Michael DeVeau - International Flavors & Fragrances, Inc. Andreas Fibig - International Flavors & Fragrances, Inc. [07BDC1-E Rich O'Leary] Richard A. O’Leary - International Flavors & Fragrances, Inc..

Mark Stiefel Astrachan - Stifel, Nicolaus & Co., Inc. Lauren R. Lieberman - Barclays Capital, Inc. Faiza Alwy - Deutsche Bank Securities, Inc. Silke Kueck - JPMorgan Securities LLC John Roberts - UBS Securities LLC Adam Samuelson - Goldman Sachs & Co. LLC Gunther Zechmann - Sanford C. Bernstein Ltd.

Jonathan Feeney - Consumer Edge Research LLC Patrick Lambert - Raymond James Financial International Ltd..

At this time, I would like to welcome everyone to the International Flavors & Fragrances third quarter 2018 earnings conference all. All participants will be in a listen-only mode until the formal question-and-answer portion of the call. 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 third quarter 2018 conference call. Yesterday evening, we distributed 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 on our website. Please take a moment to review our forward-looking statements. During the call, we'll be making forward-looking statements about the company's performance, particularly with regard to our outlook for the fourth quarter and full-year 2018.

These statements are based on how we see things today and contain elements of uncertainty.

For additional information concerning the factors that can cause actual results to differ materially from forward-looking statements, please refer to our cautionary statement and risk factors contained in our 10-K filed on February 27, 2018 and our press release that we filed yesterday.

Today's presentation will include non-GAAP financial measures, which excludes those items that we believe affect comparability. A reconciliation of these non-GAAP financial measures to their respective GAAP measures is set forth in our press release and is on our website.

With me on the call today is our Chairman and CEO, Andreas Fibig; and our Executive Vice President and CFO, Rich O'Leary. We will start with prepared remarks and then take any questions that you may have. With that, I would now like to introduce Andreas..

Thank you, Mike. On the call today, we will review our financial results for the third quarter and the first nine months for 2018, give a quick update on Frutarom since the transaction has closed, and provide an update to all financial expectations for the full year, inclusive of Frutarom. Then we will be happy to take any questions that you may have.

Starting with a recap of our first nine months performance, growth was strong across our key financial metrics. Currency neutral sales increase 6% year-to-date, with Flavors growing 6% and Fragrances growing 5%. New win performance and price increases to mitigate rising material cost, both contributed to consolidated growth.

From a profitability perspective, currency neutral adjusted operating profit grew 4%, supported by volume leverage and our focus to drive greater efficiency throughout our business via cost and productivity initiatives.

Currency neutral adjusted EPS improved 11%, driven by adjusted operating profit growth as well as a more favorable effective tax rate. Our strategic priorities continue to drive overall performance over the first nine months of 2018.

Sales of our Re-Imagine Modulation portfolio grew strong double-digit and PowderPure grew an impressive triple-digits, both indicative of our position as a leader in innovation. Performance with local and regional customers remained strong, growing double that of our global customers, which on a consolidated basis is about 50% of our customer base.

In Flavor specifically, our mid-size go-to-market platform, Tastepoint, continued to deliver strong results, improving strong double-digits in the first nine months of 2018. In terms of maximizing our portfolio towards our most margin accretive categories, cosmetic active ingredients continued its robust growth trend by improving double-digits.

Also on the Fragrance side, hair care grew double-digits and home care and toiletries improved high-single digits. In Flavors, growth was strong in dairy and beverage, improving double-digits and high-single digits respectively.

We also continue to focus on driving greater efficiencies throughout our business via cost and productivity initiatives, which allows us to reallocate resources to efforts that drive the greatest returns and maintain strong profitability. This yielded strong results in the first nine months of 2018.

And so our cost and productivity initiatives, including zero-based budgeting added approximately 5 percentage points of gross to currency neutral adjusted operating profit and EPS growth. All-in-all, I'm very pleased with how well our refreshed priorities are performing and believe better positions us to drive long-term value for our shareholders.

With that, I would like to turn the call over to Rich..

Thanks, Andreas, and good morning, good afternoon, good evening to everyone. Moving on to our Q3 performance, currency neutral sales in the second quarter grew 4%. Growth was led by new wins and price increases to mitigate the impact of raw material cost inflation.

From a profitability perspective, currency neutral adjusted operating profit increased 3% in the third quarter, as top line growth and the benefits associated with cost and productivity initiatives was offset by unfavorable price to input costs, inclusive of the BASF citral issue and weaker sales mix.

Pricing was up more than 2 percentage points in the quarter on a consolidated basis. Despite the sequential acceleration in the third quarter, as expected, it did not offset raw material pressure, as we continue to see a timing lag in the Fragrance business unit.

Currency neutral adjusted EPS increased 12%, as a more favorable year-over-year effective tax rate offset higher shares outstanding and interest expense associated with the equity and debt raise during the quarter.

It should be noted that excluding the items that impact comparability, the adjusted tax rate for the third quarter of 2018 was 14% compared to 22.7% in the prior-year period.

The year-over-year decrease was largely due to a more favorable mix of earnings, lower cost of repatriation, and the re-measurement of loss provisions, partially offset by adjustments to the impact of U.S. tax reform and the impact of current year transaction costs, including certain non-taxable gains on foreign currency in the prior year.

