At this time, I would like to welcome everyone to the International Flavors and Fragrances 2nd Quarter 2018 Earnings Conference Call. All participants will I would now like to introduce Michael DeVeau, Head of Investor Relations. You may begin.
Thank you. Good morning, good afternoon, and good evening, everyone. Welcome to IFF's second quarter 2018 conference call. Yesterday evening, we distributed a press release announcing our financial results. A copy of the release can be found on our IR website at ir.if.com.
Please note that this call is being recorded live 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 particular with regard to the outlook for the third quarter full year 2018. These statements are based on how we see things today and contain elements of uncertainty. For additional information concerning the factors that can cause actual results to differ materially from forward looking statements, please refer to our cautionary statement and risk factors contained in our 10 K filed on February 22, 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 effective GAAP measures is set forth in our press release that we issued yesterday and is available on our website. I would like to also remind everyone that state that all statements related to future results and events, including the proposed merger, are forward looking statements and are based on current expectations. Actual results and events could differ materially from those discussed here. Please refer to the information on the disclaimer slide as well as of the additional information contained in the regulatory filings of both companies.
With me on the call today is our Chairman and CEO, Andreas Fibig, our Executive Vice President and CFO, Rich O'Leary. We will start with prepared remarks and then take any questions that you may have. With that, I would now like to introduce Andreas.
Thank you, Mike. On the call today, our plan is to review our financial results for the second quarter and the first half of twenty eighteen. Provide an update on our financial expectations for the full year excluding the impact of Frutarom and give insights into the strong progress we have made relative to the Frutarom transaction. Then we will be happy to take any questions that you may have as usual. Starting with a recap of our first half twenty eighteen performance.
Growth was strong across all of our key financial metrics, and in line with the objectives we set out for ourselves earlier this year. Currency neutral sales increased 6% in the first half with both business units growing 6%, respectively. New wind performance, volume growth on existing business, and price increases to offset rising material costs all contributed to consolidated growth. From a profitability perspective, currency neutral adjusted operating profit grew 5% as volume improvements and our focus to drive greater efficiencies throughout our business via costs and productivity initiatives continue to support overall profitability. Currency neutral adjusted EPS improved 10%.
Driven by improvements in adjusted operating profit as well as a more favorable effective tax rate. I'm very pleased solidifying our position to drive differentiation, sales of our sweeteners and saver modulation portfolio continued to grow strong double digits across all categories, led by Savrin and Dare. Powder Pure our platform for clean label solutions grew an impressive triple digits as we continue to scale this unique and differentiated technology. Performance with local and regional customers also remained strong, growing double that of our global customers. And is a trend that we see across both business units.
And Flavors, specifically our midsize go to market platform Tastepoint continues to deliver strong results, improving strong double digits in the first half of twenty eighteen. In terms of maximizing our portfolio, driving growth in our most margin accretive categories, cosmetic active ingredients continued, its robust growth trend by improving very strong double digits and hair care, home care and toiletries improve high single digits. In flavors, growth was strong in dairy and beverage, improving double digits and high single digits, respectively. We also remain diligent in our focus to drive greater efficiencies in our business, allowing us to relocate resources to efforts that drive the greatest returns. This yielded strong results in the first half twenty eighteen as our cost of 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, believe our priorities are well positioned and are the strategies to drive long term value for our shareholders. Our pending transaction with Frutarom I will touch on in more detail shortly will support and accelerate efforts across all of these pillars. With that, I would like to turn the call over
to Rich. Thanks Andreas. And moving on to our Q2 performance. Country neutral sales in the 2nd quarter grew 5%. Growth was broad based as all regions and categories across flavors and fragrances posted solid results.
From a profitability standpoint, currency neutral currency neutral adjusted operating profit declined 2% in the 2nd quarter as top line growth and the benefits associated with cost and productivity initiatives were more than offset by the impact of higher raw material costs, including the previously announced BASF, citral supply issue. Pricing was up about 1.5 percentage points in the quarter on a consolidated basis. However, as expected, it did not offset raw material pressure in our fragrance business unit. As we move through the back half of the year, we expect the price to raw material cost dynamic to improve as pricing takes hold in fragrances. We are pleased that despite these challenges, we were able to achieve 8% currency neutral adjusted EPS growth as we benefited from a more favorable year over year Looking at our business unit performance for the 2nd quarter, Flavors currency neutral sales increased 6% with growth coming in all categories and all regions.
It should be noted that on a 2 year average basis, growth was very strong. At approximately 9%. North American flavors improved 9% in the second quarter led by high single digit growth at Tastepoint and strong new wins in in beverage, dairy and sweet. EMEA increased 5% on a currency neutral basis, led by strong double digit growth in Africa and the Middle East as well as mid single digit growth in Europe. Greater Asia grew 2% in Indonesia and Thailand.
Latin America increased 8% on a currency neutral basis led by strong double digit growth in Argentina and Mexico. Flavors, currency neutral segment profit grew approximately 6% led primarily by volume growth and the benefits from our ongoing cost and productivity initiatives. In terms of currency neutral segment profit margin, we achieved margin expansion year over year of approximately 10 basis points to 24.3%. Fragrance currency neutral sales improved 5% driven by broad based region and category growth. From a category perspective, consumer fragrances grew 5% on a currency neutral basis.
