International Flavors & Fragrances Q3 2023 Earnings Call Transcript

Quartr
Provided by Quartr
November 7, 2023

There are 14 speakers on the call.

Operator

At this time, I would like to welcome everyone to the ISS 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. 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 1 question per person. I would now like to introduce Michael DeVoe, Head of Investor Relations.

Operator

You may begin.

Speaker 1

Thank you. Good morning, good afternoon and good evening, everyone. Welcome to IFF's Q3 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.

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 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.

Speaker 1

For additional information concerning the factors that can cause actual results 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 their respective GAAP measures as set forth in our press release. With me on the call today is our CEO, Brett Clyvarn 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.

Speaker 2

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 Q3 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 Q3 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.

Speaker 2

Our 3rd 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 3rd 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 Q2 of 20 And our focus on ongoing working capital improvements drove strong free cash flow generation.

Speaker 2

In particular, the continued execution of our inventory reduction program has resulted in more than a 600,000,000 Dollar reduction in inventory since the end of 2022. This was the largest driver of our free cash flow, which improved $320,000,000 versus the Q2 of 2023. 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 and our R and D platform continue to drive improvements in our sales pipeline. In addition, in Functional Ingredients, as discussed on our Q2 call, we are implementing a targeted operational improvement plan to improve sales execution, strengthen our operating model and reshape the portfolio.

Speaker 2

As we shared previously, we expect this plan for 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 3 years with a 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 percent declines in Q2 of 2023. With this momentum, we have increased confidence in our ability As Glenn will highlight, we are seeing signs of green shoots in the 4th 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 aligned with our best owner mindset, We announced an agreement to sell Lucas Meyer Cosmetics to specialty chemical company Clariont for $810,000,000 which is equivalent to a high teens multiple based on our projections. We expect to complete the transaction In the early part of the Q1 of 2024, and all proceeds will support our deleveraging priorities.

Speaker 2

Moving forward, we continue to pursue strategic non core divestitures that will drive further deleverage and enable us to Moving to Slide 7. In the 3rd quarter, IFF generated $2,800,000,000 in sales, representing a 3% decline on a comparable A strong performance in Cent and Health and Biosciences was more than offset by softness in NERISH and Pharma Solutions. As I mentioned, volumes improved sequentially across nearly all businesses with particularly strong performance in scent in Health and Biosciences. Excluding Functional Ingredients, which continues to disproportionately impact our results, Overall volume declined low to single digits in the 3rd quarter. Adjusted operating EBITDA for the quarter was 506000000 down 10% year over year on a comparable currency neutral basis.

Speaker 2

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 $0.89 primarily impacted by lower profitability. Now I'll turn it over to Glen to provide more detail on profitability and our performance by business segment.

Speaker 3

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 $506,000,000 in the Q3. 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.

Speaker 3

Note that our negative absorption in the quarter was less than expected as our inventory reduction program for the year As it 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 $600,000,000 reduction in inventory since the end of 2022. As a result, At this time, we are now expecting approximately a $165,000,000 impact from negative absorption to profitability for the full year, down from $180,000,000 This could also flex further as the Q4 unfolds. To reiterate, this is a one time transitory impact to the P and 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.

Speaker 3

While functional ingredients remained a main driver of weakness in Nourish in the 3rd quarter, We did see sequential improvement and expect this to continue as we move into the Q4. 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 Incomparable currency neutral adjusted operating EBITDA. Health and Bioscience continued to deliver strong results in Q3, Led by meaningful growth in Cultures and Food Enzymes, Brain 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.

Speaker 3

Seth 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, scent 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 due to a very strong prior year with a 28% 2022 sales growth comparison and a 76% 22 adjusted operating EBITDA comparison. Price 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.

Speaker 3

Cash flow from operations totaled $795,000,000 a significant increase reflecting a strong improvement in inventory levels. CapEx year to date was $390,000,000 or approximately 4.4 percent of sales. Our inventory reduction program and working capital improvements have also greatly contributed to ISF's improved free cash flow Performance, which totaled $405,000,000 a significant increase of $320,000,000 from the Q2. Year to date, we also distributed $619,000,000 in dividends to our shareholders. Our cash and cash equivalents totaled $652,000,000 which includes $23,000,000 in assets held for sale.

