8, as Erik mentioned, our performance for the fourth quarter reflects the operational and strategic initiatives that our team has implemented over the last several months to deliver strong results amid an uncertain operating environment. Despite some continued challenges in the market, volume trends continued to improve sequentially with increases in nearly all businesses, resulting in growth for total IFF.

IFF generated $2.7 billion in sales, representing a 1% increase in comparable currency-neutral sales. This improvement reflected strong growth in our Scent business with continued volume pressure in Nourish and Pharma, both impacted by destocking. Volumes continued to improve sequentially from down mid-single digits in Q3 to down low-single digits in Q4. And if excluding the impact of Functional Ingredients, volumes for the fourth quarter would have increased low-single digits.

Adjusted operating EBITDA totaled $461 million in the fourth quarter, a 17% increase on a comparable currency-neutral basis. We also realized a year-over-year increase of approximately 260 basis points to our comparable currency-neutral adjusted operating EBITDA margin. This growth in EBITDA was supported by both internal steps IFF has taken, including continued gains and efficiencies from our productivity initiatives and favorable net pricing.

Before moving on, I wanted to share that we recorded a non-cash goodwill impairment charge of $2.6 billion for the fourth quarter related to our Nourish business. The primary drivers of the goodwill impairment are related to lower business projections due to volume declines, mainly in Functional Ingredients, continued cost inflation and unfavorable foreign exchange rate fluctuations.

Now moving to Slide 9, taking a closer look at our profitability performance for the fourth quarter, we delivered $461 million, which equates to a robust comparable currency-neutral adjusted operating EBITDA growth of 17%. I'm happy to report that in Q4, IFF realized strong productivity gains and in conjunction with favorable net price to inflation helped us overcome ongoing volume pressures to deliver against our objectives. Importantly, IFF has remained focused on executing upon our productivity program to improve our operational effectiveness and efficiency. In 2023, we continued to launch additional steps as part of these programs, while also making strategic investments in key growth areas.

Now on Slide 10, I'll provide a closer look at our performance by business segment during the quarter. In Nourish, sales declined 3% on a comparable currency-neutral basis as strong growth in Flavors was offset by continued softness in Functional Ingredients, while Functional Ingredients remained the main driver of weakness for Nourish in the quarter, it is worth noting that we again saw meaningful sequential improvement in terms of profitability, the positive impact from our ongoing pricing actions and productivity initiatives drove improvements and led to a 3% increase in comparable currency-neutral adjusted operating EBITDA.

Health & Biosciences continued show robust top- and bottom-line growth, price increases, volume growth and productivity gains led to growth across most H&B business segments, led by double-digit growth in Health. Overall, H&B delivered a comparable currency-neutral sales increase of 5% year over year and a 35% year-over-year increase in comparable currency-neutral adjusted operating EBITDA.

Our Scent segment continued to deliver a very strong performance in Q4, including 11% growth in comparable currency-neutral sales, driven by double-digit growth in consumer fragrance, as well as mid single-digit growth in Fine Fragrance. Like Health & Biosciences, Scent also saw significant growth in adjusted operating EBITDA, increasing 34% on a comparable currency-neutral basis driven by favorable net pricing, volume and productivity gains.

While Pharma Solutions experienced significant pricing and productivity gains, these improvements were offset by lower volume driven primarily by continued destocking trends, as well as strong year ago comparison. This led to comparable currency-neutral sales declining 10% and comparable currency-neutral adjusted operating EBITDA declining 13% in the quarter.

Turning to Slide 11, I'll discuss our progress improving our cash flow and leverage positions. In the fourth quarter, cash flow from operations totaled $1.44 billion, a significant increase from the previous year, reflecting the strong improvement in inventory levels. Capex for the year was $503 million or approximately 4.4% of sales.

Our progress on working capital improvement, led by an intense focus on right sizing our inventories, helped enhance our free cash flow position, which saw a sequential increase of over $500 million, totaling $936 million for the full year and ahead of expectations. Included in our free cash flow is about $430 million of costs, primarily related to integration and transaction-related items. We also delivered $826 million in dividends to our shareholders in 2023.

Our cash and cash equivalents totaled $729 million, including $26 million in assets held for sale in Q4. Additionally, we realized a $200 million sequential reduction in gross debt, which totaled approximately $10.1 billion for the quarter, with a net debt to credit adjusted EBITDA of 4.5 times. Our trailing 12-month credit adjusted EBITDA totaled approximately $2.1 billion.

With the announced sale of our Lucas Meyer Cosmetics business, which we still expect to close in the first quarter of 2024, the right sizing of our quarterly dividend and additional portfolio actions we are planning to make, we are taking decisive action to strengthen our balance sheet and achieve our leverage targets.

