Logo of jester cap with thought bubble.

Image source: The Motley Fool.

International Flavors & Fragrances Inc  (NYSE:IFF)
Q3 2018 Earnings Conference Call
Nov. 06, 2018, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

At this time I would like to welcome everyone to the International Flavors & Fragrances' Third Quarter 2018 Earnings Conference Call. All participants will be in a listen-only mode until the formal question-and-answer portion of the call. (Operator Instructions)

I would now like to introduce Michael DeVeau, Head of Investor Relations. You may begin.

Michael DeVeau -- Head of Investor Relations

Thank you. Good morning, good afternoon and good evening, everyone. Welcome to IFF's Third Quarter 2018 Conference Call. Yesterday evening we distributed a press release announcing our financial results. A copy of the release can be found on our IR website at ir.iff.com. Please note that this call is being recorded live and will be available for replay on our website.

Please take a moment to review our forward-looking statements. During the call we'll be making forward-looking statements about the company's performance, particularly with regard to our outlook for the fourth quarter and full year 2018. These statements are based on how we see things today and contain elements of uncertainty. For additional information concerning the factors that can cause actual results to differ materially from forward-looking statements, please refer to our cautionary statement and risk factors contained in our 10-K filed on February 27, 2018, and our press release that we filed yesterday.

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

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

With that, I would now like to introduce Andreas.

Andreas Fibig -- Chairman and Chief Executive Officer

Thank you, Mike. On the call today we will review our financial results for the third quarter and the first nine months for 2018; give a quick update on Frutarom since the transaction has closed and provide an update to 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 the recap of our first nine months performance. Growth was strong across our key financial metrics. Currency interest sales increased 6% year-to-date with Flavors growing 6% and Fragrances growing 5%. New win performance and price increases to mitigate rising material costs, both contributed to consolidated growth.

From a profitability perspective, currency-neutral adjusted operating profit grew 4%, supported by volume leverage and our focus to drive greater efficiency throughout our business by our cost and productivity initiatives. Currency-neutral adjusted EPS improved 11%, driven by adjusted operating profit growth as well as a more favorable effective tax rate.

Our strategic priorities continue to drive overall performance over the first nine months of 2018. Sales of our Re-Imagine Modulation portfolio grew strong double-digit, and PowderPure grew an impressive triple digits, both indicative of our position as a leader in innovation. Performance with local and regional customers remained strong, growing double that of our global customers, which on a consolidated basis is about 50% of our customer base. In Flavors specifically, our mid-sized go-to-market platform Tastepoint continued to deliver strong results, improving strong double digits in the first nine months of 2018.

In terms of maximizing our portfolio toward our most margin-accretive categories, cosmetic active ingredients continued its robust growth trend by improving double digits. Also in the Fragrances side, hair care grew double digits and home care and toiletries improved high single digits. In Flavors, growth was strong in dairy and beverage, improving double digits and high single digits, respectively.

We also continue to focus on driving greater efficiencies throughout our business by our cost and productivity initiatives, which allows us to reallocate resources through efforts that drive the greatest returns and maintain strong profitability. This year that strong results in the first nine months of 2018 and our cost and productivity initiatives including zero-based budgeting added approximately 5 (ph) percentage points of growth to currency-neutral adjusted operating profit and EPS growth. All in all, I'm very pleased with how well our refreshed priorities are performing, and believe better positions us to drive long-term value for our shareholders.

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

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Thanks Andreas and good morning, good afternoon, good evening to everyone.

Moving on to our Q3 performance. Currency-neutral sales in the second quarter grew 4%. Growth was led by new wins and price increases to mitigate the impact of raw material cost inflation. From a profitability perspective, currency-neutral adjusted operating profit increased 3% in the third quarter as top line growth and the benefits associated with cost and productivity initiatives was offset by unfavorable price to input cost, inclusive of the BASF citral issue and weaker sales mix.

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

Currency-neutral adjusted EPS increased 12% as a more favorable year-over-year effective tax rate offset higher shares outstanding and interest expense associated with the equity and debt raise during the quarter. It should be noted that excluding the items that impact comparability, the adjusted tax rate for the third quarter of 2018 was 14% compared to 22.7% in the prior year period. The year-over-year decrease was largely due to a more favorable mix of earnings, 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 on foreign currency in the prior year.

Looking at the business unit performance for the third quarter, Flavors currency-neutral sales increased 7%, even against a strong year-ago comparison of 12%, with growth coming in all categories and all regions. On a two-year average basis, growth remained very strong at approximately 9.5%. North American Flavors improved 10% in the third quarter, led by double-digit growth at Tastepoint and strong performances in Dairy & Sweet. EAME increased 6% on a currency-neutral basis, led by high single-digit growth in Europe as well as Africa and Middle East. Greater Asia grew 4% in the third quarter on a currency-neutral basis, as 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 comparison with growth in nearly all regions. From a category perspective, Consumer Fragrances grew 2% on a currency-neutral basis, as performance was driven by continued growth in hair, home and fabric care. Fine Fragrances declined 2% on a currency-neutral basis against the very strong 18% comparison from the prior year. From a regional perspective, Greater Asia increased strong double digits, and EAME increased low single digits.