Looking at the business unit performance for the third quarter, Flavors currency neutral sales increased 7% even against a strong year-ago comparison of 12%, with growth coming in all categories and all regions. On a two-year average basis, growth remained very strong at approximately 9.5%.

North American Flavors improved 10% in the third quarter, led by double-digit growth at Tastepoint and strong performances in dairy and sweet. EAME increased 6% on a currency neutral basis, led by high-single digit growth in Europe as well as Africa and Middle East.

Greater Asia grew 4% in the third quarter on a currency neutral basis, as it was led by double-digit growth in India and low-single digit increases in Indonesia, China, and ASEAN. Latin America increased 12% on a currency neutral basis, led by strong double-digit growth in Argentina as well as mid-single digit growth in Mexico.

Flavors currency neutral segment profit grew approximately 7%, led primarily by volume growth and the benefits from ongoing cost and productivity initiatives. In terms of currency neutral segment profit margin, our profile remains strong at 22.1%.

Fragrances currency neutral sales improved 2% on a strong year-ago double-digit comparison, with growth in nearly all regions. From a category perspective, Consumer Fragrances grew 2% on a currency neutral basis, as performance was driven by continued growth in hair, home, and fabric care.

Fine Fragrances declined 2% on a currency neutral basis, against a very strong 18% comparison from the prior year. From a regional perspective, Greater Asia increased strong double-digits and EAME increased low-single digits.

Fragrance Ingredients sales were up 5% on a currency neutral basis, led by strong double-digit growth in the cosmetic active ingredients business. This marks the ninth consecutive quarter of growth in Fragrance Ingredients. As we continue to successfully execute our refresh strategy and we achieve strong realization of price increases.

From a profit perspective, Fragrances currency neutral segment profit decreased 5% on a currency neutral basis, as the benefits from productivity initiatives and cost management were more than offset by an unfavorable price to input costs, including the previously announced citral issue.

In terms of currency neutral segment profit margins, our margins remains solid, yet were under pressure year-over-year. Before moving on, I'd like to provide some more commentary on the raw material environment, like I did in Q2.

As you remember, coming into the year we expected mid-single-digit raw material inflation in 2018, inclusive of the impact of the citral situation, heavier in the business units versus Flavors. Since that time, cost inflation has picked up following a series of disruptions in the supply chain.

Additional market disruptions continue to impact the Fragrance business unit, driven both by environmental considerations and new non-flavor and fragrance market demands for core raw materials. Unfortunately, we see further input cost and pressures in 2019, particularly in Fragrances. Our strategic priority is to protect our customers' business.

However, this comes at a significant incremental cost and will require additional price increases as we move into 2019 to ensure we cover our raw material cost exposure. Operating cash flow was $202 million in first nine months of 2018 compared to $199 million in the prior-year period. This was primarily driven by litigation in the prior-year period.

Core working capital was impacted by higher inventory to ensure continuity of supply during unprecedented supply chain challenges as well as higher raw material prices.

From a capital allocation standpoint, we spent approximately $102 million in capital expenditures, or about 3.7% of sales, driven by new plant and capacity investments, mainly in Greater Asia.

Some of these investments include a Flavors manufacturing facility in the Zhangjiagang Free Trade Zone, which opened on October 9, and a Natural Products Research lab located in the Nanjing Life Science Park, which opened on October 15.

The Flavors plant is our second in China and is designed to supplement our existing flavors and manufacturing operations in Guangzhou. The Natural lab is our first outside of the U.S. China is a critical component of our long-term strategy.

The opening of these new sites will support our efforts to be a partner of choice and to grow in this exciting region. We continue to believe that we will spend approximately 4% to 5% of sales for the full year 2018 on CapEx.

Regarding cash returned to shareholders, during the first nine months, we spent approximately $163 million on dividends and $15 million on share repurchases. As a reminder, as part of the Frutarom combination, we paused our share repurchase program, as we will prioritize debt repayment going forward.

We will continue to maintain a disciplined approach to capital allocation as we accelerate growth through organic investments and strategic acquisitions while returning significant capital to shareholders. Before turning it back to Andreas, I'd like to provide some commentary on Frutarom's estimated results for Q3 2018.

Please note that this information is for informational purposes only, and they reflect Frutarom's results when it was under the previous ownership and prior to the completion of the acquisition on October 4.

For the third quarter, net sales are expected to be between $360 million and $365 million, and adjusted EBITDA margin is expected to be approximately 21%. Performance from a top line perspective is expected to be up low single digits versus prior year, driven by the contribution of acquisitions and offset by foreign exchange headwinds.

It should be noted that sales growth, while up year over year, was negatively impacted by customer order patterns, specifically in more commodity-oriented businesses such as trade and marketing and Frutarom's citrus processing business, which were both down double digits.

Excluding these businesses, growth would have increased mid-single digits on a reported basis, and high single digits if we excluded foreign exchange impacts. In the third quarter, adjusted EBITDA margin continued to be solid, improving approximately 40 basis points year over year, led by gross margin improvements as well as expense control.

On a year-to-date basis, sales are expected to be approximately $1.15 billion, an increase of about 15%. In terms of profitability, we expected adjusted EBITDA margin to be approximately 21.5%, which is a strong year-over-year improvement of approximately 175 basis points. With that, I'd like to turn the call back over to Andreas..