On Slide 12, I'd like to now turn to our outlook for '24. Due to a combination of improvements across our business and end the broader market toward the tail end of '23, we are cautiously optimistic about the year ahead. For the full year 2024, we expect sales in the range of $10.8 billion to $11.1 billion. This reflects our prudent approach to volume expectations and the impact of modest negative pricing in '24, which is largely isolated to more price competitive categories such as Functional Ingredients and Fragrance Ingredients, given lower input cost and competitive dynamics. We expect overall pricing to decline approximately 2.5% in '24, following a 10% increase in '22 and a 6% increase in '23. Strategically, we believe this will position us to be more cost competitive in the market and allow us to regain market share in select businesses.

In terms of volume, the visibility to the degree and pace of the recovery remains a bit fluid and has been explicitly incorporated in our 0% to 3% range. The most significant variable impacting this range will be the pace of recovery in Functional Ingredients. However, this is a marked improvement from '23, where we finished down mid-single digits; and '22, we were down low-single digits as we believe our industry will return to more normalized growth rates.

On the bottom line, we expect to deliver full year '24 adjusted operating EBITDA between $1.9 billion and $2.1 billion. Our guidance assumes not just improved volumes from '23, but also solid profitability and a margin expansion across our segments. We are hyper focused on continuing to execute our productivity initiatives to help mitigate expected inflation, primarily labor costs and an incentive compensation reset, while continuing to reinvest in the higher return businesses.

It's also worth noting we have some benefit of one-time items such as the negative impact in '23 from the inventory reduction program and the previously announced write-down of inventory related to Locust Bean Kernel, or LBK, that will not repeat in '24. In particular, there was an approximately $130 million impact from negative absorption in '23 related to our inventory reduction program and some volume declines, which is down from an estimated $165 million we provided in the third quarter. A portion of this will be offset by higher annual incentive compensation expense as we reset our payout to target levels in 2024.

While there's still work to do, efforts to bolster our financial profile and portfolio are providing effective. And while it's hard to predict the timing and details of the market recovering and its impact on results, we see opportunity for improvement in '24, with all divisions targeting better volumes with improvements in profitability and margin expansion across all four divisions.

For the first quarter, we expect sales to be approximately $2.7 billion to $2.8 billion, with an adjusted EBITDA of approximately $475 million to $500 million. Throughout 2024, we will be relentlessly focused on our efforts to optimize our portfolio, improve financial performance and reach our deleveraging targets. I'm confident that the actions taken in '23 and our outlook for improving performance in '24 will position IFF to capture significant value creation.

With that, I'll turn the call back over to Erik for closing remarks.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Thank you, Glenn. I'm truly excited to be joining IFF during this transformative time for the company. I have long admired IFF as the category-defining leader in the industry and it's an honor to be able to work alongside our talented global teams to help us navigate and even thrive at a critical moment for our company and our industry.

Through robust efforts from our teams worldwide and shared commitment to putting the customer at the center of all we do, IFF will continue strengthening our commercial execution and become a more nimble and efficient organization. Our global teams made progress towards ensuring we can meet the evolving needs of our customers and deliver industry competitive returns and we will accelerate the progress going forward.

While 2023 was a challenging year, our financial results in the fourth quarter highlight an improving trend. Based on this performance and some improving market conditions, we are expecting a return to volume growth this year, which should enable EBITDA growth and margin expansion. Our updated dividend policy and the additional divestitures we continue to work on reflects our commitment to improve our capital structure.

While the global economic landscape is uncertain, IFF will be focused on strengthening our execution. And as I said, we have work to do to improve our businesses and achieve our vision, but I am confident we are well positioned to build on our progress and create sustainable value for all stakeholders in 2024 and beyond. I'd like to thank our teams and partners for welcoming me to IFF and look forward to seeing what we'll achieve in 2024.

With that, I'd like to now open the call for questions.

Questions and Answers

[Operator]

We will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Ghansham Panjabi with Baird. Your line is now open.

[Ghansham Panjabi, Analyst at Robert W. Baird]

Hey, guys. Good morning. And Erik, first off, congrats on your new role. I guess my question is on your fiscal year '24 EBITDA guidance and I'm hoping that you can sort of bridge on a year-over-year basis the differential between '24 and '23. And also, Glenn, highlight what changed relative to the variances you highlighted from your 3Q conference call back in November apart from just the fixed cost absorption you cited and if you could also just give us a sense as to what the embedded volumes are by segment as it relates to the low single-digit volume guidance for '24. Thanks.

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Sure. Yeah. Good morning, Ghansham. Easily done and a frequently asked question. So if you'll indulge me, I'll start with last year's results at $1,980 million. There are two adjustments to get that to a normalized basis. One is the divestitures, which you're aware of. It's a half a year of Savory Solutions and FSI, and the LMC will be closed at the end of the quarter. So it's roughly three-quarters of LMC. That's roughly $78 million of normalized impact.