Fragrance Ingredients sales were up 5% on a currency-neutral basis, led by strong double-digit growth in the cosmetic active ingredients business. This marks the ninth consecutive quarter of growth in Fragrance Ingredients as we continue to successfully execute our 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 cost, including the previously announced citral issue. In terms of currency-neutral segment and profit margins, our margins remained solid yet were under pressure year-over-year.

Before moving on, I'd like to provide some more commentary on the raw material environment like I did in Q2. As you remember, coming into the year we expected mid single-digit more material inflation in 2018, inclusive of the impact of the citral situation having (ph) on the business unit versus Flavors. Since that time, cost inflation has picked up following a series of disruptions in the supply chain. Additional market disruptions continue to impact the Fragrance business unit, driven both by environmental considerations and new non-flavor and Fragrance market demands for core raw materials. Unfortunately, we see further input costing 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 our raw material cost exposure.

Operating cash flow was $202 million in the first nine months of 2018 compared to $199 million in the prior year period. This was primarily driven by litigation in the prior year period. Core working capital was impacted by higher inventory to ensure continuity of supply during unprecedented supply chain challenges as well as higher raw material prices.

From a capital allocation standpoint, we spent approximately $102 million and capital expenditures were about 3.7% of sales, driven by new plant and capacity investments mainly in Greater Asia. Some of these investments include the Flavors manufacturing facility in the Zhangjiagang Free Trade Zone, which opened on October 9th, and a Natural Products Research lab, located in the Nanjing Life Science Park, which opened on October 15th.

The Flavors plant is our second in China and is designed to supplement our existing flavors and manufacturing operations in Guangzhou. The Naturals Lab is our first outside of the US. China is a critical component of our long-term strategy. The opening of these new sites will support our efforts to be a partner of choice and to grow in this exciting region.

We continue to believe that we will spend approximately 4% to 5% of sales for the full year 2018 on CapEx. Regarding cash returned to shareholders, during the first nine months we spent approximately $163 million on dividends and $15 million on share repurchases. As a reminder, as part of the Frutarom combination, we paused our share repurchase program as we will prioritize debt repayment going forward. We will continue to maintain the disciplined approach to capital allocation as we accelerate growth through organic investments and strategic acquisitions, while returning significant capital to shareholders.

Before turning it back to Andreas, I'd like to provide some commentary on Frutarom's estimated results for Q3 2018. Please note that this information -- is for information 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 million and $365 million, and adjusted EBITDA margin is expected to be approximately 21%. Performance from the top line perspective is expected to be up low single digits versus prior year, driven by the contribution of acquisitions and offset by foreign exchange headwinds. It should be noted that sales growth, while up year-over-year, was negatively impacted by customer order patterns, specifically in more commodity-oriented businesses, such as trade and marketing, and Frutarom's citrus processing business, which were both down double digits. Excluding these businesses, growth would have increased mid-single digits on a reported basis and high single digits if we excluded foreign exchange impacts.

In the third quarter, adjusted EBITDA margin continued to be solid, improving approximately 40 basis points year-over-year, led by gross margin improvements as well as expense control. On a year-to-date basis, sales are expected to be approximately $1.15 billion, an increase of about 15%. In terms of profitability, we expected adjusted EBITDA margin to be approximately 21.5%, which is a strong year-over-year improvement of approximately 175 basis points.

With that, I'd like to turn the call back over to Andreas.

Andreas Fibig -- Chairman and Chief Executive Officer

Thank you, Rich. I would like now to give you a quick update on our Frutarom combination. I'm very happy to say that on October 4th we completed the combination with Frutarom. This is ahead of our original expectations of six to nine months from May 7th announcement. The coming together of IFF and Frutarom is a momentous achievement and we're excited to be moving forward as one company, while pursuing new opportunities that benefit all our stakeholders around the globe. I applaud the integration teams around the world that over the past several months have been working to ensure that we capture the best of both companies and create a seamless and efficient transition to achieve both our operational and financial targets of 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 million through raw material harmonization, footprint optimization, and streamlining overhead expenses by the (inaudible) 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 in the opportunities that lie ahead and the ability of the combination to accelerate financial performance and targeting sales growth, an average of 5% to 7% and 10% plus adjusted EPS growth, excluding total company amortization that we intend in 2019 and 2021, all in the currency-neutral and pro forma basis.

