International Flavors & Fragrances Inc. (IFF) Earnings Call Transcript & Summary

So next up, we have International Flavors & Fragrances and really happy to have the company's CEO, Erik Frywald, with us. Erik, it's your first time at the conference. So really glad you're here. So before we get into some of the near-term and kind of more strategic questions, since it's a broader staples audience here and listening, who may be less familiar with your background in particular, I thought it'd be great if you could kind of introduce yourself. Maybe talk a little bit about what drew you to IFF and how your prior experiences, including 25 years at DuPont or over 25 years is kind of informing your leadership of what is now the largest specialty ingredients company.

Great. Thank you, and great to be here. So my background, chemical engineer by training. I worked in the chemical and biological industries for 42 years. Of that 8 years running DuPont Nutrition & Health, so the DuPont Food Ingredients business and 16 years as a CEO and 18 years on the board of a company called Eli Lilly, which does a lot of biotech and chemistry for health. So a lot of background in the chemistry biology area businesses. And what drew me to IFF was I think it's a terrific company with a very important purpose of bringing ingredients to consumer goods companies and working together to create consumer products that bring joy to consumers, bring health and do it with a big positive environmental sustainability impact.

Okay. Let's move on to maybe some near-term things. So last month, you mentioned that July had been off to a solid start. But I also love that you said typically, the way order patterns work, the first month in the quarter is strong and the subsequent months can get weaker. And the reason I point out that I love that is that I've covered IFF a very long time and very many times, we've also heard quarters starting great and then things progress. So you know the business you are running and the way things can progress. So I just didn't want to though check in on anything you might want to share on August, any notable changes in customer order patterns as a broad look.

Well, I tend to look longer than 1 month period. But I want -- we want to build a company that delivers this quarter and delivers this year, but in a way that builds for '25, '26 and beyond. So we're heavily focused on -- we've got 2 quarters in a row now of solid performance, solid growth. So we're working on finishing the third quarter, which has continued to be solid but then making sure we do that in a way that we deliver the fourth quarter and build for '25 and beyond. So directionally, things are in the right direction, but we've got a lot more work to do. As you said, over the years, we have disappointed, and we want to make sure now that when we give guidance, that it's guidance under any reasonable scenario we're able to achieve.

Okay. That's great. In the second quarter, the volume growth of 8%, very strong, in line with the peers on average. But mathematically, a lot of that, I think, is just driven by easy comps, right? There's some realities of the comparisons. So I'd be curious if we could talk a little bit about underlying improvement you're starting to see in the business. Areas where you've got green shoots, commercialization, win rates and so on.

Yes. First of all, part of it is driven by easier comps. Part of it is driven by, I think, some of the supply chains are being -- we went a little bit light, too much reduction and now filling up. But I also think I'm really proud of our IFF team. I mean our team is out there working hard with customers getting back to basics, focus on serving customers well, winning projects with customers and creating and delivering leading innovation to help customers create great products. And also at the same time, focusing on healthy productivity of doing -- cutting costs where it strengthens our ability to serve customers, not cutting things like research and development, but cutting costs that are waste to do that. And so I think that's helping our performance as well as the market. Where we're seeing green shoots, I mean, there's a number of various exciting areas. I think the whole health area is an exciting area, and we've stumbled a bit in our health business slowed down, but we're now back to growth in the health business. Another really interesting area I found is, I've been in the Nutrition business, the food business for many years. The scent business is new to me and the importance of scent to any consumer product, whether it's a home and personal care product or a fine fragrance product, how it evokes emotions, positive emotions is really great and the importance to product superiority. And also, this whole dynamic about scents and how more younger people are using scents and how people are using them more often. And I'll give you an example. So Charlotte Tilbury, who we work closely with, has come out with a line of fragrances that one promotes joy, one promotes energy maybe in the morning, joy throughout the day, relaxation for the afternoon, romance for the evening. So different scents and she's obviously very popular on social media. And it's great that he saw social media talking about how she worked with IFF and our AI tool to create the scents that evoke these motions in our world-class perfumers. And so that playing into that desire for mental health, mental energy, the benefits of scent in energy is fantastic. Another interesting area is alcohol-free beer and alcohol-free spirits. And to get a rum that tastes like rum, but is alcohol-free is a Flavors' challenge, but it's a really hot area. It's another example. And I would say lastly is the area around health for whether it's GLP-1, people that are using GLP-1s and need protein, they need good taste or need their gut health or people that just want more protein for health. That's another strong positive dynamic.

