Q3 2023 International Flavors & Fragrances Inc Earnings Call
[music].
At this time I would like to welcome everyone to the I S. S third quarter 2023 earnings conference call.
All participants will be in a listen only mode until the formal question and answer portion of the call to ask a question at that time. Please press star one on your telephone keypad. If you would like to remove your name from the queue. Please press star two parts.
Participants will be announced by their name and company.
In order to give all participants an opportunity to ask their questions. We request a limit of one question per person.
I would now like to introduce Michael Deveau head of Investor Relations you may begin.
Thank you good morning, good afternoon, and good evening, everyone. Welcome to Iff's third quarter 2023 conference call yesterday afternoon, we issued a press release announcing our financial results.
A copy of the release can be found on our IR website at IR <unk> 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 could cause actual results to differ materially. Please refer to our cautionary statement and risk factors contained in our 10-K and press release.
Today's presentation will include non-GAAP financial measures, which exclude those items that we believe affect comparability.
A reconciliation of these non-GAAP financial measures to their respective GAAP measures is set forth in our press release.
With me on the call today is our CEO, Craig Claiborne, and our executive Vice President and Chief financial and business transformation Officer, Glenn Director.
We will begin with prepared remarks, and then take any questions that you may have at the end with that I would now like to turn the call over to Frank.
Thank you, Mike and Hello, everyone and thank you for joining us on today's call I will begin by providing an overview of our performance in the third quarter and an update on our strong execution to position <unk>.
For long term success.
I will then turn the call over to Glenn who will provide a more detailed look at our third quarter financial results by business and discuss our outlook for the remainder of 2023, we will then open the call for questions.
Moving to slide six our third quarter story is one of sequential improvement as we've discussed improving volumes has been a top priority and we are pleased with the sequential volume improvements that we have achieved across the majority of our business on a total company basis wallet.
Volume in the third quarter was down mid single digits. It was a marked improvement from our Q2 lows, where we saw a double digit decline.
Similarly, our enhanced productivity initiatives as well as favorable price to inflation led to strong adjusted operating EBIT results.
Sequentially, our adjusted operating EBITDA margin finished at 17, 9%, which is a 50 basis point improvement versus the second quarter of 2023.
And our focus on ongoing working capital improvements drove strong free cash flow generation in particular, the continued execution of our inventory reduction program has resulted in more than a 600 million dollar reduction in inventory since the end of 2022.
This was the largest driver of our free cash flow, which improved $320 million versus the second quarter of 'twenty three.
The net result is.
Is that we delivered higher than our expectations on both the top and bottom line.
At the same time, our commercial excellence initiatives and our R&D platform continue to drive improvements in our sales pipeline. In addition, and functional ingredients as discussed on our second quarter call. We are implementing a targeted operational improvement plan to improve sales execution strength.
Our operating model and reshape the portfolio as we shared previously we expect this plan for functional ingredients will translate into low single digit comparable currency neutral sales growth in line with the market and a mid teen adjusted operating EBITDA margin over the next three years with.
The strong improvement in 2024, and while this will take time, we are seeing improvements in our volume performance, where we finished the quarter down mid teens versus low 20% declines in Q2 of 2023.
With this momentum we have increased confidence in our ability to deliver within our previously announced full year 2003 sales guidance range and we are now targeting the mid to high end of our full year 2023, adjusted operating EBITDA guidance range.
As Glen will highlight we are seeing signs of green shoots in the fourth quarter with stabilization and improvements across several parts of our business. Lastly, we've made important progress against our portfolio optimization initiatives as we are rapidly addressing our capital structure.
Most notably align with our best owner mindset, we announced an agreement to sell Lucas Meyer cosmetics, the specialty chemical company Clariant for $810 million, which is equivalent to a high teens multiple based on our projections, we expect to complete the transaction in the early <unk>.
Part of the first quarter of 2024, and all proceeds will support our deleveraging priorities.
Moving forward, we continue to pursue strategic non core divestitures that will drive further deleverage and enable us to further prioritize our fastest growing margin accretive businesses and deliver long term value for shareholders.
Moving to slide seven in the third quarter <unk> generated $2 8 billion in sales, representing a 3% decline on a comparable currency neutral basis, our strong performance in scent and health and Biosciences was more than offset by softness in nourish in pharma solutions as I am.
