At this time, I would like to welcome everyone to the IFF Third Quarter 2023 Earnings Conference Call. [Operator Instructions] I would now like to introduce Michael DeVeau, Head of Investor Relations. You may begin.

Thank you. Good morning, good afternoon and good evening, everyone. Welcome to IFF's Third Quarter 2023 Conference Call. Yesterday afternoon, we issued a press release announcing our financial results. A copy of the release can be found on our IR website at ir.iff.com. Please note that this call is being recorded live and will be available for replay. Please take a moment to review our forward-looking statements. During the call, we'll be making forward-looking statements about the company's performance and business outlook. These statements are based on how we see things today and contain elements of uncertainty. For additional information concerning the factors that can cause actual results to differ materially, please refer to our cautionary statement and risk factors contained in our 10-K and press release. Today's presentation will include non-GAAP financial measures, which exclude those items that we believe affect comparability. A reconciliation of these non-GAAP financial measures to their respective GAAP measures is set forth in our press release. With me on the call today is our CEO, Frank Clyburn; and our Executive Vice President and Chief Financial and Business Transformation Officer, Glenn Richter. We will begin with prepared remarks and then take any questions you may have at the end. With that, I would now like to turn the call over to Frank.

Thank you, Mike, and hello, everyone, and thank you for joining us. On today's call, I will begin by providing an overview of our performance in the third quarter and an update on our strong execution to position IFF for long-term success. I will then turn the call over to Glenn, who will provide a more detailed look at our third quarter financial results by business and discuss our outlook for the remainder of 2023. We will then open the call for questions. Moving to Slide 6. Our third quarter story is one of sequential improvement. As we've discussed, improving volumes has been a top priority, and we are pleased with the sequential volume improvements that we have achieved across the majority of our business. On a total company basis, while our volume in the third quarter was down mid-single digits, it was a marked improvement from our Q2 lows where we saw a double-digit decline. Similarly, our enhanced productivity initiatives as well as favorable price to inflation led to strong adjusted operating EBITDA results. Sequentially, our adjusted operating EBITDA margin finished at 17.9%, which is a 50 basis point improvement versus the second quarter of 2023. And our focus on ongoing working capital improvements drove strong free cash flow generation. In particular, the continued execution of our inventory reduction program has resulted in more than a $600 million reduction in inventory since the end of 2022. This was the largest driver of our free cash flow, which improved $320 million versus the second quarter of '23. The net result is that we delivered higher than our expectations on both the top and bottom line. At the same time, our commercial excellence initiatives in our R&D platform continue to drive improvements in our sales pipeline. In addition, in Functional Ingredients,…

Thank you, Frank, and good morning, good afternoon and good evening, everyone. Taking a closer look at our profitability performance on Slide 8. As Frank mentioned, we delivered higher-than-expected EBITDA of $506 million in the third quarter. While we continue to benefit from favorable price to inflation and productivity gains, as you can see from the slide, ongoing volume pressures impacted our profitability in the quarter. While we are encouraged by the sequential volume improvement, we have seen across most of our portfolio, it remained the primary pressure in Q3. If we look at our profitability performance, absent the unfavorable manufacturing absorption related to our inventory improvement program, adjusted operating EBITDA would have declined 6% year-over-year on a comparable currency-neutral basis. Note that our negative absorption in the quarter was less than expected as our inventory reduction program for the year has run its course and volumes have improved. We have done a good job at driving working capital improvement through our inventory reduction program, driving more than $600 million reduction in inventory since the end of '22. As a result, at this time, we are now expecting approximately a $165 million impact from negative absorption to profitability for the full year, down from $180 million. This could also flex further as the fourth quarter unfolds. To reiterate, this is a onetime transitory impact to the P&L in order to maximize cash flow moving forward. Turning to Slide 9. I'll provide a closer look at our Q3 performance by business segment. In Nourish, sales declined 7% on a comparable currency-neutral basis, driven mainly by the continued weakness in Functional Ingredients. While Functional Ingredients remained a main driver of weakness in Nourish in the third quarter, we did see sequential improvement and expect this to continue as we move into the…

