International Flavors & Fragrances Q2 2024 Earnings Call Transcript

Presentation

[Operator]

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

[Michael DeVeau, Senior Vice President, Corporate Finance and Investor Relations at International Flavors & Fragrances]

Thank you. Good morning, good afternoon and good evening, everyone. Welcome to IFF's Second Quarter 2024 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. During the call, we will be making forward-looking statements about the company's performance and business outlook. These statements are based on how we see things today and contain elements of uncertainty. For additional information concerning the factors that can cause actual results to differ materially, please refer to our cautionary statement and risk factors contained in our 10-K and our 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 the press release that we issued yesterday.

With me on the call today is our CEO, Erik Fyrwald, and our Executive Vice President, CFO and Business Transformation Officer, Glenn Richter. We will begin our 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 Erik.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Well, thank you, Mike, and hello, everyone. I'm excited to join you all today and share the positive progress we are making in our strategic refresh and a solid performance IFF delivered in the second quarter. Also, during today's call, we will provide a brief update on the business-led strategic framework we are implementing across our organization. Now over the last seven months, I've had the great pleasure to travel to many of our facilities and have met with customers that together represent over 1/3 of our sales and several thousand of our IFF team members. I've been able to get great feedback on what makes IFF special and strategic and tactical moves our leadership team needs to make to strengthen our company to better serve customers and improve our performance. We have listened and are making the changes we need to unleash more of the potential for today and for the future. And I'm very pleased that the entire IFF team is rallying behind our resulting strategic refresh to make IFF better at bringing leading innovation to our customers.

Now beginning with slide six. IFF is building on last quarter's momentum and delivered another solid quarter, and I'm pleased with our performance and our results through the first half of the year, led by Scent, Health & Biosciences and Nourish, we delivered volume growth in the high single digits in the second quarter. On a comparable basis, adjusted operating EBITDA increased 22% and driven by volume growth and productivity initiatives. This is a significant improvement over last year, and it is great to have IFF on a better sales growth and margin expansion track. Now looking ahead, we are cautiously optimistic for the remainder of 2024. Given this outlook and our solid performance to date this year, we are raising both our sales and adjusted operating EBITDA guidance for the full year. Glenn will speak more about this in a few minutes. Now it's encouraging that the steps we have taken and continue to take to refocus IFF on bringing customers leading innovation, while driving healthy productivity are yielding encouraging results. We are making solid progress advancing the business-led refresh, I've spoken about before, but we are not satisfied. We've got a lot more work to do. But I've got confidence that we are on the right track toward achieving IFF full potential.

Moving to slide seven. As I did last quarter, I would like to give a brief update on our progress as we work across the organization to refresh our strategy and focus on a business-led operating model. IFF has had a challenging last three years, constraints on our balance sheet led the company to underinvest in our core businesses and focused on divestitures. The company was not structured to effectively navigate the complex and fast-moving environment, and we underperformed relative to our peers. We have now had several quarters of growth as we have taken decisive actions to get our businesses back on track. Our strategy moving forward will be driven by four key pillars: our people, our customer focus, our position as an innovation powerhouse and our operational excellence. We will engage and empower our people to deliver customer success, while we drive profitable market share growth over time. We will also continue to develop sustainable new products and applications that are aligned with our customers' needs now and in the future, all while being relentless in our commitment to safety, quality and the efficiency in our operations.

We have already taken several steps toward resetting and refocusing our operating model, including the announced divestiture of Pharma Solutions, which is still on track to close in the first half of 2025 and our pivot to an end-to-end business-led operating model that will promote greater accountability and better performance. We are also working hard to improve employee engagement and are seeing positive results. Furthermore, each of our business units are building a 5-year strategic plan to define and close gaps where they exist versus best-in-class companies. These plans include executing a refreshed turnaround strategy for functional Ingredients and leveraging Health and Biosciences biotech expertise and capabilities across our Scent and Flavors platforms to enhance innovation and product development. Also, as mentioned last quarter, we are focusing on having lean corporate functions to support our business units with speed, agility and closer collaboration. Now as we prioritize growth investments to our highest value businesses such as Flavors, Scent and Health and Biosciences, we have already started to increase R&D and commercial investments.

At the same time, we plan to increase our capex investments, targeting about 6% of sales for the next several years to bolster capacity and accelerate our digital transformation, including ERP implementation. We believe these investments will generate strong returns providing us with incremental growth and efficiency opportunities that will lead us to continue to improve how we serve our customers profitably. Lastly, we are committed to delivering significant value creation for our shareholders. And with that in mind, we are on track to achieve our raised guidance targets for the year as we continue to drive profitable growth across each of our businesses. I'll now pass it over to Glenn for a closer look at our quarterly results, which demonstrate the continued progress and growth we are achieving. Glenn?

