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International Flavors & Fragrances Q2 2022 Earnings Call Transcript

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At this time, I would like to welcome everyone to the IFF Second Quarter 2022 Earnings Conference Call. [Operator Instructions]

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

Michael DeVeau
Chief Investor Relations & Communications Officer at International Flavors & Fragrances

Thank you. Good morning, good afternoon, and good evening, everyone. Welcome to IFF's Second Quarter 2022 conference call. Yesterday afternoon, we distributed a press release announcing our financial results. A copy of the release can be found in our IR website at 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're making forward-looking statements about the company's performance, particularly with regard to the outlook for the second half and full year 2022. 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 from our forward-looking statements, 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.

With me on the call today is our CEO, Frank Clyburn; and our Executive Vice President and CFO, Glenn Richter. We will begin with prepared remarks and then take any questions you have at the end. With that, I would now like to turn the call over to Frank.

Frank Clyburn
Chief Executive Officer at International Flavors & Fragrances

Thank you, Mike, and hello, everyone. And thank you for joining us today. Before I dive into our first half results, I want to take a moment to acknowledge the tremendous progress we have made over the last three months. Amid a challenging operating environment, our global teams continue to display their steadfast commitment to our customers and passion for innovative discoveries as IFF delivered profitable growth.

Since joining IFF, I have consistently been impressed by the caliber of the work, innovation, and expertise our people deliver as well as the creative culture that underpins our success. I once again thank our teams around the world for their hard work. I will begin today's call with an update on our strategy refresh process and value creation opportunities we are focusing on for the near and long term, as well as IFF's recent accomplishments as we execute on our operational priorities. This includes delivering $70 million of cost savings in the first half of the year, taking swift and aggressive pricing action to cover inflation, exiting our microbial control business, and ensuring that we have the right talent in the right roles. I will then turn the call over to Glenn to provide a detailed look at our second quarter financial results and discuss our outlook for the rest of 2022. We will then open the call up for questions.

Beginning with Slide 6, I'd like to provide an update on our efforts to refresh our long-term strategic plan. While we are pleased that IFF holds strong positions across many of our business segments today, we are committed to evaluating and fine-tuning both our strategy and execution to best position the business for long-term profitable growth. I am pleased to share that we are making meaningful progress and moving quickly to map out an exciting and ambitious path forward.

In Q2, we continued to advance our enterprise-widening [Phonetic] view of our business and portfolio to ensure we are well equipped to successfully navigate current and future market conditions while capturing the long-term value. Our goal for this comprehensive evaluation is to further develop the refined operating plan to generate sustainable sales growth by ensuring lasting competitive differentiation through innovation, product superiority, and provide a clear year roadmap where we can execute our priorities to create significant value to all of our stakeholders.

Already, we have successfully completed the foundational phases of the plan. We have identified meaningful opportunities to capture additional profitable growth in attractive end markets, geographies, and cross-platform synergies, while also identifying internal opportunities in near-term external pressures that must be navigated to achieve this. Now, we are working the finalized refreshed operating plans that we -- will align our operating model, talent, and incentives, as well as finalize our long-term financial targets and capital allocation strategy that prioritizes sustainable, long-term growth. In addition, we are strengthening our culture, one that embodies collaboration and accountability to ensure strong execution of our commitments. We will continue to move rapidly and with urgency over the coming months to finalize our reverse -- refresh strategy and look forward to sharing more on this with you at our Capital Markets Day to be held Wednesday, December 7, in New York City.

Moving to Slide 7. I'd like to give a brief snapshot on where we are focusing as we advance our strategic refresh. There are five core areas of focus. First, we are prioritizing a more thoughtful and data-driven approach to our resource allocation strategy. Investment is essential to our future growth, but it is critical that our spending decisions optimize returns and reflect the unique roles that each of our businesses serve in our broader portfolio. I will explain this in more detail in a moment. Similarly, we are also making strategic decisions to support our research and development efforts by focusing on the highest-return projects and identifying ways we can leverage our cross-platform offerings, we will be even better positioned to accelerate topline growth and extend our industry leadership in key categories. Shortly, we will introduce an enhanced productivity program designed to help us improve profitability and unlock additional opportunities to finance our growth opportunities -- and our growth initiatives.

At the same time, we continue to evaluate our portfolio to ensure that our offerings are closely aligned to the markets in which we operate, the evolving expectations of our customers, and with our long-term objectives. We successfully completed the divestiture of our microbial control business and we will continue to assess the portfolio as we explore additional non-core divestitures through the use of debt and improve our capital structure.

Lastly, we are reviewing our operating model to ensure that our structure, talent, and incentives maximize our unmatched portfolio and go-to-market strategy with our customers. Attracting and supporting the industry's best talent and aligning incentives is critical to drive continued collaboration and accountability across the organization. I am focused on making sure we have the right talent to execute our strategic plan and I'm pleased that we recently announced Deb Borg, who will join us as our Chief Human Resources and Diversity and Inclusion Officer on August 29, 2022. With her deep experience connecting HR, culture, employee engagement in business, as well as her change management and expertise, she has the right skillset for IFF in our people as we strengthen our execution-driven culture. She brings an extensive track record of building world-class talent and helping the business to execute and drive value for all stakeholders.

Our success with these initiatives will be supported by our ongoing work to modernize our foundation of data and technology capabilities as we strengthen our internal operations to help ensure best-in-class execution. On Slide 8, I would like to share a bit more about the deliberate choices we are making, specifically how a more strategic and disciplined approach to resource allocation will create exciting opportunities for -- profitable growth.

