Stryker Q2 2022 Earnings Call Transcript

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Provided by Quartr
August 9, 2022

There are 9 speakers on the call.

Operator

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

Speaker 1

Thank you. Good morning, good afternoon and good evening, everyone. Welcome to IFF's Q2 2022 Conference Call. Yesterday afternoon, we distributed a press release announcing our financial results. A copy of the release can be found on our IR website at ir.

Speaker 1

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're making forward looking statements about the company's performance, Particularly with regard to the outlook for the second half and full year twenty twenty two. These statements are based on how we see things today and contain elements of uncertainty.

Speaker 1

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 ks 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.

Speaker 2

Right talent in the right roles. I will then turn the call over to Glenn to provide a detailed look at our Q2 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 Exciting an ambitious path forward.

Speaker 2

In Q2, we continue to advance our enterprise wide review of our business While capturing long term value. Our goal for this comprehensive evaluation is to further develop the refined operating plan 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 And near term external pressures that must be navigated to achieve this. Now we are working to finalize refreshed operating plans That we will align our operating model, talent and incentives as well as finalize our long term financial targets 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 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.

Speaker 2

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 5 core areas of focus. 1st, we are prioritizing a more thoughtful and data driven approach 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 details in a moment.

Speaker 2

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 top line 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 initiatives. At the same time, we continue to evaluate our portfolio To ensure that our offerings closely align 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 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 In aligning incentives, it's critical to drive continued collaboration and accountability across the organization.

Speaker 2

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 Ward, Who will join us as our Chief Human Resource and Diversity and Inclusion Officer on August 29, With her deep experience connecting HR, culture, employee engagement and business, As well as her change management expertise, she has the right skill set for ISS and our people As we strengthen our execution driven culture, she brings an extensive track record of building world class talent and helping the business Our success with these initiatives will be supported by our ongoing work To modernize our foundation on 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 1st glimpse into the lens that we are viewing the company through. To move forward with this plan, we have developed a comprehensive playbook When we look at our portfolio, we will consider whether to invest to grow, maximize to drive efficiencies We're optimized to rapidly improve performance.

Speaker 2

Using this model, we remain intensely focused on achieving above market growth, Strengthening our competitive global position, increasing our return on invested capital and analyzing the most valuable use 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 and D expenses and others, we will focus on margin improvement and create opportunities We are taking a stronger approach within our optimized businesses. For example, Our Pectin business, a popular clean label natural stabilizer to quickly drive near term earnings Pricing and cost initiatives, while maintaining our market competitiveness and reallocating upside to invest I will also say for those optimized businesses where we do not have a strong improvement plan, 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.

Speaker 2

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 multiyear 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 am fully committed to unlocking this value And have asked the team to accelerate our efforts to ensure we are well positioned to execute as we move

Speaker 3

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 In order to maximize financial performance. To this end, we want to provide additional transparency to our multiyear productivity program and the expected results. First of all, let me describe the scope of our efforts. Overall, we have established 4 The efforts that cover approximately 85 percent of IFS total cost structure focus primarily on operations and overhead expenses.

Speaker 3

The 4 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 and 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 3rd initiative is our economic profit team that is focused on leveraging improved technology and disciplined processes And our 4th team is focused on building out our global shared service platform in concert 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 and L impact of $250,000,000 to $300,000,000 That we expect to be achieved between 2023 2025.

Speaker 3

2 important notes. First, this $250,000,000 to $300,000,000 annual impact is net of reinvestments that are targeted to Strengthen our innovation pipeline, expand our commercial efforts across key products, customers and regions, We look forward to sharing more details with you at our Investor Day in December. With that, I'll turn it back to Frank.

Speaker 2

Thank you, Glenn. As I said, we will provide more specifics on this program at our Investor Today in December, we wanted to share an early indication with you as we committed to provide more details on this topic More importantly, at our Investor Day, we will also provide you with a 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 focus initiative to reinforce our emphasis and address existing gaps. Specifically, we are developing a set of prioritized opportunities, each with clear financial impact, As I'm committed to delivering the value proposition of our combined portfolio and will be personally involved dedicating significant I am pleased to say that we continue to see steady wins across our portfolio.

