Frank Clyburn
Chief Executive Officer at International Flavors & Fragrances
Thanks, Mike. And thanks, everyone for joining today for an important discussion on our business performance and the critical actions underway to create an even stronger IFF.
As you are aware, recent results from across our industry in many of our largest customers has clearly demonstrated that macroeconomic headwinds continue largely unabated. This environment has challenged financial performance of IFF and our peers in the first half of 2023 and has resulted in a more cautious outlook for the remainder of the year.
However, despite this tough environment, it is also important that we highlight the significant progress we are making on transforming and strengthening IFF's business.
Consequently, today we will share promising early results from the strategic transformation initiatives we have been discussing with you as well as some additional actions we're taking, summarize our performance for the second quarter 2023 and outline the additional steps we are taking to drive shareholder value creation at IFF. Then we will be happy to take any questions you have at the end.
With that in mind, on slide 6, I'll begin with a quick summary of the key takeaways for the second quarter, which I will unpack further here in the next few slides, including the actions we're taking to progress our strategic transformation.
First, amid the current operating environment facing the industry, including temporary destocking, IFF is performing broadly in line with peers, excluding functional ingredients.
Second, consistent with our invest, maximize and optimize framework that we introduced in our 2022 Investor Day, we continue to broaden our portfolio optimization efforts, including through strategic non-core divestitures.
Third, we've outlined as clear operational improvement plan to drive improvement within our functional ingredients business. And lastly, our work behind the scenes to strengthen our organization is paying off as we're making strong progress in terms of our strategic initiatives to ensure IFF is well positioned for long term success as market conditions begin to improve.
Let me now unpack each of these a bit further. Turning to slide 7. Amid the current operating environment, Q2 results were mixed as comparable currency neutral sales growth for the second quarter was down 4%. Strong results in Scent and Pharma Solutions were more than offset by softness in H&B and Nourish, particularly functional ingredients.
From a profitability perspective, our adjusted operating EBITDA was in line with our guidance range, excluding a one-time inventory write-down due to unprecedented cost fluctuations for one ingredient, locust bean kernel.
Our focus on cash flow generation has yielded solid results, improving sequentially and versus the prior-year period, as we successfully executed on our inventory reduction same program.
Now as we look to the bounce of the year, the pace of industry recovery that we expected is not materializing according to our original expectation. Consumer demand remains soft and temporary customer destocking trends are continuing. As a result, we have adjusted our expectation for the full year 2023, lowering sales to $11.3 billion to $11.6 billion, entirely driven by lower volumes. For the full year, we expect volumes to now be down mid to high-single digits versus roughly flat previously.
Our adjusted operating EBITDA range is now $1.85 billion to $2 billion as favorable net price to inflation and enhanced productivity are more than offset by lower volume, higher manufacturing absorption costs related to our inventory reduction program, and the impact of the write-down of LBK inventory.
Approximately 75% of IFF's business including Scent, Pharma Solutions, H&B, flavors and food design are performing broadly in line with industry peers. The one area where we have significant opportunity to accelerate is the functional ingredients business where we are aggressively implementing an operational improvement plan. I will share more in a moment.
On slide 8, looking at our business more broadly, we're continuing to accelerate our portfolio optimization initiatives to maximize returns and deleverage our balance sheet according to plan. We're investing behind to maximize our high return businesses, while optimizing other businesses, including through additional divestitures across all three categories -- invest, maximize and optimize -- within our strategic framework.
We've made significant progress on this front, with the recently completed sales of our microbial control, savory solutions and flavor specialty ingredients businesses. We're continuing that momentum as we launch the sale process for Lucas Meyer Cosmetics, aligned with our best owner mindset. This is consistent with our mindset of ensuring each of our businesses has the resources and ownership most conducive to long term success and maximum returns.
For LMC, specifically, it is a fantastic business and I have no doubt that it will continue to prosper under new ownership. And for IFF, it would allow us to reduce outstanding debt while continuing to invest in our most core and accretive businesses.
We have also hired J.P. Morgan to explore additional divestiture actions within the portfolio as a pathway to accelerate, deleverage and unlock further value creation for our shareholders. We are reviewing all options, consistent with our strategic framework, and we will only pursue opportunities that are value accretive for our shareholders.
A key part of our approach is that we will not look to divest assets at depressed multiples, especially those that are impacted by temporary destocking trends. Instead, we believe there's more value creation from improving these businesses before divesting.
On slide 9, I wanted to put this in today's presentation to show the dynamics we are seeing across the portfolio. As you can see from the slide, the vast majority of our portfolio from 2021 through the first half of 2023 has performed near or at expectations volumetrically. On a quarterly average basis, even amongst this unprecedented macroenvironment over the past two years.
Also, when comparing with our peers, we believe that these businesses are largely performing in line with them based on our business mix. The main business has been functional ingredients with quarterly average volumes down approximately 6% during that same timeframe.
The message is similar. If we analyze our volume performance on a first half 2023 basis, the volumes for functional ingredients is down approximately 20% versus a mid-single digit decline for the rest of the business. Based on this, and as I mentioned on the first quarter call, we have been taking immediate action to improve functional ingredients performance, while continuing to invest in our high return businesses that make up the bulk of IFF by revenue -- Scent, H&B, Pharma and the other categories within our Nourish division.