Let's take a look how the new IFF is positioned now that the transaction has been completed. As you can see from the slide, we instantly have the number two global market position in the industry with approximately 33,000 customers globally, selling about 150,000 unique product solutions annually. Our organization is fueled by 13,000 hardworking employees in more than 110 manufacturing sites and approximately 100 R&D centers and labs around the world. This historic combination sets us up to service our customers like we never have done before, being able to offer them a stronger product offering to help them create differentiation in the marketplace. With the addition of Frutarom's offerings, we instantly become a leader and natural capabilities extending across our entire platform.

Our combination creates a highly diversified portfolio with exposure to fast growing categories and customers. Being that our product offering is now extending beyond our traditional industry, we have renamed our business segments from Flavors and Fragrances to Taste and Scent respectively. To ensure we deliver a seamless experience through our newest customers we intend to preserve Frutarom's best-in-class customer-facing capabilities, which will enable us to maintain the strong relationships Frutarom has built by capturing the significant cross-selling opportunities we will have as a combined company. As a result, our intention is to report Frutarom as a stand-alone business unit. Based on projected pro forma 2018 sales, we expect Scent to be approximately 35%, Taste to be about 33%, and Frutarom about 32% of our entire business.

And now looking at our Executive leadership team. Matthias Haeni and Nicolas Mirzayantz will continue to lead our Taste and Scent division, respectively. Leading the Frutarom division, I'm pleased to welcome Amos Anatot, who spent eight years at Frutarom in leadership positions with his most recent role as Executive Vice President of Global Supply Chain and Operations. He has a great perspective of Taste, savory solutions, Flavor and Fragrance ingredients, (inaudible) 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. He most recently held the position of President-Natural Solutions at Frutarom, where he led the company's natural food colors, antioxidants, cosmetics and health ingredients business. This leadership structure is in place since the 4th of October to run these businesses in a manner that leverage our strengths and supports our customers.

Aligned with this approach, we are already capitalizing on a few quick wins. For example, leveraging our Tastepoint go-to-market strategy for small and mid-sized customers 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 mid-sized customers in North America. This transition should be seamless as the go-to market model used by Frutaroms North America, Flavors business is perfectly in line what we have at Tastepoint.

Another example is in cosmetic actives. While we are shifting Frutarom's cosmetic active ingredients business into our Lucas Meyer Cosmetics business. Established in 1995, Israeli Biotechnology Research or IBR researchers develops manufactures and marks innovative and proprietary natural active ingredients for the cosmetics and dietary supplement industries, mainly for solar and skin -- anti-aging skin protection from UV rays and air pollution, skin whitening and pigmentation prevention. By combining these two businesses, we have strengthened our cosmetic active ingredients portfolio, sold to some of the world's leading cosmetic companies. We believe this growth 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.

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Thank you, Andreas. Before providing full year expectations, I wanted to clarify a few go-forward model assumptions. First, following successful debt raise, our total debt outstanding is approximately $4.4 billion. The annual interest expense associated with this debt is expected to be between $150 million and $155 million per year. Currently we expect our annual effective tax rate to be approximately 19%, more or less the average of the two stand-alone companies. For purposes of calculating adjusted diluted EPS on a go-forward basis, we estimate that there will be approximately 113 million diluted shares outstanding, including 6.3 million shares related to the tangible equity units.

Annual amortization is expected to be approximately $220 million, and subject to change based on the finalization of the purchase price accounting. In terms of go-forward -- in terms of our go-forward reporting, please note that we have modified the way we will disclose adjusted EPS. Previously adjusted EPS was reported EPS excluding items that affect comparability. In addition to these exclusions going forward we will also exclude full amortizations for the total company. We believe that this metric provides useful period-to-period comparisons by the results of our operational performance and cash generation capacity.

Looking at the full year 2018, inclusive of Frutarom's fourth quarter estimated results, we are targeting year-over-year advancement in both top and bottom line results. We expect our sales to be between $3.95 billion and $4.05 billion for the full year with similar contributions to Q3 in our legacy IFF business as well as sequential improvements in Frutarom's sales performance versus a growth they achieved in Q3.

We also expect our adjusted EPS to be between $6.25 (sic) and $6.45 (sic), excluding one-time items that may affect comparability and total company amortization for the full year. For reference purposes, we expect 2018 amortization for the full year to be approximately $83 million, made up of $37 million of legacy IFF amortization, $9 million from legacy Frutarom amortization, and an estimated $37 million from the purchase price accounting related to the transaction.

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

Andreas Fibig -- Chairman and Chief Executive Officer

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

As we look toward 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 the bittersweet realization that the third quarter 2018 was our final as legacy IFF. We are now embarking on the next major chapter of IFF history. We believe that our combination with Frutarom, the largest transaction of its kind in our industry is fundamentally going to expand our customer and employee base and product offerings. We will have greater exposure to fast growing customers, broader access to attractive adjacencies, and a very differentiated portfolio, with an increased focus on naturals and health and wellness as well as more comprehensive solutions. We believe this will translate into accelerated financial performance as a combined company with robust top and bottom line gross leading to strong returns for our shareholders.

