At this time, I would like to welcome everyone to the International Flavors and Fragrances 3rd Quarter 2018 Earnings Conference Call. Participants I would now like to introduce Michael DeVoe, 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 dotcom.
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 will be making forward looking statements about the company's performance, particularly with regard to our outlook for the fourth quarter full year 2018. These statements are based on 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, Richard O'Leary. We will start with prepared remarks and then take any questions as 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 1st 9 months for 2018. Give a quick update on Frutarom since the transaction has closed and provide an update to our 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 1st 9 months performance Growth was strong across our key financial metrics. Currency neutral sales increased 6% year to date with flavors growing 6% and fragrances growing 5%.
New wind performance and price increases to mitigate rising material cost both contribute 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 toward 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 1st 9 months of 2018, Sales of our reimagined modulation portfolio grew strong double digit and PowderPew grew an impressive triple digit both indicative of our position as a leader in innovation. Performance with local and regional customers remains strong growing double that of our global customers, which on a consolidated basis is about 50% of our customer base.
Enflavor specifically Our midsize go to market platform taste point continued to deliver strong results, improving strong double digits in the 1st 9 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 and flavors Gross 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 1st 9 months of 2018 as our cost and productivity initiatives, including 0 based budgeting, added approximately 5 percentage points of growth to currency neutral adjusted operating profit and EPS growth. All in all, I'm very pleased with how well our refresh 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, Gadeem, to everyone. Moving on to our Q3 currency neutral sales in the 2nd 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 productivity initiatives will have offset by unfavorable price to input costs, inclusive of the BASF Central 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 continued 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 items that impact comparability, the adjusted tax rate for the third quarter of 2018 was 14% compared to 22.7 percent in the prior year period. The year over year decrease was largely due to a more favorable mix of earnings a lower cost of repatriation and the remeasurement of loss provisions, partially offset by adjustments to the impact of US tax reform and the impact of currency current year transaction costs including certain non taxable gains Looking at the business unit performance for strong year, year ago comparison of 12% with growth coming in all categories and all regions. On a 2 year average base growth remained very strong at approximately 9.5%. North American flavors improved 10% in the 3rd quarter, led by double digit growth at Tastepoint and strong performances in dairy and sweet.
EME increased 6% on a currency neutral basis led by high single digit growth in Europe as well as Africa and Middle East. Great Asia grew 4% in the 3rd quarter a currency neutral basis as 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%.
Fragrance currency neutral sales improved 2% on a strong year ago double digit 2% on a currency neutral basis as performance was driven by continued growth in hair, home and fabric care. Fine fragrance declined percent 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 EMEA increased low single digits. Fregnancy ingredient sales were up 5% on a currency neutral basis, led by strong double digit growth in the cosmetic active ingredients business. This marks the 9th consecutive quarter of growth in fragrance ingredients.
As we continue to successfully execute our refreshed strategy, and we achieved strong realization of price increases. From a profit perspective, Fragrance, 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 unfavorable price to input costs, including the previously announced citral issue, In terms of currency neutral segment profit margins, our margins remained solid yet were under pressure year over year. Before moving on, I'd like like I did in Q2. As you remember, coming into the year, we expected mid single digit more material inflation in 2018. Inclusive of the impact of Since that time, cost inflation has picked up following a series of disruptions in the supply chain.
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 priorities 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 $202,000,000 in the 1st 9 months of 2018 compared to $199,000,000 in the prior year period. This was primarily driven by litigation to ensure continuity of supply during unprecedented supply chain challenges From a capital allocation standpoint, we spent approximately $102,000,000 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 flavor's manufacturing facility in the Xinjiang Free Trade Zone, which opened on October 9th in a natural products research lab located in Nanjing Life Science Park, which opened on October 15th.
The Flavors Plant is our 2nd 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 We continue to believe that we will spend approximately 4% to 5% of sales for the full year 2018 on CapEx. Regarding cash return to shareholders, during the 1st 9 months, we spent approximately $163,000,000 on dividends and $15,000,000 as we were prioritized 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 Fruta Rooms' estimated results 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 4th. For the third quarter, net sales are expected to be between $360,000,000 $365,000,000 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.
