ConAgra Brands, Inc.

Good day and welcome to the ConAgra Brands fourth quarter fiscal year 2020 earnings conference call. All participants will be in listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Brian Carney. Please go ahead.

Good morning, everyone. Thanks for joining us. I'll remind you that we will be making some forward-looking statements today. While we are making those statements in good faith, we do not have any guarantee about the results we will achieve. Descriptions of the risk factors are included in the documents we filed with the SEC. Also, we will be discussing some non-GAAP financial measures. References to adjusted items, including organic mess sales, refer to measures that exclude items management beliefs impacts comparability for the period referenced. Please see the earnings release for additional information on our comparability items. The GAAP to non-GAAP reconciliations can be found either in the earnings press release or the earnings slides, both of which can be found in the investor relations section of our website, conagrabrands.com. Finally, we'll be making some references to total ConAgra brands as well as legacy ConAgra brands. References to legacy ConAgra brands refer to measures to exclude any income or expenses associated with the acquired Pinnacle Foods business. With that, I'll turn it over to Sean.

Thanks, Brian. Good morning, everyone, and thank you for joining our fourth quarter fiscal 2020 earnings call. On behalf of ConAgra Brands, I want to start by expressing my heartfelt hope that you and your families are continuing to stay safe and healthy. On today's call, we're going to address our fourth quarter and fiscal 2020 results, our expectations for fiscal 2021, and our perspective on why ConAgra is uniquely positioned to succeed in this new environment. But first, I want to provide some context around what has brought us to this point. Over the past five years, we have been purposefully architecting one of the largest transformations in the food industry. When we embarked on this process, we made major strategic decisions on where to compete and how to win. After decades as a food conglomerate, we transformed into a pure play branded food company with a portfolio focused on competing in three domains, frozen, snacks, and staples. We committed to perpetually reshaping our portfolio for better growth and better margins and established a disciplined approach rooted in a playbook that we call the ConAgra Way. This relentlessly principle-based playbook is filled with repeatable and scalable processes that focus on modernizing our iconic brands through superior food, contemporary packaging, and strong, consistent marketing investment. The ConAgra way is not just a way to build brands, but an operating model that has helped cultivate our agile, motivated, and highly energized culture. As I'll describe in more detail in a moment, fiscal 2020 saw unprecedented performance as we built upon the extraordinary progress we have made over the past five years. We further strengthened our business, including getting Legacy Pinnacle back on track and delivered strong financial results. During the fourth quarter in particular, our transformation was put to the test, and you are seeing the fruits of our labor. Our modernized portfolio and agile culture enabled us to respond to the increased consumer demand driven by COVID-19. At this point, the degree to which demand will return to historical norms is still uncertain, and the timing of the changes in consumer demand is also uncertain. However, we believe that demand will likely remain elevated in the near term, given both consumer perceptions about returning to work and eating outside the home, as well as the fact that consumers are discovering and rediscovering the pleasures, conveniences, and tremendous value propositions of dining at home. Dave will cover the financials in more detail, but I want to let you know that we continue to be on track to deliver our fiscal 2022 algorithm, and we remain committed to achieving our leverage target of 3.5 times to 3.6 times by the end of fiscal 2021. As we'll detail today, we believe our portfolio is optimally positioned to succeed in the new normal. We are focused on making the right investments to ensure that we can continue to safely and reliably meet consumers' needs in fiscal 21 and the longer term. In today's presentation, we will cover our business update, the behavioral shifts we have seen, and how ConAgra is well-positioned to benefit from these shifts and what we expect going forward in terms of our near-term outlook and the opportunity to create long-term value, beginning with our business updates. Before I get into the numbers, I would like to recognize that our extraordinary results have only been possible because of the thousands of hardworking ConAgra team members on the front lines across North America. Here at ConAgra, we talk about infusing a refuse to lose attitude, and never before have we seen our team make such extraordinary efforts. The team's commitment has enabled us to meet the elevated demand from our customers and the communities we serve and deliver the strong results that we are announcing today. I couldn't be more proud of all that they have accomplished. To all of our team members, thank you. Great job all around. During the fourth quarter, we experienced significant growth across our core operating metrics, including 21.5% growth in organic net sales and a 108.3% growth in adjusted