Mentioned volumes improved sequentially across nearly all businesses with restrict particularly strong performance in scent and health and Biosciences.
Excluding functional ingredients, which continues to disproportionately impact our results overall volume decline low single digits in the third quarter adjusted operating EBITDA for the quarter was $506 million down 10% year over year on a comparable currency neutral basis.
Our favorable net price to inflation as well as enhanced productivity gains were more than offset by lower volumes due primarily to temporary customer destocking and unfavorable manufacturing cost absorption.
Adjusted EPS, excluding amortization was 89.
Primarily impacted by lower profitability now I will turn it over to Glenn to provide more detail on profitability and our performance by business segment.
Frank and good morning, good afternoon, and good evening, everyone, taking a closer look at our profitability performance on slide eight as Frank mentioned, we delivered higher than expected EBITDA of $506 million in the third quarter.
While we continue to benefit from favorable price to inflation and productivity gains as you can see from this slide ongoing volume pressures impacted our profitability in the quarter.
We are encouraged by the sequential volume improvement.
<unk> seen across most of our portfolio. It remained the primary pressure in Q3.
If we look at our profitability performance absent the unfavorable manufacturing absorption related to our inventory improvement program adjusted operating EBITDA would have declined 6% year over year on a comparable currency neutral basis.
Note that our negative absorption in the quarter was less than expected as our inventory reduction program for the year as Brian Its course and volumes have improved we have done a good job at driving working capital improvement through our inventory reduction program driving more than $600 million reduction inventory since the end of 'twenty two.
As a result at this time, we are now expecting approximately a 165 million impact from negative absorption to profitability for the full year down from $180 million.
This could also flex further as the fourth quarter unfolds to reiterate this is a onetime transitory impact to the P&L in order to maximize cash flow moving forward.
Turning to slide nine I will provide a closer look at our Q3 performance by business segment.
In Europe sales declined 7% on a comparable currency neutral basis, driven mainly by the continued weakness in functional ingredients.
Functional ingredients remains a main driver of weakness in Europe in the third quarter, we did see sequential improvement and expect this to continue as we move into the fourth quarter good growth in our flavors business and the positive impact of Iff's ongoing pricing actions and productivity initiatives were more than offset by.
Lower volumes and unfavorable manufacturing absorption.
Together this led to a 26% year over year decrease in comparable currency neutral adjusted operating EBITDA.
<unk> Bioscience continued to deliver strong results in Q3 led by meaningful growth in cultures enzymes grain processing home and personal care and animal nutrition, leading to comparable currency neutral growth of 2% year over year price increases and productivity gains.
Led to a 12% year over year increase in comparable currency neutral adjusted operating EBITDA.
<unk> was once again, our strongest performer delivering 7% growth in comparable currency neutral sales driven by double digit growth in consumer fragrance and high single digit growth in fine fragrance like health and Biosciences.
<unk> also saw strong 19% growth in comparable currency neutral adjusted operating EBITDA with profitability driven by favorable net pricing and productivity gains.
Pharma solutions growth rate was pressured this quarter in large part to a very strong prior year comparison with a 28% 2022 sales growth comparison, and a 76% 22 adjusted operating EBITDA comparison.
This increases and productivity gains for this business were more than offset by lower volumes and comparable currency neutral sales declined 9% and comparable currency neutral adjusted operating EBITDA declined 34% in the quarter.
Now on slide 10, I'll discuss our cash flow and leverage position.
Cash flow from operations totaled 795 million, a significant increase reflecting a strong improvement in inventory levels capex year to date was $390 million or approximately four 4% of sales.
Our inventory reduction program and working capital improvements have also greatly contribute to ISS improved free cash flow performance, which total $405 million a significant increase of $320 million from the second quarter year.
Year to date, we also distributed $619 million in dividends to our shareholders.
Our cash and cash equivalents totaled $652 million, which includes $23 million in assets held for sale. Additionally.
Additionally, gross debt for the quarter totaled approximately $10 3 billion with a net debt to credit adjusted EBITDA of four six times, our trailing 12 month credit adjusted EBITDA totaled approximately $2 1 billion.
We're making good progress on working down our debt levels and as Frank mentioned earlier portfolio optimization remains a near term priority as we work to reduce our leverage position and ensure our resources are focused on the businesses that will carry our success into the future.
