Earnings Call Transcript - IFF Q3 2022

Operator, Operator

Good morning. I would like to welcome everyone to the IFF Third Quarter 2022 Earnings Conference Call. 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 Mr. Michael DeVeau, Head of Investor Relations. You may begin.

Michael DeVeau, Head of Investor Relations

Thank you. Good morning, good afternoon, and good evening everyone. Welcome to IFF's third quarter 2022 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. Please take a minute to review our forward-looking statements. During the call, we'll be making forward-looking statements about the company's performance and business outlook. These statements are based on how we see things today and contain elements of uncertainty. For additional information concerning the factors that can cause actual results to differ materially, please refer to our cautionary statement and risk factors contained in our 10-K and press release. 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 our press release. With me on the call today is our CEO, Frank Clyburn; and our Executive Vice President and CFO, Glenn Richter. We will begin with prepared remarks and then take any questions that you may have. With that, I would now like to introduce Frank.

Frank Clyburn, CEO

Thank you, Mike and hello, everyone. Thank you for joining us today. On today's call, I will begin by providing an update on the strong progress we continue to make in reviewing and implementing our refreshed operating strategy. We are focused as ever on enhancing our operational plan and are making great progress towards completing the strategic refresh process and sharing this with you on December 7th at our Investor Day. I will then share our year-to-date performance and then turn the call over to Glenn, who will provide a detailed look at our third quarter financial results and discuss our outlook for the remainder of 2022. Once complete, we will then open the call up for any questions. Before we move ahead, I do want to take a moment, as I always do, to thank our dedicated colleagues around the world. It continues to be an unpredictable year, and our colleagues continue to work tirelessly to deliver for our customers. Our global IFF team members are truly committed to servicing our customers and I continue to be so inspired by our team's determination and ingenuity. Now beginning with Slide 6, I'd like to provide an update regarding our progress to complete our strategic refresh and begin putting this enhanced plan into action. We are now working diligently to operationalize our new divisional strategies and begin executing these focused, integrated and value-additive strategies with our customers and in the marketplace. This next chapter in our company's transformation is intended to ensure we are going to market as the most effective and innovative IFF we can be to extend our position as a trusted partner to our customers and maximize value for them, employees and shareholders both in the near and long-term. Let me review what we focused on and what we've accomplished through this comprehensive enterprise-wide review process. This review of our portfolio and our business is designed to ensure we are able to defend and extend our industry leadership in key markets, geographies and grow our business with key accounts and new customers. This has included evaluating our portfolio through a return on invested capital lens, identifying portfolio optimization and divestiture opportunities. This discipline will enable us to reduce debt and reinvest in our high-performing businesses as well as identify additional growth opportunities in attractive end markets and geographies that will allow us to foster long-term growth even amid ongoing external headwinds. It has been an important endeavor, not only to help us streamline the business but also ensure that we are focusing on only the highest value opportunities and maximizing our return profile across the entire business. We are in the process of refining our operating model and organizational structure to ensure better commercial engagement, enhance One IFF's company culture, strengthen talent in key roles and realign incentives to ensure accountability and ownership. We are also finalizing our financial aspirations for full year 2023 as well as what we believe the business should deliver longer term under more normalized conditions, and the capital allocation strategies necessary to achieve them all while prioritizing accelerated growth of our high-performing businesses. With this collective foundational planning, I am confident that IFF will fully capitalize on our clear portfolio advantage and deliver value to all of our stakeholders. We look forward to sharing more with you at our Investor Day on December 7. Moving to slide 7, I'd like to provide highlights of IFF's performance year-to-date. Despite a volatile market environment over the last nine months, IFF has continued to execute on our operational priorities to achieve strong top and bottom line results. Year-to-date we have delivered $9.6 billion in sales, which translates to 11% comparable currency-neutral growth and our comparable currency-neutral adjusted operating EBITDA grew 6% to $2 billion. Through the first nine months, we continued to take strategic pricing actions as necessary to offset inflationary pressures and as a result have fully recovered total inflation cost to-date. Turning to productivity by focusing on efficiency in our manufacturing processes and optimizing our supply chain and procurement, we captured over $125 million in extremely valuable operational efficiencies and deal-related synergies through the first nine months of 2022. Accelerating productivity represents one of our top priorities and is increasingly important given the more challenging economic environment heading into the fourth quarter and full year 2023. To this end, we are accelerating and expanding our efforts beyond our existing supply chain end-to-end manufacturing economic profit and global shared services platform initiatives we outlined on our second quarter conference call. We are now looking at our total cost structure to ensure we are optimized around go-forward strategic priorities to drive greater efficiency and effectiveness. These initiatives will be critical to support our growth strategy, all while positioning us to drive long-term profitable growth. To support our continuous improvement efforts within operations, I am pleased to welcome Ralf Finzel to our executive team as Executive Vice President and Global Operations Officer. He joined us from Honeywell International Performance Materials & Technologies business group where he most recently served as Vice President of Integrated Supply Chain. Ralf brings decades of leadership experience and his focus on operational excellence, sustainable continuous improvement, and customer satisfaction ensures he will be a key contributor to IFF's success moving forward as he will be accountable to deliver on our net productivity goals. In addition, I am pleased to announce that we've hired a new Chief Procurement Officer, Alex Turolla, who will be responsible for leading all of IFF's procurement efforts globally with the goal to move from procurement to strategic sourcing. Alex, who joins from Mondelēz International where he served most recently as Senior Vice President, Sourcing Global Direct Materials, managing $11 billion globally, brings significant experience in end-to-end supply chain operations and procurement. We also continue to progress against our portfolio optimization efforts now having successfully completed the divestiture of our Microbial Control business at the beginning of the third quarter. The proceeds were used to reduce our net debt to credit adjusted EBITDA ratio to 3.9 times from 4.4 times at the end of the second quarter. As mentioned earlier, we continue to assess the profitability and potential of each of our businesses and explore additional non-core divestitures and other timely optimization opportunities to improve our capital structure and achieve our deleveraging target. Now, I'll turn it over to Glenn to provide a deeper dive into our third quarter as well as an overview of the performance of each of our businesses.