Across the board, we are focused on driving margin improvements, but to do so effectively, we are pursuing differential management strategy across key areas. Last quarter, I shared an ROIC chart, which was a first glance into the lens that we are viewing the company through. To move forward with this plan, we have developed a comprehensive playbook that segments our business into three distinct market types with unique strategic imperatives. When we look at our portfolio, we will consider whether to invest to grow, maximize to drive efficiencies or optimize to rapidly include performance. Using this model, we remain intently focused on achieving above-market growth, strengthening our competitive global position, increasing our return on invested capital, and analyzing the most valuable use of our existing assets. For example, in a category like flavors, we see meaningful opportunities to drive above-market revenue growth, primarily through reinvesting in innovation and commercial initiatives. We are prioritizing above-market revenue expansion in this category as opposed to margin improvement alone as we are focusing on large, profitable, and faster-growing subcategories like beverages or dairy to drive strong value creation.

Here it is more about reinvesting margin upside to ensure we are bringing the best innovation to our customers to drive dollar profit growth. On the other hand, in a market like animal nutrition, we are focused on maintaining the consistent growth we've delivered with an emphasis on driving further productivity by identifying certain segments in which to reinvest, while strategically reducing R&D expenses and others, we will focus on margin improvement and create opportunities to invest in the highest value offerings.

We are taking a stronger approach within our Optimize businesses. For example, our Pectin business, a popular [Indecipherable] label natural stabilizer to quickly drive near-term earnings through pricing and cost initiatives while maintaining our market competitiveness and reallocating upside to invest to growth categories like flavors. I will also say, for those Optimize businesses where we do not have a strong improvement plan, we will accelerate divestitures and exit the category with work already well underway.

I am excited about this initiative and the progress we are seeing already. Make no mistake, we are running IFF quite differently and bringing enhanced rigor to our operations across every business and function. Earlier this year, we spent time reviewing our key priorities, including pricing and portfolio optimization.

Moving to Slide 9. I would now like to focus on the multi-year productivity and reinvestment program I mentioned earlier, which I believe is key to achieving our long-term growth expectations and our profitability goals. Since joining IFF, I have spent time analyzing our cost profile and believe as an organization, we have significant opportunity to optimize our cost structure. I'm fully committed to unlocking this value and I've asked the team to accelerate our efforts to ensure we are well positioned to execute as we move into the second half of the year.

For more details, I would like to ask Glenn to comment.

Glenn Richter
Executive Vice President, Chief Financial Officer at International Flavors & Fragrances

Thank you, Frank, and good morning and good afternoon to everyone. Accelerating our productivity and expense synergy efforts represents one of our top priorities, and is increasingly important in a more challenging economic environment in order to maximize financial performance. To this end, we want to provide additional transparency to our multi-year productivity program and we expect the results. First of all, let me describe the scope of our efforts. Overall, we have established four productivity efforts that cover approximately 85% of IFF's total cost structure, focused primarily on operations and overhead expenses. The four teams include: supply chain, which includes our procurement and global logistics operations. Opportunities include driving additional efficiencies in direct and indirect material spending through enhanced procurement strategies and demand management, particularly for indirect spend and reduced logistics costs, driven by improved global S&OP processes.

The second team is focused on end-to-end manufacturing operations and includes a broad-based set of initiatives, including accelerating our digital manufacturing efforts, driving yield improvements, system-wide best practices, and energy savings programs. The third initiative is our economic profit team that is focused on leveraging improved technology and disciplined processes to optimize product mix, rationalize SKUs, and enhance make versus buy decisions. And our core team is focused on building out our global shared service platform in concert [Phonetic] with technology to drive increased centralization and process standardization to drive efficiencies across our administrative and business support functions.

In total, the combined programs are targeting a preliminary net annualized P&L impact of $250 million to $300 million that we expect to be achieved between 2023 and 2025. Two important notes: first, this $250 million to $300 million annual impact is net of reinvestments that are targeted to strengthen our innovation pipeline, expand our commercial efforts across key products, customers, and regions, keep our technology and digital capabilities, and strengthen our talent. Secondly, the net savings will be slightly more skewed to 2024 and 2025. We look forward to sharing more details with you at our Investor Day in December.

With that, I'll turn it back to Frank.

Frank Clyburn
Chief Executive Officer at International Flavors & Fragrances

Thank you, Glenn. As I said, we will provide more specifics on this program at our Investor Day in December, but wanted to share an early indication with you as we committed to provide more details on this topic during our Q1 earnings call. More importantly, at our Investor Day, we will also provide you with a more clear and detailed roadmap for growth, including our incremental revenue opportunities from our combination with N&B.

We remain confident that we have significant opportunities ahead confirmed by our initial commercial wins and positive customer feedback as well as our competitors' following our lead. I know that realization of these benefits have been slower than expected due to external factors including COVID, supply chain disruption, customer bandwidth, pricing initiatives, and constrained capacity. However, since joining, I have launched a focused initiative to reinforce our emphasis and address existing gas [Phonetic].

Specifically, we are developing a set of prioritized opportunities, each with clear financial impact, owner and timeline to provide confidence in our ability to deliver. This will be a significant focus for me going forward as I'm committed to delivering the value proposition of our combined portfolio and will be personally involved, dedicating significant time and engagement with the business to drive performance.

I am pleased to say that we continue to see steady wins across our portfolio. Recently, we co-collaborated with a leading alternative protein producer to improve commercial and technical collaboration, essentially upstreaming the incorporation of heritage IFF's Flavors into heritage N&B protein base, exceeding our customers' expectation for plant-based burgers. This resulted in IFF being awarded as a core supplier, one of three, increasing our market share and ensuring a long-term relationship.

In addition, we are seeing the value of integrated solutions between our Nourish and H&B divisions. The dairy category is showing very good collaboration opportunities, thanks in large part to early technical support and a better together approach with customers. In this win, we will step ahead of the competition and do an early engagement with a dairy customer during the culture-development phase, ensuring the best flavor collaboration. These are just two examples with strong proof points that we are moving in the right direction and delivering a better value proposition to our customers.