With that, we'd now like to open up the call to questions.

Questions and Answers:

Operator

(Operator Instructions) Your first question comes from the line of Mark Astrachan with Stifel.

Mark Astrachan -- Stifel Nicolaus -- Analyst

Thanks, and good morning, everybody.

Andreas Fibig -- Chairman and Chief Executive Officer

Good morning, Mark.

Mark Astrachan -- Stifel Nicolaus -- Analyst

I've heard words by the way in the last line of substitution I think about. 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 of their trade and marketing business in those results. So thoughts on maybe how that business fits with the new company going forward.

Andreas Fibig -- Chairman and Chief Executive Officer

Yeah. Let me start the first part of the question, then I hand it over to Rich. So first of all, we had a solid start and an acceleration in growth with the Frutarom business for the fourth quarter, so that's a good, good part. And we are actually ahead of the integration. What is the big benefit for us is that we have closed the deal earlier than we saw, the teams were well prepared, the leadership structure is in place. And most of the unsecurity is gone, which you usually have when you embark in such kind of a deal. And that, let's say, feels the optimism for the fourth quarter and the year going forward. So good start, as I said financially. Secondly, we have the organization in place to perform, and we see that people are very motivated, leadership structure is there, they're going after it, we are talking already about cross-selling opportunities, which I always said is probably mid and long-term the biggest value creation opportunity we have here. We have the small signs of cross-selling successes, which is fantastic, and that, I would say, fuels the optimism of the optimization that the fourth quarter will go in the right direction. But in terms of the guidance (Multiple Speakers) --

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Yeah. Mark, in terms of the guidance range, I wouldn't read too much into that. Probably the simplest answer is, I didn't want to have to go at that three digits in terms of the -- in the range and so we picked -- we picked basically a $50 million range around that. There's nothing more than that. As Andreas said, I think that the first -- the fourth quarter and start of the first quarter is inline 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 it's customer order patterns in a couple of businesses.

Mark Astrachan -- Stifel Nicolaus -- Analyst

Okay. And then, so on the trade and marketing, any thoughts on how that fits with the business going forward? And on the implied EBITDA from a run-rate standpoint, first half of the year, I think was maybe a little bit stronger than kind of 21%-ish. Is there anything within those numbers that perhaps makes them less sustainable going forward? Where there -- how much was contributions from acquisitions for example? And is 21% kind a good run rate to use going forward?

Andreas Fibig -- Chairman and Chief Executive Officer

Okay, I'll 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 be evaluated what we want to do as a business. But so far it looks like a smart solution to have it in place, but not put too many resources behind it. Rich?

Richard O'Leary -- Executive Vice President and Chief Financial Officer

I mean, Mark, from an EBITDA margin standpoint, I think it's -- within the Flavors business, probably there's some mixed impact, probably there is a little bit of impact to expect within natural products solutions. I think there are a couple of projects in terms of productivity things that are about three or six months behind schedule that were already under way within the Frutarom business, so that's probably a little bit on what we're seeing in the second half. So, I think, overall I don't -- we don't see there's any fundamental changes. Obviously with the strong growth rates that we saw particularly in Q1, the leverage component is much more advantageous in the first half than what we've seen in the third quarter.

Mark Astrachan -- Stifel Nicolaus -- Analyst

Great. Thanks guys.

Andreas Fibig -- Chairman and Chief Executive Officer

Thank you.

Operator

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

Lauren Lieberman -- Barclays Capital -- Analyst

Thanks, good morning. My first question was just around the go-to market approach that you talked about in terms of leading Frutarom to report independently. That was definitely different from what I had anticipated or expected to be the case. So I guess, first, could you talk about one will you be giving us sort of pro forma historicals that could just help us in terms of forecasting? And the second thing is, it was just interesting to me that it looks like in terms of like that you're going to be rolling in the Frutarom North America Flavors business into Tastepoint straightaway, 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 a multi-bridge platform to go slowly such that the Frutarom piece of business independently reportable will just be going down over time?

Andreas Fibig -- Chairman and Chief Executive Officer

Okay. Rich, you get start it.

Richard O'Leary -- Executive Vice President and Chief Financial Officer

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

Andreas Fibig -- Chairman and Chief Executive Officer

And on the organizational set up, let's start with the natural products solution, which is probably the most, let's say, adjacent businesses we have here at hand. That certainly is important to leave this as it is for now to make sure that we will be capitalized 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 one. Number two, on the Frutarom business unit, we said we won't organize it like that to make sure that we don't lose speed and we don't lose our customer focus to these high growth small and mid-sized customers. And over time we will decide what part of the organization we are moving to the taste solution on our side. And it's right that the North America Taste business from Frutarom is mainly with smaller and midsized customers, so that creates for us a great opportunity to bring it together with our Tastepoint platform, because basically it 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 approved model how to be successful in the North American market, we said this is probably the best thing we can do. And we are very happy that we see early close, the integration, integration is already under way, which is way ahead of the time we saw it, because we -- actually I was thinking that we might close at the end of the year, then you have Christmas and it takes a while. Now we are already in full swing integrating this business. Okay?