EPS. These results helped contribute to our rapid progress in reducing our leverage, and I'm proud to say that we ended the quarter with a net leverage ratio of 4.0 times, down from 4.8 times in the third quarter. As you can see on slide nine, our growth was not confined to one area, but was driven by strong retail sales across our portfolio, spanning Staples, Frozen, and Snacks. Our strong growth in e-commerce continued to accelerate, both on an absolute basis and as a percentage of our overall sales. The work we've done over the past several years to improve our e-commerce capabilities has certainly paid off. As consumers increasingly adopt online grocery shopping, our share of e-commerce sales has steadily increased. Slide 11 highlights that our disciplined approach to innovation is clearly working. Our absolute sales on new innovation introduced this year increased 43% compared to our innovation slate of fiscal 2019. As a reminder, we stated at our initial investor day that our goal was to have 15% of total sales coming from products launched within the past three years. Well, today I'm proud to say that we're consistently performing above that level. In a few minutes, we'll provide you some of the new innovation that we have in store for fiscal 2021 and as we seek to build upon this success. As we've discussed previously, frozen is an increasingly important domain for consumers, especially in today's environment. For the fourth quarter, total ConAgra frozen retail sales grew 26.2% over the last year, with strong growth across each frozen category, including single-serve meals, vegetables, multi-serve meals, and plant-based meat alternatives. And as slide 13 shows, as we grew, we also gained share in the important frozen meals category during the quarter, continuing a trend we've seen for some time now. The ConAgra Way playbook continues to pay off. And while the trends have remained strong, there's even more opportunity, particularly in frozen vegetables. Birdseye faced some unique dynamics in the quarter. As I said earlier, the category remained extremely relevant for consumers. we continue to see robust demand for frozen vegetables and our retail sales up 26.5% during the quarter. Importantly, Birdseye holds the top position in category share and has two times the share of the next branded player. Given the incredible surge in demand we experienced during the fourth quarter and our number one brand position, we hit a ceiling on capacity. Furthermore, we made the decision to temporarily close a plant during the quarter due to COVID-19, which further constrained capacity. The good news is the plant is safely back up and running flat out. In addition, we have made the strategic decision to bring on more external partners to fulfill demand and rebuild inventory. These investments in our supply chain will allow us to efficiently meet the elevated demand we are seeing today and expect to see going forward. This is an important example of that investment, and I will expand on this in a few minutes. Turning to snacks. Recall that our snacks business over-indexes to convenience stores, which saw softer traffic due to COVID-19 during our Q4. Also, the seeds category was impacted by the postponement and in many areas of the country, cancellation of baseball and softball seasons. Baseball and seeds go hand in hand and the loss of these opportunities had a negative impact on the category. Even despite these discrete headwinds, the snacks business delivered a terrific 20.1% year-over-year growth and a 26.4% growth on a two-year basis. And on slide 16, you can see our performance in staples, a category that is more relevant than ever before. Our total staples business grew an incredible 46.3% for the quarter. The six brands to the right are our largest Staples brands, accounting for over 50% of our Staples sales at retail pre-COVID, and each experienced considerable growth in the quarter. These businesses are proving to be a distinct benefit to our portfolio. But while we're pleased with our results for the quarter and the year, We are particularly excited about what the quarter has taught us about the opportunity that lies ahead as consumers have shifted their behaviors and eating habits. Slide 18 shows some of the key ways in which we're seeing consumers' behavior shift in response to COVID-19. Many consumers are rediscovering the enjoyment associated with at-home eating, whether it's making fun baked goods, cooking with the family, or enjoying a movie night with some snacks. Numerous consumers are also discovering new things about food during this time. Many are learning how to truly cook for the first time or discovering they can recreate restaurant favorites at home. We believe that many of these activities have staying power and are likely to persist even after a post-COVID world in whatever new normal we settle into. We also believe our broad and refreshed portfolio of innovative products is best suited to meet consumers' needs as they engage in these food behaviors. And slide 19 shows the strong growth during the quarter across our iconic brands, demonstrating how well-suited our portfolio is to meet these behaviors. Our ability to meet the changing consumer needs is balanced across our three domains – Slide 20 shows how household penetration grew during the quarter in Staples, Snacks, and Frozen. And as we've been able to modernize and innovate our iconic brands, we are attracting younger consumers. Slide 21 shows that new consumers to our brands