Speaker 3

Additionally, gross debt for the quarter totaled approximately $10,300,000,000 with a net debt to credit adjusted EBITDA of 4.6 times. Our trailing 12 month credit adjusted EBITDA totaled approximately 2,100,000,000 We are 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 Q1 of 2024 We'll further support our strength in capital structure as we pay down debt in line with our net debt to credit 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 $11,300,000,000 to $11,600,000,000 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.

Speaker 3

On the 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 $1,850,000,000 to $2,000,000,000 driven primarily by favorable price to inflation and improved productivity. We also now expect full year interest expense to be slightly higher at approximately 450,000,000 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 Q4, we continue to expect an improving trend in a majority of our businesses as we navigate the macroeconomic Challenges impacting our industry. We are seeing signs of green shoots in the 4th 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 2024.

Speaker 3

While the macroeconomic environment remains Also with low visibility, we are optimistic heading into the New Year. We have several known one off items That we have high level of confidence will be tailwinds, including significant negative absorption related to our successful inventory reduction program and one time locust bean kernel inventory write down. Also, we will continue to execute on our costs and productivity initiatives and have a carryover benefit from this year's 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 acceleration of our strategic transformation initiatives.

Speaker 3

We will provide our 2024 guidance with our 4th 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.

Speaker 2

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 will 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.

Speaker 2

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 was 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

Thank you. We will now begin the question and answer session. Our first question comes from the line of Gunther Zechmann with Bernstein. Your line is now open.

Speaker 2

Hi,

Speaker 4

good morning, everyone. Frank, my question to you is, 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 of what you mentioned around the fixed cost measures that you're taking would be great. Thank you.

Speaker 2

Hey, Gautam, it's Frank. Good afternoon, good morning. A couple of things. 1, with regards Functional Ingredients, the business clearly across all of Ingredients is stabilizing up there and we saw good sequential Improvement when I look at Q2 to Q3, in particular, and 3 of the biggest business lines, Cortexturants, emulsifiers, 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.

Speaker 2

As far as the functional ingredient plan overall, we're focused in 3 areas: 1, enhance Our go to market approach 2, drive operational efficiencies and 3, 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 Adjusting our operating model going through 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 comp will be we're very Confident we can go sales in line with the market and deliver a mid teen adjusted operating EBITDA margin over the next 3 years.

Speaker 2

Thanks for the question.

Operator

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

Speaker 5

Hey, good morning guys. 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?

Speaker 3

Hey, Mike, it's Glenn. Why don't I attempt to start it and then Frank can sort of add into it. And good morning to you. So just we have been very transparent for many, many quarters that continue to enhance the portfolio, I. E.

Speaker 3

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 $810,000,000 gross proceeds that should net about $730,000,000 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.

Speaker 3

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 3 times 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 ROIC has a relatively high return business, which is the excipients, all that 75% and then has a lower return, More industrial business on that.

Speaker 3

So I think that I don't know, Frank, you want to add anything else to that? No.

Speaker 2

I think we can go. Yes. Thank you.

Speaker 3

Thanks, Mike. Thanks, Mike.

Operator

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

Speaker 6

Hi, everyone. Thanks for taking the question. Frank, 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?

Speaker 6

Do

Speaker 3

It was interesting to see literally essentially every single sub business within Nourish, H and V and Scent At 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 Q3 of last year, they had a +12 percent in terms of volume, so there's a bit of an overlap.

Speaker 3

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 4th quarter. I think the one segment that's a little bit of a laggard is pharma. The pharma business in terms of the customers started destocking a little bit later.

Speaker 3

It As 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 set For the Pharma business as well. So knock on wood, things are sort of moving very broad based across the entire business. Thank you.

Operator

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

Speaker 7

Thank you. Stent 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?

Speaker 3

Hey, John. This is Glenn again. Hey, by the way, welcome to your new home. So relative to Sense, 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 costs, so we're now seeing the effects of the deflation basically moving through more so. And year over year, slightly higher in the Q3 versus the Q2.