Now, turning to Slide 10, I'd like to provide an overview of our performance for the first half of the year. Our strong first-half results are once again a testament to the strength of our portfolio and the dedication of our talented global teams will continue to go above and beyond in a complex market. Despite the macroeconomic challenges of the last six months, sales grew by a strong 18% or 12% on a currency-neutral basis to $6.5 billion.

Comparable currency neutral adjusted operating EBITDA grew 8% to $1.4 billion. I am proud to report that we increased our quarterly dividend by approximately 3%, the 13th consecutive year of increased payouts to our shareholders, which underscores our belief in our business and IFF's strong future cash flow generation. We also continue to work on deleveraging objectives where we remain committed to our deleverage target of reducing net debt to EBITDA to less than 3 times, 36 months post the transaction, which is February 1, 2024. At the same time, we prudently and proactively amended the covenants on our existing credit agreements, given the market volatility and uncertainty. Glenn will discuss in more detail.

As I mentioned a bit earlier, we also completed the divestiture of our microbial control business on July 1, and continuing to evaluate additional divestiture opportunities for our non-core assets as we move ahead based on our category management approach I described earlier.

Now, I would like to turn the call back over to Glenn to provide a closer look into our second-quarter financials.

Glenn Richter
Executive Vice President, Chief Financial Officer at International Flavors & Fragrances

Thanks again, Frank. Turning first to our consolidated second-quarter results. IFF generated more than $3 billion in sales, representing 11% year-over-year increase on comparable currency-neutral basis, primarily driven by double-digit growth in Nourish and Pharma Solutions. In terms of our growth contribution, pricing represents the majority with volumes up modestly.

Our focus coming into 2022 was to fully recover inflation through pricing actions. And for the full year, we are on track to recover approximately $1 billion in cost inflation. We are doing so in a very thoughtful and strategic manner, over-indexing on lower margin and capacity-constrained businesses. While foreign exchange rates have had an adverse impact on our sales and EBITDA in the second quarter, I'm pleased to report an adjusted operating EBITDA grew 3% year-over-year on a reported basis or 7% on a comparable currency-neutral basis driven by productivity gains and pricing actions we implemented in the quarter.

We also achieved solid year-over-year earnings per share growth of 3% excluding amortization. Before moving on, I wanted to share that during the second quarter of '22, we took an impairment charge of $120 million within certain entities in Russia due to a number of factors, including reduced business focus as we have restricted our operations to essential consumer products that includes: food, hygiene, and medicine; supply chain issues; reduced product demand and exchange rate volatility; all as the result of the Russia-Ukraine conflict. It was determined that such declines in operating performance were not expected to reverse in the near future and future expected growth is expected to be limited, given the operating conditions in Russia. This non-cash impairment charge was allocated pro rata to intangible assets and property, plant, and equipment within the asset group in the amounts of approximately $92 million and $28 million, respectively.

Moving now to Slide 12, I'll provide a brief overview of the underlying performance across our business segments. As I mentioned, sales growth across each of our business segments including Nourish, Health & Biosciences, Scent, and Pharma Solutions contributed to IFF's year-over-year comparable currency-neutral sales growth of 11%.

Nourish was once again our largest growth driver, with a significant broad-based growth across our flavors, ingredients, and food design businesses. Scent had another strong quarter with currency-neutral sales growth in the high single-digits, led by fine fragrance, consumer fragrance, and ingredients.

Health & Biosciences delivered the mid single-digit growth due to consistent performance in health, cultures and food enzymes, and animal nutrition, as well as microbial control prior to the official divestiture completed in July. Both home and personal care and grain processing were negative in the second quarter as each business had very strong double-digit comparison in the prior year period.

Lastly, we are pleased by Pharma Solutions' continued rebound, having achieved double-digit growth, driven by continued strength in our industrial and pharma businesses. Turning to Slide 13, I'd like to provide a review of our profitability for the quarter. Second quarter adjusted EBITDA totaled $700 million, exceeding our expectations and representing 7% in year-over-year comparable currency-neutral growth, driven by the pricing actions and productivity gains that I mentioned earlier. Our comparable adjusted EBITDA margin in the second quarter was 21.3%, and on an inflation-adjusted basis would have been approximately 220 basis higher, or approximately 23.5% if we normalize for the impact of pricing contribution to sales. This compares to an EBITDA margin of 22% in Q2 for 2021.

As a result of our strategic pricing actions, we have fully recovered total inflation cost-to-date and we are optimistic that we will achieve full dollar cost recovery for the full fiscal year. As we continue navigating this uncertain market, we will continue to closely monitor raw materials and logistics costs in the quarters ahead and take appropriate action to offset additional inflationary pressures and maintain profitability.

On Slide 14 is an overview of our second quarter performance by business segment. Nourish, which delivered year-over-year comparable currency-neutral sales growth of 15% and 18% growth in comparable currency-neutral adjusted operating EBITDA, saw strong demand, particularly in food designs and flavors. In Health & Biosciences, high single-digit increases in health, and cultures and food enzymes, and mid single-digit growth in animal nutrition drove 4% comparable currency-neutral sales growth for the division.

While we implemented strategic pricing actions and saw notable productivity gains similar to Nourish this quarter, lower volumes and unfavorable mix led to 2% year-over-year decrease in comparable currency-neutral adjusted operating EBITDA. In Scent, fine fragrances continue to lead the way with double-digit growth, followed by high single-digit growth in ingredients and low single-digit growth in consumer fragrance. Collectively, Scent achieved year-over-year comparable currency-neutral sales growth of 9% though inflationary pressures outpaced our strategic pricing actions, which led to a 17% decrease in comparable currency-neutral adjusted operating EBITDA.