As growth was achieved in all categories, led by double digit growth in hair care as well as mid single digit increases in toiletries, home care and fabric care. Find fragrances improved 1% on currency neutral basis against the very strong 11% comparison in the prior year period. Growth was led by double digit increase in Latin America and low single digit growth in North America it should be noted that EMEA and Greater Asia was soft. However, it was due to a strong year over year comparison of 19% and 25% respectively. Fragrance ingredient sales were up 10% on a currency neutral basis with growth in 3 of our 4 regions.
Driven by improvements in volume and higher pricing related to raw material costs From a profit perspective, fragrance currency neutral segment profits decreased 9% on a currency neutral basis. As volume growth and cost and productivity benefits were more than offset by higher price to input costs, including the BASF citral issue. As I mentioned, as we move through the back half of the year, we expect the price to raw material cost dynamic to improve as pricing takes effect. In terms of currency neutral segment profit margin, our profit or profile remained solid yet was under pressure year over year. Before I move on, I want to provide some more commentary on the raw material environment.
Coming into the year, we expected mid single digit raw material inflation in 2018, inclusive of the impact of the Sitrile situation. With that heavier base in the fragrance business unit. Since that time, cost inflation has picked up following a series of disruptions in increased environmental actions on suppliers in China and to a lesser extent, rising oil prices. Based on what we're seeing today, we expect incremental inflationary pressure as we exit 2018 and head into 2019. It remains imperative that we achieve incremental price increases or identify other actions in unison with our customers to ensure we cover our raw material cost exposure overtime.
Operating cash flow was $55,000,000 compared to $58,000,000 for the first half of the year. Performance was primarily impacted by product recall payment as we previously disclosed as well as costs associated with the bridge loan commitment fees, the combination of which was approximately $40,000,000. In addition, there was an increased level of working capital. Working capital was primarily impacted by higher inventory due to rising raw material costs, increased volume associated with the pre building of inventory related to the central issue and higher than anticipated sales volumes. Over the course point, we spent approximately $67,000,000 in capital expenditures or about 3.6% of sales.
And we continually, we will expand approximately 4% to 5% of sales in 2018 on CapEx. Regarding cash returned to shareholders in the first half, we spent approximately $109,000,000 on dividend payouts and $15,000,000 in share repurchases. As part of the Frutarom combination, we have paused our share repurchase program. As we prepare for the financing of the transaction and prioritize debt repayments going forward. Also last week, our Board of Directors authorized a 6% increase in the quarterly dividend to The increased dividend reflects the board's confidence in the cash generation potential and financial strength of the company.
We will maintain a disciplined approach to capital allocation as we continue to accelerate growth through organic investments in strategic acquisitions, while returning significant capital to shareholders. As we look towards the balance of the year, I want to provide some commentary on our financial expectations, excluding the Frutarom transaction. All of our currency neutral metrics have not changed. Based on our strong year to date performance and our current outlook for the second half of the year, we are reconfirming our previously stated full year currency neutral guidance as world currencies versus the dollar continue to fluctuate we do expect to see an impact in terms of our top on consolidated sales growth versus 3% previously indicated. While many currencies have an impact, the largest euro to U.
S. Dollar exchange rate. On an adjusted profit and EPS base and adjusted EPS basis, We anticipate the benefit of FX to be the same as previously communicated due primarily to our 12 to 18 month rolling hedging program and movements of various of other movements of various other currencies. For your reference, please note that we remain hedged at approximately 80% on the euro profit exposure at $1.15 for 20.18 and are approximately hedged at 35 percent at $1.23 for 20 19. With that, I'd like to turn the call back over to Andreas who would walk you through an update on Frutarom transaction.
Thank you, Rich. First, I would like to reiterate that we continue to be very excited about the combination and it will create a global leader in natural taste Scent And Nutrition with an expected 2018 pro form a sales of $5,300,000,000 and is a win for both companies, shareholders. Together, IFF and Frutarom will have a broader customer base, more diversified product offerings and an increased market penetration. We will instantly become a leader in natural solutions. We will also strengthen our exposure to fast growing small and mid sized customer accounts, gain new opportunities in attractive and fast growing adjacencies and enhance our global reach.
We also anticipate cost synergies through raw material harmonization footprint optimization and streamlining overhead expenses. Additional cross selling opportunities and integrated solutions are expected to write revenue synergies our shareholders over time. Both organizations have a strong talent base comprising thousands of extraordinary employees globally. And through our integration planning work, we continue to be confident in the opportunities that lie ahead and the ability of the combination to accelerate profitable growth enhance free cash flow and generate greater returns for our IFF shareholders. Since the announcement of the deal on May 7, we really have made strong advancements towards the deal close, and I would like to give you an update on a few.
On Monday, Frutarom received shareholder approval for the transaction. Of the votes cast at the special general meeting, about 95% were in favor of the proposed merger, representing approximately 75% of all outstanding shares. We are pleased that Frutarom's shareholders have approved the combination with IFF, marking another milestone in our past to unlock the value creation potential of a combined company. We continue to have comprehensive pre close meetings and discussions on talent, R And D, adjacencies and business and functional integration to ensure that when this transaction closes, we are ready to execute and drive profitable growth by capitalizing on the best of both organizations. We also want to take of the transaction.