Glenn Richter, CFO

Thank you, Frank and welcome everyone. Starting on slide eight, I would like to provide an overview of our third quarter performance. In Q3, IFF generated approximately $3.1 billion in sales, representing 10% year-over-year growth on a comparable currency-neutral basis, primarily driven by double-digit growth in our Nourish and Pharma Solutions divisions. Pricing was a strong contributor to growth and as expected, volumes were down marginally in the quarter. It should be noted that on a two-year average basis, which factors in our strong 8% year ago comparison, volume growth is running at about 4%. And while we have seen strong volume growth across most parts of our Pharma and Scent businesses in the third quarter, Nourish and H&B volumes were challenged. To provide some more color, nearly two-thirds of our volume decline in the quarter came in Protein Solutions, which is part of the Nourish business, where we have seen customer destocking to address higher inventory levels in response to sluggish end consumer demand. In H&B, our held volumes were also challenged in the third quarter, a direct result from weakening market demand in the US and Europe reflected in public market data. Gross margin was negatively affected by the significant inflationary pressures we faced across our markets. Yet through strategic pricing and productivity gains, IFF delivered adjusted operating EBITDA growth of 3% on a comparable currency-neutral basis. We also delivered solid adjusted earnings per share excluding amortization of $1.36. The strong dollar continued to be a headwind to our business. In the third quarter, we saw an approximately 7% impact on sales, an 8% adverse impact on EBITDA due to foreign exchange. Before moving on, I want to share that we recorded a non-cash goodwill impairment charge of $2.25 billion for the third quarter related to our Health & Biosciences business. The primary drivers of the goodwill impairment are related to increases in interest rates and lower business projections due to adverse macroeconomic impacts on volume, continued cost inflation and unfavorable foreign exchange rate variations. Now moving to slide 9, I will provide a brief overview of the performance across our business segments. In the third quarter, we achieved year-over-year currency-neutral sales growth of 10% driven by broad-based sales growth across all of our business segments and nearly all of our sub-business units. Nourish had another strong quarter with double-digit growth and particularly encouraging performance from Flavors, Ingredients and Food Design. Health & Biosciences also saw strong single-digit growth despite pressure in our Grain Processing business. Scent again saw continued currency-neutral sales growth in the high single-digits, thanks to our Fine Fragrance, Consumer Fragrance and Ingredients businesses. Pharma Solutions rebound continues with an impressive 28% increase in sales driven by continued strength in both industrial and pharma. Turning to slide 10 and looking at our profitability for the quarter. Third quarter adjusted EBITDA totaled $612 million. Comparable currency-neutral adjusted operating EBITDA grew 3% year-over-year due to the disciplined pricing actions to fully recover total inflation. We also achieved meaningful productivity gains and operational efficiencies from our productivity program, which have helped offset volume headwinds. As discussed last quarter, while we are clearly seeing signs of raw material inflation easing, we will continue taking appropriate targeted actions to offset inflation to maintain profitability. Now on slide 11, I'd like to discuss the underlying dynamics impacting the third quarter performance of each of our business segments. Nourish delivered another strong top-line quarter. Nourish's 10% year-over-year sales growth on a currency-neutral basis was driven by double-digit growth in Food Design and Ingredients, and sustained growth in our Flavors business. Health & Biosciences also maintain strong performance delivering 3% in comparable currency-neutral sales growth driven by mid single-digit growth in our Culture & Food Enzymes, Health, Home & Personal Care and Animal Nutrition offerings. However, for each of these segments we saw 4% and 1% year-over-year decreases, respectively in comparable currency-neutral adjusted operating EBITDA as our price increases and productivity gains we discussed earlier were offset by lower volumes. Our Scent division once again delivered a strong performance with 9% currency-neutral sales growth this quarter, driven by mid-teen growth in Fine Fragrance and Fragrance Ingredients and