Our teams are continuing to work with our customers to address these ongoing inflationary pressures and we fully [Indecipherable] to recover all inflationary cost over time. Lastly, Pharma Solutions was one of our strongest performances this quarter, achieving 10% in year-over-year comparable currency-neutral sales growth and an exceptional 25% increase in comparable currency-neutral adjusted operating EBITDA, driven by double-digit growth in industrial and high single-digit growth in pharma. The division's profitability was further supported by pricing actions and productivity gains.

Turning to Slide 15, I would like to discuss our cash flow and leverage positions for the first half results. In our first six months, our free cash flow position was impacted by higher inventory values. This was a result of a combination of continued inflationary pressures and rebuilding inventories to support customer service levels. $336 [Phonetic] million in the first half, representing approximately 3.6% of sales as we continue to make necessary investments in our business. In addition, IFF delivered $402 million in dividends to our shareholders.

From a leverage perspective, we remain well positioned as we advance our strategic refresh. We finished the second quarter with cash and cash equivalents of $569 million, while gross debt for the quarter totaled $12.15 billion. Note that we received $1.3 billion gross proceeds from the sale of our microbial control business in July.

At the end of Q2, we maintained a 4.4 times net debt credit adjusted EBITDA ratio. In addition, just last week, we proactively amended our existing term loan credit agreement and revolving credit agreement in order to ensure we maintain adequate flexibility to navigate near-term market uncertainties. The associated amenity was approximately $800,000. The amended agreement delayed certain step downs from maximum permitted leverage ratio of 4.5 to 1, stepping down to 3.5 to 1 over time, with the first step down now occurring at the end of the third quarter 2023 versus the end of the fourth quarter 2022 previously.

Trailing 12-month credit adjusted EBITDA totaled $2,644 million. As Frank mentioned, on August 3, our Board of Directors authorized a 3% or $0.02 increase in the quarterly dividends at $0.81 per share of the company's common stock. The quarterly dividend is payable on October 5, 2022, to shareholders of record as of September 23. Including this authorization, we increased our quarterly dividend payment for the 13th consecutive year.

Let's now turn to our consolidated outlook on Slide 16. As we look to the remainder of 2022, we remain on track to deliver our commitments and are reconfirming full-year guidance projected sales of $12.6 billion to $13 billion and currency-neutral sales growth of 9% to 12%. While we are reconfirming our outlook, we also are increasingly cautious on the overall market environment outlook as we navigate continued foreign exchange fluctuations, ongoing inflation, and potentially recessionary pressures. We expect to achieve our sales targets through pricing actions as we press ahead for a full dollar cost recovery. We expect foreign exchange pressures to impact sales by approximately 5 percentage points compared to our previously forecasted 4 percentage points. We are also reconfirming adjusted operating EBITDA to the $2.5 billion to $2.6 billion which equates to currency-neutral operating EBITDA growth of 4% to 8%. Please note that we expect foreign exchange to impact that growth by approximately 6 percentage points versus 5 percentage points previously.

As always, we remain laser-focused on mitigating the many macroeconomic challenges with an emphasis on controlling what we can control during these uncertain times. Notably, focusing on pricing execution and productivity. In terms of the third quarter, we expect sales growth to be strong, driven by pricing actions with sales coming in modestly above $3 billion. And impacted by incremental foreign exchange headwinds, some seasonality of our business and the divestiture of microbial control. The sale of microbial control will impact Q3 revenues by approximately $110 million. For the third quarter, we expect adjusted EBITDA to be approximately $600 million to $610 million.

Before passing the call back to Frank, I want to revisit the four-core business objectives we outlined at the beginning of the year. Overall, we are executing well against our operational priorities so far this year. Relative to maintaining strong sales momentum, we achieved 12% year over year currency-neutral sales growth for the first half of '22 and are targeting currency-neutral growth of 9% to 12% for the full year.

In terms of executing our broad-based pricing actions, we fully recovered the total cost of inflation and we remain on track to achieve a full dollar cost recovery for the full-year '22. Importantly, we are closely monitoring inflationary trends in the broader market environment to ensure we are well-equipped to stay ahead and where necessary quickly respond to future challenges.

On the productivity front, we continue to make tremendous progress towards our productivity savings goals for the full year. In the first half of the year, we delivered over $70 million operational efficiencies and deal-related synergies, well above our expectations. We are well on track to exceed our $100 million full-year savings target.

Finally, relative to accelerating non-core divestitures, we successfully completed the sale of our microbial control business on July 1 and are continuing to assess our portfolio to identify additional portfolio optimization and divestiture opportunities in this uncertain market. These divestitures will help us delever our balance sheet and enable us to reinvest in our highest-performing businesses.

With that, I'll pass the call back over to Frank.

Frank Clyburn
Chief Executive Officer at International Flavors & Fragrances

Thanks, Glenn. Before I wrap up today's call, I want to say I am proud of the efforts of our global teams as we continue to execute amid challenging market conditions. We've achieved strong performance in the first half of 2022 and increased our dividend for the 13th consecutive year. I am confident in our ability to achieve our full-year financial targets as we continue executing against our operational priorities and control what we can control. At the same time, we are committed to advancing our strategic transformation efforts, deploying innovation, refining our portfolio, and strengthening our culture to deliver strong value creation for all of our stakeholders.

Moving through the second half of the year, we will be intensely and urgently focused on protecting and growing our business, identifying new strategic value creation opportunities, and communicating our refreshed operating model across the business and the market to position IFF for long-term success. I look forward to sharing more at our upcoming Capital Markets Day in early December.