And the other factor, which is the same basically we had discussed before, we also have included our updated view of foreign exchange. That's $50 million reduction. I'm not sure that was previously discussed from a standpoint. So that gets to a like-for-like base of $1,850 million. Our volume mix impact for this year is forecasted to be $170 million positive. That is inclusive of the $130 million of positive overlap on absorption. As we noted on our call, that actually came down as the fourth quarter volumes were higher from a production standpoint. So that was slightly different than we had guided.

Our net price for the year is basically zero. That is inclusive of the $44 million of LBK. So that's netted in that number, and we can certainly talk more about the pricing dynamics this year. Then we have about a $35 million reset for AIP. So that's a negative, but that's better than we thought. We thought that would be in the $70 million range from a standpoint. So I think all of the one-timers being absorption is slightly lower, the negative reset on AIP is slightly lower, FX is new, and then the deals basically were all known. The last items are sort of wage inflation. That's about $120 million. And the productivity is about $150 million in the P&L. So that's sort of consistent with our three-year view. So that adds up to the midpoint of our range of $2 billion.

And then relative to the volume question, I think it's very simple to think about our view of this year. The Functional Ingredients, which is circa less than 25% of the business. We are projecting that to be relatively flattish for the year. All the other businesses actually have growth directionally in the 2% to 3% range on a full year basis, a little bit more slower in the beginning of the year and ramping up in the latter. But that's why we mentioned, as we think about that range of guidance, Functional Ingredients is the area that probably gives us the most pause and we've been the most cautious, and that sort of is the difference between the high end of the 3% versus the 0% range. So hopefully, that answers the question.

[Operator]

Thank you.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Next question.

[Operator]

The next question comes from the line of Josh Spector with UBS. Your line is now open.

[Josh Spector, Analyst at UBS Group]

Yeah. Hi. Good morning.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Hi, Josh.

[Josh Spector, Analyst at UBS Group]

So I just wanted to -- hey. So I wanted to ask on the dividend. So I think it's been pretty clear that it's been a pretty big use of cash for a couple of years now. So really, the question is why was now the right time versus when you looked at that probably a year ago or maybe two years ago? And what does that mean as it relates to the divestment strategy or timing? Has anything changed as you think about what's next?

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

So this is Erik. First of all, I wasn't here a year ago, obviously. But I did arrive on February 6, looked at our entire situation, talked to Glenn and his team, talked to the Board and made the decision to go ahead and cut the dividend now. I think it's a wise move in terms of our overall balance sheet efforts to get our balance sheet in great shape. And it doesn't impact the investment, timing or strategy. We continue to work on our portfolio optimization. But obviously, we are focused even more on working on strengthening the businesses, increasing our earnings and cash flow.

[Operator]

Thank you.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Next question.

[Operator]

The next question comes from the line of Gunther Zechmann with AllianceBernstein. Your line is now open.

[Gunther Zechmann, Analyst at AllianceBernstein]

Hi. And Erik, welcome back to the public market as well. Erik, what are your priorities for this year? I appreciate you have only been in the role for a few weeks, but for this year, maybe also beyond when I think about the portfolio and the balance sheet, please. And in addition, how do you think about IFF mid-term targets? And lastly, Glenn, what is your free cash flow guidance for 2024, please?

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Thank you, Gunther. And glad to be back in the public markets. My priorities for 2024, I should say our priorities for 2024, are to continue the portfolio optimization work and have that be part of improving our balance sheet. But again, more importantly, we are going to strengthen each business. We are going to make sure that each business is clear on how they can strengthen their customer focus to profitably grow market share, strengthen the R&D and innovation in each business so that we better delight customers with our innovation so that we bring innovation that they value, that we can grow our market share with them. And then thirdly, we are going to keep driving productivity and strengthening our productivity in each business unit and then also corporately.

We want a very effective and efficient back office. What we'll reduce are the amount of engagement we've had with consultants, advisers and others that have caused us to be too internally focused. We're going to get back to focus on winning with the businesses by better serving our customers than our competition. In terms of how we think about the mid-term targets, it's too early for me to comment, but I'll look at them with the team here, and we'll do it by business, and then we'll roll it up for the company, and we'll get back to you in the not-too-distant future on that. But on the last one, Glenn?

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Yeah. So hey, good morning, Gunther. Our projected free cash flow for this year is $500 million. I would note that, that's inclusive of an expectation of $100 million of taxes for the sale of LMC and carryover for Savory and then another $100 million for other restructure one-time items. So there's $200 million of Reg G. But net of the $200 million, we are at $500 million full year free cash flow.

[Operator]

Thank you. The next question comes from the line of David Begleiter with Deutsche Bank. Your line is now open.

[David Begleiter, Analyst at Deutsche Bank Aktiengesellschaft]

Thank you. Good morning, and Erik, congratulations on new role. Erik, two things First, can you comment...

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Thanks, David.