high single-digit growth in Consumer Fragrance. The division also saw 3% growth in currency-neutral adjusted operating EBITDA due to volume growth, our price increases and productivity gains. Pharma Solutions contributed very strong performance, with 28% growth in currency-neutral sales, led by strong double-digit growth in pharma and industrial. Similar to Scent, Pharma Solutions also benefited from strong volume, our pricing actions and the productivity gains we achieved in the quarter leading to an impressive 76% growth in currency-neutral adjusted operating EBITDA. Turning now to Slide 12, I would like to cover our cash flow and leverage position. Through the first nine months, we generated $189 million in cash from operations, with CapEx finishing at $344 million or approximately 3.6% of sales. The net result is that our free cash flow through nine months was a negative $155 million. Our free cash flow has been significantly impacted by much higher inventories due to a combination of inflation, strategic increases and improved customer service levels and to slowing volumes. In addition, included in our free cash flow numbers are one-time deal and integration-related costs. As a result, we are implementing a series of initiatives to improve our cash flow with an intense focus on managing inventories down. Much of this will be driven by leveraging new S&OP processes and tools in concert with specific targets for each business unit, which we believe will improve our inventory efficiency across all parts of the business while continuing to maintain high service levels to our customers. In addition, we will be taking targeted actions to reduce CapEx spend and improve other working capital metrics to further improve our cash position. Importantly, we continue to make progress towards achieving our deleveraging target. As Frank mentioned earlier, we improved our net debt to credit-adjusted EBITDA ratio to 3.9 times from 4.4 times, which was supported by proceeds from our recent Microbial Control divestiture. We finished the third quarter with cash and cash equivalents of $538 million, while gross debt for the quarter totaled $10.8 billion. Turning to our consolidated outlook on Slide 13, I want to provide some update on our expectations for the remainder of the year. Our business and broader industry continues to face challenging operational conditions with persistent foreign exchange, inflationary and other economic pressures. These challenges have only increased since last quarter. We are certainly encouraged by the consistent sales growth achieved across each of our businesses this quarter, especially in this environment. However, we are adjusting our sales expectations for Q4, as we expect volume to further decelerate due to lower end-market demand and we expect foreign exchange to remain a significant headwind. These factors will also present challenges to adjusted operating EBITDA. In light of these factors, we are adjusting our full year guidance and now expect full year sales between $12.4 billion and $12.5 billion and comparable currency-neutral sales growth of 9% to 10%. We are reconfirming our adjusted operating EBITDA guidance of $2.5 billion to $2.6 billion, though we anticipate results to be at the bottom end of this range as we maintain strong cost discipline and accelerate productivity to offset persistent headwinds and softer volumes. Looking into 2023, the current macroeconomic environment makes us cautious. And as a result, we anticipate that we will be in a low-volume growth environment, particularly in the first half of next year. In addition, while we see raw material inflation easing, we do anticipate some year-over-year increases in raw materials and continued volatile energy markets, which will require additional pricing actions. As a result, we will continue to examine and refine our resource allocation to focus on strong cost discipline and accelerating our productivity across our business. We will also continue to implement pricing actions surgically, to support our profitability and ensure our business remains resilient. And while it's still early in our planning process, we are targeting strong comparable currency-neutral sales growth in 2023, to be driven more predominantly by price with more modest EBITDA growth on a comparable currency-neutral basis, as we reinvest in the business to accelerate sales momentum and drive long-term profitable growth. Foreign exchange will continue to be a headwind, as we roll forward current spot rates. We will spend more time on 2023 at our Investor Day, in a few weeks. I'll now turn it back to Frank for closing comments.