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Thank you, Erik, and thank you all for joining us today. As Erik noted, IFF had a strong second quarter. Revenue of just below $2.9 billion increased 7% on a comparable currency-neutral basis with Scent, H&B and Nourish, each growing revenue in the quarter. Volumes grew by high single digits as our performance continued to improve sequentially across nearly every business. Our volume growth and strong gains from productivity initiatives together contributed to a 22% increase in comparable adjusted operating EBITDA in the quarter. Our adjusted operating EBITDA margin improved by 310 basis points to 20.4% on a comparable basis, building off a strong first quarter and the first time we were over 20% since the third quarter of 2022. Turning to slide nine. I'll dive a bit deeper into each of our segments. Nourish comparable currency neutral sales increased 4%, and we delivered an adjusted operating EBITDA increase of 36% on a comparable basis. This was led by a second consecutive quarter of double-digit growth in Flavors, with improvements in both volume and pricing. Functional Ingredients sales declined modestly in the quarter as high single-digit volume growth was offset by lower pricing, consistent with plan.

Both Flavors and Functional Ingredients demonstrated strong year-over-year gross margin expansion. The strong profitability in Nourish was driven by volume growth and productivity improvements as well as the comparison to the onetime Locus Beam Kernel inventory write-down in the year ago period. Health & Biosciences achieved strong growth in all businesses with a noteworthy uptick in Health, led by a strong performance in probiotics. H&B comparable currency-neutral sales increased 9% and we delivered comparable adjusted operating EBITDA of $165 million, a 14% increase from a year ago. In Scent, double-digit growth in consumer Fragrance and Fragrance Ingredients led to a strong quarter for both revenue and profit growth. Fine Fragrance also remained strong, growing mid-single digits, led by new wins and volume gains. Net sales in the quarter were $603 million, up 16% on a comparable currency-neutral basis, and we delivered adjusted operating EBITDA of $137 million, up 38% on a comparable basis.

Lastly, Pharma Solutions returned to volume growth with revenue of $250 million. Profitability in this segment declined in line with our plan as we manage through unfavorable mix and onetime items. Turning to slide 10. Cash flow from operations totaled $336 million this quarter, while capex year-to-date was $200 million or roughly 3.5% of sales. For the year, we expect that capex will be approximately $575 million as we ramp up in the second half of the year. Our free cash flow position in Q2 totaled $136 million, an increase sequentially of approximately $150 million from last quarter and a significant increase from $85 million reported in the year ago period. We paid $309 million in dividends through the end of the second quarter, and our cash and cash equivalents totaled $674 million. IFF also continued to make progress toward achieving our deleveraging goals and reduced our gross debt by over $900 million from last quarter, yielding a net debt to credit adjusted EBITDA ratio of four times at quarter end, compared with 4.4 times at the end of the first quarter. This was driven by improved operational performance, including solid working capital management as well as the closure of our Cosmetic Ingredients divestiture, which occurred early in the second quarter.

It's important to note that we remain committed to achieving our net debt to credit adjusted EBITDA target of three times or less following the completion of the divestiture of Pharma Solutions, which we continue to expect to be completed in the first half of 2025. On slide 11, I'd like to turn to our consolidated outlook for '24, where we are raising both our sales and adjusted operating EBITDA guidance ranges, given our stronger-than-expected financial and operational performance in the first half of the year. We are now expecting net sales to be in the range of $11.1 billion to $11.3 billion, reflecting our expectation that volume growth will continue across the majority of our portfolio in the back half of the year albeit at lower growth rates than the first half. Given the recent economic indicators and mixed results by CPG companies of late, we remain cautious relative to the outlook for demand in the balance of the year.

Operating under this assumption for the full year, we now expect to achieve a 3% to 5% volume growth, up from our previously announced range of 0% to 3%. On the bottom line, we also raised our adjusted operating EBITDA guidance range to $2.1 billion to $2.17 billion, up from our previously stated range of $1.9 billion to $2.1 billion. This increase reflects our strong profitability performance in the first half of the year with a consistent view of the second half from our previously communicated guidance. It should be noted that we are also factoring in a greater level of annual incentive compensation given the relative strength of our performance versus budget and incremental second half spending relates to business reinvestment, specifically as part of our strategy Refresh, the team has identified investments that will accelerate the execution of our strategy, focus in business development, R&D and innovation that will yield results in 2025 and '26. Based on current market exchange rates, we expect that FX will be closer to a 4% adverse impact to sales growth within our 3% to 4% range given. For the third quarter, we expect sales to be approximately $2.75 billion to $2.85 billion, with an adjusted operating EBITDA of approximately to $520 million to $540 million. Now I'll turn it back to Erik for closing remarks. Well, thank you, Glenn. As I shared at the top of the call, I am pleased with the team's solid performance throughout the first half of the year, especially as it represents a significant improvement over our prior year lows. We are moving on the right track because our teams around the world continue to relentlessly focus on efficiently meeting the needs of our customers, resulting in driving profitable growth. And I'm energized by the progress we've made so far this year, yet I recognize that we have a lot more to do to achieve the full potential of this great company. Already, we are making progress to better meet our goals and by taking advantage of the market's tailwinds and increasing our investments in our high-growth businesses, we believe we will be positioned to deliver attractive shareholder returns over time. I want to especially thank the entire IFF team for delivering these results, including rallying behind our strategic refresh to advance our customer focus and innovation-led strategy. We want every IFF-er to share the same passion and desire to help our customers differentiate and win in the marketplace. We are making much progress towards this goal. As I look ahead to the remainder of the year, we will remain steadfast in bringing new products and innovations to the market. while simultaneously executing a turnaround strategy across our Functional Ingredients business, including with strong productivity initiatives. And I'm confident the actions we're taking and the near-term operational priorities we are executing will create a stronger IFF. And with that, I would now like to open the call for questions.