Thank you, Glenn. Let me start by saying that I am tremendously proud of what our teams have accomplished in the last quarter to advance our focused strategic initiatives and build a stronger, more resilient IFF. Our improved performance, productivity gains and reaffirmed financial guidance reflect the hard work of our global teams that continue to support our long-term vision. We executed against our strategic priorities in Q3, and we'll continue to take action in Q4 to build a stronger IFF, better positioned to accelerate growth, expand margins and deliver value for shareholders. Finally, looking at our business more broadly, we will continue to pursue portfolio optimization initiatives to strengthen our capital structure. As we've discussed previously, we are laser-focused on investing in our highest-return businesses while positioning our less margin-accretive businesses for success, either through new ownership or through focused improvement plans, such as those we're pursuing for Functional Ingredients. Our goal, as we move through the end of 2023 and beyond is to ensure that each of our businesses has the resources and where appropriate, the ownership most conducive to accelerating our growth, expanding our margins and maximizing our long-term returns as we continue to innovate for customers worldwide. With that, I will now open up the call for questions.

[Operator Instructions] Our first question comes from the line of Gunther Zechmann with Bernstein.

Frank, my question to you. Could you please talk about the development in the Functional Ingredients 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 top line and the ramp-up, what you mentioned around the fixed cost measures that you're taking would be great.

Gunther, it’s Frank. A couple of things. One, with regards to Functional Ingredients, the business clearly across all of ingredients is stabilizing, Gunther, and we saw good sequential improvement when I look at Q2 to Q3, in particular, in 3 of the biggest business lines, core texturants, some 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 key dairy and bakery end market categories. As far as the Functional Ingredient plan overall, we’re focused in 3 areas: one, enhance our go-to-market approach; two, 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, we’ve also reviewed our organization and we’re in the process of adjusting our operating model, Gunther, to drive greater efficiencies throughout. And at the same time, we have 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 is urgently acting to drive better performance across Functional Ingredients. And the net result of this Gunther will be – we’re very confident we can grow sales in line with the market and deliver a mid-teen adjusted operating EBITDA margin over the next 3 years. Thanks for the question.

Our next question comes from the line of Mike Sison with Wells Fargo.

Nice quarter. Frank, deleveraging is an important part of your thesis going forward. And can you maybe provide an update on your divestiture process? I think there's press out there that Pharma potentially is up for sale and how that fits in your strategy?

Mike, it's Glenn. Why don't I attempt to start it, and then Frank can sort of add into it. So just we have been very transparent for many, many quarters that continue to enhance the portfolio, i.e., 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 Meyers Cosmetics for $810 million gross proceeds. That should net about $730 million net. All of that will be used for divestitures. And the company went for a circa 18 multiple based on this year's forecast earnings. So we're pleased by that. We have a number of 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 3x or less leverage ratio. Relative to your question around Pharma. Pharma is a very good business. It's a sticky business. It's in 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 IFF, 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. It has a relatively high-return business, which is the excipients, all that 75% and then has a lower return, more industrial business on that. So I think that -- I don't know, Frank, do you want to add anything else to that?

No, I think we can go. Yes.

Our next question comes from the line of Nicola Tang with BNP Paribas.

Actually, Frank and Glenn, you both commented that volume performance improved sequentially through Q3, and you pointed to signs of green shoots. So I was wondering if you could give more color either 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 overall, do you think that destocking is now behind us?

Thanks for the question. It was interesting to see literally essentially every single sub-business within Nourish, H&B and Scent 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 general, the HPC categories were stronger from an absolute volume standpoint than 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. They had a plus 12% in terms of volumes. So there’s a bit of an overlap. We had 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 normalization from the standpoint. Relative to your question on destocking, it’s very difficult to say per se. However, our feedback from our business is, we would say that the majority of the customers at this point are either done or expected to be winding down by the end of the fourth quarter. I think the one segment that’s a little bit of a lagger is Pharma. The Pharma business in terms of the customers started destocking a little bit later. It has a meaningful distributor component of the business as well and also the industrial side. And I think that’s also been reflected very clearly in the competitive side for the Pharma business as well. So knock on wood, things are sort of moving very broad based across the entire business.