Frank Clyburn, CEO

Thank you, Glenn. I am tremendously proud of the work our teams at IFF have accomplished in the last quarter, as we remain laser-focused on developing innovative solutions and exceeding the expectations of our customers around the world. As you can see from our outlook, though we are moving into Q4 with caution, I am confident as we have demonstrated time and again our global team's ability to navigate even the most complex environments. As Glenn said, we are closely monitoring shifts in the market to effectively address any emerging challenges. We remain intensely focused on controlling the controllable, through the year-end and we continue to work with our customers to surgically implement pricing actions, meet or accelerate our productivity and portfolio optimization objectives, continue to delever our balance sheet and focus on driving profitable growth. As you know, we have made significant progress this year to strengthen our business and become more efficient. By leveraging our strong foundation and being laser-focused on our growth initiatives, I am confident in IFF's ability to be resilient and drive long-term value creation regardless of the market environment. Before I open the call up to questions, I would like to share official details about our upcoming Investor Day, which will be held on Wednesday, December 7 in New York City. We are excited to host this event and share more about the opportunities ahead for IFF including how we will capitalize on our leadership position, innovate for our customers, generate strong productivity and grow our business for the future. We hope you will all join us, and we look forward to seeing you there for what promises to be an engaging interactive and informative experience. Registration links for the in-person live event have been sent out, but if you have not received one or have questions, please feel free to reach out to our Investor Relations department. This will also be webcasted broadly for those that cannot travel to New York City. With that, I would like to open up the call for questions.

Operator, Operator

Thank you, Frank. We will now start the Q&A session. Our first question today comes from Adam Samuelson with Goldman Sachs. Adam, your line is now open.

Adam Samuelson, Analyst

Yes. Thanks. Good morning, everyone. I guess a question on cash flow, which year-to-date has been more challenged. I think, Glenn, previously there's been a target of $800 million or so of free cash flow this year. Can you provide an update on what that might ultimately shake out to be? And just more broadly, what's the plan on improving the cash conversion as we go into 2023 and beyond? Thanks.

Glenn Richter, CFO

Good morning, Adam. Thank you for your question. This year has been more challenging than we anticipated, largely due to our inventory levels. At the beginning of the year, we aimed for a $1 billion target, but we've adjusted this to an $800 million target. We've encountered about $125 million in unexpected pricing and inflation, along with an anticipated $200 million more in inventory by year-end. This is down $100 million from our current situation, as we ended the third quarter with $600 million more in inventory than at the beginning of the year. Of that, roughly $200 million is attributed to raw material inflation, and about $400 million relates to our efforts to maintain service levels. However, demand has slowed, leading to higher inventories overall. We believe we can recover the $200 million difference from our initial target and expect to do this in the first half of next year, with the potential to exceed that. Additionally, our business slowdown and some timing issues with tax payments contribute to about $150 million of our adjustments, bringing us over $500 million in total adjustments. To clarify, our reported free cash flow on a GAAP basis includes significant costs related to transactions and integration due to the sale of our Microbial Control business. This amounts to around $225 million this year, which will be deducted from the $525 million. Consequently, our true operating cash flow would be near $500 million. Furthermore, we anticipate that the $200 million inventory issue will be resolved, along with $100 million related to tax timing, which would bring us over $800 million. We expect to gradually recover the increased raw material costs in inventory over time, over $250 million since the beginning of the year. I hope this information helps.

Operator, Operator

Thank you, Mr. Samuelson. The next question is from the line of Mark Astrachan with Stifel. Mark, your line is now open.

Mark Astrachan, Analyst

Yeah. Thanks and morning, everyone. I guess just to start I wanted to follow-up on the last question. So thinking about free cash flow more broadly, you wrote down the H&B business. I assume that implies incremental investment for that. So the question maybe sort of broadly is, how do you fund that? Obviously, you just talked about free cash flow improvement kind of over the next 12, 18 months with other sort of underlying drivers. But can you comment on what a reasonable rate of free cash flow productivity for the business would look like kind of 2024 and beyond? Certainly, in the context of some of your competitors having targets out there, are those reasonable levels? And then second question is just on volumes. You're implying the volumes will be down mid-single-digits in the fourth quarter. Which categories are driving that? And then how do you think about those trends through at least the first half of 2023, I would guess are challenged before comparisons get easier? Thank you.

Glenn Richter, CFO

Hey, Mark, it's Glenn. Good morning. Relative to our longer-term objectives on cash flow, we're going to hold that to our Capital Markets Day. So, we're less than a month away from that. We'll have a chance to actually discuss more specifically our longer-term targets. And then I'll turn it over to Frank to talk about some of the flow trends.