Speaker 3

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 Q2 of last year, we're now sort of at fully overlapped last year's 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 in that basically sells ingredients. About 50% of the production is used for own products and 50% sold.

Speaker 3

There's a commodity component such as turpentine as an example, galaxolite, 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.

Operator

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

Speaker 8

Thanks. Good morning, everybody. So, I guess I'm curious about how you think about your volume performance relative to 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?

Speaker 8

And then just lastly tied together, when do you think Your sales can go back to the long term algorithm. Thank you.

Speaker 2

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 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.

Speaker 2

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 Very well positioned against our competitive set. Health and Biosciences, you actually saw growth versus prior year, Mark, which was very encouraging. And in fact, you saw growth in culture and food enzymes, animal nutrition, Home and 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.

Speaker 2

And then also our fine fragrance business had good performance. So I feel really good about the 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 Proportionate volume declines versus our competitors as we've highlighted as Functional Ingredients. If you were to exclude Functional Ingredients, Mark, our Volume would be down low single digits.

Speaker 2

So we feel as though we are 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

Operator

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

Speaker 9

Thank you. Good morning. 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 form a?

Speaker 2

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 as we implemented in some SAP shipments that went into Q3 of 'twenty two. And then EBITDA growth last year was 76 So that was the comparative 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.

Speaker 2

There are some distributors that are starting to right Size inventory in this business, that is something that we see more of a de Stocking 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 And as well, I should say, our core pharma business is well positioned with our customers. So destocking Contributors rightsizing inventory temporary in nature and we feel good about the growth potential performance as we go into 'twenty four and beyond.

Operator

Thank you. Our next question comes from the line of Adam Samuelson with Goldman Zacks, your line is now open.

Speaker 9

Yes, thank you. Good morning, everyone.

Speaker 3

So Glenn,

Speaker 9

In your prepared remarks, I'm 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 Q2, 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, we should be thinking about a lot of price costs, 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? Thanks.

Speaker 3

Thank you, Adam, and good morning. So let me kind of break that down into 2 components. 1, Just normalizing, I'll say, the one time 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 $75,000,000 Of EBITDA related to divestitures. So that's roughly 6 months of Savory Solutions and then FSI or Fragrance Specialty Ingredients Business.

Speaker 3

And then basically a full year directionally for LMC, that's about $75,000,000 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 $600,000,000 of volume related inventory this year. That's about 100 $65,000,000 benefit.

Speaker 3

On top of that, the LBK write off in the 2nd quarter was $44,000,000 And then lastly, in terms of sort of abnormal items, I would add about $25,000,000 of additional benefit With the annualization of our headcount reduction program this year. Offsetting that, as you mentioned, is roughly $70,000,000 ish Of basically truing up our incentive plans back to 100%, given this is a challenging year, it will payout at a lower percentage. So those are the normalized items I would take to sort of baseline the 2023 results. Candidly, relative to 2024, we are We'll be prepared to have a very fulsome discussion at the February call. We're in mid planning process right now.

Speaker 3

We're working with all the businesses is in terms of their plans from volume, net price, procurement on deflation, productivity programs, etcetera. 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.

Operator

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

Speaker 9

Hi, good morning. Just a follow-up on positive absorption or just absorption coming off next year. What percentage of the portfolio is Built to order versus built to stock? And are there any specific businesses where that split is skewed towards 1 or the other?

Speaker 3

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 built to stock, 45 built to order in terms of the overall portfolio. So the built to stock is more the legacy DuPont Entre and NB portfolio versus the legacy FNF for the build to order. So as a result that Nourish is split, Slightly more built to stock than built to order, but combination of the ingredients business, the food systems and then the obviously the flavors business.

Speaker 3

The H and B and Pharma businesses are largely built to stock and the scent business is largely built to order.

Operator

Thank you. Our next question comes from the line of Lauren Lieberman with Barclays. Your line is now open.

Speaker 10

Great. Thanks. Good morning. I was curious if you guys could talk a little bit about pricing. Pricing in the quarter came grew a bit stronger I think than we had anticipated.