Given the progress to date, we our previously communicated timeline of 6 to 9 months from May 7th announcement. This timing continues to be driven primarily by the completion of the remaining antitrust reviews. To ensure the most successful integration, we have structured our approach in a very disciplined manner. With strong and dedicated teams. Foundational in our approach are 4 guiding principles.
The first includes establishment of a cross functional team across both organizations, directly involving about 75 people committed 30 to 100 percent of that time to the integration, depending on the nature of their role. To complement and support this team, who engaged external advisors such as leading consulting firm across a variety of specialties. Our 2nd core principle is to protect the core business and deliver the plan As both organizations are entering the transaction as a position of strength, it's very important that we do not lose focus and continue to deliver strong financial performance. Unities. Leading the integration for us is Francisco Fortinet and I'm with Anadark for Frutarom.
Francisco's is the EVP of operation for IFF, and has extensive experience leading manufacturing procurement plus strong cross function leadership, robust commercial supporting expertise, bringing innovation to market. Armos is the EVP of Global Supply Chain And Operations for Frutarom and has a robust knowledge of the day to day operations at Frutarom is actively involved in all business aspects. Together, both are excited and very engaged to ensure the successful completion and integration of our 2 great companies. Aligned with our 2nd core principle to protect growth trajectory of those businesses We are structuring our day 1 model to ensure that. Once the transaction closes, putar room will remain a standalone unit for now and will maintain their current to go market strategy.
Given they are very customer centric organization, it is critical that we limit the changes on the front end of the business. We want to ensure that there are zero disruption to customers and they continue to provide their products as effectively and efficiently as they have done in the past. To drive cost synergy realization, which I will cover in more details in a moment, we plan to leverage IFF's global expertise and share service model. As time progresses, we will slowly centralize various group functions to further unlock value. Simultaneously, we intend to drive cross selling through sharing our vast technologies and categories expertise across the organization.
While going through the integration process, there will be areas where we selectively lift and shift as appropriate based on the long term strategy of the business. One example is the cosmetic active ingredients where we are moving Frutarom's business into our LMC infrastructure. As we outlined on May 7, we plan to unlock significant cost synergies related to the Frutarom acquisitions. I'd note I now like to give you a bit more clarity on where the $145,000,000 cost synergies target will come from and the estimated timing of this. Expect approximately 40% of the cost synergies targeted to come from procurement as we accelerate the rationalization harmonization of raw materials across both organizations.
Activities include make versus buy vendor consolidation, centralization of spend, which will all contribute to the savings. Approximately 30% will come from operations as we optimize the global footprint. Given the large infrastructure of both organizations, approximately 110 sites on a combined basis There are a lot of potential options to optimize our combined footprint. Out of the anticipated million of our run rate cost synergies, we estimate approximately 20% to 30% to come from streamlining of overhead expenses. It should be noted that less than 10% will come from business development as we are taking steps to ensure the preservation of the customer service levels at most companies.
In terms of timing, achieved in 2019, 'seventeen in 2020 and the remainder in 2021. In addition to the cost synergies, and that's where I'm most excited about. We believe there's a strong potential to drive accelerated growth by capitalizing on revenue synergies. Stepping back, not only does this combination create a global leader in taste and nutrition, the combined organization will have the broadest customer base and strongest product offering and deepest market penetration in our industry. With respect to customers, we at IFF are extremely well positioned with Global Multinationals.
Out of our approximately 3000 customers 50% of our sales are global customers, where we are participating on nearly all global core lists. The balance Our sales, our best local and regional customers, strategic focus for us, where we are utilizing mid tier customer go to market model. Like Tastepoint. Frutarom, on the other hand, has approximately 30,000 customers of which 20% 70 percent are small, midsize and private label accounts. By putting us together, we will have a very strong distribution network.
Ranging from the largest global customers to startups and private label accounts. In terms of products, we pride ourselves in our ability to bring differentiating and unique innovation industry leading technologies across various areas, including modulation, delivery, natural cosmetics and so on. And our pipeline right now is as well filled as it was never in the history of IFF. Frutarom has a leading natural portfolio. 75% of their consolidated sales as well as access to adjacent technologies such as natural savory solutions, natural colors, natural food protection, and health ingredients.
The combination will create a comprehensive portfolio with the potential for integrated solutions to offer our customers one of the strongest
portfolios
key markets around the world. IFF as a leading market share in Greater Asia and Latin America, as well as strong positions in North America and Western Europe. Fudome is a great compliment as they have very strong exposure to key emerging markets and a complementary position developed markets. While we haven't quantified the contribution of revenue synergies yet, we look forward to driving incremental growth by capitalizing on these three uniquely beneficial positions. I would like to provide an update on the antitrust approval process.
We are currently on track as all applications have been submitted to the 8 countries that we needed to file in. In June, We have already received approval in the U S and have recently received approval in Israel. The rest, we are waiting feedback under normal circumstances expect to conclude the process in the fourth quarter. Rich, can you please take us through deal financing considerations?
Thank you, Andreas. Given our progress to date, We want to briefly give an update on the sources and uses of funds. From a source of funds perspective, we will be providing approximately 2,000,000,000 of new equity to Frutarom's shareholders at closing of the deal. We'll then be issuing about $2,200,000,000 of new equity issuance to the market, of the $2,200,000,000, approximately 67 percent is expected to be common equity and approximately 33 percent tangible equity units. From a debt standpoint, we'll be taking on approximately 3,100,000,000 of new debt financing.