Frank Clyburn, CEO

Hey, Mark, good morning. A couple of things that I wanted to highlight. You are correct. We are in the fourth quarter assuming volumes do decelerate versus the Q3 number that we just posted. And it's really two factors and I'll give you where the areas that are a focus for us right now what we're seeing. I'll start with our health business under the Health & Biosciences division, Mark. In health, and I signaled this I think even earlier in the quarter, we are seeing both end-market demand slow as consumers are making choices between probiotics dietary supplements. So we are seeing some slowing end-market use in health and we are also seeing destocking in that business in particular in North America. And we expect that to continue through the fourth quarter as also well in Europe. So that's what we're seeing in our health businesses. And we went through the quarter, Mark. We did see July down. We saw August come back. September was down. And as we now started to see in October, we're seeing a similar trend of the deceleration I mentioned in that business. In Ingredients under Nourish and we highlighted this on our prepared remarks, Mark, we are also seeing more inventory destocking is the primary aspect of what we're assuming will continue as we go into the fourth quarter. We also within the Ingredients business did make some trade-offs from a pricing perspective. We had some of our Protein Solutions business that was capacity-constrained, where we did increase price and made some volume trade-offs to preserve some margin, but it's primarily destocking. So that is the main reason and we're also assuming in that business that will continue in the fourth quarter. As we go into '23, we're expecting at least in the first half moderate volume growth. We'll explain a lot more of what we're anticipating for '23 as we get to Capital Markets Day, Mark, but that's what hopefully gives you some color on what we're seeing in the business. The other thing, I would highlight though and I think it's an important reminder for us that, if you do take a step back over the two-year time period and we mentioned this through Q3, we are growing our volumes 4%. And we are still seeing good growth in particular in Scent and Pharma that we highlighted as well. So, the isolation that I highlighted is really primarily in those two areas, which is where we're anticipating seeing the deceleration continue as mentioned.

Operator, Operator

Thank you for your question. The next question comes from the line of John Roberts with Credit Suisse. John, your line is now open.

John Roberts, Analyst

Great. Thank you. The goodwill write-downs seem to only affect Health & Bioscience, but I assume the higher discount rate would have affected goodwill on the other segments as well. So, the difference must be in the longer-term assumptions for Health & Bioscience relative to the macro assumptions for the other segments. Could you discuss a little bit why the longer-term macro assumptions for Health & Bioscience appear to be worsening relative to the other segments?

Glenn Richter, CFO

Yes, John, thank you for your question. It's primarily about the amount of goodwill and intangibles allocated to the business. Before the end of the quarter, we had approximately $25 million in goodwill and intangibles on our books, which were assigned to each of the four divisions, largely due to acquisitions. Most of this allocation comes from the N&B acquisition. Consequently, H&B Pharma and to some extent Nourish carry a significant burden of goodwill and intangibles, while H&B and Pharma do not have the legacy IFF business that Nourish has. Before the write-down, about 45% of the goodwill and intangibles were attributed to H&B. Furthermore, we are required to conduct an annual test for impairment, or sooner if there are events suggesting a potential impairment. The current interest rate environment significantly impacts these assessments. We perform discounted cash flow calculations for each business with forward projections, which for the H&B business, were reduced in part due to exchange rates. All businesses experienced lower earnings because we must account for current exchange rates. There was also a slight decline in operating performance, but exchange rates were impactful. Most importantly, the discount rate increased significantly due to rising interest rates. This higher discount rate directly led to the $2.25 billion write-down. We do have approximately a 10% cushion on Pharma, which will likely come under scrutiny next, given the goodwill and intangibles assigned to it. The impact is less pronounced for Scent and Nourish, as their legacy IFF businesses do not carry the same goodwill and intangible repercussions. Overall, this situation reflects more on the interest rate environment and exchange rate effects rather than a direct negative outlook on the business.

Operator, Operator

Thank you. The next question is from the line of Gunther Zechmann with Bernstein. Gunther, your line is now open.

Gunther Zechmann, Analyst

Thank you. Good morning, Frank, Glenn and Mike. Now your Q4 guidance also from what you just said on volumes implies around 10% pricing. That's pretty similar to Q3. We know that peers reported pricing getting harder in a weakening demand environment, which is what you're flagging as well and new price rounds getting even tougher. So how do you see this develop into 2023 then? What are your expectations for the raw material costs into next year as well? And also how much of the lower volumes that you indicated, do you think are due to stronger price increases that you pushed through as opposed to consumer demand down-trading or destocking please?

Glenn Richter, CFO

Good afternoon, Gunther. I will start by discussing the inflationary environment, after which Frank will address pricing dynamics in relation to volume. First, we are observing a slowdown in the raw materials market, particularly in certain commodities. I'd like to provide an overall outlook for 2023, highlighting three components. First, logistics appear favorable, remaining flat or slightly decreasing. We are encouraged by an improvement in the supply chain, which is beneficial for freight costs and allows us to ensure timely deliveries to our customers. This is a positive development. The energy market remains highly unpredictable and challenging to forecast. We have been implementing direct surcharges or variable pricing related to energy prices for our customers, which will fluctuate depending on market conditions. This is consistent with trends observed across many industry players, particularly in Europe. Regarding raw materials, we are still experiencing inflationary pressures. I would categorize this into three areas: certain commodity groups are affected by energy fluctuations or supply chain issues, such as synthetics and chemicals; we are seeing some roll-offs from previous contractual pricing or hedging; and while some commodity prices are starting to decline year-over-year, they still show modest increases for us, including soybean and palm oil. We anticipate next year's raw material inflation to be about half of this year's, projecting high single-digit impacts. You are correct that the pricing environment is tightening. With a slowdown in consumer demand, everyone is becoming more cautious about passing on commodity price increases. We are preparing to introduce our 2023 pricing strategy and have carefully evaluated what pricing makes sense for our customers based on market conditions. Consequently, we expect to implement another round of pricing actions in 2023 to address the ongoing raw material costs.