Great. Let me ask one more short-term question.

Sure.

I can't promise, but I think it's one. Just in terms of the guidance, the back half guidance is for volumes up 4% in the third quarter and flat in the fourth quarter, which I believe implies no underlying change in trend on the 2-year stack kind of when you think about that fourth quarter flat. Is there any risk to the fourth quarter volume conversation if consumer demand weakens further. Because all week, what we've been hearing so far at the conference is more pressure on the certainly low-end consumer in the U.S. Does it sound like things have worsened much though since mid-summer. But sort of the malaise continues with no one really expecting much improvement in the back half is how that fits in with your expectation on order patterns and customer inventory levels.

Well, back to building the trust of our investors and our broader shareholders, but also our employees. We're committed to achieving what we say we're going to achieve. So we said this year we would get in the range of 3% to 5% volume growth. First half has been ahead of that. As I said before, the third quarter is off to a good start. We haven't finished it yet. We've got another month. But the trends are headed in the right way, but there is softness in the end markets, and we're just assuming very, very low end market growth. The fourth quarter will be a stronger comparison year-over-year. The fourth quarter last year was stronger than the third quarter of last year. So we're just looking at all that, all the uncertainties in the world and saying that we want to do what we say we're going to do. So our guidance reflects that.

Okay. Perfect. Just moving to some questions by segment. So in Functional Ingredients, you've made the decision to bring down pricing this year down high single digits, I think it was in the second quarter. So I guess, what are the tools you're using or the approach in how you are doing this kind of in terms of rolling back pricing that it's the right decision for the long term that it's not effectively conceding in the name of volume, but how are you walking that line?

So in our functional ingredients business, we're putting a lot of emphasis on where do we have healthy business within that unit and where do we have unhealthy business? And we overpriced back in 2022 and then going into '23, we lost a significant amount of business. We didn't price well. We weren't intelligent about how we did it, and we paid the price. So now what we're doing, starting last year and into this year is looking across each product line, each customer, each market, and seeing where we're outlined with the market and where we need to adjust and where we want business and coming back to the market, and that's what we're doing to get back customers that want to work with IFF where we're bringing value. They want to be with us, but we've just overpriced versus the market. So we're surgically doing that. We're not one-size-fits-all. But the benefits of that have been positive, that plus significant productivity efforts, have that business starting to turn around. And it's headed in the right direction. We've got a lot more work to do. But at least it's off to a good start for the year. We've got a couple of good quarters behind us, and we've got to keep working it, and then figure out long term, what's the strategy that makes sure that, that business is fully competitive and doing well.

Okay. Are there areas of the business where you're deciding not to adjust price because also sort of fresh set of eyes on the business, like maybe this just isn't a contract, a piece of business an area we want to be in. So is there also effectively like a portfolio pruning that's happening.

Yes, there's absolutely a portfolio optimization. There's parts of that business that are very high value that we're working with customers that want more of our product and are willing to pay for the value that we're bringing and therefore, the prices aren't going down at all. And there's other parts of the business which are more commodity, which we've got to respond to the commodity markets.

Okay. But being in some of those commodity businesses, does that make sense over the long term?

I think for us, what's really important is that we are in businesses where innovation really matters. When you think about our flavors business, our fragrance business and our Health & Biosciences businesses, all 3 of them, innovation is the core determiner of success. And that's exactly fit with the IFF model. And Functional Ingredients, we've got parts of that business that fit that model, and we've got parts of it that don't. So we've got to figure out how to work through that and can we get the more commoditized pieces to be more responsive to innovation. And if not, those pieces need to be dealt with. But we have to be a company that's there because we're bringing great innovation to our customers.

Okay. But in the interim, you'd rather bring the business back and then make the decision over time?

Absolutely. The entire business is turning around. And now we're strategically figuring out what does the functional ingredients business need to look like for the long term.

Okay. Okay. Great. Let's go back to scent which you brought up, but your growth in Consumer Fragrances has been in the double-digit range since the beginning of 2023 accelerated in the first half of this year. Well, interestingly, fine fragrances has actually decelerated to mid-singles. And those 2 things are very different than what we see in the end markets, right, in terms of what we see in terms of broad strokes like HPC, where the consumer fragrance would be. And then fine fragrance from an end market standpoint has remained very strong, probably more like double digits. So how do you reconcile the disconnect between your performance and then what we're seeing in the end markets?