Thank you, Rich. I would like now to give you a quick update on our Frutarom combination. I'm very happy to say that on October 4, we completed the combination with Frutarom. This is ahead of our original expectations of six to nine months from May 7 announcement.

The coming together of IFF and Frutarom is a momentous achievement, and we're excited to be moving forward as one company while pursuing new opportunities that benefit all our stakeholders around the globe.

I applaud the integration teams around the world that over the past several months have been working to ensure that we capture the best of both companies and create a seamless and efficient transition to achieve both our operational and financial targets for this combination. Together, we create a global leader in natural taste, scent, and nutrition.

IFF has now a stronger product offering, broader access in attractive adjacencies, and stronger exposure to fast-growing customers. We expect to generate cost synergies of $145 million through raw material harmonization, footprint optimization, and streamlining overhead expenses by the third full year after the completion of the merger.

Additionally, cross-selling opportunities and integrated solutions are expected to provide revenue synergies to our shareholders progressively over time.

Through this combination, we are confident in the opportunities that lie ahead and the ability of the combination to accelerate financial performance and targeting sales growth an average of 5% to 7% and 10%-plus adjusted EPS growth, excluding total company amortization between 2019 and 2021, all on a currency neutral and pro forma basis.

Let's take a look how the new IFF is positioned now that the transaction has been completed. As you can see from the slide, we instantly have the number two global market position in the industry, with approximately 33,000 customers globally, selling about 150,000 unique product solutions annually.

Our organization is fueled by 13,000 hardworking employees in more than 110 manufacturing sites and approximately 100 R&D centers and labs around the world.

This historic combination sets us up to service our customers like we never have done before, being able to offer them a stronger product offering to help them create differentiation in the marketplace. With the addition of Frutarom's offerings, we instantly become a leader and natural capabilities extending across our entire platform.

Our combination creates a highly diversified portfolio, with exposure to fast-growing categories and customers. Being that our product offering is now extending beyond our traditional industry, we have renamed our business segments from Flavors and Fragrances to Taste and Scent respectively.

To ensure we deliver a seamless experience to our newest customers, we intend to preserve Frutarom's best-in-class customer-facing capabilities, which will enable us to maintain the strong relationships Frutarom has built, while capturing this significant cross-selling opportunities we will have as a combined company.

As a result, our intention is to report Frutarom as a standalone business unit. Based on projected pro forma 2018 sales, we expect Scent to be approximately 35%, Taste to be about 33% and Frutarom about 32% of our entire business.

And now, looking at our Executive Leadership team, Matthias Haeni and Nicolas Mirzayantz will continue to lead our Taste and Scent division respectively.

Leading the Frutarom division, I'm pleased to welcome Amos Anatot, who spent eight years at Frutarom in leadership positions, with his most recent role as Executive Vice President of Global Supply Chain and Operations.

He has a great perspective of the taste, savory solutions, flavors and fragrance ingredients, Taura and trade & marketing businesses and that's been actively involved in integration as a leader from Frutarom.

Within Frutarom, I would like also to welcome Yoni Glickman, who will run Natural Product Solutions, which includes health, colors and food protection. He most recently held the position of present Natural Solutions at Frutarom, where he led the company's natural food colors, antioxidants, cosmetics and health ingredients business.

This leadership structure is in place since the 4th of October to run these businesses in a manner that leverage our strengths and supports our customers. Aligned with this approach, we are already capitalizing on a few quick wins.

For example, leveraging our Tastepoint go-to-market strategy for small- and mid-size customers in North America, we are integrating Frutarom's North America taste business into our own. As a reminder, Tastepoint is designed to serve the dynamic and faster-growing middle-market customers in North America, a key driver of growth.

By combining the Frutarom North America taste business with R&D, technology and consumer insight of IFF, we are strengthening the innovative go-to-market approach that targets unique needs and expectations of this subset of customers.

As you have seen since inception, Tastepoint has been a success, evident by our strong growth with small- and mid-sized customers in North America. This transition should be seamless, as the go-to-market model used by Frutarom's North America flavors business is perfectly in line with what we have at Tastepoint. Another example is in cosmetic actives.

While we are shifting Frutarom's cosmetic active ingredients business into our Lucas Meyer Cosmetics business.

Established in 1995, Israeli Biotechnology Research or IBR researches, develops, manufactures, and markets innovative and proprietary natural active ingredients for the cosmetics and dietary supplement industries, mainly for cellular and skin anti-aging, skin protection from UV rays and air pollution, skin whitening, and pigmentation prevention.

By combining these two businesses, we have strengthened our cosmetic active ingredients portfolio sold to some of the world's leading cosmetic companies. We believe this will support continued growth in this highly profitable category. And all of these measures we have started already since the closing of the deal, which is ahead of time.

With that, I would like to ask Rich to provide some perspective for the full-year 2018 financials..

Thank you, Andreas. Before providing full-year expectations, I wanted to clarify a few go-forward model assumptions. First, following the successful debt raise, our total debt outstanding is approximately $4.4 billion. The annual interest expense associated with this debt is expected to be between $150 million and $155 million per year.

Currently, we expect our annual effective tax rate to be approximately 19%, more or less the average of the two standalone companies.