On slide 10, I would like to focus on functional ingredients in particular. Digging deeper into functional ingredients and what has happened. Overall market declines and alternative protein consumption, including demand decline for plant based products, persistent supply chain challenges, given the macro backdrop since the pandemic, and more aggressive inventory management by customers have collectively contributed to pressure on functional ingredients.
Looking forward, while food demand volumes are beginning to stabilize and service challenges across the entire supply chain have improved, we do expect customer destocking to persist through the second half of the year based on what we're hearing from our customers. This destocking, while temporary in nature, will continue to pressure our functional ingredients volume as we move through the second half.
Now moving to slide 11. Our plan includes several near term actions to improve performance in functional ingredients. First and foremost, there are clear opportunities to enhance our go-to-market approach with several key customers and accelerate our pipeline to win more opportunities.
Since the early part of the year, we have hired over 50 new commercial professionals entirely focused on functional ingredients to pursue incremental market opportunities. We are already seeing early signs of improvement with a strong and growing pipeline.
The second opportunity is strengthening our operating model. We will be disciplined in our approach from a productivity and operational excellence perspective, delivering 2% to 4% of annual productivity and also as we think strategically about how to allocate capital to this business to deliver strong ROIC growth.
We have also made the decision to report functional ingredients to provide increased transparency on performance and ensure increased management accountability with well-defined KPIs.
Lastly, we are working to significantly reshape the functional ingredients portfolio for success. This means increasing the competitive edge of our successful core product lines, while modifying or discontinuing those that have proven not to be additive to the portfolio.
The net result of this operational improvement plan, supported by our new leader in Nourish and functional ingredients, will allow us to grow sales in line with the market and deliver a mid-teen adjusted operated EBITDA margin over the next three years. We expect that, through this plan, plus the elimination of more transitory challenges, such as the LBK inventory write-down and negative absorption, we will see a meaningful improvement in 2024.
Moving to slide 12, I would like to now focus on the significant progress we are making against our strategic plan as we seek to be the premier partner, build our future and become one IFF. Despite the current macroenvironment we see our industry in, our teams around the world are putting in the work to ensure we are setting ourselves up to capitalize as economic conditions begin to normalize.
Our commercial excellence initiatives are yielding strong results. We have greatly improved customer service performance, identified more than $250 million in new growth opportunities in 2024 and beyond, and are expanding the sales pipeline up more than 50% year-over-year across all divisions.
We are building our future and extending our leadership in R&D, with 15 new technology launches year-to-date and an expected revenue contribution exceeding $100 million. At the same time, our focused productivity initiatives yielded approximately $140 million in savings through the first half of the year.
We're optimizing our portfolio to focus on our highest growth, highest margin businesses through selective divestitures, which will complement our efficiency objectives as we meet our deleveraging targets.
Lastly, we're making exciting progress in building a more unified IFF. We're finalizing our transition to our new customer aligned operating model, which will be completed in the first quarter of 2024.
We've also continued to enhance our culture and deepen our bench of world class talent. In June, we appointed Yuvraj Arora, an experienced CPG executive who previously led US categories for Kellogg as president of our Nourish division. With our leadership team and incentive structure now in place, the organization is poised for sustainable profitable growth and expansion.
Now on slide 13, I would like to highlight the strong improvements we have made in terms of our pipeline opportunity. Our scientific and technological expertise remains a key differentiator in the competitive market. We win by introducing new and unique capabilities to meet our customers' evolving needs. We're seeing the benefits of our refocused R&D and commercial excellence initiatives, including a more than 50% increase in opportunities so far in 2023 versus the same 2022 period. This increase is giving us continued optimism in the future potential of IFF.
In Nourish, increased opportunities across regions and categories has led to a greater than 60% pipeline inflow versus last year. Our recent notable wins included Xylitol, which is a sweetener used in bars, cereals and other confectionery goods.
In Scent, our compounds pipeline opportunity continues to be healthy and strong. Included in this was a significant win for our Boost Powder Detergent, a 100% active powder laundry detergent that is effective and safe to use on washable fabrics.
In Health & Biosciences. greater capacity is driving a robust pipeline in our cultures and food enzymes and our health and grain processing units. Included within this is a notable win in North America Probiotics, a dietary supplement that supports gut health.
And in Pharma Solutions, the pipeline has doubled while the team has delivered key wins in METHOCEL, a plant-based, water soluble functional ingredient that supports dietary supplement manufacturing in a high growth category.
Collectively, our team's creativity and efficiency in bringing innovative solutions to market provides confidence in our ability to strengthen our long term leadership as the preferred partner for CPGs worldwide.
Moving to slide 14, our management team is aligned on key objectives essential to IFF's success as market conditions normalize, turning IFF into a leader in high value innovative solutions.
Through the second half of this year and beyond, we are focused on accelerating growth and maximizing shareholder value, expanding our margin, enhancing our return on capital and improving our leverage ratios.
We believe we have a strong, achievable plan in place to ensure we are well positioned to rebound growth and profitability and continuing executing on our broader strategic transformation in 2024 and beyond.
I will now turn it over to Glenn to discuss our second quarter performance and financial position entering the second half of 2023.