Questions and Answers

[Operator]

[Operator Instructions] Our first question comes from the line of Josh Spector with UBS. Josh, your line is now open.

[Josh Spector, Analyst at UBS.]

Yeah. Hi. Good morning. And first, congrats on a really solid second quarter here. So I wanted to ask two related pieces here is first really around the sequencing of EBITDA in the second half. So the step down in 3Q versus 2Q and then your implied 4Q is a pretty material seasonal step down. So what is driving that in your view versus the stronger 2Q? And then related is around volumes, so the 3% to 5% lift is clearly better than you expected, but that's largely just a reflection of, I think, 2Q flow going through. I would say volumes in the second half were up 1% to 2%. The comps maybe do get harder but it seems like it was sequentially stable, maybe moving around a little bit. That's a pretty easy bar to beat. So what are you seeing on the volume side that we might be missing?

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Josh, thanks for the questions. I'll start with your second one and then we'll come back to the EBITDA question. We are expecting more modest volume growth in the second half of the year, specifically in the fourth quarter. We are forecasting about a 4% volume uplift year-over-year in Q3 and flattish in Q4. As a reminder, last year, sequentially was negative 7%, negative 11%, negative 7% and negative 3%. We are somewhat sort of cautious on Q4, a combination of, a, the overlap from last year. And then secondarily, the end consumer continues to be very, very anemic. And the economic indicators that you're well aware, are probably more negative now than they were a few months ago. So that's what's driving sort of the volume expectations. The EBITDA first half versus second half is really a reflection of lower revenues in the second half, big portion of that is seasonal. We expect that basically, we will be about $400 million less revenue based on our guide in the second half of the year, than in the first half of the year, that is notably $300 million in the fourth quarter, which is always our seasonally our lowest. So that really drives the vast majority of the change in the first half versus the second half.

I will also add that we are investing about $20 million to $30 million incremental opex in the back half of the year. Given the performance this year, we want to reinvest to begin to accelerate growth for '25 and '26. So that's another PC equation.

[Operator]

Our next question comes from the line of Nicola Tang with BNP Pariba. Nicole. Your line is now open.

[Ming Tang, Analyst at BNP Paribas]

Hi. Everyone. Thanks for taking the question. It actually feeds on quite nicely from your last answer there Glenn. I was wondering if you could give more color on some of those incremental investments around R&D and commercial efforts and capacity. Could you give a few more specific examples and how you expect that to feed through or contribute to '25 and '26? And you gave some helpful quantification on the capex for the next few years in terms of this opex step-up, should we also extrapolate that going forward as well?

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Great. Thanks for the question, Nicola. And we're very excited about the increased investment in opex, as Glenn mentioned, $20 million to $30 million that we're putting into the company this year to have impact in the coming years, '25, '26 and beyond. That includes, of course, R&D, and we're increasing R&D spend in both Health and Biosciences, Scent and Flavors. And that includes, by the way, accelerating our transformation to -- in Biotech to come out with new fragrances and flavors with our biotech capabilities that will enhance our Scent and Flavors businesses. We are also increasing the R&D to find more naturals, both for Scent and for Flavors. Obviously, a great market trend towards naturals. We're leaders in that area, and we want to continue to strengthen our leadership position. Also across all three of those businesses, we're adding commercial capability. And in our Functional Ingredients business, we're adding more technical service capability to better sell higher-value products that we have in our Functional Ingredients portfolio.

On the opex -- or excuse me, on the capex side, we're adding capacity, especially in Health & Biosciences, but across all three of those high-growth markets businesses, Health and Biosciences, Scent and Flavors, to ensure that we always have very reliable, high-quality supply for all of our customers around the world for all those product lines. So we're making significant investment now and we'll continue to ramp that up in the coming years to ensure that we continue to profitably grow very aggressively those business units. Thank you.

[Operator]

Our next question comes from the line of John Roberts with Mizuho. John, your line is now open.

[John Roberts, Analyst at Mizuho]

Congrats on the quarter. Erik, on slide seven, this end-to-end operating model replaces the reorganization that your predecessor has started, is the new model fully in place? Or can you tell us where you are or when it will be fully in place?