Speaker 2

Recently, we co collaborated with a leading alternative protein producer to improve commercial and technical collaboration, Essentially upstreaming the incorporation of heritage IFF flavors into heritage and indeed protein base, Exceeding our customers' expectation for plant based burgers. This resulted in IFF being awarded as a core supplier, 1 of 3, increasing our market share and ensuring a long term relationship. In addition, we are The value of integrated solutions between our Marish and H and 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 were a step ahead of the competition due to early engagement with a dairy customer During culture development phase, ensuring the best flavor collaboration.

Speaker 2

These are just two examples, But 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 Once again, a testament to the strength of our portfolio and the dedication of our talented global teams We have continued to go above and beyond in a complex market. Despite the macroeconomic challenges of the last 6 months, Sales grew by a strong 18% or 12% on a currency neutral basis to $6,500,000,000 Comparable currency neutral adjusted operating EBITDA grew 8% to $1,400,000,000 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 3x 36 months post the transaction, which is February 1, 2024.

Speaker 2

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 Glen to provide a

Speaker 3

Thanks again, Frank. Turning first to our consolidated second quarter results, ISF generated more than $3,000,000,000 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 represented 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 $1,000,000,000 in cost inflation.

Speaker 3

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 2nd quarter, I'm pleased to report that adjusted operating EBITDA grew 3% Productivity gains and pricing actions we implemented in the quarter. We also achieved solid year over year earnings per share growth of 3%, Before moving on, I wanted to share that during the Q2 of 'twenty two, We took an impairment charge of $120,000,000 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 include food, hygiene and medicine, Supply chain issues, reduced product demand and exchange rate volatility, all as a 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 $92,000,000 $28,000,000 respectively.

Speaker 3

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 and Biosciences, Sense 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. Scenthe had another strong quarter with currency neutral sales growth in the high single digits Led by Fine Fragrance, Consumer Fragrance and Ingredients. Health and Biosciences delivered 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.

Speaker 3

Both Home and Personal Care And grain processing were negative in the 2nd 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 provide a review of our profitability for the quarter. 2nd quarter adjusted EBITDA totaled $700,000,000 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 2nd quarter was 21.3% and on an inflation adjusted basis would have been approximately 220 basis higher or approximately 23.5 percent if we normalize for the impact of pricing contribution to sales. This compares to an EBITDA margin of 22% in Q2 of 2021.

Speaker 3

We will continue to closely monitor raw materials and logistics costs in the quarters ahead and take appropriate action to offset additional inflationary pressures On Slide 14 is an overview of our 2nd quarter performance by business segment. Nourish, which delivered year over year comparable currency neutral sales growth of 15% and 18% growth In Health and 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 an 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%, So inflationary pressures outpaced our strategic pricing actions, which led to a 17% Decrease in comparable currency neutral adjusted operating EBITDA.

Speaker 3

Our teams are continuing to work with our customers to address ongoing inflationary pressures and we fully anticipate to recover all inflationary costs over time. Lastly, Pharma Solutions was one of our strongest performers this quarter, achieving 10% in year over year comparable currency 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 Further supported by pricing actions and productivity gains. Turning to Slide 15, I would like to discuss our cash to $36,000,000 in the first half, representing approximately 3.6% of sales As we continue to make necessary investments in our business. In addition, IFF delivered $402,000,000 in dividends to our shareholders.

Speaker 3

From a leverage perspective, we remain well positioned as we advance our strategic refresh. We finished the 2nd quarter with cash and cash equivalents of $569,000,000 while gross debt for the quarter totaled $12,150,000,000 Note that we received the $1,300,000,000 gross proceeds from the sale of our microbial control business in July. At the end of Q2, we maintained a 4.4x 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 Sure, we maintain adequate flexibility to navigate near term market uncertainties. The associated amendment fee was approximately 800,000 The amended agreements delay certain step downs from maximum permitted leverage ratio of 4.5:one, Stepping down to 3.5:one over time with the first step down now occurring at the end of the third quarter 2023 versus the end of the Q4 2022 previously.

Speaker 3

Trailing 12 month credit adjusted EBITDA Total $2,644,000,000 As Frank mentioned, on August 3, our Board of Directors authorized a 3% or $0.02 increase in the quarterly dividend to $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 $12,600,000,000 The $13,000,000,000 in currency neutral sales growth of 9% to 12%.