For purposes of calculating adjusted diluted EPS on a go-forward basis, we estimate that there will be approximately 113 million diluted shares outstanding, including 6.3 million shares related to the tangible equity units.

Annually amortization is expected to be approximately $220 million and subject to change based on the finalization of the purchase price accounting. In terms of our go-forward reporting, please note that we have modified the way we will disclose adjusted EPS. Previously, adjusted EPS was reported EPS excluding items that affect comparability.

In addition to these exclusions, going forward, we will also exclude full amortization for the total company. We believe that this metric provides useful period-to-period comparisons of the results of our operational performance and cash generation capacity.

Looking at the full year 2018, inclusive of Frutarom's fourth quarter estimated results, we are targeting year-over-year advancement in both top- and bottom-line results.

We expect our sales to be between $3.95 billion and $4.05 billion for the full year, with similar contributions to Q3 in our legacy IFF business as well as sequential improvements in Frutarom sales performance versus the growth they achieved in Q3.

We also expect our adjusted EPS to be between $6.25 and $6.45 excluding one-time items that may affect comparability and total company amortization for the full year.

For reference purposes, we expect 2018 amortization for the full year to be approximately $83 million, made up of $37 million of legacy IFF amortization, $9 million from legacy Frutarom amortization, and an estimated $37 million from the purchase price accounting related to the (00:25:02) transaction.

With that, let me turn it back over to Andreas for his final remarks..

Thank you, Rich. In summary, we are pleased with a strong financial performance in the third quarter, as we achieved growth in all of our key financial metrics.

Our strong performance in the first nine-months was driven by our refreshed priorities, as we continue to focus on the execution of our long-term strategy, accelerating growth, increasing differentiation and driving cost efficiencies to drive sustainable, profitable growth in the future and maximize value creation for our shareholders.

As we look towards the remainder of the year, inclusive of Frutarom results for the fourth quarter, we expect strong advancements in top- and bottom-line results as noted by Rich. Looking forward, comes a bittersweet realization that the third quarter 2018 was our final as legacy IFF. We are now embarking on the next major chapter of IFF history.

We believe that our combination with Frutarom, the largest transaction of its kind in our industry, is fundamentally going to expand our customer and employee base and product offerings.

We will have greater exposure to fast-growing customers, broader access to attractive adjacencies and a very differentiated portfolio, with an increased focus on naturals and health and wellness, as well as more comprehensive solutions.

We believe this will translate into accelerated financial performance as a combined company, with robust top- and bottom-line growth, leading to strong returns for our shareholders. With that, we would now like to open up the call to questions..

Your first question comes from the line of Mark Astrachan with Stifel..

Thanks and good morning, everybody..

Good morning, Mark..

Hi, Mark..

I have heard worse by the way on the last news if that's what you're talking about.

So, on the business, though it's helpful commentary on Frutarom for 3Q, I guess, related to that, so what gives you confidence that it can improve in 4Q? And if I'm doing the math correctly, why give such a large implied range of sales for the business? And kind of related to that, if I remember also from Frutarom's results earlier this year, there was some volatility in their trade and marketing business in those results.

So thoughts on maybe how that business fits with the new company going forward?.

Let me start the first part of the question, and then I hand it over to Rich. So, first of all, we had a solid start and an acceleration in growth with the Frutarom business for the fourth quarter, so that's a good part. And we are actually ahead of the integration. What is the big benefit for us is that we have closed the deal earlier than we sought.

The teams were well-prepared. The leadership structure is in place. And most of the insecurity is gone, which we usually have when you embark in such kind of a deal. And that, let's say, fills the optimism for the fourth quarter and the year going forward. So good start, as I said, financially.

Secondly, we have the organization in place to perform and we see that people are very motivated, leadership structure is there. They're going after it. We are talking already about cross-selling opportunities, which I always said is probably mid- and long-term, the biggest value creation opportunity we have here.

We have the first small signs of cross-selling successes, which is fantastic, and that, I would say, fuels the optimism of the organization that the fourth quarter will go in the right direction. But in terms of the guidance....

Yeah, Mark, in terms of the guidance range, I wouldn't read too much into that. It's probably the simplest answer is I didn't want to have to go out to three digits in terms of the range, and so we picked basically a $50 million range around that. There's nothing more than that.

As Andreas had said, I think that the first – the fourth quarter, the start to the first quarter is in line with what we expected. We've seen the improvement in Frutarom's performance into the start to Q4.

I mean, I think we do believe that a big piece of the Q3 performance was driven by specific incident-related items, whether it's the trade and marketing or whether it's customer order patterns in a couple of businesses..

Okay. And then on the trade and marketing, any thoughts on how that fits with the business going forward? And on the implied EBITDA, from a run rate standpoint, first half of the year I think was maybe a little bit stronger than kind of 21-ish.

Is there anything within those numbers that perhaps makes them less sustainable going forward or were there – how much was contribution from acquisitions, for example, and is 21% kind of a good run rate to use going forward?.

Okay. I'll take the first part. For the trade and marketing, it's probably too early to tell, and it's part of a service we are providing with this business unit to some of our customers. It's certainly not a focus area where we want to invest, but we will evaluate it what we want to do with the business.

But so far, it looks like a smart solution to have it in place, but not put too many resources behind it.

Rich?.