Our next question comes from the line of John Roberts with Mizuho.

Scent benefited from favorable price versus raws. Was that both sequential and year-over-year? Are you getting more price sequentially? And how are you thinking about 2024?

John, this is Glenn again. By the way, welcome to your new home. So relative to Scents, sequentially, it’s relatively neutral, Q2 to Q3 in terms of the net price versus cost, although it is less moving, less price and more cost. 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 and Fine Fragrance, our final pricing actions were implemented at the beginning of this year. So really what we’re now beginning to do – and there was some implementation in the second quarter of last year, so we’re now sort of fully overlapped last year from a neutrality standpoint, and what we’ll be seeing more is the cost reduction. One important asterisk, we have a percent of our business, as you know, that’s basically sells ingredients. About 50% of the production is used for our own products and 50% sold. There’s a commodity component such as turpentine as an example, Galaxolide, 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.

Our next question comes from the line of Mark Astrachan with Stifel.

So I guess I'm curious about how you think about your volume performance relative to peers as it appears that they're 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. 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?

Mark, it’s Frank. Let me take that one. And a couple of things that I really wanted to highlight on this question. So first, we spent a lot of time, obviously, with our teams throughout the quarter and at the end of the quarter, looking at our competitive dynamics and how we are positioned. And to highlight, maybe if 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 a very well positioned against our competitive set. Health & Biosciences, you actually saw growth versus prior year, Mark, which was very encouraging. And in fact, you saw growth in Cultures & Food Enzymes, Animal Nutrition. Home & Personal Care was a good growth quarter for us. Grain Processing, good growth from a sales perspective as well. And then if I look at our Scent business, our Scent business actually grew above market, Mark. Consumer Fragrance above market. So clearly growing market share there. And then also our Fine Fragrance business had good performance. So I feel really good about this Scent 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 our 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 is 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 about 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 that’s 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 overall business is sequentially improving and is in a really good position as we head into 2024.

Our next question comes from the line of David Begleiter with Deutsche Bank.

Frank, on Pharma Solutions, can you comment on the sequential margin decline? Was it more mix or more costs? And what does this mean for you, do you think for margins in Q4 and next year for Pharma?

Yes, David. So Pharma, as we mentioned, the comparison versus prior year, as we highlighted, was a 28% growth. Last year with a lot of shipment catch-up as we implemented in some SAP shipments that went into Q3 of ‘22. And then EBITDA growth last year was 76%. So that was the comparator versus last year. And obviously, you can see that we’re down 9% on the top line this year because of that comparator. If you look sequentially, Mark, 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 – what should I say, our core Pharma business is well positioned with our customers. So destocking by our distributors, rightsizing inventory, temporary in nature, and we feel good about the growth potential performance as we go into ‘24 and beyond.

Our next question comes from the line of Adam Samuelson with Goldman Sachs.

So Glenn, in your prepared remarks and 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. Obviously, there's the absence of the inventory absorption charges, the inventory write-off in the second quarter. You've got headwinds on incentive comp, and if you can quantify that? It doesn't sound like there's a lot -- at this point, should we be thinking about a lot of price cost tailwinds? You're going to have the divestiture kind of impact. But can you help us think about productivity kind of savings that we should be kind of thinking about going into 2024 on a year-over-year basis? And then from there, is the major swing really just volumes and the operating leverage associated with that? Or is there anything else that you would highlight?