[David Begleiter, Analyst at Deutsche Bank Aktiengesellschaft]

Can you comment on press reports that a sales process for former solutions is underway? And secondly, in addition, is 2.5% reduction in pricing you are forecasting in '24? All the pricing you expect to give up versus the roughly 19% pricing you've achieved over the last three years on a cumulative basis? Thank you.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

I'll take the first one, and Glenn, you can have the second piece, because I'm not that familiar with the details at this point, but I'm getting into it. But in terms of any portfolio optimization, we are not going to comment on rumors. All I can tell you is we continue to work on portfolio optimization, and we will not sell a business at a price that doesn't make sense, but we are looking at what does make sense for IFF and for our employees and any business that we might consider divesting. So with that, Glenn?

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Yeah. Thanks. Good morning, once again, David. As you pointed out, we've had three years of very significant pricing to reflective of the inflation environment of 18%, 19% cumulatively. 2.5% is all we are anticipating. That actually reflects sort of overall price declines. So as I mentioned, net price is sort of zero in our P&L. It is highly concentrated in the Functional Ingredients and the Scent Ingredients space, and we've been extremely surgical in terms of where we needed to give it back. And at this point, we are pretty much locked in to most of our pricing for the year at this point. So that actually feels like a pretty safe number relative to the plan.

[Operator]

Thank you. The next question comes from the line of Lisa De Neve with Morgan Stanley. Your line is now open.

[Lisa De Neve, Analyst at Morgan Stanley]

Hi. Thank you for taking my questions. So the question I have is twofold. I mean, how is IFF positioned versus peers? I mean, does it expect to grow in line with the market, in line with its direct peers or believe that it's actually better positioned in this year, but also maybe more structurally? And next to that, how should we really think about delivery of the Functional Ingredients optimization and efficiency program for this year? And then I have a small follow-up on the pricing. So on the negative pricing in Fragrance Ingredients, have your customers come back to pricing here? And are your peers offering the same price reductions or comparable price reductions? Thank you.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Thank you, Lisa, and I'll take the first part of that question. I've looked very hard at the data over the last five years. And clearly, we have underperformed, as all of you know. We have pockets of strength. Scent is an example I mentioned in the opening comments. But we have some businesses that are challenged like food ingredients. What I can tell you is we are going to have each business be very clear on what is their strategy to win? How are they going to delight their customer set and make sure that we profitably grow our market share, how are we going to make sure that we have our innovation targeted at needs that customers value and how are we going to make sure we're driving productivity. So each of the business end to end, how do we drive the businesses. And as you know, we've got strong businesses in great markets. like our Flavors and our Fragrances or Scent business, terrific businesses that should be able to fully compete with margins and growth rates with Givaudan and others.

We've got a strong business unit in Health & Biosciences in great markets, and we should be able to fully compete with margins and growth against Novonesis. In our challenged businesses, we've got very good markets in food ingredients and protein solutions, and we should be able to be fully competitive with Kerry and other food ingredient players. And we've got a very good business and very good markets with pharmaceutical ingredients, and we need to be fully competitive with our ingredient set there, Ashland and others. So I don't -- we have not performed as a company across the company in the last five years like we should. In the next five years, we'll get back on track.

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

So Lisa, this is Glenn, let me address your second question regarding Functional Ingredients. As you know from past conversations, 2021, '22, we had a number of missteps in our part that caused this business to step backwards. Since that, we've been working on basically four major items. One, getting service levels up to the right standard. I'm happy to say, for the last year plus, service levels have been at 95% plus across all the businesses and across the entire globe.

Secondly, and perhaps most importantly, is getting volume back on track, which is a combination of our sales execution pipeline. As we mentioned, that has dramatically picked up over the last year and getting our pricing right in the market. We just talked about that. We've been very smart this year thinking about market by market, product by product, what makes sense to be competitive to win and retain business. We feel much better about that.

The third item has really been around sort of our general go-to-market strategy. And as Erik has mentioned, being much more focused across the ingredients team, making sure that they own the results.

And lastly, it's cost. So we have been really focusing on all of the costs, but largely the 85% that sits in cost of goods. So it's SKU rationalization, raw material consolidation, manufacturing footprint consolidation, taking out fixed costs, et cetera. And we are making very good progress. We are seeing successive improvements in volume quarter to quarter. Q2 last year was a low watermark. We are actually moving into sort of flattish as we start this year, and we are also continuing to see good expansion in margins. So we have a lot of work to do, as Erik mentioned, but we are beginning to see some progress in terms of what we've been doing. Thank you.

[Operator]

Thank you. The next question comes from the line of Nicola Tang with BNP Paribas. Your line is now open.