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 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 $1,150,000,000, 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 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 us 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 6 to 9 months from May 7th's 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 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 and attractive adjacencies and stronger exposure to fast growing customers. We expect to generate cost synergies of $145,000,000 through raw material harmonization, footprint optimization and streamlining overhead expenses, but as 3rd 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. For this combination, we are confident 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% 10% plus adjusted EPS growth.
Excluding total company amortization between 2019 2021, all in the currency neutral and pro form a 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 2 global market position in the industry with approximately 33 sales and customers globally, selling about 150,000 unique product solutions annually. Our organization is fueled by 13,000 hardworking employees and more than 110 manufacturing sites and approximately 100 R and D centers and laps 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 in 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 Frutom 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 form a 2018 sales, we expect sent 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, Matias Haney and Nicholas Mersiens, will continue to lead our taste and scent division, respectively. Leading the Frutarom division, I'm pleased to welcome Amoz Anadot who spent 8 years at Frutarom and 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, savor solutions, flavor and fragrance ingredients, trauma and trade marketing businesses, and has 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. We 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 October to run these businesses in a manner that leverage our strengths and supports our customers. Aligned with this approach we are already capitalizing in North America. We're integrating Frutarom's North America taste business into our own. As a reminder, Tastepoint is designed to serve as a 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 midsized customers in North America This transition should be seamless.
As a go to market model used by Frutarom's North America, flavors business is perfectly in line what we have at Case Point. Another example is in cosmetic actives, where we are shifting Frutarom's cosmetic active ingredients business into our Lucas Myers Cosmetics business. Established in 1995, Israeli Biotechnology Research or IVR researchers develops, manufacturers and marks 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 fermentation prevention. By combining these two businesses, we have strengths in 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 a successful debt raise, our total debt outstanding is approximately 4,400,000,000 The annual interest expense associated with this debt is expected to be between $150,000,000 $155,000,000 per year. Currently, we expect our annual effective tax rate to be approximately 19%, more or less the average of the 2 stand alone companies. For purposes of calculating adjusted diluted EPS on a go forward basis, we estimate that there will be approximately 113,000,000 diluted shares outstanding including 6,300,000 shares related to the tangible equity Annual amortization is expected to be approximately $220,000,000 and subject to change based on the finalization of the purchase price accounting. In terms of our closed 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 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 4th quarter estimated results We are targeting year over year advancement in both top and bottom line results. We expect our sales to be between $3,950,000,000 $4,050,000,000 for the full year, with similar contributions to Q3 in our legacy IFF business as well as sequential improvements in Frutarom's sales performance versus the growth they achieved in Q3. We also expect our adjusted EPS to be between $626.25 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 made up of $37,000,000 of legacy IFF amortization $9,000,000 from legacy Frutarom amortization and an estimated $37,000,000 from the purchase price accounting related to the transaction.
With that, let me turn it back over to Andreas for final remarks.
Thank you, Rich. In summary, we are pleased with the strong financial performance in the third quarter as we achieved growth in all of our key financial metrics. Our strong performance in the 1st 9 months was driven by our refresh 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're 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.
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
Your first question comes from the line of Marcus Raschten with Stifel.
Thanks and good morning everybody. Good morning, Mark. I've heard worse, by the way, in the last name, if that's So
on
the business, those helpful commentary on Frutarom for 3Q. I guess related to that, so what gives 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?
Yes. Let me start the first part of the question and then I hand it over to Rich So, 1st of all, we had a solid start and an acceleration in growth with the Frutarom business for the fourth quarter. So that's that's a good, good port part. And we are actually ahead of the integration as what is the big benefit for us is that we have closed the deal earlier than we thought. The teams were well prepared.
The leadership structure is in place. And most of the unsecurity 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 structures 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 1st 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 Yes, Mark, in terms of the guidance range, I wouldn't read too much into that. I mean, it's probably the answers. I didn't want to have to go out to 3 digits in terms of the in the range. And so we picked, we put basically a $50,000,000 range around that. That's there's nothing more than that.