Thank you, Adam. So let me kind of break that down into 2 components. One, just normalizing, I’ll say, the onetime items from this year into next year and then talk a little bit about 2024. In terms of normalizing this year, first thing you do is you have to take out $75 million of EBITDA related to divestitures. So that’s roughly 6 months of Savory Solutions and then FSI, or Fragrance Specialty Ingredients business. And then basically a full year directionally for LMC, that’s about $75 million in earnings. In addition, you have to add back the impact of absorption which goes away. That absorption is related to the inventory reduction. So as we’ve mentioned, we’ve taken out nearly $600 million of volume-related inventory this year. That’s about $165 million benefit. On top of that, the LBK write-off in the second quarter was $44 million. And then lastly, in terms of sort of add normal items, I would add about $25 million of additional benefit associated with the annualization of our headcount reduction program this year. Offsetting that, as you mentioned, is roughly $70 million-ish of basically truing up our incentive plans back to 100% given this is a challenging year, they’ll pay out at a lower percentage. So those are the normalized items I would take the sort of baseline the 2023 results. Candidly, relative to ‘24, we are – we’ll be prepared to have a very fulsome discussion at the February call. We’re in mid-planning process right now. We’re working with all the businesses in terms of their plans from volume, net price, procurement on deflation, productivity programs, et cetera. So it’s a little early to talk about those components at this point, but we promise you, we’ll have a very detailed discussion in February.

Our next question comes from the line of Patrick Cunningham with Citi.

Just a follow-up on positive absorption or just absorption coming off next year. What percentage of the portfolio is build-to-order versus build-to-stock? And are there any specific businesses where that split is skewed towards one or the other?

Yes. And I wouldn't say that those that are built-to-order don't have absorption impact because they do. But to answer your question, we're roughly 55% build-to-stock, 45% build-to-order in terms of the overall portfolio. So the build-to-stock is more the legacy DuPont or N&B portfolio versus a legacy FNF for the build-to-order. So as a result, that Nourish is split, probably slightly more build-to-stock and build-to-order, but a combination of the Ingredients business, the food systems and then the -- obviously, the Flavors business, the H&B and Pharma businesses are largely build-to-stock and the Scent business is largely build-to-order.

Our next question comes from the line of Lauren Lieberman with Barclays.

I was curious if you guys could talk a little bit about pricing. Pricing in the quarter came through a bit stronger, I think, than we had anticipated. And so just curious about that because I didn't think that there was any incremental pricing going through. So maybe it was just sort of stickiness, but would love some detail on that.

Yes. It’s more related to deflation than price per se. Pricing – actually, all of our pricing was implemented earlier this year. We really have not been implementing any more pricing actions this year. So it’s really been the favorability associated with deflation that enhance our earnings versus expectations.

Our next question comes from the line of Josh Spector with UBS.

So I was just wondering if you could give an update on free cash flow. What your expectations are for this year now? And just given you scaled back your inventory, I guess your manufacturing headwind from inventory adjustments, does that mean you're done? Or is there more opportunistic inventory reduction to do to shore up free cash flow further?

So the second part – Josh, this is Glenn. So the second part of your question, we are largely done with the inventory reductions. We’re basically going to be largely flatlined for the balance of the year. Relative to our free cash flow estimates for the year, they are unchanged versus our previous quarter. We will be, call it, circa $450 million on reported free cash flow for the year. I will note, once again, that includes about $440 million-ish of Reg G items. So we’re right around $900 million of adjusted free cash flow for the year. Just as a reminder of those Reg G items, they’re broken down into about a little over half of them, call it, about $240 million are literally associated with our divestitures. A big portion of those are taxes, not surprisingly. We also have another roughly $80 million of the final integration costs. Those are associated with systems conversion and legal entity changes from DuPont. Those will be completed this year. And then there’s about $75 million-ish related to restructure. That’s from the implementation of this year, and then, call it, $50 million-ish sort of all other related expenses. So that’s sort of a breakdown of the Reg G items.

The next question will come from the line of Laurence Alexander with Jefferies.

Can you update how much of your business ex Pharma is in the fix or shift category? And how much it needs to improve in aggregate or on average for you to be happy with it? I mean like not just like a minimum threshold, but what your like 3- to 5-year target might be?

When you reference fix or shift, I'm assuming you're talking about the Ingredients business, so is that correct?

Most of it, but I guess I'm fishing for if you have anything else that you're now putting in that category?

That's largely -- it's 90% of it. And as we mentioned, that business is of our total businesses about 20% to 25% of the total portfolio. And Frank outlined on the call previously, the major initiatives. It will take some time to fully implement those initiatives. So we are seeing some progression improvement in the business. But we're ways away from sort of getting back to sort of the full historical level of both earnings profile and growth. Our target is to go from largely a high single-digit EBITDA margin level to mid-teens and to basically get the business basically growing in line with the industry which historically has been sort of on a volume basis, 1% to 2% a year.