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Yes. We're making a lot of really good progress, John. Thanks for the question. And what I would say is that the clarity has been very well received by our people. And I think that the uncertainty has been cleaned up. The business teams are getting put in place. They're very excited and very energized by the clarity of decision-making, their ability to set strategy and then to execute all elements of the business from R&D, operations, commercial and all the functions to support that -- those gears working together to drive each of the business units. And I can tell you that we're starting to feel the benefits of that by seeing the strategies being executed and being strengthened in terms of being able to take our innovation from R&D and get it through the creation and into the commercial operations, produce it and then get it in there commercially. And it will take a while to fully drive the benefits, but we're starting to feel the strength and improvements in energy and ability to do that.

The other thing that's really interesting here is with the focused business units, having their strategy, and by the way, from that becomes a 5-year plan, which gives us more clarity on where we're investing. We're able to better differentiate between the units and where we put more of the investment and where we put less of the investment, where we need more productivity and where we need to focus that productivity to make sure that we're competitive cost-wise and enable to drive margins. And then also, as you get that clarity on each business unit, what they need to do to win, it also increases the ability of businesses to collaborate effectively. And so that collaboration, the synergy is now much less driven corporately with corporate programs and lots of consultants and lots of complexity and much more from the businesses where they know the customers and where that synergy where that leverage makes sense. So we're making good progress. And by the end of the year, we'll have all five units operating well, and that's when we'll start reporting the five business units.

[Operator]

Our next question comes from the line of Ghansham Panjabi with Baird. Line is now open.

[Ghansham Panjabi, Analyst at Robert W. Baird]

Thank you, operator. Good morning, everybody. Erik, I just want to go back to the strategic refresh specific to R&D. Does that entail more spending as it relates to R&D as a percentage of sales? Or is it more repositioning resources with an overlay of accountability? And then also on the capex piece, the company has been spending roughly $0.5 billion in capex post the DuPont acquisition. So as you sort of look back, was that just maintenance capex basically and now you're adding growth capex? Is that right sequencing to think about as you go back to your comments about 6% capex to sales going forward?

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Yes. Thanks for the question. Very important. Let me start with the capex. So we -- now with the strategic clarity with the business units, the clarity of our strategies, we know we have to spend more on growth investments to realize our growth ambitions but we also have some foundational investments that we need to make that were underinvested before in basic, making sure that our plants are up to standards that we need to have them operate well reliably with high quality. We have some ERP investments that we need to make that are kind of -- that are foundational. But on top of that, we have aggressive growth targets, and we're going to make sure that we've got the facilities to deliver on those growth targets. On the R&D spend, we are absolutely increasing R&D spend as a percentage of sales in our Health & Biosciences business and will increase the R&D spend in our Flavors and Scent businesses as we grow those businesses. And I think that will be really important to ensure that we continue to strengthen those businesses and get the full benefit of their potential.

On the Functional Ingredients side, it's heavily leaning towards making sure that we've got the right cost position that we've got enough productivity to continue to turn around that business and get it on the right track and get it competitive with its competitive set. And we're making good progress on that, by the way. And part of that will involve consolidation of some of our manufacturing facilities, which will take some initial capex, but we'll have very, very high returns. And then finally, we are pushing, strengthening our productivity across the company. When we talk about and empowered business units. Each of the business units also has a productivity leader now that's focused on making sure that we're driving productivity within each business unit to be able to improve margins and invest more in innovation and then we're talking about lean corporate functions that effectively and efficiently support the business units and each of those corporate functions has a productivity lead to make sure that we're fully competitive on costs for our corporate functions. Thank you.

[Operator]

Our next question comes from the line of Kristen Owen with Oppenheimer. Kristen, your line is now open.

[Kristen Owen, Analyst at Oppenheimer]

Hi. Good morning. Thank you for taking the question. I wanted to know if we could unpack some of the volume drivers behind each of the businesses in Q2. Just help us understand the mix between end- user demand, channel restock and/or some of the pricing incentives that you've talked about.

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Good morning Kristen, thank you for the question. What we're seeing is actually no incremental improvement in the consumer. So I know everyone sort of tracks what's happening, but neither Food and Bev or HPC really are showing any strengthening in the market. So our volume growth, we believe, is a function of two things. First of all, the lack of destocking from prior year, so it was pretty significant, as you know, in the first half of the year. We do not see any restocking at this point in time. I would note that Pharma's destocking lagged a bit. All the other businesses, we think were largely done at the end of last year Pharma largely done at the end of this quarter so that we see the volume trajectory for Pharma improving going forward.

We also track very closely our volume performance vis-a-vis our key competitors by segment. And we're pleased in terms of where we are generally performing at or better across the entire board. And we believe it's really a function of sort of three things. One is, as Erik mentioned, the innovation focus, we've increased our intensity relative to our innovation pipeline, secondarily, our sales pipeline. We spend a lot of energy to rebuild our pipeline and really accelerate our ability to win new business and win back the business. And then third, I would have a special call out for the Ingredients business. Ingredients business has actually come back very strongly based on the remediation efforts that we launched last year into this year.