The sale of our cosmetic ingredients business, which is expected to close in the early part of the first quarter of 2024 will further support our strengthened capital structure as we pay down debt in line with our net debt to adjusted EBITDA targets.
Now on slide 11, I would like to focus on our consolidated outlook for the rest of the year.
First we are reaffirming our full year revenue guidance range of 11, three to 11 6 billion, which reflects the improved momentum we are seeing across the majority of our business and accounts for the macroeconomic environment and foreign exchange impact, which we expect will persist through the end of the year on.
Bottom line, we are now expecting to deliver full year 2023, adjusted operating EBITDA at the mid to high end of our previously announced guidance of $1 $85 billion to $2 billion, driven primarily by favorable price to inflation and improved productivity.
We also now expect full year interest expense to be slightly higher at approximately $450 million.
Our projected effective tax rate for the year is expected to be approximately 21%. The same estimate we provided last quarter.
Finally, as we look to the fourth quarter, we continued to expect an improving trend and a majority of our businesses as we navigate the macroeconomic challenges impacting our industry. We are seeing signs of green shoots in the fourth quarter with stabilization improvements across several parts of our business.
As we near the end of the year I know many of you have questions on 2020 for.
While the macroeconomic environment remains volatile with low visibility we are optimistic heading into the new year. We have several one off items that we have high level of confidence will be tailwind, including significant negative absorption related to our successful inventory reduction program and.
One time, Lukas being kernel inventory write down.
Also we will continue to execute on our cost and productivity initiatives and have a carryover benefit from this years restructuring program.
These of course will be partially offset by a reset of our annual incentive compensation program, where we have reduced payments in 2023 related to our performance versus target.
In the end improved volume performance will be critical to our success and we believe that destocking will largely be done as we exit the year and we also believe we will benefit from the acceleration of our strategic transformation initiatives.
We will provide our 2024 guidance with our fourth quarter results, which we expect to be towards the end of February with that I'll turn the call back over to Frank for closing remarks.
Thank you Glenn let me start by saying that I am tremendously proud of what our teams have accomplished in the last quarter to advance our focused strategic initiatives and build a stronger more resilient.
Our improved performance productivity gains and reaffirmed financial guidance reflect the hard work of our global teams that continue to support our long term vision.
We executed against our strategic priorities in Q3 and will continue to take action in Q4 to build a stronger better positioned to accelerate growth expand margins and deliver value for shareholders.
Finally, looking at our business more broadly we will continue to pursue portfolio optimization initiatives to strengthen our capital structure.
As we've discussed previously we are laser focused on investing in our highest return businesses, while positioning our less margin accretive businesses for success, either through new ownership or through focused improvement plans such as those we are pursuing for functional ingredients.
Our goal as we move through the end of 2023 and beyond is to ensure that each of our businesses has the resources and where appropriate the ownership most conducive to accelerating our growth expanding our margins and maximizing our long term returns as we continue to.
For customers worldwide with that I will now open up the call for questions.
Thank you we will now begin the question and answer session. So as a reminder to register a question. It is star one hour.
Our first question comes from the line of Gunther Zechman with Bernstein your.
Your line is now open.
Hi, Good morning, everyone. Frank My question to you is could.
Could you please talk about the development in the functional ingredients as part of the business.
It looks like a V shaped recovery, but any color you could give around the moving parts within that business on the topline and the ramp of what you mentioned around the fixed cost measures.
That you are taking would be great. Thank you.
Hey, John It's Ryan Good afternoon. Good morning, a couple of things one with regards to the functional ingredients business clearly across all of ingredients is stabilizing got there and we saw good sequential improvement when I look at Q2 to Q3 in particular.
And three of the biggest business lines core texturing, the multipliers sweeteners and protein solutions. Good sequential improvement. So that's a very positive sign for us and obviously those products are going into some of our tea dairy and bakery end market categories as far as the functional ingredient plant.
Overall, we are focused in three areas one enhance our go to market approach to drive operational efficiencies and three really reshaping the product portfolio and since we've announced we've added targeted commercial professionals to pursue incremental opportunities with our customers.
<unk>.
We have also reviewed our organization and we're in the process of adjusting our operating model to drive greater efficiencies throughout and at the same time, we Havent completed a full review of our product lines and we're in the process of investing behind our strongest products as well as rationalizing those that are underperforming team.