Mark, from an EBITDA margin standpoint, I think it's – within the Flavors business, probably there's some mix impact, probably there is a little bit of mix impact within Natural Product Solutions.

I think there are a couple of projects in terms of productivity things that are about three or six months behind schedule, that were already underway within the Frutarom business. So that's probably a little bit of what we're seeing in the second half. So I think overall, we don't see that there's any fundamental changes.

Obviously, with the strong growth rates we saw particularly in Q1, the leverage component is much more advantageous in the first half than what we've seen in the third quarter..

Right. Thanks, guys..

Thank you..

Your next question comes from the line of Lauren Lieberman with Barclays..

Thanks, good morning. My first question was just around the go-to-market approach that you talked about in terms of leaving Frutarom to report independently. That was definitely different from what I had anticipated or expected to be the case.

So I guess first, could you talk about, one, will you be giving us pro forma historicals that could just help us in terms of forecasting? And the second thing is, it was just interesting to me that it looks like in terms of you're going to be rolling in the Frutarom North America flavors business into Tastepoint straight away.

Is the approach going to be that piece by piece, Frutarom will be integrated into Taste and Scent? And this is just to create almost a bridge platform to go slowly, such that the Frutarom piece of this is independently reported will just be going down over time?.

Okay. Rich, you get started..

In terms of pro forma information, Lauren, we will on the year-end call, once all the numbers have been finalized, we'll provide a full-blown full-year pro forma for both the combined companies, so that represents the reference point going forward to the three-year guidance that we've talked about earlier. So we will provide that on the next call..

And on the organizational setup, let's talk about the Natural Product Solutions, which is probably the most, let's say, adjacent businesses we have here at hand.

That certainly is important to leave this as it is for now to make sure that we really capitalize on the growth opportunities because many of these businesses have higher growth in our core business and good profitability as well. So that's number one.

Number two, on the Frutarom business unit, we said we won't organize it like that to make sure that we don't lose speed and we don't lose our customer focus to these high-growth smaller and mid-sized customers. And over time, we will decide what part of the organization we are moving to the Taste solution on our side.

And it's right that the North America Taste business from Frutarom is mainly with smaller and mid-sized customers, so that creates for us a great opportunity to bring it together with our Tastepoint platform because it basically has the same business mechanics.

And we believe that we can grow it significantly over the next couple of years when we house it in that area because, as I said, the mechanics are the same. And because we have already an approved model how to be successful in the North American market, we said this is probably the best thing we can do.

And we are very happy that with the early close, the integration is already underway, which is way ahead of the time we sought, because we – actually I was thinking that we might close at the end of the year, and then you have Christmas and it takes a while. Now we are already in full swing integrating this business.

Okay?.

Okay, great. And then my second question was just around the pricing and raw material environment commentary that Rich offered.

So just where do you stand in terms of your sense of the incremental pricing you're going to want to be taking? Where do you stand in terms of those customer conversations? Do you have visibility for how that starts to flow through, or should we be thinking about it more as it will be gradual throughout 2019, so that you'll probably still see some gross margin pressure as you play catch-up throughout the year?.

Lauren, a couple things. I think there is – unfortunately there's always a time lag as we go through this process..

Yeah..

I think we've talked about that in the past about certain contracts and arrangements have windows for that. But we are already having conversations, the businesses certainly are starting to have the conversations around what is going to be necessary.

We're going to expect to see – on an overall basis, I would expect to see mid-single-digit increases next year, again, skewed heavily towards the Fragrance business, given the continued supply chain interruptions that we're dealing with there.

The teams are already having those conversations with and teeing those things up with the customers, but I would expect to see some continued pressure during the course, but I also fully expect to see progress quarter by quarter going forward also..

Okay, that's great. Thank you so much..

You're welcome..

Your next question comes from Faiza Alwy with Deutsche Bank..

Yes. Hi, good morning..

Good morning..

Good morning, Faiza..

So two questions for me too. One is just to follow up on the raw material and pricing commentary. Could you give us more color in terms of where you're seeing the most raw material inflation? I know you said Fragrances.

But just more specifically, is it the naturals? Is that synthetics, petrochemicals? Where are you seeing more of that? And then do you think that you're going to be able to recover the entire raw material inflation, because it looks like you talked about two points of pricing this quarter, but you said that you still haven't offset the entire inflation.

So do you anticipate being able to offset that as you go through 2019?.

So, Faiza, remember, a portion of that is related to the BASF, so that's something that still is being worked through. We're doing everything we can to mitigate the effects of the citral stuff.

Some of it doesn't show up in pricing because we'll go through and work with customers on reformulations to adapt the cost base, so not everything is going to show up exactly. But I do expect over time that we will be able to recover this. We've got to protect our customers' business, but we also have to protect our bottom line. It's not easy.

I'm never going to say it's easy. So I do expect, as I said to Lauren's question, I do expect us to see further pressure and continued focus on price realization in 2019. In terms of where is it coming from, it's very much in the core feedstock type of ingredients for the Fragrance business.

Again, in my comments, I mentioned that we've had supply chain interruptions. We started the year and we were at mid-single digits including citral. We've had issues in suppliers in India. We've had fires in India. We've had shutdowns in China on some of the core ingredient suppliers – chemical ingredient suppliers.