Part of that, as a reminder, is taking some of the deflation that business has experienced in reinvesting in pricing, at the start of the year, and that's actually played out very well. We had about 7%, 8% plus volumes in the Ingredients business in the second quarter alone. So that's how we sort of characterize again. We're we're confident in terms of what we can control, but the market continues to give us pause because we're just not seeing a lot of strength in the consumer.

[Operator]

Our next question comes from the line of Patrick Cunningham with Citi. Patrick, your line is now open.

[Patrick Cunningham, Analyst at Smith Barney Citigroup]

Hi. Good morning. Given some of the incremental increase in opex and capex, but revised guidance upward, is any update to free cash flow guidance for the year and any items we should be monitoring there?

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Patrick, thanks for the question. We are still guiding full year of $600 million. As a reminder, when we started the year, it was $500 million. We upped our guidance to $600 million in the last quarter, in part to reflect we were pointing towards the higher end of our previous guidance. We are expecting earnings to be up as we mentioned, with the higher guidance. There'll be a slightly higher working capital as the businesses are growing, basically have to make sure our inventories are in the right position to continue to support it. I would note that, that $600 million of free cash flow includes roughly $350 million of Reg G items. Those are largely related to transactions, taxes, implementation costs, fees, etc. So adjusting for that with taking the Reg G cost out, we're more like $950 million for the year, which is very consistent with what we guided previously as well.

[Operator]

Our next question comes from the line of Mike Sison with Wells Fargo. Mike, your line is now open.

[Mike Sison, Analyst at Wells Fargo & Company]

Hey, guys. Nice quarter and outlook. In terms of functional ingredients, how has the new strategy driven the volume recovery? I think you had a nice high single-digit recovery in 2Q. In addition, pricing is lower. Can you share a little bit details on EBITDA margin? Is it up meaningfully? Did it improve? And then just your thoughts on the second half for Functional Ingredients.

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Thanks, Mike, Yes, relative to functional ingredients, not only is the top line performing well, but gross profit and our EBITDA trajectory is actually progressing very nicely against expectations. So for the second quarter alone, on a like-for-like basis, including normalizing for the LBK write-off last year. So if you normalize for that, we were up about 250 basis points in terms of gross margin, which is consistent from the first quarter as well and consistent with where we think the full year is going to be. As we mentioned last year, the business had dropped to high single-digit EBITDA margin. Our goal has been to get it to basically mid-teens. We are tracking well to be low teens this year. Generally, the volume recovery, the sales pipeline, the innovation recovery is performing very well. The last set of initiatives are really focused on the cost structure of our global manufacturing footprint. We've begun to implement some of those initiatives in the second half of the year, but they're going to fully begin to kick in, in next year 2025. So, still a lot of work to do. We actually have put a lot of effort against that business, but we have another sort of full year plus to sort of get the business back to where we think we are. But good progress today. Thanks, Mike.

[Operator]

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

[Adam Samuelson, Analyst at The Goldman Sachs Group]

Yes, thank you. Good morning, everyone. Maybe keying off of that last question and answer, Glenn, Erik, to a little more detail on some of the more tangible steps within the Functional Ingredients business to improve the the profitability and get that where it needs to be from a margin and earnings and returns perspective. I think in the prepared remarks, you alluded to a kind of a refreshed strategic plan there. So is that really about facility consolidation to lower -- to lower manufacturing costs? Is there intention on product and business mix across some different categories? And can you talk about kind of how you think your volume performance in 2024, which was -- is been up nicely against kind of a very challenging '23, compares to the end markets and peers that you look at in that space.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Yes. Thanks for the question. I think we're making good progress on transforming the business and getting it back healthy. We have achieved some significant volume recovery ahead of the market by going back to customers that we had before and making sure that they realize that we're serious about reliable supply, about serving them well, but making sure that we're very customer-focused, and that's played out well. We've had to make some price moves with the market as others have done as well. But that was as expected, actually has resulted in the combination of the productivity, aggressive productivity with some price giveback, we've still enabled us -- still enabled us to achieve our margin goal -- margin improvement goals in that business. So we're very much on track. But it is a combination of focusing on customers, really getting the clarity of strategy for the Functional Ingredients business, which we've been working hard on which tells us where we focus our commercial efforts, what customers, what segments, what geographies and making sure that we're driving the volumes so that our plants are operating well plus a very aggressive approach on productivity to ensure that we've got competitive costs and are able to have the target margins that we want for that business. It's a work in progress. We've still got a lot of room to go. As Glenn mentioned, we've got another year plus to get back to where we believe that business should be, but I'm very, very proud of the team and the progress that they're making.