[Nicola Tang, Analyst at Exane BNP Paribas]

Hi, everyone. I just wanted to pick up on a few topics that were just asked there by Lisa. On this pricing side, I was wondering if you could give a bit more detail on this expected price declines in Functional Ingredients and in Fragrance Ingredients and whether you could expand on your comment on competitive dynamics in these markets? And then in addition on the volume side, I was wondering why you don't expect more in terms of year-on-year volume improvement, bearing in mind, I mean, I guess, the headwind of destocking and shrinkflation that are clearly in the base in 2023. Thanks.

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Two very good questions. So on the pricing of our 2.5%, 80% of our downward pricing is concentrated in Functional Ingredients and the Scent Ingredients business. Those areas, by definition, are more commoditized. And in addition, those areas have seen some more meaningful deflation in terms of commodities. So it's natural. As I mentioned previously, we are doing a very good job of making sure we are competitive in the market by product, by region, and we feel good that that 2.5% sort of is reflective of the environment.

The second question regarding why are we not more optimistic. We are -- honestly, we are just cautious. We're very cautious and prudent, given the environment. Last year was extremely bumpy. We do believe that the destocking for most of our business is largely behind us, and we are seeing positive signs. But we need a couple of quarters of positive momentum, I think, in stabilization before we can move from cautious to optimistic.

[Operator]

Thank you. The next question comes from the line of John Roberts with Mizuho. Your line is now open.

[John Roberts, Analyst at Mizuho]

And welcome back, Erik. Two-parter, if I could. Is the Functional Ingredients business significantly different today than when you were at DuPont? Sounds like you think it's just more of a cyclical problem that can be addressed through productivity, but do you think there are structural changes you need to make there? And then your predecessor was targeting going from four segments to three segments. Have you gone back to the whiteboard to start over on those plans? Or was that nearing completion and there's just some fine-tuning left to complete it?

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Thanks, John. And let me start with the first one. The makeup of our Functional Ingredients business is better than what it was when I had responsibility for that as part of Agriculture & Nutrition back at DuPont a number of years ago. But -- so I believe our potential is significantly higher than it was then. I think that it's in a very good market. I think we've underperformed. And I think we've underperformed because we've been too internally focused. We've had lots of consultants. We've had lots of advisers talking about helping us to figure out what to do around synergies. And what I can tell you is I've been in these businesses for many, many years, these types of businesses.

The goal is not synergy. Synergy is a tool. The goal is to have a very clear strategy for our Functional Ingredients business, how are we going to profitably grow our market share with customers by delighting the customers with our solutions approach, with our innovation and then do that in a productive way with our assets and our functions, very productive. We have the potential to significantly improve the performance of this business. I've spent time with our business leaders. I think they're headed in the right direction, and we are going to further accelerate the progress and make sure that we profitably grow our Food Ingredients business and fully compete with our competitors, the leading competitors in Food Ingredients because we have so much value to bring customers. If we do it right, when we do it right, we'll have a very good business.

And then in terms of the organization structure, no decisions today, but what I will tell you is I'm a big fan of business units that have end-to-end accountability and responsibility to drive all the levers of the P&L making sure that everything we do is to delight customers, profitably grow our market share, but do it in a way that's efficient and effective, so each business unit can win. And I find when business units are winning, all of a sudden, synergies become clear and become more powerful and easier to access. So we are going to ensure that our businesses are on the right track and that our synergies are additive to further strengthen each of our businesses.

[Operator]

Thank you. The next question comes from the line of Kevin McCarthy with Vertical Research Partners. Your line is now open.

[Kevin McCarthy, Analyst at Vertical Research Partners]

Yes. Thank you and good morning. Erik, welcome back. Glenn, two questions from my side, please. Your Health & Bio segment margin was the best in more than three years. Can you just maybe rank order the drivers of the improvement there? And more importantly, is the 30%-plus level sustainable into 2024? And then secondly, what are your input cost trends and the outlook that you are baking into your guidance for this year?

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Yeah. So I think for the -- H&B had a very good year, and that was a result of a progressive improvement in volumes. As we noted, the Health business, one of our largest segments actually had a very good fourth quarter. Secondarily, productivity. So we've driven a lot of productivity across the business. And third, really net price. So the -- there's been, to your second question, a decline in input costs in that business as well. So that got us to the 30% range for the business. I did note on the call that we are anticipating H&B like all four of our businesses that demonstrate both EBITDA growth and margin expansion this year. So we expect that would be the case for H&B.

In general, our input costs, as I mentioned, are anticipated to be down this year. Energy is flattish at this point. Logistics are down, and we are seeing some raw materials deflation. As a reminder, it takes about four months for a purchase to run through the balance sheet. So that's a positive momentum. That's a net zero, as I mentioned, for the overall enterprise for the year. So thanks for the question.

[Operator]

Thank you. The next question comes from the line of Laurence Alexander with Jefferies. Your line is now open.