As Andreas said, I think that the first, the 4th quarter, the start to the 1st quarters in line with what we expected. We've seen the improvement in Frutarom's performance to 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 customer order patterns in a couple of businesses.
Okay. And then so on the trading 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, were there how much was contribution from acquisitions, for example, and is 'twenty one kind of a good run rate to use going forward?
Okay. I take the first part. For the trade and marketing, it's probably too early to tell, and it's part of the 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 as a business. But so far, it looks like a smart solution to have it in place, but but not put too many resources behind it.
Rich?
I mean, more from an EBITDA margin standpoint, I think it's within the flavors business, probably there's some mix impact. There's probably there is a little bit of impact within Natural Products Solutions. I think there are a couple of of projects in terms of productivity things that are about 3 or 6 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, I don't we don't see that there's any fundamental changes, obviously, with the strong growth rates they saw particularly in Q1, the leverage component is much more advantageous in the first half of
Your next question comes from the line of Lauren Lieberman with Barclays.
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, 1, will you be giving us, sort of pro form a 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 like that 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 sort of to create almost a bridge platform to go slowly such that the Frutarom piece of this is independently reported will just going down over time?
We will on the year end call once all the numbers have been finalized. We'll provide a full blown full year pro form a for both combined companies so that that performed that represents the reference point going forward to the 3 year guidance that we've talked about So we will provide that on the next call.
Yes. And on the organizational setup, let's start with a natural product solution, which is probably, the most, let's say, adjacent businesses we have here at hand, that certainly is 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 a good profitability as well. So that's number 1. Number 2, on the Frutarom business unit, we said we want to 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 midsized 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 it's right that the North America Taste business from Frutarom is mainly with smaller and midsized customers. So that creates for us a great opportunity to bring it together with our taste point 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 proved 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 integration is already underway, which is way ahead of the time we saw it because you know, 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're 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 this 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 20 team so that you'll probably still see some gross margin pressure, as you play catch up kind of throughout the year?
Lauren, a couple of things. I think there's there is unfortunately, there's always a time lag as we go through this process and we've talked about that in the past about certain contracts and arrangements have windows for that. But I mean, we are already having conversations, the business is 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 to see mid single digit increases next year. Again, skewed heavily towards the fragrance business, given the continued supply chain interruptions that 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 pressure continue 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. So two questions from 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 sort of the most raw material inflation?
I know you said fragrances, but just more specifically, is it is it the naturals, is it synthetics, petrochemicals, sort of where you're 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 haven't you still haven't offset the entire inflation. So do you anticipate being able to offset that as you go through 2019?
Yes. So Pfizer, remember a portion of that is related to the BASF. So that's something that's still is being worked through. We're doing everything we can into mitigate the effects of the citrull stuff. Some of it doesn't show up in pricing because we'll go through and work with customers on be formulations and 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. It's just we got to protect our customer's business, but we also have to protect our bottom line. It's not easy. I'm never going to say it is easy.
So I do expect, as I said on to Lawrence'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. I mean, it started. 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 FNF market for the same raw materials, which is creating a supply and demand pressure point and we don't expect that to be 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, it's we're in a period where it seems every 6 months something else is popping and we're having to deal with it with our customers. We're probably going to have the 3rd round of conversation with customers in a very short period around price increase that are necessary for us
then just my second question is around Frutarom again. I guess I'm still not convinced that this is the 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 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, are there 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 full? Thanks.
Sure, Faiza. I mean, it's hard obviously, it's hard to pinpoint exactly. What I can tell you is we've been able to as I said in my comments, so we look at some specific issues, the Color's business as is 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 on 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's one of the biggest challenges any company that's going through this type of combination has to deal with this distraction.
We always do our best to try to keep everybody 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 is that. But I can tell you, again, if you take out these 3 or 4 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. Yes. And then as Andreas and I talked about, 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 a very comforting in particular in the start into the quarter, which is really, really good. 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, drive performance. So that's good. What have we learned during the months we own, own the business?