Within this debt financing, will be using a combination of 10 and 30 year U. S. Dollar bonds as well as Europublic bonds with maturities. The remainder will be cash on hand from the balance sheet. In terms of uses of funds, we will delivering approximately 2,000,000,000 of equity and 4.3 $900,000,000 of debt on both sides, on both the IFF side as well as Frutarom.
All this was done while maintaining our focus on keeping an investment grade rating.
Back to you Andreas. Thanks Rich. Let's summarize. We're very pleased with our performance in the first half of twenty eighteen. Sales growth was robust at 6% with growth across both business units.
We also have achieved strong improvement in currency neutral adjusted operating profit and currency neutral adjusted EPS. Based on our year to date performance, our current outlook for the second half of the year, we have reconfirmed our previously stated full year currency neutral guidance. On this strong foundation, we are pleased to have made great advancements towards a Frutarom deal close, faster than our original expectations. We are very excited that together, the combination of IFF and Frutarom will have a broader customer base, more diversified product offerings and an increased market penetration. It will create a global leader in natural taste, center nutrition, with a very attractive financial profile in terms of growth, profit and cash flow, which is expected to unlock significant value for our shareholders.
With that, we would now like to open up the call for questions.
Your first question comes from the line of Mark Astrachan with Stifel Nicholas.
Yes, thanks, and good morning, everybody.
Good morning, Mark. Good morning, Mark.
Hey, so wanted to ask first just on a logistics standpoint. So sales growth expectations for the back half of the year. So there's a pretty large implied range from guidance. There's obviously much tougher comparison. So I guess any sort of broader strokes you can give on to think about that, including how much pricing should we expect given the commentary about incremental input cost pressures and the underlying volumes as well as new wins?
Sure, Mark. I think a couple of things for me as I think about it. We've been talking since the end of last year, certainly in the first two quarters that a big component of the higher growth in the first half of this year was the volume on existing business. So and we've expressed and I certainly have expressed an expectation that, that will soften. I think overall on a 2 year basis, the numbers are fairly consistent first half, second half, but I do think the mix is going to change where I think our wind performance is pretty consistent.
At good rates, our commercial performance are good. But I think in the second half of the year, we're expecting low a decrease in the impact associated with volume in existing business and an increase in the pricing impact. As I said, in the second quarter, We were about a point and a half of pricing impact in Q2, and I would expect that to be higher than that in the second half of this year.
Okay. So I guess kind of putting that together then, it sounds like you're expecting basically the 2 year or 2 we can somewhat, but maybe not as much as I guess I would have thought given incremental pricing. Is that fair?
Yes, very fair.
Okay. And then just switching more to a strategic question, Andreas, I guess I want to understand a bit more what gives you conviction in commentary you've had before more about sustainability of Frutarom's about 6% core sales growth in the context of seems like some increasing competition within the natural space from competitors, not just chivet on the Terex, but just sort of broader strokes is customers out there move towards cleaner labels and more helpful products?
Yes. Well, I think that's a very fair question. And an important question for us as well as we are redoing now our strategy. Let me answer it in a way that First of all, we have now probably the broadest customer base in the industry. So a lot of business is done with the midsize and smaller customers.
Where we expect to have a higher growth rates going forward than our core business. Secondly, if you look at the categories, we have now a portfolio as a combined company or we will have after closing, which gives us the ability to move categories, which have good and high growth rates like natural colors, for example. And we mentioned that natural color, that's still a trend, which where we have, let's say, the exchange from synthetic to natural colors in the U. S. Just in front of us, where we will see high growth rates going forward.
For the customer base and the categories give us a good confidence that the growth rate will be, will be really good despite the competition in some of these areas, but the market is so big that we believe that will not hamper our ability to have a fast growing business in front of us. And if we're combining both, I believe it, we can see a good uptake in the growth rate here.
Your next question comes from the line of Lauren Lieberman with Barclays. First thing
I wanted to ask about was just the commentary on the incremental inflation. So it sounded like both there's incremental inflation versus the outlook 6 months ago for the second half of the year and also very much heading into 2019. And so just wanted to be clear on, expectations for the back half. Is there incremental pricing going in? Do you have visit I mean, it sounds that way from you've said you're reiterating, but how you're going to be covering that incremental inflation that's kind of close in?
And then also as you're looking into 2019, just to maybe try to help us where the kind of rate inflation we're talking about because if you're discussing needing to work with customers on solutions outside of pricing, it suggests it's a pretty severe severe rate? Thanks.
Hey, good morning, Lawrence, Rich. Yes, I think, look, as I indicated in my comments, I think we we started the year. We ended last year, started this year, we expected of a Citra, the BASF issue to be mid single digits, it's now above that given the other dynamics. I think what we feel good about is that the vast majority of our discussions and pricing negotiations with our customers have been completed. And so it's a matter of phasing those in.
We've talked about that in the past. These things don't happen overnight, but we're confident in our ability to recover those increases over time. As I think about next year. What we're current view of what we're seeing today, I mean, obviously, we expect the BASF situation to normalize in the second half of this year. So that will relieve some of the pressure.
I think that as we see it today, input costs next year are probably going to be in the low to mid single digit level.