More recently, more environmental-related supply chain restrictions, and we're also starting to see situations where demand is coming from non-F&F markets for the same raw materials, which is creating a supply and demand pressure point, and we don't expect new capacity come on in the short term. So I think we're going to have to deal with it.

Our customers understand what's driving it. We spend a lot of time walking them through the details, and then working with them in terms of how do we mitigate the impacts on both sides. So, it's going to continue.

Unfortunately, we're in a period where it seems every six months something else is popping up and we're having to deal with it with our customers. We're probably going to have the third round of conversation with customers in a very short period around price increases that are necessary for us to protect our bottom line in the long run..

Okay. Okay. Thanks for that. And then just my second question is around Frutarom again.

I guess, I'm still not convinced that this is – like, I guess, I'm looking for more comfort from you in terms of how much of the Frutarom sales issue this quarter were timing related? And perhaps if you could update us on what your outlook is for like the Frutarom sales and EBITDA for fiscal 2018? So how much of a snapback are you expecting in the fourth quarter? So, were the timing issues more just the first half was better or are they going to come back in the fourth quarter? And then related to that, now that you've owned the business for maybe a month, are there any surprises outside of the revenue shortfall in the third quarter? What are some of the key – biggest integration risks that you see around Frutarom? Just more color around that would be really helpful.

Thanks..

Sure, Faiza. Obviously, it's hard to pinpoint it exactly. What I can tell you is we've been able to, as I said in my comments, so if we look at some specific issues, the colors business has a pricing issue related to changes in the underlying raw materials. But that's had a big impact in that business.

I talked about the timing of orders and order patterns, both in the citrus business as well as part of the savory business. So I think that's part of the reason why we believe it's a unique circumstance. Undoubtedly, there is – one of the biggest challenges any company that's going through this type of combination has to deal with is distraction.

We always do our best to try to keep everybody focused on both sides, but I can't – it's hard for me to sit there and say specifically how much of what we saw in Q3 is that.

But I can tell you, again, if you take out these three or four specific items that we know what was driving it, we were more in line with the long-term expectations of that business of mid-single digit growth on a currency neutral basis..

Yeah..

And then, as Andreas and I talked about in terms of the outlook and where we expect to see Q4, we are seeing and we do expect to see growth in Q4, probably not all the way back to where we would think it long-term, but certainly a marked improvement from what we saw in Q3..

And that's actually very comforting, and particularly in the start into the quarter, which is really, really good.

And again, I believe this early closing of the deal gives us a great opportunity to be ahead of schedule with our integration, because we just can – we have named our leaders already, the organization is in place and we can drive the performance. So, that's good.

What have we learned during the months we owned the business? Actually nothing which is a super big surprise to us.

Maybe the only thing and that's more positive is when I listened to the teams which are working together on the cross-selling opportunity, and I said it in the last couple of months, but it solidified my view that the opportunity we can cross-sell their products and vice versa into different customer bases with the technology is probably a bigger opportunity than we had sought at the beginning, and that really can drive value over time.

And it will take some time, but the first signs are actually very, let's say, very encouraging.

We had the first win actually on a West Coast customer where we helped the Frutarom team with our vanilla technology and vanilla formulation and that has led to a $3 million order, which they probably would never had received if we would not have helped out here, just to give one example. It's small, but it started earlier than I sought it.

So that's how I would describe it..

Okay. Thank you very much..

Your next question comes from Silke Kueck with JPMorgan..

Good morning.

How are you?.

Good morning. Very well. Thank you, Silke..

So there were a couple of acquisitions pending under Frutarom. And so I was wondering whether you can quantify what the – that maybe in like dollar terms, like, what the acquisitions of Frutarom added to Frutarom sales in the third quarter.

What you expect for the fourth quarter and what you expect to – they may add in 2019?.

Look, Silke, I think given that those – that the third quarter results are their numbers and we don't – I'm not comfortable disclosing that. I think in terms of M&A for – I mean we just continue to work together as you've heard Andreas and I talk about that we keep continue to work together on the pipeline.

We've now reprioritized the comp – the two team's standalone pipelines into to a refined list based on our priorities and our needs going forward. We look to continue to execute against that pipeline.

But I'm not – I really don't feel comfortable given the standalone nature of their results in Q3 coming in on the individual components of it?.

What you have seen so....

Well, but....

Sorry. If I could add on this, Silke, what we have seen is that there were no acquisitions made this year during the process of the, let's say, the deal, let's say, the pre-deal months. But we have – as Rich said, actually we have a good pipeline of very value and technology-added opportunities.

And I would not wonder if we could hopefully close two of these deals until the end of the year. They are smaller ones, but they would fit exactly into our wheelhouse. So, you see we're at a bit of a pause during that period. But now we are basically taking the combined pipeline with the new priorities and then going after it.

And I think it will be a big success going forward..

I was just, like, interested in knowing what sort of, like, the acquisitions added that were already announced, not even like the things that may have happened between when the transaction was announced and at closing, just sort of like what was announced prior to acquiring Frutarom, of things that may have closed? I was just wondering what those acquisition benefits were for the quarter and what they may add for next year?.

Look, again, they're going to disclose their results in the next two or three weeks. And then, we'll be in a better position to answer any questions at that point in time. I don't feel comfortable covering it right now..

Okay. In terms of the DNA, and I apologize because I'm not as familiar with Frutarom as I could be.

