International Flavors & Fragrances Inc (IFF) 2024 Q2 法說會逐字稿

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.

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 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 could 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 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 Erik.

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 the solid performance IFF delivered in the second quarter.

Also, during today's call, we will provide a brief update on the business lead 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 a third 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.

Beginning with slide 6, 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%, 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 our efforts on bringing customers leading innovation while driving healthy productivity are yielding encouraging results. We are making solid progress advancing the business lead 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's full potential.

Moving to slide 7. 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 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 five 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 & Biosciences biotech expertise and capabilities across our Scent & 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. As we prioritize growth investments to our highest value businesses such as Flavors, Scent and Health & 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 the 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?

Thank you, Erik, and thank you all for joining us today. As Erik noted, that 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 9, 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 Nourish was driven by volume growth and productivity improvements as well as the comparison to the one-time locus being current 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 said, 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 decline in line with our plan as we managed to unfavorable mix and one-time 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.

I've also continued to make progress toward achieving our deleveraging goals and reduce our gross debt by over [$900 million] from last quarter, yielding a net debt to credit adjusted EBITDA ratio of 4 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 3 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 the outlook for demand in the balance of the year. Operate 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 $520 million to $540 million.

I'll now turn back to Eric for closing remarks.

Thank you, Glenn. As I shared at the top of the call, I'm 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.

I'm energized by the progress we've made so far this year, and 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 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 lead strategy. We want every IFF 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. And 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.

With that, and we'd now like to open the call for questions.

We will now begin the question-and-answer session. (Operator Instructions)

Josh Spector, UBS.

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 it pretty material seasonal step down. So what is driving that in your view versus the stronger 2Q?

And then related is around volumes for the 3% to 5% lift is clearly better than you expected, but that's largely just a reflection of I think 2Q flowing through. I would say volumes in the second half are up 1% to 2% comps maybe do get harder, but it seems like with sequentially stable, maybe moving around a little bit. That's a pretty easy bar to be. So what are you seeing on the volume side that we might be missing? Thank you.

Hey, morning, 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 brief and flattish in Q4. As a reminder, last year sequentially was [negative 7] [negative 11] to [negative 7] and [negative 3] on 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, as you're well aware, are probably of 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 a 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 and 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.

But I will also add that we are investing about $20 million to $30 million incremental op ex 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 piece of the equation.

Nicola Tang, BNP Paribas.

Hi, everyone, and thanks for taking the question. And it actually fits quite nicely from your last answer that, Glenn. I was wondering if you could give more color on some of those incrementally as around R&D and commercial efforts and capacity. Could you give a few more specific examples and how you expect that to feed through will contribute to '25 and '26? And you gave some helpful quantification on CapEx. And for the next few years in terms of this OpEx step-up, should we also extrapolate that going forward as well? Thank you.

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 & 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 & Flavors businesses.

We also increasing the R&D to find more naturals, [12%]. And the for flavors, obviously a great market trend towards naturals were 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 -- 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 & Biosciences Scent & 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 investments 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.

John Roberts, Mizuho.

Thanks, and also congrats on the quarter. Erik, on slide 7, this expanded and operating model replaces the reorganization and your predecessor has started on home model fully in place? Or can you tell us where you are when will be fully in place?

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 clearly cleaned up. The business teams are getting put in place, and they're very excited and very energized by the clarity of decision banking, 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, 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 that the strategy is 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 a commercial operations product, produce it and then get it in there commercially. And it'll take a while to fully drive the benefits. But we're starting to feel the that is 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 comes the five-year plan, which gives us more clarity on where we're investing, we're able to better differentiate between the units on where we put more of the investment and where we put less of investment where we need more productivity and where we need to focus that productivity to make sure that we're competitive cost wise and able to drive margins.

And then also as you get that clarity on each business unit on what they need to do to win it also increases the ability of businesses to collaborate effectively. And so that's the that that collaboration is 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, that synergy where that leverage makes sense. So we're making good progress in 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.

Ghansham Panjabi, Baird.

Thank you, operator. Good morning, everybody. And Erik, I just want to go back to the strategic refresh specific to on to R&D, does that entail more spending as it relates to R&D as a percentage of sales or is it more?

We're repositioning resources with an overlay of accountability also on the CapEx piece. And 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, right sequencing to think about as you go back to your comments about 6% CapEx to sales going forward?

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 we're under invested before in basic making sure that our plants are up to standards that we need to have them operate well reliably with high quality.