Speaker 10

And so, just curious about that because I didn't think that there was any incremental pricing going through. So maybe it was just

Speaker 3

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

Operator

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

Speaker 3

Yes. Hi, thanks. 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 So the second part Josh, it's Glenn.

Speaker 3

Second part of your question, we are largely done with the inventory reductions. We're basically going to be largely flat lined for the balance of the year. Relative to our free cash flow estimates for the year, they're unchanged versus our previous quarter. We will be, call it, circa $450,000,000 on reported free cash flow for the year. I will note once again that that includes about 4 $140,000,000 ish of Reg G items.

Speaker 3

So we're right around $900,000,000 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 $240,000,000 are literally associated with our divestitures. A big portion of those are taxes, Not surprisingly, we also have another roughly $80,000,000 of the final integration costs. Those are associated with Systems conversion and legal entity changes from DuPont, those will be complete this year. And then there's about $75,000,000 Related to restructure, that's from the implementation of this year, and then call it $50,000,000 in sort of all other related expenses.

Speaker 3

So that's sort of a breakdown of the Reg G items. Thanks, Josh.

Operator

Thank you. The next question will go to the line of Laurence Alexander with Jefferies. Your line is now open.

Speaker 7

Good morning. 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's your like 3 to 5 year target might be?

Speaker 3

When you referenced 6 or shift, I'm assuming you're talking about the ingredients business. Is that correct?

Speaker 7

Yes, most of I guess I'm fishing for if you have anything else that you're now putting in that category.

Speaker 3

That's largely it's 90% of it. And as we mentioned, that business is of our total business is about 20% to 25% of the total portfolios. 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 a 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.

Speaker 2

And the thing 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 don't want to lose also sight of the 80% or so of the business as we've been highlighting today that has seen good sequential improvement in It actually grew versus prior year.

Operator

Thank you. Our next question comes from the line of Silk Puig with JPMorgan. Your line is now open.

Speaker 11

Hi, good morning. Is there a $70,000,000 SG and A benefit this year from the compensation changes? And did most of that occur in the 3rd quarter? And secondly, if there's a $160,000,000 headwind from unfavorable manufacturing absorption, which is 150 basis point headwind to gross margin. Do you expect as a base case your gross margin to be up by 150 basis points next year?

Speaker 11

And do you need volume growth in order to achieve that?

Speaker 3

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 $70,000,000 that we've referenced really are the savings from headcount reductions we've implemented this year.

Speaker 3

So as a reminder, there was a program that where we targeted $100,000,000 of annualized cost reduction, so roughly $70,000,000 $75,000,000 of that this year. And then about $25,000,000 will be the annualized impact. It's all been implemented, so it's all done. So it's really just the timing element of that. And then lastly, there's always some choppiness quarter to quarter because of accruals around variable incentives.

Speaker 3

So Depending on up and down, things can get trued up and can be a little bit choppy. So that does affect the quarter to quarter RSA as well. Thank you.

Operator

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

Speaker 12

Yes, thank you. I want to ask if you can remind us a little bit your exposure to some of the key Soybean well, to the soybean price as well as to Key oilseeds, vegetable oils and whether the recent pretty steep decline in some of these edible oils It can be a meaningful contributor to 2024 EBITDA.

Speaker 3

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 And over time, we typically hedge out for a period.

Speaker 3

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.

Operator

Thank you. Our next question comes from the line of Andrew Keches with Barclays. Your line is now open.

Speaker 13

Yes, thanks. Congrats on the quarter. Just to confirm, in the past, you've mentioned the 3.0 times 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?

Speaker 13

I know the covenant horizon Pushed out about a year to early 2026. So any help on the timeline would be great. Thanks.

Speaker 3

We are great question, Andrew. We're very confident that relative to our current M and 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 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.

Operator

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

Speaker 2

So first, I want to start by thanking all of our IFF 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 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 4th quarter Update and full year guidance for 2024 update in February, and I wish everyone well. And thanks for joining our call.

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Earnings Conference Call
International Flavors & Fragrances Q3 2023
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