I'd now like to open the call for any questions. Thank you.

Questions and Answers


[Operator Instructions] And we will take our first question from Mark Astrachan with Stifel. Please go ahead, your line is open.

Mark Astrachan
Analyst at Stifel Nicolaus

Yes, thanks. And good morning, everyone. Wanted to ask about the productivity program and how you're thinking about balancing margin versus volume growth, especially given I think what you said Glenn of modest volume growth in this period, and sort of, how do you think about that going forward? And how we think about net savings as it relates to long-term targets, including implied margin expansion? I think the math would get you something north of 200 basis points in the implied margin, so how do we think about that, longer-term? Thank you.

Frank Clyburn
Chief Executive Officer at International Flavors & Fragrances

Hey, Mark. This is Frank. Good morning. A couple of comments I'll start with. First, the productivity program that we've announced, we see that as really important not only near-term, Mark, but really building a continuing productivity mindset. We want that built into the company. We also want to be able to use that to be able to invest in our growth opportunities.

What we're trying to achieve, Mark, is really sustainable, profitable growth, and to start to really get leverage throughout the P&L. We think that's going to be really important for us from a profile perspective. This is why we've also done the ROIC work, Mark, on our portfolio, and we'll be able to share with you in December some of the specific targets from a financial perspective.


And we'll take our next question from Heidi Vesterinen with BNP Paribas Exane [Phonetic]. Please go ahead, your line is open.

Heidi Vesterinen
Analyst at Exane BNP Paribas

Good morning. So, if we look at your Q2 currency-neutral growth, I understand this is mainly price, while we see that most of your peers had strong volumes this quarter. Why do you think you weren't able to grow volumes? And perhaps you could comment on the exit rate in Q2 in terms of volumes and momentum into Q3, please?

And then, somewhat linked to that, what was the reason for not upgrading or -- upgrading your full-year guidance after such a strong H1 in terms of EBITDA? Thank you.

Glenn Richter
Executive Vice President, Chief Financial Officer at International Flavors & Fragrances

Hi. Good afternoon, Heidi. This is Glenn. Thanks for the questions. Relative to sort of volume comparatives I would sort of maybe answer it three ways. One is, as you're well aware, the compares are difficult given the apples to oranges sometimes comparisons of the business. But I would say that if you really kind of strip our business down and look at sort of the first half results, most of our core business is actually through in quite well. So, Flavors, Scents, or both, mid single-digit in terms of volume growth. Core business units within H&B Health is up high single-digit. Cultures, food enzymes, and nutrition mid single-digits. Pharma is up low single-digit.

So, the difference is, as we discussed throughout the year, will be very thoughtful regarding a balance between volume and profitability. So, we've been very strategic and thoughtful relative to margin enhancement actions and focusing on those businesses that have those capacity constraints and/or are lower margin businesses. So, that's the difference.

We're very specifically trying to focus on making sure we deliver good outcomes for our shareholders as well as our customers from performance. And then lastly, I would note that this is very consistent with what we signaled. We said very early in the year, we were planning basically the balance of the year to be relatively flattish at one point, and this is very consistent with the strategy and how we're implementing it.

Relative to kind of guidance, the reality is the pace at which sort of inflationary pressures flow through raw materials into our cost of goods, it does vary by business. So, there's a little bit of a lag here in terms of how that's hitting quarter-to-quarter that explains some of the overperformance in the quarter, third quarter relative to kind of the full-year outlook. And consequently, because of that lag and this, just generally, a perspective on cautionary outlook given the macro environment, we're being sort of realistic in terms of how we guide. And consequently, we're sticking to the same guidance. So hopefully -- hopefully that's helpful.


And we'll take our next question from Gunther Zechmann with Bernstein. Please go ahead, your line is open.

Gunther Zechmann
Analyst at Sanford C. Bernstein

Good morning, Frank, Glenn, and Mike. Can you talk about the volume contribution within Nourish that you expect in Q3? And how much revenue synergies and integrated solutions are included in that, please?

And then secondly, what is your updated inflation forecast for the year, and any insight that you can share into 2023, please?

Frank Clyburn
Chief Executive Officer at International Flavors & Fragrances

Hi Gunther. It's Frank. I'll get started. So first, with regards to revenue synergies, and as Glenn mentioned, we did see really good performance, especially within Flavors, within Nourish, and we're excited about the significant opportunity we believe we have there.

We also highlighted on the call some examples, Gunther, that we are really encouraged by some of the wins that we're seeing where we're utilizing our legacy N&B expertise as well as legacy IFF expertise for vanilla [Phonetic] flavor, it's an important win there. We highlighted an important win with regards to plant-based burgers, we're seeing good cross-selling opportunity.

So, overall, we're starting to see revenue synergies and we're hearing good positive feedback from our customers. With that said, Gunther, there's work to be done. And I highlighted that on the prepared remarks. This is something that's going to be a significant area of focus for myself, personally, as well as the executive team. We're going to be leaning into how do we bring our broader platform portfolio technology to our customers.

So this is something we'll share a lot more about in our December Capital Markets Day. Glenn, I don't know if you want to maybe touch on inflation?

Glenn Richter
Executive Vice President, Chief Financial Officer at International Flavors & Fragrances

Sure. Yeah. Good afternoon, Gunther. Relative to 2022, it's still choppy. But in general, no change to our outlook relative to the impact of inflation. Generally, energy has been slightly better, logistics has been slightly better, raw materials have been slightly worse in pockets. But generally, things are sort of stable.

I would also note that just the nature of the time it takes raw materials to go through inventory and show up in the P&L, any additional impact of the balance of the year is likely to be muted to zero and really hit 2023. We are taking a very deep look at '23. We've run through a preliminary scenario. We're doing an update in the coming weeks here as we plan for 2023. And our perspective at this point is we do anticipate another, I'll say, meaningful round of cost increase from inflation. That's going to be concentrating our view more in raw materials.