[Laurence Alexander, Analyst at Jefferies Financial Group]

Good morning. If end markets did not cooperate, can you provide more granularity on how you can delever in 2024 and 2025 in terms of reviewing business lines for exit, productivity relative to comp and so forth. And Erik, given your initial impressions on IFF's operating culture and discussion around productive solutions, can you speak more to the mindset around productivity and R&D? Is it more about operational fixes, or do you see structural or philosophical issues around how the firm has targeted ROIC margins or profit growth?

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Yeah. Thanks, Al. This is Glenn. I'll answer the first part of your question. In general, we are pretty cautious on our outlook on volumes. So as I mentioned, flattish to 3%. So we've been -- we haven't expected a giant recovery this year in our base case. So that's kind of the starting point. In the absence of that materializing, we have been very good at delivering productivity. As Erik mentioned in his opening comments, we are accelerating both ongoing efforts, and we have additional efforts underway to take costs out that aren't reflected in the plan. So that will be my second comment.

Relative to the deleverage, so that gives you some sense on the earnings profile and offsets if there's additional softness in the external market. The deleverage will largely be accomplished through divestitures. As Erik mentioned, we are on path. We feel very good in terms of our activities underway, and we do think we'll accomplish our targeted divestitures, which will be the biggest driver of achieving our deleverage goal.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

And then on your second question, Laurence. My initial impressions of IFF's capabilities are we've got really great people, we've got really great capabilities in each of our businesses, and we have just underperformed, but there are pockets of examples where we are performing tremendously well that give me so much confidence that we can make this happen across the company.

I spent time with the leadership of arguably the largest consumer products company in the world, where we have a very strong relationship, very much innovation driven, their innovation people with our innovation people to make sure that the best consumer products are being developed. And we were meeting both with our Scent teams and their Fragrance team and with our Health and Biosciences team and their Consumer Products teams. And it was the best relationship, the best dynamic that I've ever experienced in my have 42 years of customer interactions. So when -- and then I had another interaction with the top management of a leading beauty care company in Europe.

And same thing, our people are working hand in glove with their people to create great, great consumer products that consumers love. So we can do it. We do it. We just need to do it more across the company. And I'm really excited by helping our teams stop not being so internally focused, get more focused by business unit on winning with customers and then collaborate where it makes sense to enhance across our portfolio to bring even more to customers so that the customers win more and we win more.

Now in terms of productivity, as Glenn mentioned, there are pockets there where we're doing very well, but there's more we can do on productivity. Ralf Finzel and his production team are really driving tremendous productivity in our operations. And it's still early phase, but they are ramping that up very nicely. We've already had efforts and back-office productivity for our corporate functions. That's going okay, but we are going to accelerate that. You'll see more shared service centers and more activity with IT systems to make sure that we are effective serving the businesses and very efficient. So I love what I see. There's so much excellence here, but we've got to get it across the company, and we will.

[Operator]

Thank you. The next question comes from the line of Patrick Cunningham with Citi. Your line is now open.

[Patrick Cunningham, Analyst at Smith Barney Citigroup]

Hi. Good morning. Just a question on the Q1 guide. So it's about $487 million, $488 million at midpoint in a seasonally weak quarter. And you noted some nice volume ramp in productivity throughout the year. So even annualizing that is above the low end of the guide. So can you help us understand if that guide is just conservative? And then just a small follow up, when do you expect to see the end of destocking within your Pharma Solutions business?

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Yeah, I'll start with the second. Generally, we've seen destocking basically, I'll say it's done everywhere with the exception of pharma largely. And it's the second half of the year. Pharma just started late as an industry part of the destocking for logical reasons, given the margin structure, but we do anticipate the second half of this year to be done with Pharma.

Q1, we think, is a very reasonable guide, $475 million to $500 million. We have started off the year generally pretty good on the volume side, but we just want to be cautious as we sort of go through the quarter. Generally, the volume is slightly lower than the average for the year. So that's a little bit of the impact there, Patrick.

[Operator]

Thank you. The next question comes from the line of Adam Samuelson with Goldman Sachs. Your line is now open.

[Adam Samuelson, Analyst at The Goldman Sachs Group]

Yes. Thank you. Good morning. A couple of questions on cash flow and investment. One, just wanted to clarify on the deleveraging targets. It had previously been 3 times by the end of calendar '24. Are you no longer committing to that time line? Second, the last slide in the deck references high-return growth investment. Can you provide any more clarity on kind of what those are, size and timing of those?

And then finally, Glenn, I think you said to an earlier question of $500 million free cash flow guidance for the year. Can you bridge $2 billion of EBITDA to $500 million of free cash flow? Because even acknowledging some deal-related charges, cash flow would be down year on year. And I just want to make sure I understand [Indecipherable] of that.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Thank you, Adam, and I'll start, and then Glenn can add on. First of all, I fully am aligned with and agree with a target of 3 times net leverage debt as a target to get to. I think the year end '24, I'd like to see us get there by the end of '24, but we are not going to do something stupid that destroys significant value to get there in '24. But I can tell you, we are going to make very good progress at least towards that goal in '24. In terms of high-return growth investments alluded to, I'll just reinforce that Flavors and Fragrances, we call it Scent, and Health & Biosciences are strong business units in great markets. I've been in many chemistry and biological markets. These are great markets, and we are going to invest in them to win.