Frank Clyburn, CEO

And Gunther, this is Frank. Regarding the second part of your question about the lower volumes and significant price increases, we don't believe that our pricing measures have negatively affected volume. In fact, observing the market, many of our competitors are also raising prices, and we don't see this as an issue. We've communicated with numerous customers and have done so in collaboration with them, and they have indicated clearly that we haven't experienced any share losses due to our pricing strategies. The only area I want to emphasize is within our Ingredients business, where we faced capacity constraints. We did raise prices and made some volume adjustments to maintain margins, which is the key point I want to highlight. Additionally, as mentioned, our primary driver for changes is inventory destocking; our customers are assessing their year-end inventory levels and managing their working capital effectively. That's the main factor here. Lastly, I want to mention that we plan to further develop our commercial execution, focusing on how we work with our customers to effectively promote our entire IFF portfolio, enhance our market share with key and regional customers, and attract new customers. I'll provide more details about our growth aspirations at the Capital Markets Day, so there will be more information to come.

Operator, Operator

Thank you, Mr. Zechmann. Our next question today is from the line of Heidi Vesterinen with BNP Paribas. Heidi, your line is now open.

Heidi Vesterinen, Analyst

Morning. So, I have another question on your outlook please. We noticed that your peers aren't calling out a volume decline or any major destocking in Q4, although I do appreciate that many of them reported much earlier than you have. Have market trends weakened significantly in recent weeks, or is your cautious outlook driven more by IFF-specific factors? Thank you.

Frank Clyburn, CEO

Yes. Heidi, it's Frank. And as I highlighted, as we went through the quarter and in particular in September, Heidi, we did start to really see the destocking that I mentioned. And also, we are seeing that in the month of October. So, as we look at now for our forecast for this fourth quarter, we're obviously taking those most recent data points into consideration. And that is why we feel as though appropriately so we have guided to the top line sales that we've mentioned in our prepared remarks. The one thing I do want to take a step back though Heidi and do highlight is we still are confident that for the full year growing the business, 9% to 10%, if you were excluding exchange, we feel as though is a very good overall performance. Like I said clearly, the fourth quarter is where we're seeing some challenges, and this is primarily due to our customers wanting to manage the inventory. And we think it's the prudent approach to take based on what we're seeing in the last couple of months end of Q3 and then as I mentioned in October.

Operator, Operator

Thank you. Our next question is from the line of David Begleiter with Deutsche Bank. David, your line is open.

Anthony Mercandetti, Analyst

Good morning. This is Anthony Mercandetti on for David. You touched on it a bit throughout the call, but I was wondering if you can maybe elaborate on how much more destocking you're expecting into 2023 will be a headwind in Q4. And then maybe what particular end markets and regions you expect the destocking to be more pronounced in regards to maybe the first half of 2023?

Glenn Richter, CFO

Hey, Anthony, this is Glenn. Thanks for joining us. I’d say it’s really hard for us to make predictions. We closely monitor end-consumer demand, primarily through scanner data and also through extensive dialogues with our customers about their activities. We believe that destocking, coupled with declining end-consumer demand, are major factors in what we are experiencing. As Frank mentioned, we see this especially in two categories: protein solutions and probiotics. When looking at the end market and the reports from major CPG firms, they are experiencing double-digit declines. Particularly in probiotics, which saw significant growth during COVID, it makes sense that we would see a decline now. So, the first point is that we believe this is driven by destocking and consumer demand. As for how long this will last, we really don’t know. Some customers have told us they expect to have their inventories in check by year-end, but that relies on accurately predicting consumer behavior. Others think this could extend into the first and second quarters of next year. We will provide more insight into our outlook for 2023 at our Investor Day, but we will likely consider additional destocking and a slowdown in consumer activity as we assess our financial performance for next year. I appreciate the question.

Operator, Operator

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

Mike Sison, Analyst

Hi guys, nice quarter. Frank, when you think about the portfolio now, and it does seem like folks think we're heading into a downturn in 2023, how do you think each of those segments should perform if the recession unfolds? And maybe give us a little bit of color what you've learned on those businesses as we head into 2023.