Actually nothing, which is a super big surprise surprise to us. Maybe the only thing and that's more positive is when I listen to the teams which are working together on the cross selling opportunity that, 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 big opportunity than we had saw it at the beginning. And that really can drive value over time. 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 West Coast customer where we helped the Frutarom team with our Vanilla Technology And Vanilla formulation and that has led to a $3,000,000 order, which we they probably would never had received if we would on help to help out here.
Just to to give one example. It's small, but it starts already and it started earlier than I saw it. So that's how I would describe it.
Very much.
Your next question comes from Silke Kueck with JP Morgan.
Very well. Thank you.
So there were a couple of acquisitions pending under Frutarom And so I was wondering whether you can quantify what the maybe like dollar terms of what the acquisitions of Frutarom added to Frutarom sales in the third quarter, what you expect for the 4th quarter and what you expect to, they may add in 2019?
Look, Sakai, I think given that those that through the 3rd quarter results are their numbers and we don't I'm not comfortable disclosing that. I think in terms of M and A, for Keith, I mean, we're continuing to work together. As you've heard Andreas and I talked about that we keep continuing to work together on the pipeline. We've now reprioritized the comp, the 2 teams standalone pipelines into a 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 I really don't feel comfortable given the standalone nature of their results in Q3 common in on the individual components of it.
Right. Sorry, if I could add on this, What we have seen is that there were no acquisitions made this year during the process of the, let's say, the deal there, let's say, the pre deal months. But we have, as Richard said, actually, we have a good pipeline of very value and technology added opportunities. And I would not wonder if we could hopefully close are 2 of these deals until the end of the year. There are smaller ones, but they would fit exactly into our wheelhouse.
So you see we had a bit of a pause during that period, but now we are we are basically taking the combined pipeline with the new priorities and going after it. And I think it will be a big success going forward.
I was sort of like interested in knowing what those acquisitions added that were already announced, not even like the things that may have happened between when the transaction was announced and closing, just sort of like what was announced prior to your acquiring Frutarom of things that may have not closed yet. 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 2 or 3 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 they're not as familiar with Frutarom as I could be. I thought that the for the past 2 quarters, the D and A at Frutarom was something that was close to like $17,000,000 a quarter. And What you said is that you thought maybe it's something like $9,000,000 a quarter?
Because we're just doing the amortization, not the DNA. So it's just adding back amortization.
Okay. So amortization is like $9,000,000 of that, okay? Okay. And then d is like another, you know, 8. Okay.
The, the last thing is more of like a comment rather than a question, but I thought, rather than having like an aggressive accounting treatment on earnings, maybe it's helpful to just provide, like, an EBITDA estimate, And it's like kind of like a separate EBS 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 levels of 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
Hi, John. John? Hi. Can you hear me?
Yes. We can. No. Yes.
On slide 18, are we going to get
operating
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 fruit and rum and taste segments?
Look, John, we're going through that right now, but what I would tell you that where I expect this to end up is we're going to report it the way we run to 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 send side, we'll report around the categories. And on the Frutarom side, I think, again, around the regional numbers.
Directionally, that's where we're heading.
Your next question comes from the line of Adam Samuelson with Goldman Sachs.
Maybe just I want to make sure on the guidance, so you can just clarify. The underlying IFF business as we think about the fourth quarter, I mean, or where the previous constant currency or currency neutral sales growth was has that expectation changed in any way? I know there was an embedded deceleration in growth in the prior guidance based on based on the tougher comps. And you slowed a little bit this quarter, but I just want to make sure I'm understanding kind of what the assumption is on both the top line and then see operating profit for the legacy business for 4Q?
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 19 on the Frutarom side. Again, going back to some of the questions on the desal implied in 3Q, I mean, it's a pretty pretty the constant currency growth looked like they were up in the high single digits kind of the 8%, 9% range in the first half the year. And I don't know exactly what it was for 3Q, but it looks to be kind of flat to up slightly organically.
I mean, the confidence that that is this is really just a timing of order patterns and not some something kind of more serious that what it would impact the revenue growth into next year? Is there any additional thoughts there?