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Yeah. So hey, good morning, Adam. So let me take you through the cash flow reconciliation is a good question. And I'll start from the top with EBITDA. So the midpoint of our guide is $2 billion. We are forecasting $345 million of interest expense, cash taxes of roughly $450 million. That includes the Reg G or transaction related. I'll back them out later. We have net working capital slightly negative. We are being a little cautious in terms of the overall full year and part is just the growth of the business. And then there's miscellaneous sort of others, about $100 million of other items to get an operating cash flow of $1.050 billion-ish [Phonetic].

As we mentioned, we have a capex target up this year. We're trying to invest in our growth business of about 4 -- I'm sorry, about $540 million for the year. That gets us to a free cash flow, including Reg G, of $500 million. I would note, as I mentioned, there's $200 million of Reg G items, $100 million of that's transaction, largely taxes, a little bit of other deal costs, but largely taxes. And then there's $100 million of other miscellaneous Reg G items as well. So that gets you to -- if you back those out, on adjusted free cash flow, around $700 million for the year. Biggest -- the other note I'd say, Adam, biggest shift year over year is net working capital. We had an improvement last year of $500 million. We are being sort of conservative and flattish to slightly down this year.

[Operator]

Thank you. The next question comes from the line of Mike Sison with Wells Fargo. Your line is now open.

[Michael Sison, Analyst at Wells Fargo & Company]

Hey. Good morning. Hey, Erik. Welcome back. I'm sure you've seen several chemical businesses go awry over the years for a lot of different reasons. What's your sort of playbook in terms of turning around a business? And clearly, Functional Ingredients has been a sore spot here. Anything in particular you are going to sort of work on to get that business back? And then just a quick follow-up on Pharma, Glenn. Since Erik has only been here a couple of weeks. But where do you think margins can get back to for that business? The last two quarters have been pretty light relative to its historical past.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Thanks, Mike, and I'll start with the Functional Ingredients question. First of all, I like the Functional Ingredients business. It is a very good business with lots of opportunity to bring value to customers. And by having multiple elements of the solution set, you can bring value in terms of helping customers achieve their goals and what food products they want to have that delight customers, delight consumers. So I think what we really have to do here is -- and the team is working on this, is make sure that we are clear on what is our strategy, how are we going to create value in this business, how are we going to make sure that we're focused on the right consumers -- excuse me, the right customers in the right way, profitably growing our market share, and how do we make sure that our assets are very competitive, that our costs are very competitive that we are driving productivity so that we can be competitive with our product portfolio, both in terms of the value we bring and the cost to deliver that value.

And then we are spending money on innovation. We've got lots of great innovation, make sure that innovation is tied to real customer needs that they're willing to pay for that can be part of the solution set. And I think that we've taken our eye off the ball, as I said before, too much internal focus, listening to too many consultants, going all different directions. We get clear, what we are trying to do, what the goals are and execute well against those goals. This business will significantly improve in 2024 and beyond.

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Yeah. Hey. Good morning, Mike. Good to hear your voice. Regarding Pharma, I mean, as you know, this business quarter to quarter could be a little lumpy based on demand. And fourth quarter is typically a lower volume quarter. The margins are always compressed seasonally for fourth quarter. So it's difficult to look at that. We are very optimistic on the strength of this business and the go-forward plan. We do expect the business to be in approximately the mid-20s from an EBITDA margin this year from a standpoint. And there's tons of other initiatives to continue to drive up the margin further. So I think what you are seeing is the function of destocking, idle mills, seasonality over the last couple of quarters that's just not reflective of the fundamentals of the business.

[Operator]

Thank you. The next question comes from the line of Mark Astrachan with Stifel. Your line is now open.

[Mark Astrachan, Analyst at Stifel Nicolaus]

Yeah. Thanka, and morning, everybody. I guess lots of questions, but I'll try to keep it narrow here. So today's IFF was created to provide a suite of products to customers. At least that was the initial idea in merging the legacy IFF into the DuPont business. I guess, Erik, how do you think about that as an effective go-to-market strategy? And as a corollary to it, we hear a lot from investors that this was arguably a better business pre even Frutarom. Is there a scenario where you can divest nearly all of those assets of the acquired businesses? How integrated are they? Is that possible? And sort of just holistically thoughts on kind of all of that together.