I thought that for the past two quarters that the D&A at Frutarom was something that was close to, like, $17 million a quarter, and what you said is you thought maybe it's something like $9 million a quarter?.

Because we're just doing the amortization, not the D&A. So it's just adding back amortization..

Okay, so amortization is $9 million of that, okay? That's helpful..

That's correct..

Okay. And then D is like another $8 million, okay.

The last thing is more of a comment rather than a question, but I thought rather than having an aggressive accounting treatment on earnings, maybe it's helpful to just provide the EBITDA aspect of it because I get a separate EPS estimate rather than including all amortization, which just seems like an aggressive treatment..

I would disagree that it's an aggressive treatment. It's looking at the underlying profitability. But then, again, bridging – it's a simple way to bridge it back to cash flow generation. We've seen this done on several of the acquisitions of similar sizes. So I don't consider it aggressive.

I'm trying to keep it, – the number of metrics that we have to communicate and monitor going forward to keep it simple..

Your next question comes from the line of John Roberts with UBS..

Hi, John..

John..

John?.

Hi.

Can you hear me?.

Yeah, now we can..

Yes. We can now..

Yeah.

On slide 18, are we going to get operating earnings for four segments or three segments?.

Only three..

Three..

Okay..

You're going to have Scent, Taste and then Frutarom..

And then in terms of sales granularity reporting going forward, will we get the same granularity on Fragrances that we currently get, the regional plus Fine and Ingredients? And will we get any additional granularity on sales underneath the various Frutarom and Taste segments?.

Look, John, we're going through that right now. But I would tell you that where I expect this to end up is we're going to report it the way we manage the business. So, on the Taste side of the business, we'll report along the regions, that's the way that business is run. On the Scent side, we'll report around the categories.

And on the Frutarom side, I think we're getting around the regional numbers. Directionally, that's where we're headed..

Okay. Thank you..

Your next question comes from the line of Adam Samuelson with Goldman Sachs..

Thank you. Good morning, everyone..

Good morning, Adam..

Maybe just, I want to make sure on the guidance, that you can just clarify, the underlying IFF business, as we think about the fourth quarter and/or where the previous constant currency or currency neutral sales growth was, has that expectation changed in anyway? I know there was an embedded deceleration in growth in the prior guidance based on the tougher comps and you slowed a little bit this quarter.

But I just wanted make sure I am understanding kind of what the assumption is on both the top line and then constant currency operating profit for the legacy business for 4Q?.

No, no, nothing significant in terms of change, in terms of the legacy business, both in terms of top line and overall profitability. We're on target..

Okay. That's helpful. And then just as we think about 2019, on the Frutarom side, again, going back to some of the questions on the decel implied in 3Q, I mean it's a pretty – the constant currency growth looks like they were up in the high-single digits, kind of the 8%, 9% range in the first half of the year.

And I don't know – we don't know exactly where it was for 3Q, but it looks to be kind of flat to up slightly organically.

I mean, the confidence of that is this is really just a timing of order patterns and are not something kind of more serious that would it impact the revenue growth into the next year, just some additional thoughts there?.

No, actually not. Because the good thing is that fruit, the fruit business has a very wide and broad customer base, and it will be very unlikely that all of these customers also for the different categories decide all of a sudden not to buy. I think that gives us a great comfort that we will reaccelerate in terms of the growth.

And we are in the middle of the budget process right now, and I hope in the next two or three weeks we will see how the numbers come out. But no big surprises here on this side, I would say it's actually what Rich alluded to, a couple of timing topics and on color, certainly the pricing topic.

And then it were the weeks and the two months before we were doing the closing, and that certainly impacted the business as well. As we see, we are coming back right now and that's comforting for us. So that's how I would describe it.

And I think it's important to see, because the portfolio has such a wide range of different portfolio topics, plus the broad customer base, that gives us actually good protection against downside movements in the mid and the long term. And that's the reason why we are reasonably optimistic here for the future..

Adam, just a quick follow-up on my side. Again, I don't see anything in the discussions with the team around the third quarter or any expectations that would change our long-term expectations for the business. I think you're right.

As we look into 2019, certainly the first half and the first quarter in particular are going to have tougher comps, stronger growth in the first half than what we expect to see in the second half in 2018..

Okay, I appreciate the color. Thank you..

Sure..

Your next question comes from the line of Gunther Zechmann with Bernstein..

Hi. Good morning, everyone..

Hey. Good morning, Gunther..

Good morning, Gunther..

Hey. Just a clarification on the amortization, the $220 million that you mentioned, just to make sure this includes also the non-Frutarom part of amortization that you're now including there. Thinking of David Michael, I think it was $7 million or so, and Fragrance Resources a few, so you're taking all of them together.

And also on the amortization schedule, is there anything you can share at this point or when would you be able to give the phasing and the details around how to model that over the coming years? That's the first one.

And the second one on free cash, more a longer-term question, you've been run-rating with the IFF legacy business for a number of years now very consistently around the 12% free cash flow to sales level per year. I appreciate that you have cash outflows as you integrate the business.

But as a run rate, is there any reason to believe why the cash profile should be different from that?.

Let me start with the first question, Gunther. In terms of the $220 million, it's really roughly $36 million for the historical Frutarom, $37 million roughly for legacy IFF amortization, and then the incremental – the difference to that to $220 million, which is call it $147 million, is our current estimates of what the step up is going to be.