[Operator]

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

[David Begleiter, Analyst at Deutsche Bank Aktiengesellschaft]

Thank you. Good morning. Eric, I know you've been working on improving performance in your Health business. With return to growth in the second quarter, can you share what's driving the strong performance in Probiotics and how sustainable is that growth?

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Great. Thanks for the question, David. First of all, I think there's increasing emphasis on healthy -- health and gut health which is great. And the U.S. market particularly has rebounded and is picking up nicely. And as you know, we focused a lot recently on our finished format approach, which is working very well. I would also say that we've added significant commercial capability. Our team there has actually done a great job of bringing back some really strong salespeople that left IFF in previous years and have now come back home, which is really helpful because it's great that they went out and thought that there were things were better, but now come back to IFF because they like what we're doing at IFF. And by the way, that's happening in some other areas as well. And then finally, the current performance is starting to turn and making some good progress. But I've got to tell you, we've got a very exciting pipeline in our Health business that I think will bode well for the coming years.

[Operator]

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

[Salvator Tiano, Analyst at Bank of America]

Thank you very much. I want to ask about a couple of recent trends on how they are or the main impact to your volumes. And firstly, a bunch of CPG in the Fragrance sales you mentioned are considering moving back to discounting products to get some volume. So are you hearing about that? And could it give another boost in your volumes perhaps next year? And on the other hand, lot has been said about the return of innovations and more SKUs by your customers post COVID, which is helping now. How important has this been in your 2024 results so far? And, is there any risk that this runs out of steam after your customers have new products late and they're done with this innovation focus?

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Thanks for the question. And what we're seeing from CPGs is that they want to strengthen their growth and profitable growth like we all do. And the way we're hearing most about their strategy is to drive more innovation. And that's terrific for us because we love working with our customers to enhance innovation. And just a couple of examples of what's happening there. Obviously, the health -- the desire for better health and our ability to reduce sugar and salt content through modulation with our flavors in a way that gets you the same taste, but significantly lower sugar or salt levels, is really strong and is one of the key drivers of our Flavors business, which is doing very well. We also, in the Scent business are working with our Fine Fragrance customers, for example, to enhance the ability to trigger emotions that the fine fragrance companies want to have. Just an example of that is Charlotte Tilbury, wanted to come out with a range of products that triggers different emotions for consumers. And we used our AI tool, our IFF Scent Cube Algorithm with her and her team to develop this line of fragrances that bring one product brings joy another product brings energy, another product brings relaxation and another product brings romance, a whole slate of products, innovative products.

But if you go online on TikTok and you go, you search for Charlotte Tilbury, she talks about how exciting it was to develop these great products, which are doing extremely well together with IFF to make them happen. And then we're seeing other innovation, which helps to drive cost, productivity, such as cocoa prices are very high. We have cocoa extender capabilities in our Flavors and our Biosciences businesses that are helping companies reduce significantly the amount of cocoa they use, but having the same exact same taste at lower cost. And then one other example I think is really exciting is that we recently with a very large global food company, developed and they have launched a lactose-free milk in China where our enzymes take out the lactose and turn it into fiber. And so you get lactose-free milk that is lower calorie and healthier for you. And as you know, there are many, many lactose-intolerant consumers in China, so a big market. So this focus on innovation and our ability to work with our customers to bring great innovation that helps them drive their growth profitably is really paying off.

[Operator]

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

[Mark Astrachan, Analyst at Stifel Nicolaus]

I guess two clarifications. One, just on the outlook over the balance of the year, the volume outlook to be weaker in 4Q. Is it something that you are theorizing, is it something that you have line of sight on? It sounds like from your guidance that 3Q in July has gotten off to solid starts. I guess I'm curious just how you disaggregate those two pieces, 3Q versus 4Q? And then as we go into next year, are there any one-offs to consider like incentive comp? I think you had mentioned resets this year, so just things to think about going into next year.

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Mark, thanks for the questions. Q4, we have very little visibility at this point in time. We have a very good view towards the third quarter book. Obviously, July is in the bank. And we have a good view to the current month and then September. So there's not a lot of data points at this point in time, to sort of give us any direction on Q4. Beyond, we are overlapping an improvement from prior year. So we're negative 7% in Q3 of last year versus negative 3%. And again, we do think that the consumer dynamics basically suggests that end market demand will be flattish. We don't see restocking happening either. We do think that the CPG firms are conservative. They're not going to restock until they see a strength in the market. So all those factors basically just make us cautious on the fourth quarter until we begin to see the order book emerge.

One-offs is a good question. The annual incentive plan is a very significant variable this year out of plan, because of the very strong performance across all of our businesses, we are accruing an incremental $100 million, is share of AIP. That's actually $140 million aggregate versus prior year, that -- so think about our guide of $2.1 billion to $2.17 billion, that includes $100 million that will be normalized for next year as you just go into next year and get back to 100% sort of payout from a standpoint. That's the most significant really -- there's always puts and takes and other items relative to where we are, but that's probably the most significant item by far within our P&L. Thank you.