Lauren Lieberman -- Barclays Capital -- Analyst

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

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Lauren, a couple of things. I think, 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're already having conversations. The business is certainly or having starting out the conversations around what is going to be necessary. We're going to see -- expect to see -- on an overall basis I would expect to see mid single-digit increases next year. Again, skewed heavily toward the Fragrance business, given the continued supply chain interruptions that we're dealing with there. The teams are already having those conversations with and tying those things up with the customers, but I would expect to see some pressure -- continued pressure during the course. But I also fully expect to see progress quarter-by-quarter and going forward also.

Lauren Lieberman -- Barclays Capital -- Analyst

Okay. That's great. Thank you so much.

Andreas Fibig -- Chairman and Chief Executive Officer

You're welcome.

Operator

Your next question comes from Faiza Alwy with Deutsche Bank.

Faiza Alwy -- Deutsche Bank -- Analyst

Yes. Hi, good morning.

Andreas Fibig -- Chairman and Chief Executive Officer

Good morning.

Faiza Alwy -- Deutsche Bank -- Analyst

So two questions for me too. One is just to follow-up on the raw material and pricing commentary. Could you give us more color in terms of where you're seeing sort of the most raw material inflation? I know you said Fragrances, but just more specifically is that the naturals? Is it synthetics? Petrochemicals? That the way 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 thought 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?

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Yeah. So, Faiza, 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 to mitigate the effects of the citral stuff. Some of it doesn't show up in pricing, because we'll go through and work with customers on the formulations and to adapt the cost base, so we're not -- everything is going to show up exactly. But I do expect that over time that we will be able to recover this. It's just -- we had to protect our customers business, but we also have to protect our bottom line. It's not easy. I'm never going to say it's easy, so I do expect -- as I said on to Lauren's next question, I do expect this 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 had supply chain interruptions. I mean it started -- we started the year and we are at mid-single digits. Including citral we've had issues in suppliers in India, we've had fires in India, we have shutdowns in China on some of the core ingredient suppliers, chemical ingredients suppliers. More recently more environmental-related supply chain restrictions and we're also starting to see situations where demand is coming from non-F&F markets for the same raw materials, which is creating 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.

My customers understand what's driving and we spend a lot of time walking them through the details and then working with them in terms of how do we mitigate the impacts on both sides. So it's going to continue. Unfortunately we're in a period where it seems every six months something else is popping up and we're having to deal with it with our customers. We're probably going to have the third round of conversation with our customers in a very short period around price increases that are necessary for us to protect our bottom line in the long run.

Faiza Alwy -- Deutsche Bank -- Analyst

Okay. Thanks for that. And then just my second question is around Frutarom again. I guess, I'm still not convinced that this is like -- I guess I'm looking for more comfort from you in terms of how much of the Frutarom sales issue this quarter were timing-related. And perhaps if you could update us on what your outlook is for like the Frutarom sales and EBITDA for fiscal 2018? So how much of a snapback are you expecting in the fourth quarter? So were the timing issue is 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 helpful. Thanks.

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Sure, Faiza. I mean, obviously it's hard to pinpoint it exactly. What I can tell you is, we've been able to -- as I said in my comments, we look at some specific issues, the colors business has -- is a pricing issue related to changes in the underlying raw materials, but that has had a big impact in that business, I talked about. The timing of orders and order patterns, both in the citrus business as well as part of the savory business. So I think that's part of the reason why we believe it's a unique circumstance, undoubtedly there's -- one of the biggest challenges any company is going through this type of combination is to deal with this distraction. We always do our best to try to keep everybody focused on both sides, but I can't -- it's hard for me to sit here and say specifically how much of what we saw in Q3 is that, but I can tell you, again, if you take out these three or four specific items that we know what was driving it, we were more in line with the long-term expectations to that business in mid-single digit growth on a currency-neutral basis. And then as Andreas and I talked about in terms of the outlook and where we expect to see Q4, we are seeing and we do expect to see growth in Q4, probably not all the way back to where we would think at long term, but certainly a marked improvement from what we saw in Q3.

Andreas Fibig -- Chairman and Chief Executive Officer

And that's actually very comforting particularly in the start into the quarter, which is really, really good. And again, I believe this early closing of the deal gives us a great opportunity to be ahead of schedule with our integration, because we just can -- we have named our leaders already. The organization is in place and we can drive to our performance, so that's good.