Urgently acting to drive better performance across functional ingredients and the net result of that has gone through it will be.
Very confident we can grow sales in line with the market and deliver mid teen adjusted operating EBITDA margin over the next three years. Thanks for the question.
Yes.
Thank you.
Our next question comes from the line of Mike Sison with Wells Fargo. Your line is now open.
Hey, good morning, guys nice quarter.
Frank.
Deleveraging is an important part of your.
Our thesis going forward.
Can you maybe provide an update on on your divestiture process I think there is.
Press out there that pharma potentially is out for sale and how that fits into your strategy.
Hey, Mike It's Glen why don't I attempt to start it and then Frank can sort of add into it and good morning to you.
So we have been very transparent for many many quarters that.
Continue to enhance the portfolio refine it is the key enabler of getting to our future leverage goals.
We were pleased to announce in the quarter the sale of Lucas Meyer's cosmetics for $810 million gross proceeds that shouldn't at about 730 net all of that will be used for divestitures and the company went for a circa 18 multiple based on this years forecast earnings. So we're pleased by that we have a number.
Other additional portfolio actions underway.
We have not publicly mentioned pharma, but as you noted it's in the press from that standpoint, we are confident that these actions will get us to where we need to which is a three times or less levered.
Our leverage ratio relative to your question around pharma pharma is a very good business, it's a sticky business.
A very healthy sector.
In terms of the pharma business, but candidly it has relatively limited overlap in terms of end customers for the rest of ISS. There are limited revenue or other synergies across the complex with.
Pharma and to answer your question regarding.
How pharma fits into our overall framework as a reminder, pharma was sort of in the middle of the pack in terms of ROIC has a relatively high return business, which is the excipient call that 75% of them has a lower return more industrial business on that so I think Frank you want add anything else to that.
Thank you thanks, Mike Thanks, Mike Thank you.
Thank you.
Our next question comes from the line of Nicola Tang with <unk>. Your line is now open.
Hi, everyone and thanks for taking the question.
Frank actually if I can go out and you guys commented that sluggish performance improved sequentially from Q3, and you pointed to signs of Green shoots I was wondering if you could give some more color.
Neither by division or by specific end markets in terms of where you're seeing that improvement.
And what's your latest assessment of customer inventory levels or do you think that Destocking is now behind us.
Next question.
Yes.
Good morning, or good afternoon Nikola Thanks for the question. It was interesting to see literally essentially every single sub business within <unk> <unk> had a sequential improvement in volumes from Q2 to Q3. So it was very broad based in terms of the performance improvements we saw I'd say in <unk>.
General the HBC categories were stronger from an absolute volume standpoint in the food and Bev, which is not surprising given what's happening from a consumer demand standpoint.
Pharma was the one exception pharma actually had volumes down I would note, though they had an incredibly strong third quarter of last year, we had a plus 12% in terms of volume. So there's a bit of an overlap we have converted a system in Q2 of last year. So there was a bit of a backlog of orders, which were cleared up in Q3, so a little bit of a normal.
<unk> from the standpoint relative to your question on Destocking, it's very difficult to say per se. However.
Our feedback from our businesses, we would say that the majority of the customers. At this point are either done or are expected to be winding down by the end of the fourth quarter I think the one segment, that's a little bit of a laggard as pharma the.
The pharma business in terms of the customers started destocking a little bit later as a meaningful distributor component of the business as well and also the industrial side and I think Thats also been reflected very clearly in the competitive set for the pharma business as well so knock on wood things are moving very broad based across the entire <unk>.
<unk>.
Thank you.
Thank you.
Our next question comes from the line of John Roberts with Mizuho. Your line is now open.
Thank you.
<unk> benefited from favorable price versus raws is that.
Both sequential and year over year are you getting more price sequentially and how are you thinking about 2024.
Hey, John This is Glenn again, hey by the way welcome to your new home so relative to <unk>.
<unk>, it's relatively neutral Q2 to Q3 in terms of the net price versus cost.
It is less moving less price and more costs. So we're now seeing the effects of the deflation basically moving through more so and year over year slightly higher in the third quarter versus the second quarter as a reminder, in our core markets being the consumer in fine fragrance.