And then, I'm not sure if you'll be able to comment on this yet, but the Frutarom outlook, I think, sort of implies that they are baking in some incremental M and A, before year end. Is that, I mean, to what degree do you have visibility on that? Because that's one piece of sort of the forward look that left me a little bit less comfortable, assuming M and A for something that's about to be bought sort of a bit of a funny dynamic. So anything you can offer there would be great.
Look, in general, what we said when we announced the deal is that we certainly, want to go ahead with a model of good acquisitions on this business and particularly on the adjacent businesses. Paul, we know that the same rate as Frutarom is doing it because some of them were just, geographic expansions where we probably don't need it because as a combined company are very well covering the globe. We know and we have visibility of their pipeline in terms of deals I can't give you any details, but there are certainly a good pipeline and there are deals to be happen. Over time. And that's what I can say for now.
Yeah, and we have planned in our business model for money to be spent on M And A on this side as well. So that's what I what I probably can announce today.
Your next question comes from the line of Heidi Verestrian with Exane BNP Paribas.
Hi, good morning. So a question on the pro form a business as well. I think in the past year, talked about increasing profitability through the combination. You know, there's a debate on the market about how high margins can go. Some people are saying there's a cap.
So where do you see significant margin potential for yourself and more broadly in the industry, please? Thank you.
Yes, Heidi. And in particular, when you look at the change in product portfolio, and customer portfolio going forward. What we certainly see is that in some of the adjacent businesses, you have good margins and probably better margins than in the core FNF business. And now it's up for us actually to manage our portfolio in a way that see a margin increase over time for the total for the total cooperation. I'll give you just one example you might remember when we moved 3 years ago into the active cosmetics, that's a very high margin business, at least the piece or part where we are playing in And we see now some of these businesses coming to us as well with Frutarom.
And now we are right now in the middle of discussion in terms of strategy, what are the product categories we really want to push to, to move ahead on on that time. Certainly, it's true on the core FNF business. It's not easy to push the margins up and up and up and up. But we'll see, let's say, the acceleration of the, of the different portfolios I think, and then don't forget, that we have the cost synergies for us as well, and they will help us on the margin side. In particular, when you look at cumin and at the manufacturing footprint because that's another driver for us for margin.
So it was probably a little bit of a long winded answer, but I wanted to give you some details, but the answer is yes, we can move it up.
Thanks. And if I could squeeze in a very quick short one. On the citral issue, is there any scope to get compensated, after this disruption perhaps from the supplier? Thank you.
Yes, I mean, Heidi, we're looking at every possibility there in terms of obviously working with our customers, our priority number 1 priority has been to maintain surety of supply with our customers, and figure out the best way to work with them. From there, we'll look at any other option out there.
Thank you. Your next question comes from the line of Mike Sison with KeyBanc Capital Markets.
Hey, guys. Nice quarter.
Hey, Mike. Thank you. Good morning, Mike.
When you think about the slides 2021, appreciate the update on integration approach and such. And so I understand you're keeping food makes a lot of sense. Could you give us a little bit of color how you plan to change the culture within Frutarom, a lot of different businesses? That have bought over the years, what's sort of the plan inside that box to integrate that and make that more efficient?
Mike, that's certainly something where we look into it right now to look what really makes sense to change or what makes sense to, to keep we have to say that, there's certainly some elements like the nimbleness and the customer focus we like, like a lot we certainly will not change that. So there are a couple elements actually within the where we have to take to consideration whether we make them even bigger within the combined company. But we are in the middle of the assessment to do it. We will also in day 1, integrate some business already. As I said, we, we lift and shift, but it has to make sense and we can't jeopardize the top line grows because that's so important for both businesses.
That's the reason while we have also kept our business people really focused on our core business and doing the integration basically in the back office work. Okay. And I we can give you certainly more details over the next couple of months when we are coming closer to closing and after closing sales as well.
Sure. And then in terms of revenue synergies, you have 3 buckets that you talked about. Is there any particular is it going to be quicker to see the synergies in either the 3 buckets, all three buckets that just sort of want to feel for where and how soon some of these little areas can come in?
Look, it's actually, an easy answer, but maybe not always as easy done. It's basically we give them access to our technology. And what we have seen so far when we disclose some of the technology to them, there's a lot of excitement around that. What they can do with it with their own customer base Usually, you know, they have small and midsize customers. So I expect actually a pretty quick uptake of this kind of business or top line synergy on on this side.
On the other hand, they have all the adjacent businesses, which we can sell into our bigger customers as well. And there's actually a lot of excitement on our bigger customer side as well, what they can do there. For example, an interesting company, it's called Tara, have a technology, which is very complementary to our powder pure technology, which goes into natural natural solutions. We are right now talking how we can bring this together and make sure that this gives a great offering offering to our customers. So there are a lot of discussions, but it means basically our technology into their customer base and it means that Jason into our customer base, and that's what we are working on it.
And we haven't put too much of the revenue synergies already into our plan because we said we want to be really diligent to go over it and make really good plans how to do it in the best way. And when we have our, let's say, 1st, let's say investor conference after the closure, we certainly was we'll disclose some of it, okay?
Great. Thank you.
Your next question comes from the line of Jeff Zekauskas with JP Morgan.
Thanks very much. When you calculate, currency neutral operating profit growth, Is the base what you actually reported last year, or is it a different base that's current currency neutral that that's not immediately visible?