And then just one follow-up for you, Glenn. The flattish to plus 3% volumes, considering how easy the comparisons are would still suggest that two years is strongly negative. How do you think about that from a competitiveness standpoint, meaning it would suggest that you are still losing share? And I get it's not across all of the businesses equally, but it's still a pretty stark difference relative to your closest peers. Thank you.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Okay. Thank you. I'll start by saying that I believe that the historical IFF plus the DuPont, Nutrition and Biosciences business are stronger together than they were separately. The potential, the opportunity is greater than it was separately. So I believe in that combination very strongly. Now as I said before, we haven't executed it well. And I've seen this happen before. When I got to Syngenta almost eight years ago, the seeds in the crop protection businesses had been mushed together and the focus was on synergies versus having a great crop protection business and a great seeds business. We made clear that we are going to have those two businesses as business units, end-to-end business units. And as soon as we did that, we found out that we had been losing share, losing margin versus the competition. We started regaining that. And by the way, when the business units were clear and what they were trying to do, the synergies grew a lot because there were synergies. I see the same thing here at IFF.

As we're really good at Flavors, at Fragrances or Scent, at Health & Biosciences, at Food Ingredients, those businesses when they're performing well, the synergies will increase, not decrease. The ability to help each other, the different businesses to help each other to help customers more together will increase, but we've got to get the businesses performing extremely well by themselves and not have synergy, the goal have synergy a tool. When we do that, I can assure you that the combination will be very strong.

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Hey. Good morning, Mark. Thanks for the question. You are right. If you look at a three-year stack, we would still be negative over the three-year average by about 1%, 1.5% over -- including if you hit the 3% this year. But I would note, as we've said in the past, I think you have to sort of think about the performance of the business between 75% and 25%. 75% of business, our core Scent business is performing very well. Flavors has pockets of strengths, H&B, both enzymes, probiotics, cultures business are doing well. Pharma overall is doing well. It's really the other 25%, which is the Functional Ingredients we've talked about that actually has been a drag on the overall results of the business. So if you separate that, I think you have -- you clearly have a very different view in terms of that three-year stack, and the 75% is nicely positive.

And I would submit it's in line with competition. For the most part, we have opportunities, as Erik said, to perform better, but it's focused on that 25%. I also will note once again is we're trying to be realistic. There's prospects that the markets improve more significantly. Certainly, the start of the year, knock on wood is pretty encouraging, but it's too early to call anything above that range until we see a consistency month by month in terms of volume coming back. So appreciate the question.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

The only thing I would add is that even in the 75%, there is significant improvement opportunity. And we've got businesses that are looking at that, and we are going to work with those businesses to support them, both with the -- for the businesses to win more and for the corporate cost overheads to be lower and more effective in supporting the businesses. So there is great opportunity, of course, in Food Ingredients to turn it around, but even the rest of the company to significantly improve performance, and we are going to do it.

[Operator]

Thank you. The next question comes from the line of Salvator Tiano with Bank of America. Your line is now open.

[Salvator Tiano, Analyst at Bank of America]

Yes. Thank you very much. I wanted to ask a couple of questions from the -- on the, I guess, strategy shift to grow that you mentioned a little bit more -- a few more details. And essentially, as you're trying to reposition the business and gain market share, that's becoming the clear focus. What would that mean for R&D spending, SG&A spending and capex in the next few years, not necessarily 2024, but let's say on a three- or four-year basis. And you made a comment about the 2024 price that 2.5% negative in part being because of competitive pressures, but also because it will allow you to gain some market share. So how are you thinking in this new strategy about the trade-off between price and volume?

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

So I'll start. And I think our R&D spend is significant today. I think if you look at what we spend, it's very competitive versus the industry leaders -- other industry leaders, but I do think we can focus it better, connect it better to the business units and to customers and ensure that R&D efforts are fully aligned with the highest value needs that our customers have. So I think we can get more out of the R&D spend that we have. And where there are areas that we need to spend more R&D, particularly in Health & Biosciences and Flavors and Fragrances, we will spend more on R&D. On capital expenditures, I feel similarly that the level of capital expenditures are reasonable, but we have to look at where we are spending it and make sure that it's optimized and we are spending the capital in places that have significant returns, have very good returns and strengthen the businesses where we need to win.

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Yeah. And I would just add to that. As we mentioned, we are going to be up about 8% year over year on capex, and that core operational capex, which is really supporting growth in our core products is up 10%. So we are in the right range from a capex, around 5% of sales in terms of what we need to maintain and grow the business.

[Operator]

Thank you. There are no further questions at this time. So I would like to hand the call back to the team for concluding remarks.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Great. Well, thank you for joining the call this morning. Again, I just want to finish by saying that I'm thrilled to be at IFF. We've got a tremendous team at IFF. We've got great capabilities. We haven't performed to our potential in the past, but I can tell you, we are all completely committed to making sure that we unleash the full potential of our businesses and drive the right kind of synergies that enhance each of the businesses and make customers very pleased, delighted with what we bring in our innovation and, by doing that, profitably grow our market share and, through their productivity efforts, make sure we do that with leading margins. Thank you.

[Operator]

[Operator Closing Remarks]