What have we learned during the months we owned the business? Actually nothing which is a super big surprise to us. Maybe the only thing and that's more positive is, when I listen to the teams which are working together on the cross-selling opportunity, that -- and I said it's 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 basis with the technology is probably a bigger opportunity than we had sought at the beginning. And that really can drive value over time. And it will take some time, but the first signs are actually very, let's say, very encouraging. We had to first win actually on a West Coast customer where we helped the Frutarom team with our Vanilla Technology and vanilla formulation, and that has led to a $3 million order which we -- they probably would never have received if we don't have to help out -- adjust to give one example. It's small, but it starts already and it started earlier than I thought it, so that's how I would describe it.

Faiza Alwy -- Deutsche Bank -- Analyst

Okay. Thank you very much.

Operator

Your next question comes from Silke Kueck with J.P.Morgan.

Silke Kueck -- J.P.Morgan -- Analyst

Good morning. How are you?

Andreas Fibig -- Chairman and Chief Executive Officer

Good morning. Very well. Thank you, Silke.

Silke Kueck -- J.P.Morgan -- Analyst

So there were a couple of acquisitions pending under Frutarom, and so I was wondering whether you can quantify what the -- like -- maybe like, in terms of the acquisitions of Frutarom added to Frutarom sales in the third quarter? What you expect for the fourth quarter and what you expect to -- they may add in 2019?

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Look, Silke I think, given that those -- through third quarter results, their numbers and we don't -- I'm not comfortable disclosing that. I think in terms of M&A for Q3 -- I mean we're continuing to work together. As you've heard, Andreas, and I talked about, that we keep continue work together on the pipeline. We've now reapproved -- reprioritized to come the two teams stand-alone pipelines into a refined list based on our priorities and our needs going forward. We look to continue to execute against that pipeline, but I really don't feel comfortable given the stand-alone nature of their results in Q3 coming in on the individual components of it.

Andreas Fibig -- Chairman and Chief Executive Officer

What you have seen -- sorry, maybe if I could add on this, Silke. What we have seen is that there were no acquisitions made this year during the process of the -- let's say, the deal there -- let's say, the pre-deal months. What we have -- as Rich said, actually we have a good pipeline of very value and technology-added opportunities. And I would not wonder if we could hopefully close two of these deals until the end of the year. They're smaller ones, but they would fit exactly into our wheelhouse. So you see a bit of a pause during that period, but now we're basically taking the combined pipeline with some new priorities and going after it. And I think it will be a big success going forward.

Silke Kueck -- J.P.Morgan -- Analyst

I was also interested in knowing what sort of like the acquisitions added that -- that were already announced. That like the same things may happen between when the transaction was announced and the closing just to reflect what was announced prior to your acquiring Frutarom of things that may have closed those. Wondering what those acquisition benefits were for the quarter and what they may add to next year?

Richard O'Leary -- Executive Vice President and Chief Financial Officer

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

Silke Kueck -- J.P.Morgan -- Analyst

Okay. And in terms of the DNA, and I apologize because I'm not familiar with Frutarom as I could be. I saw that for the past quarters that the DNA at Frutarom was something that was close to like $17 million a quarter. And what you said is, you thought maybe it something like $9 million a quarter.

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Because we're just doing the amortization not the DNA, so it's just adding back amortization.

Silke Kueck -- J.P.Morgan -- Analyst

Okay. So amortization is like $9 million of that? Okay?

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Correct.

Silke Kueck -- J.P.Morgan -- Analyst

Okay. And then DNA is like another $8 million. Okay.

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 just provide an EBITDA aspect of it, and it looks like stuck with EPS estimate rather than including all amortization which just seems like an aggressive treatment.

Richard O'Leary -- Executive Vice President and Chief Financial Officer

I would disagree that it's an aggressive treatment. It's looking at the underlying profitability, but then, again, bridging -- a simple way to bridge it back to cash flow generation, we've seen this done on several other 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.

Operator

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

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Hi, John.

Andreas Fibig -- Chairman and Chief Executive Officer

John.

John Roberts -- UBS -- Analyst

Hi, can you hear me?

Andreas Fibig -- Chairman and Chief Executive Officer

Yes, we can now.

John Roberts -- UBS -- Analyst

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

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Only three.

Andreas Fibig -- Chairman and Chief Executive Officer

Three.

Richard O'Leary -- Executive Vice President and Chief Financial Officer

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

John Roberts -- UBS -- Analyst

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

Richard O'Leary -- Executive Vice President and Chief Financial Officer

We're going through that right now, but what I would tell you that where we expect this to end up is we're going to report the way we run and manage the business. So on the taste side of the business we'll report along the regions, that's the way that business is run. On the Scent side, we'll report around the categories. And on the Frutarom side, I think we'll gain around the regional numbers, but directionally that's where we're heading.