Yes. I mean, Mike, what we do is no, Jeff, sorry. Sorry.
You see, Rich still has a little bit of a summer cold perfect odds. Perfect operating for this.
Yes. We take the prior year. And then we're adjusting prior year results the current year exchange rates. Keep in mind though, keep in mind that when you're looking at last year's reported numbers, the pension accounting change, which which is a pretty significant number, where the pension income is no longer reflected in operating profits now in other income and expense.
Okay. I just say that since your analysis of your own results were live so much on currency neutral values, you might simply supply those values so that your financial statements are are somewhat more transparent. And since it's simply a translation to currency neutral, I don't think it would give away anything competitive. Just secondly, can you describe what the tangible common equity units are in a little bit more detail? And what's the timing of your equity financing?
Sure. In terms of the financing, we expect to go to do the the debt and equity raised, equity 1st, debt 2nd, in the middle of September, the exact dates, we're still working through that. In terms of the tangible equity units, they're issued at a premium and They have both the debt. They both have the they convert from a tangible equity unit into common shares at the future. They have a interest component to that.
And the premium allows the company to benefit up to a cap on growth in our share price over the 3 year period that gets the upside in terms of as our as we deliver upon the plan and shares reflects that we'll have a lower dilution effect.
Okay, good. Thank you so much.
Your next question comes from the line of Gunter Seckman with Bernstein.
Hi,
good morning, everyone. From what you said about pricing versus raw material costs, very interesting. Do you expect higher gross margins in the second half this year compared to last?
Compared to last year?
2nd half last year?
No, I mean, I think what we expect to see is that if you look at the the pressure year over year pressure that we saw in the second quarter, I would expect the second half of the year to be better than that or less year over year pressure.
Pressure from raw materials, but also less pressure, but also better pricing from what you said so higher gross margins in the second half of 'eighteen versus 'seventeen?
Yes. So I mean, if you look at the 2nd quarter numbers, we were down about 200 basis points year over year in Q2. As we get the pricing in the second half of this year, I would expect that decline to decrease in the second half of the year.
Okay. That's very clear. Thanks. And then just on the second quarter itself on the gross margin, can you help me split out what or how big the effects were between the ongoing raw material cost inflation and the situation impact. And I think you already mentioned 1.5% price in Q2, if I heard that right?
Yes. So pricing was about 0.8.
Because you
don't provide that bridge anymore, that EST.
Yes. So let me give you the background. So yes, as I said, 1.5% of price increases when you as I just mentioned, we were down about 200 basis points year over year on gross margins. All of that can be attributed actually most likely more than that, but all of that can be attributed to net price to input cost, the dynamic. And as best as I can, we can estimate it, it's split roughly fifty-fifty between the citral issue and the other price increases.
And as I said, it's a timing issue that we expected to normalize over the balance of the year and earn Flipping into early next year.
That's great. Thanks very much.
Your next question comes from the line of John Roberts with UBS.
Thank you. Your mysterious largest shareholder vendor increased their position in your stock again recently. That surprised me a little bit given they'll be able to buy all they want on the secondary offering in a month or so. Have you talked to them about participating in the secondary?
Hey, John, it's Mike. From a largest shareholder perspective, look, we've had pretty lengthy conversations with them with respect to every ongoing institutional investor we have. They remain passive evident with their filing of their 13G, so there's no change there. With respect to secondary offering, unfortunately, we don't disclose the process, but what I can say is that there's technical rules that they abide by even their size. So, it's ongoing conversations as we move forward more to come.
Okay. And then secondly, are you concerned at all about the persistent low growth in the Greater Asian Flavors business? You had an easy comp this quarter. It was against minus 2% a year ago, and you haven't had a comp above 2% in over a year.
No, actually not because, we are happy that finally, we were turning or we are turning around the situation in China with good growth in in China in the flavors business. What is in, let's say, an issue for us was Indonesia because we are have a big business in Indonesia and the market is pretty, pretty soft that what's taking the growth rate down But eventually, that will come back. The rest of the, of the Asian business is performing very well. And as I said, particular, John, China, we are happy to be back. Interesting enough is you might recall that the whole thing goes back to our factory issue we had in 2015.
So it took us longer to recover. We have now a second manufacturing plan actually in place and we will open it in the fourth quarter of this year. So we have a backup plan. And we believe that the China will be for us a good, good growth country going forward. And now even with the consolidation of a footer room even better because we, we will get, some of their volume basically into our factories as well.
Your next question comes from the line of Adam Samuelson with Goldman Sachs.
Maybe just a clarification on the guidance and a lot of ground covered today. There is a pretty sharp deceleration implied in second half currency neutral sales growth and understanding the comps get considerably tougher, especially in fragrance, but you've got better pricing expected to flow through. Is it such that you think volumes are actually down year on year in the back half either company wide or at least fragrance? And if so, is it just comps? Is there anything on win rates, or customer order patterns that would you think that.
I just want to make sure I understand some of the moving pieces in there.
No, again, I think as I said, as I mentioned earlier, overall, when we look at it on a 2 year basis, it's there's not any significant change. What I do believe what we do see it happening is that the first half of this year, lower comps, but a big, bigger chunk of the improvement was volume on existing business. The growth the volume on existing business were above, let's call it 5 year norms. Our win rates and impact of new wins was can consistent with the 5 long term trends. So we were not seeing anything slowing or increasing there.