Speaker 3

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 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 be 2 point $5,000,000,000 to $2,600,000,000 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 In terms of the Q3, we expect sales growth to be strong driven by pricing actions with sales coming in modestly above $3,000,000,000 The sale of Incrobio Control will impact Q3 revenues by approximately $110,000,000 For the Q3, we expect Adjusted EBITDA to be approximately $600,000,000 to $610,000,000 Before passing the call back to Frank, I want to revisit the 4 core business objectives we outlined at the beginning of the year.

Speaker 3

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 'twenty 2. 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 Well above our expectations. We are well on track to exceed our $100,000,000 full year savings target.

Speaker 3

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.

Speaker 2

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 twenty twenty two 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.

Speaker 2

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

Operator

And we will take our first question from Mark Astrachan with Stifel. Please go ahead. Your line is open.

Speaker 4

Yes, thanks and good morning everyone.

Speaker 1

I wanted to ask

Speaker 4

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, How do you think about that going forward and how do 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 implied margins. How do we think about that longer term? Thank you.

Speaker 2

Hey, Mark, this is Frank. Good morning. A couple of comments I'll start with. 1st, 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 and L.

Speaker 2

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.

Operator

And we'll take our next question from Heidi Vesterinen with BNP Paribas. Exane. Please go ahead. Your line is open.

Speaker 5

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 Volumes and momentum into Q3, please. And then somewhat linked to that, what was the reason for not upgrading your full year guidance after such a

Speaker 3

Good afternoon, Heidi. This is Glenn. Thanks for the questions. Relative to sort of volume comparatives, I would sort of maybe answer it 3 ways. 1 is, As you're well aware, the comparisons are difficult given the apples to oranges sometimes comparisons of the business.

Speaker 3

But I would say that if you really kind of Our business down and look at sort of the first half results. Most of our core businesses actually are delivering quite well. So flavors, scents are both mid single digit in terms of volume growth. Core business units within H and D, health is up High single digit, cultures, food enzymes, animal nutrition, mid single digits, pharma is up low single digits. So The difference is as we've discussed throughout the year, we're being very thoughtful regarding a balance between volume and profitability.

Speaker 3

So we've been very strategic and thoughtful relative to margin enhancement actions and focusing on those businesses that have both capacities constraints and Our lower margin businesses, so that's the difference. We're very specifically trying to focus on making sure we deliver good outcomes for our And then lastly, I would note that this is very consistent with what we signaled. We've said very early in the year, we were planning basically the balance of The year to be relatively flattish to 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.

Speaker 3

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 over performance in the quarter, 3rd quarter relative to kind of the full year outlook and consequently because of that lag and 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. Hopefully, that's helpful.

Operator

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

Speaker 6

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?

Speaker 2

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 NARISH 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 and B expertise as well as It's a legacy IFF expertise for vanilla flavor is an important win there. We highlighted an important win with regards We're seeing good cross selling opportunities.

Speaker 2

So overall, we're starting to see revenue We're hearing good positive feedback from our customers. With that said, Duncan, 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 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 Sure.

Speaker 3

Yes. 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 Better raw materials have been slightly worse in buckets, 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 and L, any additional impact for the balance of the year is likely to be muted to 0 and really hit 2023.

Speaker 3

We are taking a very deep look at 2023. We've run through it in a preliminary scenario. We're doing an update in the coming weeks 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 concentrated in our view more in raw materials. So there's a number of areas including Oil, 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.

Speaker 3

We're likely to see some sort of modest increase as well. So kind of overall, we are expecting probably 'twenty three, not to the same degree

Operator

to Mike Sison with Wells Fargo. Please go ahead. Your line is open.

Speaker 3

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 $1,000,000,000 in positive free cash flow in 'twenty two. Can you make up some of this in the second half of the year? Yes.

Speaker 3

So good question, Mike. The sole impact is well, there's seasonality, as you know. So typically in the First half of the year, first quarter, there's a build on working capital, namely inventories. Secondarily, there's the year end Compensation that basically gets paid out, etcetera. We are running actually worse On cash flow than anticipated to the tune of about $200,000,000 that is 100% attributable to higher inventory levels That is principally related to basically higher costs.