Frank Clyburn, CEO

Thank you for the question, Mike. Looking at our entire portfolio, we believe we are quite resilient as we approach a potential recession. Starting with Nourish, our ingredients in the food and beverage markets should hold steady. Our Flavors segment is robust, as is Food Design. Excluding some short-term challenges related to inventory destocking, we anticipate that our divisions will remain resilient during recessionary periods. Regarding the Scent business, we initially thought Fine Fragrance would face challenges in a recession, but we're experiencing strong growth in that area this year, and our Scent business is performing well with solid volume growth. In Health & Biosciences, we believe we are well-positioned, particularly in Cultures & Food Enzymes and Home & Personal Care, both of which tend to perform well during recessions. While we've acknowledged some challenges in the probiotic marketplace, the overall segment remains fairly resilient. Additionally, we believe the pharmaceutical sector is also very stable during economic downturns. With that said, we are aware of some challenging headwinds ahead, and our team is focused on those. We'll provide further insights during our 2023 outlook. Overall, we feel confident in our business's resilience across various segments, and we'll be delving into more details at Capital Markets Day.

Operator, Operator

Thank you, Mr. Sison. The next question comes from the line of Ghansham Panjabi with Baird. Ghansham, your line is now open.

Matt Krueger, Analyst

Hi. Good morning. This is actually Matt Krueger sitting in for Ghansham. So I was hoping that we could touch on some of your own internal initiatives here. So what are some of the internal offsets across the business that can counter the tougher macroeconomic backdrop as we cycle into 2023 and into the back half of this year? And what are some of the primary concerns when entering a downturn for the business? Are you already taking actions to offset this? And if so what might those be?

Frank Clyburn, CEO

Hi, this is Frank. I'll begin by highlighting our significant focus this year on productivity initiatives, mainly within our operations group where we've concentrated on our supply chain. We're emphasizing economic profit as a key factor in our decisions regarding manufacturing and logistics costs. I want to start by saying we've made excellent progress in enhancing productivity, which Glenn mentioned in his prepared remarks. As we approach a potential downturn, we are examining our total cost base for IFF. We're exploring ways to further accelerate productivity beyond our previous focus on manufacturing operations, something we will share in more detail at Capital Markets Day. We believe there are opportunities to lower our cost base and boost productivity while also maintaining our investments in innovation and continuing to collaborate with our customers to drive growth. More information will be available at Capital Markets Day, but we are confident that we can accelerate productivity as we move into 2023.

Operator, Operator

Thank you for your question. Our next question comes from the line of Josh Spector with UBS. Mr. Spector, your line is open.

Josh Spector, Analyst

Yeah. Thanks. Good morning. I was wondering if you'd discuss the margins in Scent in the quarter. You previously talked about that segment taking much longer to catch-up on price/cost. I believe, prior calls you talked about maybe later next year. I mean, it appears you made a pretty big step-change improvement this quarter. So what happened in third quarter? And does that change any of your expectations for the forward few quarters from here? Thanks.

Glenn Richter, CFO

Hey, Josh. Good morning. Yeah. We're very pleased by the progress that our Scent business is making. Two things are exhibited in the third quarter trend versus the first half of the year. One is, we are beginning to sort of normalize for price versus inflation. So there was another round of pricing year to sort of catch-up for what's been happening with raw materials. That has been implemented. So it's been extremely helpful relative to the gross margin performance, and we expect that to normalize into the first half of next year. But then secondarily, the team has also undertaken actions to continue to manage their costs very tightly. So you'll notice that their RSNA expenses also showed improvement from the first half to the third quarter as well. So the team is smartly and on a paced manner implemented pricing maintaining volumes quite well and on top of that taking additional productivity actions to make sure they manage the bottom line and had a nice currency-neutral year-over-year growth as a result of that.

Operator, Operator

Thank you. Our next question comes from the line of Christopher Parkinson with Mizuho. Mr. Parkinson, your line is now open.

Christopher Parkinson, Analyst

Great. Thanks so much. You kind of hit on a few of these just tangentially your other remarks. I just want to circle back to it. Despite the 3Q result being solid, it still appears the cost backdrop is still challenging. I understand you want to save a lot for your Analyst Day, but just can you currently just highlight what you're seeing in raws transportation and logistics, and then just also general operating costs just how we should be considering those at least on a preliminary basis entering 2023? Thank you so much.

Glenn Richter, CFO

Hey, Chris, yeah, relative to logistics costs year-over-year pretty flattish to slightly down. So we've actually seen nice improvement in the global supply chain. As I mentioned previously, raws we still have pressure about half of what we've seen this year. So think about it as sort of high single digit on our total raw material cost. And that's a function of contracts rolling off. It's also a function of certain categories those driven by energy prices continue to see escalation in areas that are being affected by continued war in Ukraine and other global supply chain issues. So call it half of the rate of this year, still meaningful for us to basically go capture. And as a byproduct of that, not only do we need to be smart on our next round of pricing actions, but everything Frank had mentioned around managing our cost structure as a way to sort of offset those pressures as well.