And so we expect to see a slowdown in the volume on existing business, that'll be offset by pricing.
Okay. And then just, below the line, tax rate has come in, I think below kind of the expectations the beginning of the year? Is there an expectation that you see a notable pickup in tax in the back half or what's the full year expected rate?
Yes. So for the first half of the year we're between 'eighteen and 'nineteen, I would expect we're going to end the year between 'nineteen and 'twenty.
Okay. And then there's no the financing for Frutarom is not embedded in the EPS outlook for the year. Is that correct?
No, no. Everything related to that is is excluded at this point.
Your next question comes from the line of FinTech Ryan with Berenberg.
Questions for me, please. Firstly,
in
terms of the integration with the Frutarom deal on the Frutarom side, given that we are a few further down the line. Have you thought about or have you seen any impact so far in terms of some Frutarom employee turnover? And would you be confident that most of the core management team there will remain with IFS and help that integration process post acquisition, particularly given that I saw that the Frutarom shareholders rejected the bonus, $20,000,000 bonus opposed for CEO of Frutarom, how does IFF intend to keep him compensated or interested in the business And then in terms of the regulatory approvals, would you anticipate any issues in terms of where Frutarom operates in terms like Russia and the European Union. Is there potential for any divestments that you can see stage? Or do you think it's just merely box taking exercise to get the regulatory approvals?
Thank you.
Well, thank you, Finjan. Let me start with the last one. First, on the regulatory side, we don't see any issues. And we don't expect to have to divest any business before we get regulatory approval, which is positive And that made us actually believe that the fourth quarter is good for closing, which is ahead of the initial time line we have given ourselves. We're very happy about that.
On the, on the talent side for the integration, we haven't seen any significant departures, and we believe that, many of the senior leaders will have a good position within IFF and will stay. And we are very happy with many of the talented people who will join the new IFS in the new makeup of the company and help us driving growth.
From my standpoint, Fin, I mean, I think we're also obviously, we have a completely separate work stream around talent management and the people As Andreas previous comments in his prepared remarks, very strong talent base. Part of that work stream is identifying who those key people are and reaching out to them and having discussions before closing in terms of what the vision is for the future.
Your next question comes from the line of Faiza Ali with Deutsche Bank.
Hi, good morning.
Good morning, Faiza.
Hi. I just wanted to go back first to pricing in the quarter. If you could just update us on or give us more color around where the pricing is coming from? Like is it more my sense is that coming maybe more from the smaller customers and then you expect in the back half to get more pricing from your more global customers? And then maybe if you could disaggregate sort of how much of it is coming from fragrances versus flavors and within fragrances, how much is ingredients versus the other components?
Sure, Faiza. I mean, in general, I would say that the the pricing is skewed towards fragrances versus flavors. And then within that, it's a balance between compounds and the ingredients business, as you've we've talked in the past, fragrance ingredients business generally works off a 6 month contract. So They generally the impact is seen sooner on the ingredient side. On the fragrance compound side, it's the timing is often driven by One, the process to identify where and when the choices are made about the adjustments and in some cases can be driven by the to see or the contract on when the windows open up.
So, but it's the details on global versus local and regional, it's hard to say. So I think it's more around those 3 businesses, more fragrances than Flavors, and more of what we see today is on ingredients versus compounds.
Okay, understood. And then unless I missed it, I'd think you reiterated your previous outlook around double digit EPS cash accretion in your to post the deal. So I was just wondering if that still stands. And if it does, maybe you could walk through some of the components of that. I know we understand the synergy phasing, but maybe if you could just update us on what type of underlying growth you're expecting And maybe if you've baked in anything for incremental acquisitions there?
Mike, Mike, I'm sorry, I can't control that.
Yeah. But it still stands. Let's put that, That's clear. And Rich can
explain. Yes.
I mean, we haven't we reiterated the guidance today around our core business. We were not talking about Frutarom deal that we'll cover, as Mike said earlier, and Andreas talked about, we'll cover that after the deal closes. But in overall, the big part of the year over year on a cash basis accretion is driven by the synergy when we go from 25 percent to 70 percent, the cash flow generation of the business is quite significant. We expect it to pay down the debt quite significantly. Very quickly.
So we get both the operating profit gain as well as the interest expense reductions that are driving it.
Your next question comes from the line of Patrick Lambert with Raymond James.
Thanks for taking a few questions, brief one. Just going back on Ctrip, I mean, every company has a different timing of impact capacity. And do you think that actually for you guys, the bulk of the impacts, and I think it was at last year about $45,000,000 for the year, total without any mitigation. Is it more in Q2 versus the rest of the year or is there still more to come? In terms just for C12 impact?
That's the question number 1.
Yes, I think for that first part, I mean, as we talked about on the last call, I mean, the impact was small in Q1. As I talked about at the time, most of the higher costs were sitting in inventory. So I think when you think about the overall impact, Q2, Q3 are the pressure points And then on the input cost side, we expect the purchasing cost to come down. As the sit trial line stabilizes. And then on the other side, we get we start to fully recover we get the pricing takes hold, then that'll further mitigate the impacts.
And you still believe you can out of the 7%, we cover about 5% of the impact, the percentage points
of your budget. We currently we still believe that currently the impact in the year this year will be about a 2% headwind. So somewhere between $10,000,000 $15,000,000. On operating profit.