Speaker 3

So as you may recall, when we entered the year, we had our Kind of wave 1 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 $1,000,000,000 We're sort of targeting to be probably about $200,000,000 less than that at this point in time. That being said, we are implementing series of very important initiatives Largely against the legacy N and B businesses, in terms of putting in new S and OP processes and enhancements, we're hopeful that those will drive efficiencies, I. E.

Speaker 3

Be able to bring some inventory levels, but I'd say best guess at this point is probably $800 ish versus the original $1,000,000,000

Operator

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

Speaker 7

Yes, thanks. Good morning, everyone. So I guess I wanted to come back to the inflation and cost question. I appreciate there's a business, but Help us just balance think about the price cost balance in the second half specifically. And I think you entered the year having Been behind on price cost from 2021 and hoping you'd be catching up to that into 2023.

Speaker 3

Is there still do

Speaker 7

you still see or still have line of sight to Recapturing kind of that price cost and balance on a cumulative basis in 2023. And I guess along those lines, can you talk about the actions you're taking maybe try to shorten some of the price lags in some

Speaker 3

of the businesses and probably see it a

Speaker 7

little bit more in the scent segment this quarter. But What can we do to maybe compress that the length of those inventories and cost cycles?

Speaker 3

Thank you. Hey, Adam, thanks for the question. I'd say a couple of answers. One is just relative to this year, I'd say we're slightly ahead, I. E.

Speaker 3

Price versus cost, back to the how things roll through inventory, slightly behind 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 the timing given the nature of the relatively large customers and generally our Indices tagged to the contracts from the standpoint and we would fully expect that The only question mark here is how one thinks about 'twenty three.

Speaker 3

So as I just mentioned, 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 You said around inflation, we need to catch up, which would suggest probably late 'twenty three or even 'twenty four if that's the case. But to your last part of your question, 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 the 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 type of sort of open more open agreements relative to changes in the marketplace.

Speaker 3

So that's been a bigger factor Relative to the contracts we put in place, and I suspect it will prevail in the future as well as we think about 2023.

Operator

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

Speaker 8

Thanks. Glenn, I think you earlier had quantified its 3 or 4 divestments for $1,500,000,000 to $1,700,000,000 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, it's 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 versus structural, The European gas constraints in China, rotating lockdowns and logistics stuff, can you separate Well prices or commodity prices versus the structural issues you're facing?

Speaker 3

Yes. Good question, John. So relative to our outlook for divestitures, we still think the 1.5 to 1.7 gross proceeds with 3 to 4 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 and A activity is substantially less With the volatility in the credit markets that has made it more difficult, particularly for private equity investors.

Speaker 3

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. From an initial dialogue standpoint, the interest level seems very good. So we think that things may be a little slower from a process standpoint, but we're still fairly Confident that we will hit 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 Again, the legacy N and B businesses, I will say though, I'm increasingly confident that through the implementation of Improved S and OP processes across a number of our businesses that will allow us to actually to reduce some of those higher inventories. The third thing you mentioned is really the global supply chain.

Speaker 3

Clearly, we like everybody have an extended Supply chain, I. E, there's more products sitting on the water for longer times. There's more inventory buffer stock in our system, etcetera, To basically accommodate for the volatility of 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

Operator

Question from David Begleiter with Deutsche Bank. Please go ahead. Your line is open.

Speaker 3

Thank you. Good morning. Frank

Speaker 7

and Glenn, where are you seeing initial

Speaker 2

David, it's Frank. Thanks for the question. A couple of thoughts From a demand weakness perspective, the geography that we are seeing is Probably no surprises really China. We had the lockdowns and we did see an impact clearly in the Q2. And just to recall, David Chang is our 2nd largest market, so that's been somewhat of a challenge for us.

Speaker 2

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, Finding consumer fragrance as well, so that's a positive. If you think about the resiliency of our portfolio, we feel overall Cautiously optimistic, one would anticipate as pressures continue to malefine 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 some of our 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.

Speaker 2

Our global key account teams, our customer insight teams 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 top line at 9% to 12% growth Range and then also our EBITDA range of 48%. So that's why we feel comfortable and confident in reconfirming our guidance today.