And this is Frank. What I would add is on that 20% Glenn mentions and a number of those have – assets have been disposed and we continue down the path of optimizing our portfolio as we’ve highlighted. And then within Functional Ingredients, as we’ve mentioned, we are making good progress, as I highlighted earlier, and that’s really where the majority of the improvement area needs to be. But I don’t want to lose also sight of the 80% or so of the businesses we’ve been highlighting today that has seen good sequential improvement in a number of businesses that actually grew versus prior year.

Our next question comes from the line of Silke Kueck with JPMorgan.

Is there a $70 million SG&A benefit this year from the compensation changes? And did most of that occur in the third quarter? And secondly, if there's a $160 million headwind from unfavorable manufacturing absorption, which is 150 basis points headwind to gross margin. Do you expect as a base case, your gross margin to be up by 150 basis points next year? And do you need volume growth in order to achieve that?

I think to the second question, you should definitely normalize the absorption as a starting point. The ultimate margin dynamics for next year, which we’ll discuss in more detail in February, will be a combination of mix, volume growth and ultimately, any additional sort of price inflationary pressures. So it’s a complex. I don’t think you can just straight line the improvement. I think you can reset the baseline, but then you have to sort of think through all the variables of what’s driving the gross margin rate for next year. So we’ll park that, come back to that in February. The $70 million that we've referenced really are the savings from headcount reductions we've implemented this year. So as a reminder, there was a program that where we’ve targeted $100 million of annualized cost reduction, so roughly $70 million, $75 million of that this year and then about $25 million will be the annualized impact. It’s all been implemented. So it’s all done. So it’s really just a timing element of that. And then lastly, there’s always some choppiness quarter-to-quarter because of accruals around variable incentives. So depending on up or down, things can get trued up and can be a little bit choppy. So that does affect the quarter-to-quarter RSA as well.

Our next question comes from the line of Salvator Tiano with Bank of America.

Yes. I wanted to ask if you can remind us a little bit your exposure to some of the key soybean -- sorry, well, to the soybean price as well as to key oil seeds, vegetable oils? And whether the recent -- previously decline in some of these edible oils can be a meaningful contributor to '24 EBITDA?

I would say 2 things. We have a very, very large basket of raws. So there’s lots of things moving in either direction. In general, the cost trends or deflation trends are working in our favor. So that’s a general statement. Relative to soy, we do actually lock in over time. We typically hedge out for a period. So we don’t necessarily always capture either the immediate upside or downside, but over the longer arc, obviously, as those prices decline, we capture it.

Our next question comes from the line of Andrew Keches with Barclays.

Congrats on the quarter. Just to confirm, in the past, you've mentioned the 3.0x net debt-to-EBITDA as a level you plan to hit in 2024. So I guess just based on where you are in the asset sale discussions, do you still have confidence and visibility into achieving that level next year? Or is there some risk that, that gets extended? I know the covenant horizon was pushed out about a year to early '26. So any help on the time line would be great.

We are -- great question, Andrew. We're very confident that relative to our current M&A activity in the market, it will allow us to accomplish our goal of 3x or less. And it should be -- we should be able to accomplish it by the end of next year. This is always a -- there's always, I'll say, a timing element relative to closing transactions given the separation, legal entity changes, those sort of things. But barring sort of a normal path, we should be in good shape by the end of next year.

That will conclude the question-and-answer session. I will now turn the call over to Frank for closing remarks.

So first, I want to start by thanking all of our IFF FERC colleagues around the world and all of the tremendous work that they are focused on to really help our customers and to continue to innovate. Our vision as a company is truly to be the innovative leader in essential solutions, and we’re very proud of the progress that we’re making through this quarter. And I also want to thank everyone for joining our call. We look forward to our fourth quarter update and full year guidance for ‘24 update in February, and I wish everyone well, and thanks for joining our call.

That concludes today's conference call. Thank you for your participation. I hope you have a wonderful rest of your day.