So, there's a number of areas including soy, oils; obviously certain commodity groups such as agricultural grains, and those sort of things, we're seeing pretty significant inflation. Energy is choppy but likely to also be some increase modestly in energy prices. And logistics as well, we're likely to see some sort of modest increase as well. So, kind of, overall, we are expecting, probably '23 not to the same degree as '22, but we are expecting additional inflationary pressures for next year.


We'll go next to Mike Sison with Wells Fargo. Please go ahead, your line is open.

Michael Sison
Analyst at Wells Fargo & Company

Hey guys. Nice quarter and outlook. In terms of free cash flow performance for 2Q, any more color maybe by segment, what's sort of driving that consumption? And then I think you were hoping to do about $1 billion in positive free cash flow in '22, can you make up some of this in the second half of the year?

Glenn Richter
Executive Vice President, Chief Financial Officer at International Flavors & Fragrances

Yeah, so good, good question, Mike. The sole impact is where there's seasonality, as you know. So typically, in the first half of the year, first quarter, there is a build on working capital, namely inventories; secondarily, there is the year-end compensation that basically gets paid out, etc.

We are running actually worse on cash flow than anticipated to the tune of about $200 million, that is 100% attributable to higher inventory levels, that is principally related to basically higher costs. So, as you may recall, when we entered the year, we had our kind of wave one inflation, subsequent, very early in the year. We identified another significant round of inflation coming through, that is rolling into inventory. So, as a byproduct of that, we had guided to the full year that we'd be relatively flat to prior year from a free cash flow standpoint of about $1 billion-ish. We are sort of targeting to be probably at about $200 million less than that this point in time.

That being said, we are implementing a series of very important initiatives, largely against the legacy N&B businesses. In terms of putting in new S&OP processes and enhancements, we're hopeful that those will drive some efficiencies. You'd be able to bring some inventory levels, but I'd say, best guess at this point is probably $800 million-ish versus the original $1 billion.


And we'll go next to Adam Samuelson with Goldman Sachs. Please go ahead, your line is open.

Adam Samuelson
Analyst at The Goldman Sachs Group

Hi. Yes. Thanks. Good morning, everyone. So, I guess I wanted to come back to the inflation and cost question. I appreciate there is a [Technical Issues] business, but help us just balance -- think about the price-cost balance in the second half, specifically?

And I think you answered the year having been behind on price cost from '21 and hoping you'd be catching up to that into '23, is there still -- do you still see -- or still have line of sight to recapturing kind of that price cost and balance on a cumulative basis in '23?

And I guess along those lines, can you talk about the actions you're taking to maybe try to shorten some of the price lags in some of the businesses, I think, price [Phonetic] is a little bit more in the Scent business segment this quarter, but how -- what can we do to maybe compress that -- the length of those inventories and cost cycles? Thank you.

Glenn Richter
Executive Vice President, Chief Financial Officer at International Flavors & Fragrances

Yeah. Hey, Adam. Thanks for the question. I said -- a couple of answers. One is just relative to this year, I'd say, we're slightly ahead i.e. price versus cost, back to how things roll through inventory, slightly behind the second half of the year. That's part of the reason for the -- how one thinks about the balance of the year implied guidance versus kind of the first half of the year. So, that's a piece of it.

We normally -- 18 months would be the full lag from inflation to capture. You can see that, it's sort of manifesting itself differently by business. Scent is the one that's the furthest behind from a timing, given the nature of the relatively large customers, and generally are indices tag to the contracts from the standpoint. And we would fully expect that to continue to be the case.

The only question mark here is how one thinks about '23. So, as I just mentioned in my prior answer to Mike is that, we probably are going to see another round of inflation come through. So, from that standpoint, it may be 18 months from the first round, but we may have a continuous sort of rounds of inflation to catch up, which would suggest probably late '23 or even '24 if that's the case.

But to your last part of your question, and obviously, we've all been in a very unprecedented environment relative to pricing, and that's required us to sort of rethink traditional contracts. And the way we've been rethinking them is to some extent just having realistic discussions with our customers on these, a level of inflation and having to share the burden. And then, in addition, just rethinking contracts in terms of the frequency. So, as opposed to annual, semi-annual, or other types of sort of open to -- more open agreements relative to the changes in the marketplace.

So, that's been a bigger factor relative to the contracts we put in place. And I suspect that will prevail in the future as well as we think about '23.


And we'll take our next question from John Roberts with Credit Suisse. Please go ahead, your line is open.

John Roberts
Analyst at Credit Suisse Group

Thanks, Glenn. I think you earlier had quantified as three or four divestments for $1.5 billion to $1.7 billion in expected proceeds. Is that still the right ballpark target as you look at the portfolio?

And then, to your comments on inflation and higher working capital, so a way to think about how much is just oil prices working their way down the supply chain, and it's just taking time to get to you versus structural, the European gas constraints, and China rotating lockdowns and logistics stuff, can you separate oil prices or commodity prices versus the structural issues you're facing?

Glenn Richter
Executive Vice President, Chief Financial Officer at International Flavors & Fragrances

Yeah. Good question, John. So, relative to our outlook for divestitures, we still think the $1.5 billion to $1.7 billion gross proceeds, three to four transactions completed by the end of next year is in the right ballpark. The market, as you're well aware, has slowed down. So, the level of M&A activity is substantially less with the volatility in the credit markets that has made it more difficult, particularly for private equity investors. However, the size of our transactions -- you can just do the simple math, aren't that large. They tend to be sort of nice strategic fits for other businesses.