Operator, Operator

Thank you. Our next question comes from the line of Jonathan Feeney with Consumer Edge. Jonathan, your line is now open.

Jonathan Feeney, Analyst

Good morning. Thank you very much. I believe I have a solid understanding of how your primary customers are responding to trade-down behavior among consumers. However, regarding your business, you mentioned that in some instances you are prioritizing pricing over volume to safeguard margins. How do your customers trade down within your portfolio without switching to a competitor or innovating? Are there any indications of trade-down? Also, how does this differ in the legacy DuPont businesses compared to the newer businesses at IFF? I felt we had a clear understanding of this dynamic before 2021. Thank you.

Glenn Richter, CFO

Well, let me attempt to answer it in a couple of dimensions, Jonathan. Obviously, with the consumer under pressure from inflation, there is a visible movement from branded to private label. So that's happening both in Europe and the US, although more pronounced in Europe. We play across the customers that play in both spaces. So we serve both markets. In general, not all cases, but in general our margins are fairly consistent between branded and private label from the standpoint. So from that standpoint, while the consumer is moving across branded to private label generally, we hold up well relative to the shift of our business. The customer also will look at formulations and how do they think about saving money through reformulations, it's very constant. It actually happens in all environments, but it's more pronounced in this type of environment. So we work very closely with them in terms of helping them, reformulate products basically to take cost out and deliver the same solution for the consumer. The third thing, I would say relative to the behavior of consumer is and this is clearly happening in the marketplace is, while the consumer may still actually stay within branded oftentimes they will reduce dosage. So think about that as sort of less home and personal care products usage, or less fabric softener as an example. So that is another factor that's happening that affects our business, as well as the customers' business. But it may in essence, also result in sort of lower volumes in the marketplace as well. So, hopefully, that's helpful.

Frank Clyburn, CEO

Yes. The only thing I would add, Jonathan, I think it's important though that we do still continue to see our customers seeing, how important innovation is for the future. So as we engage with them and as Glenn mentioned, some of what we're seeing, some down-trading near-term, et cetera. But the fact is, we are still seeing very high engagement from our customers wanting to work with us, with regards to our pipeline new projects innovation, which we think is going to be very important for the future for us and going forward. So that's something that I just wanted to also make sure that is reinforced. We're not seeing a pullback of customers not wanting to innovate for their future growth. And that's something that we're focused on really helping them to deliver on.

Operator, Operator

Thank you, Mr. Feeney. Our last question today comes from the line of Matthew DeYoe with Bank of America. Matthew, your line is now open.

Matthew DeYoe, Analyst

I wanted to ask a question about Nourish. Essentially, for every dollar gained in revenue, there was a dollar lost in EBITDA. This shows a significant drop in decremental margins from the third quarter and seems somewhat inconsistent with the commentary on price offsetting raw costs. Can you explain what occurred there and how this impacts margin progression heading into the fourth quarter?

Glenn Richter, CFO

Yes. Matt, one underlying factor relative to the quarter is how we're trying to correct manufacturing volumes to offset the decline in demand in order to address our cash flow and inventory problems. So as a result of that the production volumes in the third quarter for Nourish were dropped even more so than demand. So there's an absorption issue relative to that's hitting the business. So that does affect sort of the marginal flow-through of the dollar if you will. Also quarter-to-quarter there was some inflationary pressures like energy and some other things that were, sort of, not outside of the period per se in terms of kind of the effects. So it's a little bit hard to, sort of, normalize one quarter to another as being, sort of, an apples-to-apples. But the reduction in volumes in order to get our inventories down is a factor that's hitting our business collectively in Q3 and also in Q2. And it's more pronounced in Nourish and H&B we've seen a more pronounced volume decline. So that's a factor in that calculus you cited.

Operator, Operator

There are no further questions waiting at this time. So it's my pleasure to turn the call back over to Frank Clyburn for closing remarks.

Frank Clyburn, CEO

So thank you everyone for joining our call. Hopefully, you can see and hear despite some of the near-term challenges, we are extremely excited about the future in front of us with IFF. We look forward to December 7 in our Investor Day in the next couple of weeks where we'll really spend time sharing with you our growth our aspiration from an innovation perspective, how we'll continue to drive productivity to be able to reinvest in the business and why I'm very excited about the future of IFF going forward. So look forward to seeing many of you in New York City on the 7th, and thank you for joining our call.

Operator, Operator

That concludes the IFF third quarter 2022 earnings call. Thank you all for your participation. You may now disconnect your lines.