[Operator]

Our next question comes from the line of Kevin McCarthy with Vertical Research Partners. Kevin, your line is now open.

[Kevin McCarthy, Analyst at Vertical Research Partners]

Yes. Thank you and good morning. You're making some pretty good progress on the balance sheet in the quarter, and it appears as though that will most likely continue with the EBITDA upgrade and of course, the pending Pharma deals. So my question would be, if we were to jump ahead, Erik, to a time when the balance sheet is fully repaired, so to speak. Are there other things that you have in mind that you'd like to do strategically if capital were not a constraint?

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Thanks for the question. And absolutely, our plans are to continue to significantly strengthen our Health & Biosciences business, our Flavors and our Scent businesses. We see a lot of opportunity with organic investments, both in R&D, commercial capability, digital capability as well as capex opportunities to expand capacity and make sure that we always have enough products to sell all around the world. And then also I foresee us returning sometime next year to really looking at bolt-on -- bolt-on acquisition opportunities and collaboration opportunities, with companies that bring complementary capabilities, especially technologies that would be useful for us. So we will -- we're already working on our strategies and you'll see us get more proactive in these areas.

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Yes. I think it's also important to emphasize given I'll say, our jaded history here relative to acquisitions is we feel like we have a phenomenal portfolio in place. We're going to prioritize the organic. And as Erik mentioned, the focus really is on bolt-ons, small acquisitions that provide either a complementary technology, a geographic strength, etc, as a way to continue to progress the business. At this point, anything large would be completely out of the question.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Yes. And I think if you look at my experience, which in the last 16 years as a CEO, we've had a lot of positive experience with bolt-on acquisitions that clearly fill a strategic gap and are integrated well, thoughtfully, carefully and done in a way that enhances the company's performance immediately doesn't distract and doesn't take us backwards like you've seen that's happened over the last six years here.

[Operator]

Our next question comes from the line of Lisa De Neve with Morgan Stanley. Lisa, your line is now open.

[Lisa De Neve, Analyst at Morgan Stanley]

Hi, everyone, and thank you for taking my questions. I have one follow-up and one question. So one follow-up on the capex program, sorry, one more. Can you please provide some detail on your digital investments, including the ERP system? And can you please share how this will improve or impact the organization? And also whether there's any risk to execute on implementing on the ERP system, in particular. And the second question I have is really how has your position with local and regional customers versus multinational customers evolved over the last couple of years? And can you share your exposure to these type of customers and how dynamic they are versus multinationals at the moment?

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Great. So let me take the first question first. and just tell you that we are taking an ERP approach that is very step-by-step and very careful to minimize wasted investment and also to minimize risk of implementation. And I'll just give you a couple of examples. So the first step in our corporate ERP system development was implementing something called CFI, our finance system, which we've done already. It's in place. We've done the improvements, and it's getting better and better and enabling us to better do our closes with less people and less complexity and less corrections. The next step was just implemented in the past week called Workday for the HR systems. That's going as planned so far, going very fine, and then we'll do additional steps in the coming three years. So we're doing it step by step to spread out the investment and spread out the manpower, the focus required on it and to make sure that we do it well with minimum risk.

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

If I could just add two comments. So we will be converting. We're currently on three incidences of SIP. We will be converting them probably over the next five years into a single pipe, if you will. We will be leveraging one of the legacy IFF pipe, if you will. That's going to be approximately $250 million over that 5-year period to get that done. It's very important to also add to Erik's comments is we actually have already separated one of our ERPs, we're on 4, a little over a year ago with the divestiture basically of our microbial control business and we want to get basically Pharma out of the way before we sort of launch on the ERP conversion. So think about this as the second half of the year once Pharma's done, we'll be in a good shape. It's about $50 million a year over the next five years.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Now on your second question, the way I would look at it, I've just been all over in the world and I've met with customers representing over 1/3, probably about 40% of our revenues with our people and many of them top-to-top discussions with major global multinationals, regionals and locals, talking about what we do well, what we need to do better and how we can even more closely work together on innovation, co-creation of their product lines. And I tell you, I'm very excited about the desire of customers global multinationals, regionals, locals to work with us to tap into our innovation and our people capability to do that is really, really strong. And so what I believe is that our history with the large multinationals, our understanding of the markets around the world of what works has enhanced our ability to better serve them as we focus more on customers as a core part of what we do in our innovation powerhouse, but also as we increase our commercial capability, better serve them and the regionals and the globals -- or excuse me, the regionals and the locals, which will enhance our ability to drive our growth rates ahead of the market, and that's a core part of our strategies for each of our business units.

[Operator]

Our next question comes from the line of Lauren Lieberman with Barclays. Lauren, your line is now open.