Well, first of all, let's take the more difficult side, the Fine Fragrances, which is mid-single digits, which, by the way, mid-single digits isn't so bad. Very good margins. But I think the challenge there has been that we had strong double digits a few years before. So the comparisons are very, very -- more difficult. But I can tell you that Sabrya Meflah and her Fine Fragrance team are out there working really hard to make sure that we stay single digits and above growth rates going forward. And Ana Mendonça who's now our President of our Scent business, is also out a lot with customers and our perfumers are working hard. So we've got a great team making sure that we continue to grow nicely and with or ahead of the market and Fine Fragrances, which has very good market dynamics. In Home & Personal Care, I'm very proud of our team there that have been able to come out with great fragrances that make home and personal care products, whether it's body wash, shampoo, other products smell great, which makes those products superior and has enabled us to grow market share and grow our business with very attractive margins, but in ways that help our customers grow their market share, which is really what's important.

Yes. Okay. It's been interesting because the Consumer Fragrance business for IFF has been remarkably resilient, above resilience, right, throughout all the tumult over the last several years. Do you think that fine -- knowing there have been management changes, right? So it's about the look forward. But if we just take a moment and look back, did Fine feel orphaned? Did Fine feel as the business mix was shifting post acquiring or merging with N&B that IFF was changing and Fine wasn't going to be a focus area and that created opportunity for competitors?

I think there was some concern about that absolutely. And I would say even across Scent division. So in February, when Ana Mendonça was named President of Scent -- and by the way, she is hugely respected across the company and the industry. I think that was a great relief and a great sign that not only scent is an important business, it's a critically important business to the company and our shift to end-to-end business model, where instead of corporate functions across each of the functions and the business is really being commercial units, that each of the businesses now is an end-to-end model with research, operations, commercial and all of that accountability. That also, I think, has energized not only our scent business, but all of our other businesses. I think if you go out to IFF people, you'll find that the engagement is high, the energy is high. People love being focused back on basics, serving customers with great innovation, that's motivating to all 22,000 of our people.

Yes. Okay. With the resilience of consumer fragrances, is the technology platform just that much stronger that was able to remain as strong as it was even with these, let's call it, cultural concerns prior to the management change?

Yes. We've got great perfumers. We've got great people that call on our customers that are passionate about it. So my appointment was announced January 6 or something and I was supposed to join the company February 6. And the first thing I did was go to the ACI in Florida, the American Cleaning Institute, where many of our home and personal care customers were there. And I got a chance to visit with the Procter & Gambles of the world, the Unilevers and the Henkels, the Rackets, many others, and it was really great for me to hear from them how important we are to the success of their products before I even joined the company. So that made me committed to supporting our people to drive this innovation and get that customer focus. And so all we're doing is unleashing our people to do what they know how to do, and IFF has done historically. I mean IFF for many, many years, has been the clear leader in Flavors & Fragrances and the Nutrition & Biosciences business of DuPont formerly partly Danisco, was also a leader. We just need to get back to focusing on the basics and reestablishing a leadership position.

Okay. Great. Let's talk a bit about some of the more sort of strategic changes that have been underway. So we've started to hear you talk a bit more about stepping up reinvestment, commercial talent, R&D, innovation, I'd say I'd just look maybe a little bit more specificity at least because I'm just not aware of on priority areas. I know it's not functional in terms of where that money is going per se. But just getting a little bit more granular. What are the biggest kind of gaps in competitiveness today maybe and where you're focusing or prioritize reinvestment.

Great. So what we've been clear on is that we're going to invest aggressively in Flavors, Scent and Health & Biosciences. All 3 businesses have excellent margins, have great innovation, but we need to make sure that we're investing to strengthen our leadership capabilities. So in Health & Biosciences particularly, R&D investment and capital investment to make sure that we've got plenty of capacity as we grow that business. In Flavors and Fragrances making sure that we're investing in commercial capability, and we've got plenty of people to serve existing customers and to go after new geographies and end markets. I'm going to China next week. The Chinese economy is challenged, but there's still lots of opportunity in China. And then in the Scent business, new molecules, both naturals, biology, biotech molecules and synthetic chemistry molecules, we need to strengthen our pipeline there. So we're adding research capability there. The good news is that we're leaders in biotech. So with our biotech and chemistry people, R&D people coming together in scent, we should have a really strong future in biotech molecules for the scent industry.

Okay. Awesome. And then in terms of the reinvestment, how much did you say about the turnaround plan and is about money being spent that has a longer-term payback sort of that net -- that pipeline, for example, sort of existing customer change in approach like the operating model changes that you described or just that leveraging the resources and the IPs that the company already has.