And we have some ERP investments that we need to make and that are kind of in 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 we'll increase the R&D spend in our flavors and incent 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 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 beat to make sure that we're fully competitive on costs for our corporate functions. Thank you.

Thank you.

Kristen Owen, Oppenheimer.

Good morning. Thank you for taking the question. Now I wanted to -- if we could unpack some of the volumes drivers behind each of the businesses in Q2, but let's understand the mix between end user demand, channel restock and or some of the pricing incentives that you're talking about?

Thanks. Good morning, Kristen, and 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 beverage HPC really are showing any strengthening 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's 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 farmers destocking lagged a bit all the other businesses. We think we're 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 of these, the 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 that's really a function of sort of three things.

One is, as Erik mentioned, the innovation focus was increase our intensity relative to our innovation pipeline. Secondarily, our sales pipeline. We spent a lot of energy to rebuild our pipeline and really accelerate our ability to win new business and win back business.

And then third, I would have a special call out for the Ingredients business. The 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 70%-plus volumes in the Ingredients business in the second quarter alone. So that's how we sort of characterize again, were 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.

Patrick Cunningham, Citi.

Hi, good morning. Given some of the incremental increase in OpEx and CapEx, but no revised guidance upwards because any update to free cash flow guidance for the year and the items we should be monitoring there. Thank you.

Hey, good morning, Patrick, and thanks for the question. We are still guiding to the full year of $600 million. As a reminder, when we started the year, it was $500 million. We upped our guidance to $600 million 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 to be at 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, et cetera. So adjusting for that, with taking that direct cost out for more like [$950 million] for the year, which is very consistent with what we guided previously as well.

Mike Sison, Wells Fargo.

Hey, guys, nice quarter and outlook. In terms of functional ingredients, how powerful the new strategy driven the volume recovery2? I think we had nice high single digit recovery into Q2. In addition, pricing is lower. Can you can you share a little bit of details on EBITDA margin? Is it up meaningfully to did it improve? And then just your thoughts on the second half for Functional Ingredients? Thank you.

Hey, thanks, Mike, and good morning. Yeah, 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 LVK 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 or 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 next year, 2025. So still so a lot of work to do.

We've actually a full-out 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 to date. Thanks Mike.

Adam Samuelson, Goldman Sachs.

Yes, thank you. Good morning everyone. Maybe keying off of that last question & answer Glenn, Erik. A little more detail on some of the more tangible steps within the Functional Ingredients business to improve the profitability and get that where it needs to be from a margin earnings and returns perspective, you think in the prepared remarks, you alluded to kind of refreshed strategic plan there.

So is that really about facility consolidation to lower your lower manufacturing costs? Is there intention on product and business mix across different categories? And can you talk about kind of how you think your volume performance 2024, which up it's been up nicely against kind of a very challenging '23 compares to the end markets and peers you look at in that space?

Yeah. Thanks for the question. I think we're making good progress on transforming the business and getting it back healthy and that 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 and 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 to achieve our margin goal and margin improvement goals in that business.

So we're very much on track, but it is a combination of focusing on customers really getting that 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.

David Begleiter, Deutsche Bank.

Thank you. Good morning. Erik, I know you've been working on improving performance in your health business with return to growth in the second quarter to show what's driving the strong performance in probiotics and how sustainable is that growth? Thank you.

Great, thanks. 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 US 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 and our team there has actually done a great job of bringing back some really strong sales people 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 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.

Salvator Tiano, Bank of America.

Thank you very much. I wanted to ask about a couple of recent trends, how they are all that may impact your volumes and personally a bunch of CPGs seeing the segment sales you mentioned are considering moving back to discounting products, we get some volume.

So are you hearing about that that could this give another boost in your volumes perhaps next year and on the other hand, a lot has been said about the return of innovation, some more SKUs by our customers post COVID, which is helping now how important has this been in your 2024 results so far. Is there any risk that these ramps out of steam after that your customers have a new product slate and their data with us innovation focus?

Thanks for the question and what we're seeing from CPGs as 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 use our AI tool our IFF sent cube algorithm with her and her team to develop this line of fragrances that bring one product brings joy, another product brings energy, and other product brings relaxation, another product brings romance. A whole slate of products innovative products. If you go online on TikTok and you do your research 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 extend our 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 it's really paying off.

Mark Astrachan, Stifel.