Your next question comes from Jonathan Feeney with Consumer Edge.
Good morning. Thanks very much. I wanted to, when you think about your sales forecast, maybe this is question more for Rich or maybe Andreas. Do you have implicit in that an assumption about acceleration or deceleration in your end customer markets, how much visibility do you have into that? And finally, could you characterize the growth in your portfolio in your customers right now between small or local either small local or both kinds of customers versus global customers.
And I asked because it seems like persistently, your growth rate is so much better than if I put together just a sloppily put an index together of what appear to be all your major CPG customers, you've been growing a lot faster for a long time on organic basis. So just trying to get my hands around that and how you think about that as your forecast? Thank you.
Sure. John. So first of all, what we see certainly is that the smaller and midsized customers are providing us with better growth than the big ones. And now with some of the moves we have done in our own core business like Tastepoint, for example, we are covering better these small and midsized customers, which gives us some good growth here. So that's good.
And actually, this is one of the reasons for the Frutarom deal because it will give us even more exposure towards these customers And we feel very excited about this. In general, if you look at the volume trends, they are pretty robust. I would say also our end customers. Since I would say probably third quarter last year, and we see still pretty robust volume trends. We saw it in our first quarter, for example, where we were circling through our inventory, much faster than we saw it in particular on the fragment side.
We don't see a deceleration of these trends, but you never know. So that's certainly for something we have to see and we are in constant dialogue with our customers all the time to figure out where they stand and how much growth they see going forward. But so far, the volume trend is intact for our customers, which is actually good news for us.
Your next question comes from the line of Brett Hundley with Vertical Group.
Hey, thanks for fitting in guys. I just have one question. I'm trying to think more about your, the ability of your fragrance segment margins to rebound in 2019. And Rich, I thought you had an interesting comment on pricing when you talked about raw material inflation continuing into fiscal 2019. And I don't know.
I'm just reading your comment as very public and signaling and talking about how it's imperative that you get pricing through or look at other actions. And if I'm not reading too much into that comment, is there as you guys have pricing discussion ongoing pricing discussions with customers. Do you feel like you're getting to any type of price ceiling on the synthetic side? Are you feel like you're running into any challenges on taking pricing higher? And maybe related to that, if it's not pricing, do you guys believe that you can deliver another round of cost savings following what you've done over 20172018?
Are you feeling better about maybe walking your synergy number from Frutarom higher or maybe walking it faster? Can you just talk about the other ways that if you don't go out and get pricing that you might be able to offset further on coming inflation? Thank you.
Sure. Thanks. Look, I'm never going to sit here in my role and tell you that getting the price increases easy. It's not, it's a long process. I think we're better we have better tools available to us today to help our teams have fact based conversations with our customers at a very detailed level that we hadn't had 6 or 7 years ago.
And that that's imperative to our ability to get those price increases. Would I like them to come sooner? Absolutely. But we have to manage our business and these are long term relationships with our customers and we have to work together in some kinds some cases we can come quicker. In other cases, we have to make a choice and work with them around formula optimization or opening up the formulas.
And reformulating. Sometimes we have to look at options around phasing in the price increases. But I think the business both businesses have shown the ability to recover the price increases. Again, sometimes the timing was probably not what Andreas and I would like, but I think we're able to do that. Now from a margin standpoint, obviously it's dilutive because what we don't what we don't do is try to mark up the cost increases.
So So I think those will continue. We'll continue to work that next year. I think what's important to me, I think when I look at the trajectory on the input costs can increase Again, we're not sitting here saying that we're expecting it to be double digit increases across 80% of the portfolio which is what we faced back in 10, 11, 12, and that took us 2 or 3 years to recover that. So I think we will continue to do that. In terms of your question around cost savings and what we do as a business, I mean, that's part of what we're constantly doing is managing productivity programs.
I mean, the productivity programs that, that, you know, Francisco's led over the last 11 years that I've been with the company have been dramatic terms of what they've delivered to the bottom line and help give us flexibility. I'm not going to sit here and tell you we have the same ability to achieve those that we've had in the last 10 years over the next 10 years because we've done all the easy stuff. But it's a constant part of our agenda. And then, obviously, we will obviously look to accelerate the synergies and turn over every possible zone to have as much flexibility in our operating model. And I think we will then look at how much do we reinvest in the business.
That becomes to me the variable, of terms of, okay, if we're ahead of schedule, we can potentially reinvest quicker. If we're behind, we'll be more in terms
of where we make incremental investments. Actually, on the cost side, in particular, on manufacturing, as Rich said, the easy stuff is done, but now in front of the Force Industrial Revolution, we see much more of a drive into, artificial intelligence and robotics which will help us actually significantly to decrease some of the costs we are having in that area. And that's actually very, very helpful. So profitability and, potential savings agenda is still on for the core business. And then on top of it, certainly the savings we get through the Frutarom deal.
So that's where we are, and we feel actually very, very good about it.
And we have reached the allotted time for Q And A. I would now like to turn the call back over to Andreas for closing remarks.
Yeah, thank you for all the great questions was a was a good session. I hope you got the answers. Yeah. You need it. And as usually we follow-up with, with a one on one call for more detailed information.
Thank you very much guys. Have a good day. Bye bye.
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