No, actually not because, the good thing is that fruit, 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 a middle of the budget process right now. And I hope in the next 2 or 3 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, timing topics and on color, certainly the pricing pricing topic.
And then it were the weeks 2 months before we were doing the closing and that certainly impacted the business as well. As 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 port has such a wide range of different portfolio topics plus the broad customer base that gives us actually good protection against the against downside movements in the mid and the long term. And that's the reason why we are reasonably, optimistic here for the future.
Yes. Adam, just a quick comment, follow-up on my side. I mean, again, I don't see anything in discussions with the team around the third quarter and the expectations that would change our law and firm expectations for the business. I think you're right. As we look into the 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. So, in 2018. Okay.
I appreciate the color. Thank you.
Sure. Your
next question comes from the line of Gunther Zechman with Bernstein.
Hi, good morning, everyone.
Hey, good morning, Gunther. Good morning, Gunther.
Hey, just a clarification on the amortization the million that you mentioned, just to make sure this includes also the non Frutarom part of amortization that you're now including their thinking of David Mikael. I think it was 1,000,000 or so and fragrance resources a few. So you're taking all of them together. And also the amortization schedule 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 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 where the cash profile should be different from that?
Let me start with the first question, Gunther. I mean, in terms of the 2 20, it's really roughly $36,000,000 for the historical Frutarom, 37 roughly for our legacy IFF amortization. And then the incremental, the difference to that to 220, which is call it 140 7 is our current estimates, of what the step up is going to be. I don't think Bob's finished the couch 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 mean, 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'll 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 payable side for the Frutarom business. So I think there's upside to the historical numbers that you were talking Absolutely.
And then if you go mid, mid and longer term, also the CapEx will be ramped down because we have on legacy IFF business, as you might know, still to finish our plant in India. And in China and 2 big creative centers here here in the in the U. S. And when we have done it, then the structure is actually in place. We need some CapEx investment on the legacy food business to absorb some of our capacity here as well.
But this is all done in the next 2 years, then CapEx will go down significantly with 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. Yes, I think as I said earlier, I mean, we've, you know, I don't, we don't look at it anymore as Frutarom's historical M and A and our historical legacy M and A, it's now one combined pipeline that's based on the strategy and the priorities, prioritize segments that we see going forward. For the combined businesses. We're not done with all that work yet. But we're there are things that are in the pipeline that we are confident with and we're continuing to work to pursue those.
Andreas's comment about CapEx. I mean, on a combined basis, I do see that coming down to probably somewhere between 3% 3.5% on a combined basis after we get through 2019 2020 with all the integration work. So we have built into our cash flow projections. We have built into our leverage ratios incremental M and A over the next 3 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 form a 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
$9,800,000 settlement from a supplier related to a prior recall? I haven't seen that quite seen that before. Thank you.
Okay. Let me start with the Fine fragrance versus 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 fragrances significantly better, 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 wanna guest 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 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.
Your next question comes from the line of Patrick Lambert with Raymond James.
Few questions. Very simple. Could you quantify a bit the parts of Fruta on that but are getting into taste and said, I think Iberia is pretty small, but, I don't know how to model the flavors if you could help us in that. And the second is regarding, again, the remodeling of integration, in particular, the costs 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.
Yes, I was Well, I guess, can you hear me?
Yes. Go ahead. Sorry.
Yes. Just, guess, like everybody were trying to fully integrate now, Frutarominal model, and I was trying to focus the integration costs that you mentioned at the time of the acquisition. And if you had a bit more precise a picture on the timing of spending already in Q4 and 2019?
Sure. No problem. So on the internal transfers of IVR and the North American flavors, it's really small. So it's insignificant. So it's not a big number.
It's not going to impact the regional numbers much at all. In terms of the integration cost 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 2020. Yes. With a slight lag, I would say in terms the severance costs by a quarter or 2, but I think the bulk of it's going to be in 2019 2020.
And I would now like to turn the call back over to Andreas for closing remarks.
You very much for all these, great questions. We follow-up in the one on one calls as usual, and have a great day.
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