Yes, thanks, and morning, everybody. 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 that something that you have line of sight on. It sounds like from your guidance that 3Q on July has gotten off to a solid start. So 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 two things to think about going into next year. Thank. you

Yes, and good morning, 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 years that were negative 7 in Q3 of last year versus negative 3. And again, we do think that the consumer dynamics basically suggests that and 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-off is a good question on the annual incentive plan is a very significant variable this year on out of plan because of the very strong performance across all of our businesses, we are accruing an incremental $100 million this year of AIP. That's actually $140 million in aggregate versus prior year that, so think about our guide of $2.1 billion to $2.17 billion.

That includes the $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 standpoint, that's the most significant there really are there's always puts and takes and other items relative to where we are, but that's the probably most significant item by far within our P&L. Thank you.

Kevin McCarthy, Vertical Research Partners.

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 deal.

So my question would be wanted to jump ahead, Erik, to a time when the balance sheets fully repaired, so to speak, are there other things that you have in mind that you'd like to do strategically capital are not a constraint?

Thanks for the question. And it 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-ons 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.

Yeah, I think it's also important to emphasize, given our -- 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 their organic. And as Erik mentioned, the focus really is on bolt-ons, small acquisitions that provide either a complementary technology or geographic strength that center as a way to continue to progress the business at this point? Anything large would be completely out of the question.

Yeah, I think if you look at it, my experience which had 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. It doesn't distract and doesn't take us backwards, like you've seen, that's happened over the last six years here.

Lisa De Neve, 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 case. Please provide some detail on your digital investments, including the ERP system. And can you please share how this will improve or impact your organization and also whether there's any risk to execute and implementing on this 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 multi-nationals at the moment? Thank you.

Right.

So let me take the first question first, and just tell you that, Lisa, 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.

Just give you an exact couple of examples. So the first step in our corporate ERP system development was implementing something called (inaudible) Our finance system, which we've done already, it's already in place. We've done the improvements, and that'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 this past week called Workday for the HR systems that's going as planned, so for going very fine and then we'll do additional steps in the coming three years. So we're doing it step by step two to spread out the investment and spread out the manpower, if you have the focus required on it and make sure that we do it well with minimum risk.

If I could just add two comments. So we will be converting with currently on three incidences of SAP. 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, and that's going to be approximately $250 million over that five 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 for a little over a year ago with the divestiture basically over 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 the second half of the year once farmers done, we'll be in good shape and it's about $50 million a year over the next five years.

Now on your second question, what the way I would look at it. I've just been all around the world and I've met with customers representing over one-third, 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 and 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.

It 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 -- the regionals and the locals, which will enhance and enhances 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.

Lauren Lieberman, Barclays.

Hey, thanks. Good morning. So two quick questions. One was just and you guys have historically given fourth quarter guidance for sales and EBITDA and you didn't for 3Q. So I was just kind of curious, are we 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 500 basis points of margin expansion beyond lapping the LBK., What was deflation, raw materials 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. Thanks.

Yeah. 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 $520 million to $540 million 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 absorption, LTK and other items. We still are forecasting a solid improvement year over year.

In terms of our gross price drop of gross margin for the second half of the year, it's going to be driven by volumes won't be quite up as much. So that's a little bit of a difference versus the first half. But the productivity print programs are continuing to deliver consistently quarter on 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 is going because we don't really see any significant upsides relative to that, nor do we see downside at this point in time. So hopefully that's helpful.

Jeff Zekauskas, JPMorgan.

Two questions. Was there a diminishment of your volume growth in July or how were you volumes in July? How did they compare to for the second quarter. And to 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?

Sequentially (multiple speakers) Yeah, so I'll answer our total net price in the business, largely concentrated 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 to the other businesses are relatively flat year over year from a raw materials Standpoint.

July started off well, and I would note that 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 concern generally the third month of the quarter, and this is our outlook tends to be the sources we believe is this is just consistent with our customers sort of managing their inventories tighter at the end of the quarter. So a good start in terms of July, but that's been consistent with what we've seen is a pattern in the last couple of quarters.

Laurence Alexander, Jefferies Finance.

Hi, guys. This is Dan Rizzo on for Laurence. Just one question. 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?

We are focused right now on the divestiture of pharmaceuticals and doing that well. And we're also going through this 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 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.

Thank you. There are no questions registered at this Time so I'll pass the call back over to Erik for closing Remarks

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.

That concludes today's call. Thank you for your participation. You may now disconnect your lines.