Operator

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

Speaker 7

Thank you and good day everybody. I just wanted to first off 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 you talked about preparing for more uncertain market conditions, including a recession. How do you think the portfolio is positioned as we Potentially go into some level of macroeconomic slowdown.

Speaker 7

And I'm just asking in context of your leverage profile at current.

Speaker 2

Yes. So on the resiliency, as I mentioned, we feel overall cautiously optimistic on the portfolio. Clearly, there's a lot 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 overall that the portfolio, going into possibly some challenging times It's 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 are going to maybe not think about 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 we're really excited about our pipeline and portfolio.

Speaker 2

And my belief is that's still going to be critically important for the future. It's something that we'll spend time in December really sharing with you why we're excited about our pipeline and portfolio, but that's going to be really key for us. So yes, you'll 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 Working with us on innovation is going to be really important to the future.

Speaker 3

Yes. 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 2 as customers sort of destock inventories. But in general, you don't See massive swings in terms of volume.

Speaker 3

Secondarily, very, very importantly, we do believe that sort of pricing resiliency and being able to continue to Sustain passing inflation through, which is helpful. 3rd, productivity, as we've mentioned, is sort of a major driver here to 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 is more stable as well and maybe even slower CapEx investments. So not only from P and L standpoint, but from a cash flow, very resilient Sort of manage the cycle, particularly with the success in pricing and the focus on productivity.

Operator

And then we'll take our next question from Josh Spector with UBS. Please go ahead. Your line is open.

Speaker 3

Yes, 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.

Speaker 3

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. Yes.

Speaker 3

Good question, Josh. It really is related to the sort of the matching of the build in inventories relative to the flow through 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 that 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.

Speaker 3

So, I wouldn't expect to have I'll say artificial pickup from a timing standpoint.

Operator

And we'll take our next question from Chris Parkinson with Mizuho.

Speaker 6

Great. Thank you so much for taking my question. 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 2023, 2024 and Frank, now that you've had some time to look at your 4 primary businesses, can you talk about just any potential mix and arrangement, Specifically in H and B and anything else that could really help us try to compartmentalize your longer term margin opportunities across segments?

Speaker 6

Just any quick thoughts. Thank you.

Speaker 2

Yes, 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 3 categories that we highlighted invest to grow and then So maintaining our business and then some that we actually have to really improve or exit. We're We have significant opportunities within the Invest to Grow area and I've highlighted flavors, we've highlighted Health, our 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 end markets.

Speaker 2

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 unpack a lot more of that when we get to December.

Operator

We'll go next to Jeffrey Zekauskas with JPMorgan. Please go ahead. Your line is open.

Speaker 1

Thanks very much. The margin compression in scent was weaker from the first to the second quarter that is weaker sequentially. That seems to be the one business where you've not had the same profit resiliency. Why is that? And for Glenn, your deferred tax line in your funds flow was an outflow of $178,000,000 And for the full year last year, it was an outflow of $2.36 What's going on with your taxes so that you have this cash outflow?

Speaker 3

Jeff, you want to answer the first question or the second question? Okay. So your first question was relative to The Centrand and the reality is that two things. 1, there were some one time expenses in the 2nd quarter relative to secondarily, as we mentioned, that there's been 2 rounds of inflation. So as we talked, it's a little bit more of a In that business from a standpoint, so if you think about the rounds of impact that's basically coming through and there's a bit of delay.

Speaker 3

And relative to taxes, there's lots of every year, as you know, 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 settlements, so 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 I do appreciate the question.

Speaker 1

We can go to next one.

Operator

We will take our final question from Matthew Deo with Bank of America. Please go ahead. Your line is open.

Speaker 7

Hi, good morning everyone.

Speaker 3

If I were to look at the top line kind of just on a rough cut basis, what percent of your sales or businesses fall in

Speaker 2

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?

Operator

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

Speaker 2

So I would like to just thank everyone for joining the call and also thank all of our IFF colleagues once again around the world. We feel very proud of our first half business performance and 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 Q3 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

Thank you. And this does conclude today's program. Thank you for your participation. You may disconnect at any time.

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Earnings Conference Call
Stryker Q2 2022
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