[Lauren Lieberman, Analyst at Barclays]

Hey, thanks. Good morning. So two quick questions. One was just you guys have historically given forward quarter guidance for sales and EBITDA and you didn't for 3Q. So I was just kind of curious, should we expect a change in that policy and approach? And then secondly, was just on gross margins, if we could walk through the bridge to get to the 500 basis points of margin expansion beyond lapping the LBK, was deflation raw materials a benefit? I know you mentioned productivity gains a bunch in the release in the slides. But just how should we maybe think about gross margin progression in the back half? And any detail on some of those productivity programs could be helpful, too.

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Yes. Lauren, we actually did provide outlook for Q3. So we guided top line of $2.75 billion to $2.85 billion. And then relative to EBITDA, $5.20 to $5.40 for the quarter. So that's the outlook for the quarter. relative to progression on gross margin for the balance of the year, we have more significant upside in the first half of this year because of the absorption LBK and other items. We still are forecasting a solid improvement year-over-year in terms of our gross margin for the second half of the year. And it's going to be driven by -- volumes won't be quite up as much. So that's a little bit of let's see a difference versus the first half. But the productivity programs are continuing to deliver consistently quarter-to-quarter in the second half versus the first half. The net raw material basket is generally flattish in terms of where we are running from the first half to the second half going. So we don't really see any significant upside relative to that nor do we see downside at this point in time. So hopefully, that's helpful.

[Operator]

Our next question comes from the line of Jeff Zekauskas with JPMorgan. Jeff, your line is now open.

[Jeff Zekauskas, Analyst at JPMorgan Chase & Co.]

Two questions. Was there a diminishment of your volume growth in July? Or how are your volumes in July? How do they compare to the second quarter? And to try Lauren's question once again, your cost of goods sold was down 9% on flat to down sales. How much were your raw materials down I know you said that they would be flat sequentially into the second half?

[Glenn Richter, Chief Financial and Business Transformation Officer at International Flavors & Fragrances]

Sequentially, yes. So I'll answer it. Our total net price in the business, largely concentrated in Functional Ingredients is around 2.5% in the first half of the year versus prior, that's equivalent to basically the reduction in raw materials year-over-year. So we basically use that to reinvest. Again, that's largely concentrated in Functional Ingredients. So the other businesses are relatively flat, year-over-year from a raw material standpoint. July started off well. I would note that we have a very good start of the quarter. However, Jeff, in the last two quarters, the pattern has been a very, very strong first month and then it diminishes second and third. Generally, the third month of the quarter, and this is our outlook tends to be the softest. We believe as this is just consistent with our customers sort of managing their inventories tighter at the end of the quarter. So a good, good start in terms of July, but that's been consistent with what we've seen as a pattern in the last couple of quarters.

[Operator]

Our next question comes from the line of Laurence Alexander with Jefferies. Laurence, your line. Is now open.

[Unidentified Participant, at International Flavors & Fragrances]

This is Dan Rizzo on for Laurence. Just one question. So I mean, can we expect any more potential divestitures? Are there certain businesses where maybe you're making them or improving them just so you can sell them because they're noncore?

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

We are focused right now on the divestiture of Pharmaceuticals and doing that well. We're also going through the strategy refresh for each of our other businesses. And today, our total focus is on performance and performing those well, enhancing the growth rates of our Health & Biosciences, Fragrances, Scent business and Flavors businesses and turning around our Functional Ingredients business. As I mentioned before, as we separate pharmaceuticals, we'll give you an update if there's any change in our strategy. But right now, we're totally focused on performing well in 2024 and strengthening for '25 and beyond.

[Operator]

Thank you. There are no questions registered at this time. So I'll pass the call back over to Erik for closing remarks.

[Erik Fyrwald, Chief Executive Officer at International Flavors & Fragrances]

Just let me thank everybody for joining the call today. I'm very proud of our IFF team and the improvements that we're making to deliver not only today but to strengthen our innovation and our productivity and our customer focus to not only deliver in the second half, but further strengthened for '25, '26 and beyond. So thank you for your interest in IFF and have a great day.

[Operator]

[Operator Closing Remarks]

Participants

Corporate Executives

• Michael DeVeau, Senior Vice President, Corporate Finance and Investor Relations
• Erik Fyrwald, Chief Executive Officer
• Glenn Richter, Chief Financial and Business Transformation Officer

Analysts

• Josh Spector, UBS.
• Ming Tang, BNP Paribas
• John Roberts, Mizuho
• Ghansham Panjabi, Robert W. Baird
• Kristen Owen, Oppenheimer Holdings Inc.
• Patrick Cunningham, Smith Barney Citigroup
• Mike Sison, Wells Fargo & Company
• Adam Samuelson, The Goldman Sachs Group, Inc.
• David Begleiter, Deutsche Bank Aktiengesellschaft
• Salvator Tiano, Bank of America Co.
• Mark Astrachan, Stifel Nicolaus
• Kevin McCarthy, Vertical Research Partners
• Lisa De Neve, Morgan Stanley
• Lauren Lieberman, Barclays PLC
• Jeff Zekauskas, JPMorgan Chase & Co.
• Unidentified Participant