John Roberts -- UBS -- Analyst

Okay, thank you.

Operator

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

Adam Samuelson -- Goldman Sachs -- Analyst

Thank you. Good morning, everyone.

Andreas Fibig -- Chairman and Chief Executive Officer

Good morning, Adam.

Adam Samuelson -- Goldman Sachs -- Analyst

Maybe just -- I want to make sure on the guidance that you just clarify. The underlying IFF business as we think about the fourth quarter are aware of the previous constant currency or currency-neutral sales growth was. Does that expectation changed in anyway? I know there was an embedded deceleration in growth in the prior guidance based on the tougher comps. And do you saw 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 constant currency operating profit for the legacy business for 4Q?

Richard O'Leary -- Executive Vice President and Chief Financial Officer

No, nothing significant in terms of change in terms of the legacy business both in terms of top line and overall profitability.

Andreas Fibig -- Chairman and Chief Executive Officer

We're on target.

Adam Samuelson -- Goldman Sachs -- Analyst

Okay. That's helpful. And then just as we think about 2019 on the Frutarom side, again going back to some of the questions on the D-cell (ph) implied in the Q3, I mean it's pretty -- the constant currency growth looks like they were up in the high single digits kind of the 8%, 9% range in the first half of the year. And I don't know exactly what it was for Q3, but it looks to be kind of flat to up slightly organically. I mean the confidence with that is, this is really just a timing of order patterns, and there are not something kind of more serious that would impact the revenue growth into next year. Just some additional thoughts there.

Andreas Fibig -- Chairman and Chief Executive Officer

No actually not, because the good thing is that, fruit -- the fruit business has a very wide and broad customer base, and it will be very unlikely that all of these customers also for the different categories despite all of sudden not to buy. I think that gives us a great comfort that we will reaccelerate in terms of the growth. And we are in the middle of budget process right now, and I hope in the next two or three weeks we will see all the numbers come out. But no big surprises here on this side. I would say it's actually what Rich alluded to a couple of timing topics and on colors that made the pricing topic. And then, whether the weeks and the two months before we were doing the closing and that certainly impacted the business as well. As we see we are coming backward now on that, that's comforting for us, so that's our how I would describe them. And I think it's important to see because the portfolio has such a wide range of different portfolio topics plus the broad customer base, that gives us actually good protection against downside movements in the mid and the long term, and that's the reason why we are reasonably optimistic here for the future.

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Yeah. Adam, just a quick kind of 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 long-term expectations for the business. I think you're right. As we look into the 2019 certainly the first half and first quarter in particular, we're going to have tougher comps, stronger growth in the first half than what we expect to see in the second half, so -- in 2018.

Adam Samuelson -- Goldman Sachs -- Analyst

Okay. All right. I appreciate the color. Thank you.

Andreas Fibig -- Chairman and Chief Executive Officer

Sure.

Operator

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

Gunther Zechmann -- Bernstein -- Analyst

Hi, good morning, everyone.

Andreas Fibig -- Chairman and Chief Executive Officer

Hey, good morning, Gunther.

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Good morning, Gunther.

Gunther Zechmann -- Bernstein -- Analyst

Hi. Just a clarification on the amortization, the $220 million that you mentioned, just to make sure, this includes also the non-Frutarom part of amortization that you're now including there. I'm thinking of David Michael, I think go $7 million or so and Fragrance resources refused (ph), so you're taking all of them together. And also on the amortization schedule, is there anything you can share at this point or when would you be able to give the phasing and the details around how to model that over the coming years? That's the first one.

And the second one on free cash, more 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?

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Let me start with the first question, Gunther. I mean, in terms of the $220 million, it's really -- roughly $36 million for the historical Frutarom, $37 million roughly for our legacy IFF amortization, and then the incremental -- the difference to that to $220 million which is call it $147 million is our current estimates of what the step-up's going to be. I don't think Bob has finished the calcs yet, so it's going to take us a while. I would certainly expect that to be the basis for 2019, but we'll have more clarity, I'd say, midpoint of 2019 at the earliest. But we'll update everybody if anything changes materially.

In terms of free cash flow generation, given the incremental step-up, I 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 pricing and 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 about.

Andreas Fibig -- Chairman and Chief Executive Officer

Absolutely. And then if you go 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 two big creative centers here in the US. And when we have done it, then the structure is actually in place. We need some CapEx investment on the legacy fruit business to absorb some of our capacity here as well. But this is all done in the next two 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.

Gunther Zechmann -- Bernstein -- Analyst

And that's 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 on the long term?

Andreas Fibig -- Chairman and Chief Executive Officer

It's in the business plan.

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Yeah. I think as I said earlier, I mean, we've -- I don't -- we don't look at it anymore as Frutarom's historical M&A and our historical -- legacy M&A is now one combined pipeline, that's based on the strategy and the priorities -- prioritized segments that we see going forward for the combined business. 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 are continuing to work to pursue those.