Final pricing actions were implemented at the beginning of this year. So really what we're now beginning to do it and there was a some implementation in the second quarter of last year. So we're now sort of that fully overlap last year's from our neutrality standpoint, and what we'll be seeing more of the cost.
Reduction one important Astro we have a percent of our business as you know that's basically sells ingredients about 50% of the production is use for our own products at 50% sold there's a commodity components such as turbine turpentine as an example, <unk> light, which is somewhat commoditized. So the pricing dynamic is.
A little bit more on a downward cycle given those categories, but in general the net price cost is generally very stable in the scent business. So thanks for the question.
Thank you.
Our next question comes from the line of Mark Astrachan with Stifel. Your line is now open.
Yeah.
Thanks, Good morning, everybody so.
I'm curious about how you think about your volume performance relative to peers is it appears that there is still.
Outgrowing.
You all I suppose somewhat related maybe to the last question, but bigger picture it looks like pricing was a much smaller contributor sequentially.
Sequentially does that factor into how you think about volumes and then just lastly tied together when do you think your sales can go back to the long term algorithm. Thank you.
Hey, Mark it's Frank let me take that one in a couple of things.
That I really wanted to highlight on this question. So first we spent a lot of time, obviously, what our teams.
Throughout the quarter and at the end of the quarter looking at our <unk>.
Competitive dynamics and how we are positioned and to highlight maybe you could give me a minute just to walk through some of our key business lines. So flavors for instance, Mark we actually grew the business this quarter and.
Feel very good about our performance in particular in North America, and Greater Asia and are very well positioned against our competitive set.
Health <unk> Biosciences, you actually saw growth versus prior year, Mark which was very encouraging.
<unk>.
So growth in poultry in food enzymes animal nutrition.
Home and personal care was a good growth quarter for screening process and good growth from a sales perspective as well and then if I look at our <unk> business, our <unk> business actually grew above market Mark consumer fragrance above market. So clearly growing market share there and then also our fine fragrance.
<unk>.
Had good performance, so I feel really good about the performance versus prior year and then also as we've already highlighted across just about all of our business lines. Good sequential improvement. So when I look at the overall business I feel really good about.
The sequential improvement the one area that we do have disproportionate volume declines versus our competitors as we've highlighted this functional ingredients. If you were to exclude functional ingredients mark our volume would be down low single digits. So we feel as though we're well within our peer set there and like I said, we feel very.
Good above the majority of our business and how we're performing.
And then the other one that we have highlighted mark was with regards to pharma, but pharma as we've mentioned had a very strong competitive quarter last year. So thats more of a competitive issue for us in this quarter compared to last quarter of last year, but all in all Mark we feel as though the AUM.
All businesses are sequentially improving.
<unk> and <unk>.
A really good position as we head into 2024.
Thank you.
Our next question comes from the line of David Begleiter with Deutsche Bank. Your line is now open.
Thank you good morning.
Frank on the <unk>.
Pharma solutions can you comment on the sequential margin decline was it more mix or more or more costs and what does this mean for you do thing for margins in Q4 and next year for format. Thank you.
Yes, David So pharma as we mentioned.
Parison versus prior year as we highlighted was a 28% growth.
Last year with a lot of shipments catch up as we implemented and some SAP ship.
Shipments that went into Q3 of 'twenty two.
EBITDA growth last year was 76% so that was the comparator versus last year.
So you can see that were down 9% on the top line. This year because of that comparator. If you look sequentially. Marc you do see some choppiness as Glenn highlighted earlier there are some distributors that are starting to rightsize inventory.
In this business.
That is something that we see more of a destocking as we ended kind of Q3 and as we go into Q4, we anticipate that the inventory Destocking will continue with that said, we think it's temporary in nature I have no concerns about the overall outlook for the pharma business very sticky.
Business, our core pharma position is.
Well I should say, our core pharma business is well positioned with our customers. So destocking by our distributors to rightsize the inventory temporary in nature and we feel good about the growth potential perform as we go into 'twenty four and beyond.
Thank you.
Your next question comes from the line of Adam Samuelson with Goldman Sachs. Your line is now open.
Yes. Thank you good morning, everyone.
So Glenn.
In your prepared remarks was hoping you could just maybe elaborate a little bit around some of the high level puts and takes.
As they stand today for 2024 EBITDA versus 2023.
Do you see there is the absolute.
Inventory.