So, from an initial dialog standpoint, the interest level seems very good. So, we think that the things may be a little slower from a process standpoint, but we're still fairly confident that we will hit [Phonetic] our target.

Relative to sort of broader global supply or how one thinks about inventory over the longer cycle, about half of our growth -- of our dollar growth of inventories is related to inflation this year, and about half is related to higher inventory levels, as higher inventory levels if you recall were to basically improve our customer service levels because we had low inventories, again, in the legacy N&B businesses.

I will say though I'm increasingly confident that through the implementation of improved S&OP processes across a number of our businesses, that will allow us to actually reduce some of those higher inventories.

The third thing you mentioned is really the global supply chain. Clearly, we like everybody have an extended supply chain, i.e., there's more product sitting on the water for longer times, there is more inventory buffer stock in our system, etc., to basically accommodate for the volatility in the market. We're actually thinking about what that means longer-term in terms of working capital, and I suspect by the end of this year, we'll be able to sort of come back and provide some visibility on that.

But I do think, at the end of the day, that will be a meaningful improvement opportunity, not just for ourselves, but for everyone as the supply chain gets back to order.


And we'll take our next question from David Begleiter with Deutsche Bank. Please go ahead, your line is open.

David Begleiter
Analyst at Deutsche Bank Aktiengesellschaft

Thank you. Good morning. Frank and Glenn, where are you seeing initial signs of demand weakness either by geography or by business?

And secondly, if we do go into a deeper downturn, what -- what [Indecipherable] can would you pull to offset this -- offset that downturn? Thank you.

Frank Clyburn
Chief Executive Officer at International Flavors & Fragrances

Hey David. It's Frank. Thanks for the question. A couple of thoughts. From the demand weakness perspective, the geography that we are seeing, it's probably no surprise, is really China. We had the lockdowns and we did see an impact, clearly in the second quarter. And just to recall there, China is our second largest market. So, that's been somewhat of a challenge for us.

And then if you think about our portfolio, on the positive side, as Glenn mentioned, we did see good growth in health, cultures, and food enzymes, flavors, fine and [Phonetic] consumer fragrances were all set, so a positive. If you think about the resiliency of our portfolio, we feel overall cautiously optimistic. One would anticipate as pressures continue to mount, fine fragrances may be somewhat of a challenge.

As we think about the additional levers and this is what we're really staring into, but if you listen to the more prepared remarks, clearly productivity is going to be continuously important for us. And that's something that we are spending a lot of time on as a team and thinking about levers there. Glenn has already spoken about our pricing and our working with customers to really do everything we can to recoup the inflation that we're seeing.

And then the other lever we have is really staying close to our customers -- our global key account teams, our customer insight teams are really trying to be as quick and agile as possible working with our customers to make sure we have good connection with them to understand kind of what we're seeing in the marketplace.

So, those are all levers that we are focused on. But it's also why we feel good on our recommitment of our guidance; both the topline and 9% to 12% growth range. And then also, our EBITDA range of 48% [Phonetic]. So, that's why we feel comfortable and confident in reconfirming our guidance today.


And we'll take our next question from Ghansham Panjabi with Baird. Please go ahead, your line is open.

Ghansham Panjabi
Analyst at Robert W. Baird

Thank you and good day, everybody. I just wanted to -- first up, a follow-up on the last question as it relates to new product development. I mean, have you seen any signs of slowing as major customers sort of worry about consumer elasticity on a global basis?

And then on Slide 16, Frank, where we talked about preparing for more uncertain market conditions, including the recession, how do you think the portfolio is positioned as we potentially go into some level of macroeconomic slowdown? I'm just asking in context of your leverage profile at current [Phonetic].

Frank Clyburn
Chief Executive Officer at International Flavors & Fragrances

Yeah, so on the resiliency as I mentioned, we feel overall cautiously optimistic on the portfolio. Clearly, there is a part of moving pieces right now, but if you think about food and beverage, you think about health, you think about what we have seen resiliency from our pharma business, so we feel our overall like the portfolio going into possibly some challenging times is really well-positioned overall, and I've kind of highlighted that fine fragrances may be an area that we start to see some pullback from a demand perspective.

As far as the innovation question in our portfolio, there are some customers that are going to really focus on our core offerings and they're going to maybe not think about the new offerings at this point in time. However, we still are seeing very strong signals of customers wanting to innovate, co-develop, and work with us, and really excited about our pipeline and portfolio. And my belief is they're still going to be critically important for the future, and something that we'll spend time in December, really sharing with you why we're excited about our pipeline and portfolio. That's going to be really key for us.

So yes, you will see some customers' focus in the near term, maybe on core offerings. However, as we look out, we're still seeing signals from customers that are working with us and integration is going to be really important to the future.

Glenn Richter
Executive Vice President, Chief Financial Officer at International Flavors & Fragrances

Yeah. And if I can maybe just add to that relative to the leverage question, Ghansham, is that, as Frank indicated, and as you're well aware, this business is highly resilient through cycles. So, you may be down a couple percent -- you may have some temporary transition, quarter or two, as customers sort of destock inventories.

But in general -- you don't see massive swings in terms of volume. Secondarily, very importantly, we do believe that sort of pricing resiliency and being able to continue to sustain by passing inflation through which is helpful. Third, productivity, as we've mentioned, is sort of a major driver here that's sort of offset some of the potential demand drop in the marketplace.

And then in general, a slowdown probably helps other elements of working capital such as inventory's more stable as well. And maybe even slower capex investment. So, not only from a P&L standpoint, but from a cash flow, very resilient to sort of manage through this cycle, particularly with the success in pricing and the focus on productivity.


And we will take our next question from Josh Spector with UBS. Please go ahead, your line is open.