Andreas' comment about CapEx, I mean on a combined basis I do see that coming down to probably in the -- to somewhere between 3% and 3.5% on a combined basis after we get through 2019 and 2020 with all the integration work. So we had built into our cash flow projections. We have built into our leverage ratios, incremental M&A over the next three years.

Operator

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

Jonathan Feeney -- Consumer Edge Research -- Analyst

Good morning. Thanks very much. A few question -- a few quick ones. First, can you characterize the margin differential between Fine Fragrance and Fragrance Ingredients. Is this one materially higher than the other and any comment about that?

Second, what can you -- those are just a lot of great discussion about CapEx relative to depreciation. Can you give us a full year run rate depreciation number? And then roughly what a full year CapEx number looks like pro forma right now depreciation versus CapEx for 2018 for the combined businesses on a full-year basis.

And third and finally, how did you get a $9.8 million settlement from a supplier rated -- related to our prior recall. Now I haven't seen that -- quite seen that before. Thank you.

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Okay. Let me start with the Fine Fragrance versus Fragrance Ingredients, and I'm going to put -- I'm going to take the cosmetic actives out of that comparison. I think on a gross margin basis, there's a significant difference. On a return on sales basis, it's much closer to -- they're much closer to each other given the relative overheads of those two businesses, so they're both attractive on an accretive basis. But gross margin wise, if you think about mix, Fine Fragrance is significantly 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 want to guess and do my math on my head over the call.

In terms of the insurance recovery, again this is related to the product recall issue. We settled with our customer last year. We wrote the check in the early part of 2018. And then we've gone back to the vendors insurance company and work done getting reimbursement from them, because they had their own product liability insurance, and that's where the money came from.

Jonathan Feeney -- Consumer Edge Research -- Analyst

Got you. Thanks very much.

Operator

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

Patrick Lambert -- Raymond James -- Analyst

Hi, good morning. Thanks for taking. A few questions, very simple. Could you quantify a bit the part of Frutarom that are getting into Taste and Scent. I think IBR is pretty small, but I don't know (inaudible) all the Flavors North America. If you could help us on that? And the second is regarding again the remodeling of integration, in particular the cost that you will incur in Western China. I think you commented on the overall amount, but if you're bit more clear on when the timing of this spending in Q4, and I guess 2019? Thank you.

Richard O'Leary -- Executive Vice President and Chief Financial Officer

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

Patrick Lambert -- Raymond James -- Analyst

Yeah. I was -- I guess what -- can you hear me?

Andreas Fibig -- Chairman and Chief Executive Officer

Yeah.

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Yeah. Go ahead, sorry.

Patrick Lambert -- Raymond James -- Analyst

Just -- I guess like everybody were trying to fully integrate now Frutarom in our model. And I was trying to forecast the integration costs that you mentioned at the time of the acquisition. And if you had a bit more precise picture on the timing of the spending already in Q4 and 2019?

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Sure, no problem. So on the internal transfers of IBR in the North American Flavors, it's really -- it's 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 suspect that -- the bulk of those things to be both in 2019 and 2020 with the slight lag I would say in terms of the severance cost by a quarter or two, but I think the bulk of it's going to be in 2019 and 2020.

Andreas Fibig -- Chairman and Chief Executive Officer

Yeah.

Operator

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

Andreas Fibig -- Chairman and Chief Executive Officer

Thank you very much for all these great questions. We follow-up in the one-on-one calls as usual. And have a great day. It's election day.

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Thank you.

Operator

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

Duration: 63 minutes

Call participants:

Michael DeVeau -- Head of Investor Relations

Andreas Fibig -- Chairman and Chief Executive Officer

Richard O'Leary -- Executive Vice President and Chief Financial Officer

Mark Astrachan -- Stifel Nicolaus -- Analyst

Lauren Lieberman -- Barclays Capital -- Analyst

Faiza Alwy -- Deutsche Bank -- Analyst

Silke Kueck -- J.P.Morgan -- Analyst

John Roberts -- UBS -- Analyst

Adam Samuelson -- Goldman Sachs -- Analyst

Gunther Zechmann -- Bernstein -- Analyst

Jonathan Feeney -- Consumer Edge Research -- Analyst

Patrick Lambert -- Raymond James -- Analyst

More IFF analysis

Transcript powered by AlphaStreet

This article is a transcript of this conference call produced for The Motley Fool. While we strive for our Foolish Best, there may be errors, omissions, or inaccuracies in this transcript. As with all our articles, The Motley Fool does not assume any responsibility for your use of this content, and we strongly encourage you to do your own research, including listening to the call yourself and reading the company's SEC filings. Please see our Terms and Conditions for additional details, including our Obligatory Capitalized Disclaimers of Liability.

Motley Fool Transcribers has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.