What we've done is, for each of the business units, we've -- we're developing strategies and 5-year plans. We didn't really have clear strategies or 5-year plans and so if things got tough, you would just cut across the board equally regardless of the business and situation. With these 5-year plans, we're figuring out where to invest, where the highest priority areas are to invest and where we need to meet customer needs and to be competitive. So I think that's really important because from that strategy, the 5-year plan guides where we put the additional resources. At the same time, we're focused on healthy productivity so that we can invest even more than our growth rate into innovation and into capital investments to make sure we've got plenty of product, most reliable, highest quality, sustainable production facilities. So all that's coming together now as we develop our new strategies and our 5-year plans and make them happen. And even this year, we're not waiting for next year, even this year because we've got some market tailwinds because our team is performing very well in this market. We've got some headroom to invest in growth. So we're not waiting until next year in a new budget. We're spending ahead of plan this year in R&D and in commercial resources to strengthen the 3 high-growth businesses. And that, the benefit of that is coming in '25, '26 and '27, but the other benefit right now is our people are seeing that instead of cutting, we're investing and that brings energy to our people to wake up every day and feel better about what they're doing. And from that, you get benefits. You get better customer service, you get better engagement and projects, you get -- everything goes better when people are excited, passionate and unleashed to do what they know they need to do.

When do you think the last time is that employees had that feeling, they feel that there is investment being made in this business. How long has it been?

I wasn't here so I can't really say, but I think that -- I think there's been a lot of frustration since the Frutarom deal and the complexities that, that brought and then the DuPont Nutrition & Biosciences deal and the added complexities that brought and that the effort was around, okay, how do we get synergies from this. So there were a lot of consultants, advisers, corporate staffs being built to drive the synergies rather than saying, okay, we've got these businesses. Now businesses, what are your strategies go out and win and work together, help each other, collaborate and not be so complicated with all these corporate structures and corporate complexity and all these advisers, there were people are telling me that they were spending 30% of their time talking to consultants and then the consultants were coming back with recommendations that they didn't agree with. So getting back to basics, we're about serving customers, bring great innovation to those customers. Operational excellence, plants that run well, healthy productivity and people. And each business has its strategy, and then we collaborate across businesses. It's simple. It's straightforward. And then all brought together by our purpose of we bring ingredients to consumer goods companies to help them make superior products that bring consumers joy and health and make the planet more sustainable. That simplicity, that clarity unleashes our people. And by the way, our executive team has really come together well. Having an executive team that works well together, that runs the different businesses and functions, but do it together to make sure that IFF is doing the right thing for IFF is really an important part of this.

Talk about time line of reinvestment. We talked about a bit on payback starts to come in '25 and '26. As you think about multiyear margin trajectory or let's talk about structural profitability potential of the business. There have been lots of targets out there since -- well, all the mergers, let's put it that way. Somewhere between 23% and 26% in terms of EBITDA margins. What do you think is the structural profitability of this company longer without even putting a time on it?

I think the way to look at it, the way we're looking at it is we're improving and the whole idea is let's continuously improve. Let's keep getting better. I like to benchmark the different businesses with leading competitors. So in our Health & Biosciences business, what we're doing, not just me, but the company and the Health & Biosciences business is saying, okay, how's Novanesis doing? Both in growth rates and in margins. And we've got some gaps and we're understanding where those are, and we're working to have that motivate us to better serve customers and bring better innovation. On the Flavors and Scent side, Givaudan has better margins than we do, and they've historically grown faster than we have through all this, not in the Scent business, but certainly in the Flavors and combined. And at higher margins. Why is that? And let's use that to motivate us about how we can grow faster, but also narrow the gap in margins by bringing great innovation and great customer service and great products.

Okay. You talk about motivating people, I'm curious about compensation changes that have been made or will be made. I don't know if you'd give what you're ready to share in terms of -- you've had the operating model changes. I don't believe there's been any kind of formal restructuring or announced cost savings as attached with that ongoing end to end. But so like to know if there's something coming on that front. And then compensation changes. What kind of metrics should the business units be measured by going forward?

So let me start with the restructuring question. I don't see us doing any corporate restructuring. I just -- I've seen many announced, and I think it creates -- would create even more confusion and internal focus versus focusing on customers. So every business unit, go out and focus on customers and every corporate function focus on serving the businesses to serve customers and check our impact and our cost effectiveness versus competition, so that we're competitive cost-wise, but let's win with customers. And then every business unit has a productivity leader, every corporate function has a productivity leader make sure that we're cost competitive. So go and do it in your unit and figure out how to grow into it or whatever you need to do, but no corporate restructuring because I don't think they work well. I think they're distracting and kind of along the lines of our -- some of our synergy targets in the past of a corporate effort versus you go out and do it in your unit.