Joshua Spector
Analyst at UBS Group

Yeah, hi. Thanks for taking my question. I just wanted to follow up on Nourish, and particularly in the quarter, segment margins were much higher than our expectations; I believe higher than your expectations. You talk about the visibility of raw materials flowing through your system, so I'm curious really what went better in the quarter? And why can't something like that occur in the next couple of quarters? What's different versus what happened this quarter? Thanks.

Glenn Richter
Executive Vice President, Chief Financial Officer at International Flavors & Fragrances

Yeah, I think -- hey, good question, Josh. It really is related to the sort of the matching of the build in inventories relative to the flow-through as a sales. And as mentioned, we've sort of built inventories. And at this point, we think we're going to be fairly -- i.e., the raw materials have come through. Raw materials are generally sort of static from a cost standpoint, so we do expect them to sort of run through the next quarter. So -- and wouldn't expect to have this, I'll say, artificial pickup from a timing standpoint.


And we'll take our next question from Chris Parkinson with Mizuho. Please go ahead, your line is open.

Christopher Parkinson
Analyst at Mizuho

Great. Thank you so much for taking my questions. So, we've hit on price cost, we've hit on productivity. When we look out -- obviously, there's some uncertainty in the second half of the year, but when we look out into '23, '24, and -- Frank, now that you've had some time to look at your four primary businesses, can you talk about just any potential mix enrichment, specifically in H&B, and anything else that could really help us try to compartmentalize your longer-term margin opportunities across segments? Just any quick thoughts. Thank you.

Frank Clyburn
Chief Executive Officer at International Flavors & Fragrances

Yeah, Chris, just, I mean, we'll spend some time in December around the portfolio in particular. This is why we have really looked at our business through the ROIC lens that we've spoken about. And you can see the three categories that we highlighted, invest-to-grow, and then also, maintaining our business, and then some that we actually have to really improve or exit.

We're excited that we have significant opportunities within the invest-to-grow area, and I highlighted flavors -- we've highlighted health and food and culture enzyme businesses. So there is, we think, significant profitable opportunities for very good growth, big categories. The categories are growing very strong in end market, so we're excited about that, Chris.

And then also, we will continue to take a very disciplined approach overall to areas where we do not think we are the best owners, and Glenn highlighted our divestiture strategy will continue to do that as well.

So all in all, we feel good about the portfolio. And like I said, we'll impact a lot more of that when we get to December.


And we will go next to Jeffrey Zekauskas with JPMorgan. Please go ahead, your line is open.

Jeffrey Zekauskas
Analyst at JPMorgan Chase & Co.

Thanks very much. The margin compression in Scent was weaker from the first quarter to the second quarter, that is weak -- weaker sequentially. That seems to be the one business where -- you've not had the same profit resiliency and why is that?

And for Glenn, your deferred tax line in your funds flow was an outflow of $178 million, and for the full year, last year, it was an outflow of $236 million. What's going on with your taxes so that you have this cash outflow?

Glenn Richter
Executive Vice President, Chief Financial Officer at International Flavors & Fragrances

Jeff, to your [Phonetic] answer, the first question or the second question?

Michael DeVeau
Chief Investor Relations & Communications Officer at International Flavors & Fragrances

He's off. You can go.

Glenn Richter
Executive Vice President, Chief Financial Officer at International Flavors & Fragrances

Okay, sorry. Okay. So, your first question was relative to us, the Scent trend and --

Frank Clyburn
Chief Executive Officer at International Flavors & Fragrances

Quarterly performance.

Glenn Richter
Executive Vice President, Chief Financial Officer at International Flavors & Fragrances

So, the reality is that two things: one, there were some one-time expenses in the second quarter relative to Scent. And secondarily, as we mentioned that there has been two rounds of inflation. So, as we've talked, it's a little bit -- it's more of a lag in that business from a standpoint. So, if you think about the few rounds of impact, that's basically coming through and there's a bit of delay. Relative to taxes, there's lots of -- every year, it should have -- Jeffrey, there's lots of ebbs and flows depending on what's happening across various parts of the globe in terms of our tax positions and settlement.

So, if everything is actually trending fine versus sort of our expectations at this point in time, there's nothing sort of abnormal from a year-over-year standpoint. But do appreciate the question.


And we can take our --

Frank Clyburn
Chief Executive Officer at International Flavors & Fragrances

Still good. We can go to the next one.


[Speech Overlap] I think we will take our final question from Matthew DeYoe with Bank of America. Please go ahead, your line is open.

Matthew DeYoe
Analyst at Bank of America

Hi. Morning, everyone. If I were to look at the top line, can I just on a rough cut basis, what percent of your sales or businesses fall into the Invest category versus Maximize versus Optimize?

Frank Clyburn
Chief Executive Officer at International Flavors & Fragrances

Hey. And thanks for that question. And that's something that, at this time, we're not prepared to share the different cuts percentage-wise. What I would share is that we do have really good opportunities in the invest-to-grow category.

And as I mentioned, we'll clearly unpack that a little bit more as we get into December and Investor Day, and really share the excitement we have around the portfolio as well as the opportunities. But right now, we're not prepared to share the specific percentages. Okay?


And there are no further questions at this time, I'll turn the call back over to Frank Clyburn for any closing remarks.

Frank Clyburn
Chief Executive Officer at International Flavors & Fragrances

So, I would like to just thank everyone for joining the call and I'll also thank all of our IFF colleagues once again around the world. We feel very proud of our first half business performance and the results, and we know that the teams around the world continue to work with our customers to bring innovation and to help our customers to be successful in the marketplace. And we look forward to seeing you at our third quarter call as well as once again our Capital Markets Day on December 7. And hope everyone has a good rest of the morning. Thank you.


[Operator Closing Remarks]

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