I don't think Bob has finished the calcs yet, so it's going to take us a while. I would certainly expect that to be the basis for 2019, but we'll have more clarity, I'd say midpoint of 2019 at the earliest, but we'll update everybody if anything changes materially.

In terms of free cash flow generation, given the incremental step up, I would expect that ratio to go up.

As we begin to see improvements on the IFF side in terms of working capital, we get through some of the inventory pressures that I've talked about earlier, both from a price and a supply chain issue, I think we will be able to drive further improvements from a working capital standpoint on legacy IFF businesses, and I think we see a significant opportunity, particularly on the payables side for the Frutarom business.

So I think there's upside to the historical numbers that you were talking about..

Absolutely. And then if you go mid and longer term, also the CapEx will be ramped down, because we have on legacy IFF businesses, as you might know, still to finish our plant in India and in China and two big creative centers here in the U.S. And when we have done that, then the structure is actually in place.

We need some CapEx investment on the legacy fruit business to absorb some of all our capacity here as well. But this is all done in the next two years, then CapEx will go down significantly. We had actually a CapEx discussion last Friday, and that will generate more free cash flow going forward as well.

So that's how we see it, and it looks like it will go in the right direction..

And that's all on the organic side.

How do you think about providing capital to the Frutarom business to pursue acquisitions, and also what about the IFF legacy business looking for acquisitions longer term?.

It's in the business plan..

I think as I said earlier, we don't look at it anymore as Frutarom's historical M&A and our historical legacy M&A. It's now one combined pipeline that's based on this strategy and the prioritized segments that we see going forward for the combined businesses.

We're not done with all that work yet, but there are things that are in the pipeline that we are confident with, and we continue to work to pursue those..

Yeah..

Andreas's comment about CapEx, on a combined basis, I do see that coming down to probably somewhere between 3% and 3.5% on a combined basis after we get through 2019 and 2020 with all the integration work..

Yeah..

So we have built into our cash flow projections, we have built into our leverage ratios incremental M&A over the next three years..

Your next question comes from the line of Jonathan Feeney with Consumer Edge..

Good morning, thanks very much, a few quick ones. First, can you characterize the margin differential between Fine Fragrance and Fragrance ingredients? Is one materially higher than the other, and any comment about that? Second, what can you – there was just a lot of great discussion about CapEx relative to depreciation.

Can you give us a full-year run rate depreciation number, and then roughly what a full-year CapEx number looks like pro forma right now, depreciation versus CapEx for 2018 for the combined businesses on a full-year basis? And third and finally, how did you get a $9.8 million settlement from a supplier related to a prior recall? I haven't quite seen that before.

Thank you..

Okay. Let me start with the Fine Fragrance versus Fragrance ingredients, and I'm going to put – I'm going to take the cosmetic actives out of that comparison. I think on a gross margin basis, there's a significant difference.

On a return on sales basis, it's much closer to – they're much closer to each other, given the relative overheads of those two businesses. So they're both attractive on an accretive basis, but gross margin wise, if you think about mix, Fine Fragrance is significantly higher than the Fragrance Ingredients business.

CapEx as a percent of sales, I have to come back to you on that one. I think for – let me come back to you on that one. I don't want to guess and do my math in my head over the call. In terms of the insurance recovery, again, this is related to the product recall issue we settled with our customer last year. We wrote the check in early part of 2018.

And then, we've gone back to the vendor's insurance company and worked on getting reimbursement from them, because they had their own product liability insurance and that's where the money came from..

Got you, thanks very much..

Your next question comes from the line of Patrick Lambert with Raymond James..

Good morning. Thanks for taking a few questions, very simple. Could you quantify a bit the parts of Frutarom that are getting into Taste and Scent? I think IBR is pretty small, but I don't know to model the flavors North America.

If you could help us in that? And the second is regarding again the modeling of integration, in particular, the cost that you will incur in restructuring. I think you commented on the overall amount, but if you're a bit more clear on when the timing of the spending in Q4 and I guess 2019? Thank you..

Patrick, could you just repeat the second part of that question, because I'm not sure I got it?.

Yeah.

I was – can you hear me?.

Yeah..

Yeah. Yeah. Go ahead, sorry..

Yeah. Just I guess like everybody were trying to fully integrate now Frutarom in our model. And I was trying to forecast the integration costs that you've mentioned at the time of the acquisition.

And if you had a bit more precise picture on the timing of the spending already in Q4 and 2019?.

Sure. No problem. So on the internal transfers of IBR and the North American flavors, it's really, it's small. So it's insignificant, again. So, it's not a big number. It's not going to impact the regional numbers much at all.

In terms of the integration costs spend, I think it's what Andreas said earlier, I think the bulk of that, the CapEx as well as I would expect that the bulk of those things to be both in 2019 and 2020....

Yes..

...with a slight lag, I would say in terms of the severance costs by a quarter or two. But I think the bulk of it's going to be in 2019 and 2020..

Yeah..

And I would now like to turn the call back over to Andreas for closing remarks..

Thank you very much for all these great questions. We'll follow up in the one-on-one calls as usually and have a great day, and it's Election Day..

Thank you..

Thank you for participating in today's conference. You may now disconnect..