Compensation.

So on compensation, I think it's really important to compensate for growth. So for revenue growth, but it has to be attractive revenue growth. We have some -- as you mentioned before, we had some more commoditized businesses, if they're not returning good returns, we don't want to incentivize growth in those areas. So we're trying to figure out how do we incentivize just the attractive growth areas. How do we incentivize healthy productivity? And how do we incentivize or how do we first measure and then incentivize innovation pipelines. I mentioned before, I'm on the Board of a pharmaceutical company and that company started incentivizing the pipeline development. And everybody in the company could see that, and everybody in the company became more interested in making sure that they supported the pipeline development. So we're thinking about how do we make sure that we can measure the progress that we're making with our innovation pipeline and somehow reward that.

Okay. Great. I wanted to just switch gears for a moment and ask a broader industry question around scale and consolidation. Knowing you were not at IFF when kind of went through the Frutarom, even the small deals before that and, of course, N&B. But we've also seen competitors make pretty similar moves, right? There's just been an enormous amount of consolidation in the industry in the last 2, 3 years. So what's your take on the importance of scale in this industry, scale versus specialization as sort of 2 ends of the spectrum?

I think scale with specialization is what matters. And I think that -- so one of the things I feel great about being at IFF is really great is that the flavors, the scent and the Health & Biosciences business and the ingredients business need to be the best at what they do. But there's also synergies between them that when -- and all my experience is, if the business is really good at what they do and really focus and really expert than synergies by collaborating inside and outside are a lot easier. When the business isn't performing as it should, synergies, if you're forcing them corporately actually become a negative because they distract you from what you need to do to be good. But once you're good, if you're really good at flavors in health and biosciences, you have in health and biosciences business, you can open doors at customers from health and biosciences for flavors or vice versa. You can have combined projects if there's something that needs both. I mean there's huge benefits at being in these having really good businesses and multiple businesses, if you're able to keep the business is really good. So I feel great about having these 4 businesses as we get really good at that. And the secret is you've got to make sure that each one is as good as the best competitor and that the synergies are created to make them stronger, not because of some corporate edict or some corporate complexity, bureaucracy issue. And that's what we're trying to do.

Okay. We hear a lot from people like investor-wise. This is a super attractive industry. Would you say it's more complex than people think? Nothing is unattractive, but is it maybe more complex than people appreciate?

Yes. But I think we made it more complex than it needs to be. I think by all these acquisitions and not cleaning it up and not being clear about accountability, for example, there was a lot of confusion about who makes decisions and so decisions were very slow and sometimes they never even got made. I mean my first day, we cut the dividend in half. for a couple of reasons. One, we were borrowing money to pay a dividend, and we were not investing in things that we needed to invest in, there were huge great return investments. But I also want to just signal to everybody because I kept hearing it, we can make decisions and then got the executive team together and said, okay, what other decisions do we need to make? And if you remember, back in December of 2022, there was an organization change announced that we never did. So when I get there in '24, people were asking me, what about this organization change that was announced in 2022. Well, the executive team got together and said, okay, let's be very clear about the organization. So we waited a month so that it didn't look like it was knee-jerk, but we announced here's how we're going to operate as a company. And here's the clarity around accountability, decision-making, et cetera. So it takes a little bit of time to get that machinery going, but I think we're headed in the right direction. And I would encourage you or anybody else, if you're interested, talk to IFF people, talk to anybody, talk to people in our plants, talk to salespeople, talk to research people, talk to our perfumers, talk to our flavorers how do they feel about IFF today? And are we getting back to the basics and are we getting back to the great history of where IFF was a strong leader and very reliable performers.

Okay. Wonderful. Last question. Hopefully, you join us again next year that this has been an okay interaction for you and you come back. But what does success look like for you? We're sitting here a year from now, what are kind of the 1 or 2 things that you worry could derail you, what are you excited about, hopefully, a year from now being able to point to a successive.

We've continued to improve, and we're on a continuous improvement track where we're winning more with customers. We're strengthening our innovation pipeline further. Our productivity is stronger. Our people are excited and we've figured out strategy on how we're going to -- what we're going to do long term with our Functional Ingredients business, how to do that right.

Okay. Great. We will wrap there. Please join me in thanking Erik and IFF for being at the conference this year.

Thank you.