over-index in the younger millennial and Gen X market segments. Driving new trial is always a key focus for us. The investments that we've made over the past five years in updating our food with bold, on-trend flavors and modern food attributes were premised on the belief that if we can get people to try our food, they will come back for more. And that is exactly what's happening. Slide 22 shows the continuously improving repeat rates from consumers who tried our foods for the first time in March, when the pandemic really started to accelerate in the U.S. The improved repeat rates are broad-based across many of our iconic brands. Importantly, when we attract new triers to our brands, they are coming back to purchase again more often than they did a year ago. It's worth noting that this trend holds true for the big three pinnacle brands, validating our work over the last 12 months. As slide 24 shows, we're not just seeing an increase in repeat buyers, but we're seeing an increase in the frequency at which they return. Customers are not just coming back for more, they're coming back time and time again. In addition to the strength of our trial and repeat results on an absolute basis, we are outperforming our peers in terms of new trial. Let's take Frozen as an example. Slide 25 demonstrates how our Banquet, Healthy Choice, and Marie Callender's brands are leading frozen single-serve peers in new buyer acquisition. And as slide 26 shows, these new frozen buyers are disproportionately coming from the millennial and Gen X market segments, similar to what we see in total ConAgra trends. And like the total ConAgra trends we discussed, not only are we attracting new buyers, but we're seeing higher repeat rates in our frozen segment than our peers. Similarly, Despite the supply constraints we faced that I noted earlier, Bird's Eye continued to lead its category in terms of both new consumers and repeat purchases compared to peers during the quarter. All of these trends have important implications for our value creation opportunity as we look ahead. We believe the dynamic environment in which we find ourselves provides a unique window of opportunity to maintain the current momentum and such that we maximize our long-term value creation potential. To make that possible, we need to make investments focused on doing everything in our power to ensure the physical availability of our products. Instead of choosing to simply accept the elevated demand as transitory and focus on maximizing near-term margins, we have chosen to bolster the long-term earnings potential of our companies. We plan to accomplish this through investing in the key areas you see on this slide, which include increasing capacity, both internal and external, innovation, inventory, e-commerce, and safety. By investing behind today's elevated trial rates, we will build relationships with new consumers and maximize consumer conversion. The lifetime value of these consumers easily justifies these actions. Slide 31 shows some highlights of our fiscal 21 innovation slate. Some of these items began launching in Q4, and we will continue to roll out these new products throughout the year. Overall, we are confident that the investments we are making will produce strong ROIs. They will also maximize our long-term value creation and ultimately shareholder value. Turning to our guidance on slide 32, We know that you would like as much information about our expectations for the year as possible. Given the very dynamic nature of the external environment, forecasting the full year right now is more difficult than normal. As of today, therefore, we're providing Q1 guidance. We hope that when we report Q1 results, we will be in a position to give you a further update on our outlook. While we don't expect the next few months to drive as much change as the past few, we expect to know a lot more by then. Dave's going to go into more depth regarding the guidance, so I'll just hit the highlights here. During the first quarter of fiscal 2021, we expect to deliver organic net sales growth of 10 to 13%, adjusted operating margin of 17 to 17 and a half percent, adjusted EPS of 54 cents to 59 cents. As I said earlier, we remain on track to reach our fiscal 2022 targets outlined on this slide, as well as our deleveraging ratio. With that, I'll turn it over to Dave.

Thanks, Sean, and good morning, everyone. Before I discuss the details of the quarter, I want to take a moment to wish you all well. I hope you and your families are continuing to stay healthy and safe. I'll kick off this portion of the call by pointing out a few highlights for the quarter and the full fiscal year, which are captured on slide 34. Overall, we're very pleased with our performance for Q4 and the fiscal year. As Sean discussed earlier, in the fourth quarter, the COVID-19 pandemic led to unprecedented demand in our retail businesses, which more than offset the softer food service demand. This increased retail demand, combined with our strong execution, enabled us to exceed the most recent full-year fiscal 20 guidance for total company sales, profit, and free cash flow metrics. The key takeaways for Q4 and fiscal 20 are organic net sales increased 21.5% in the fourth quarter and 5.6% for the full year. Adjusted operating margin increased almost 400 basis points for the fourth quarter and over 100 basis points for the full year. Adjusted EPS more than doubled in the fourth quarter and grew 13% for the full year. And adjusted EBITDA increased 21.6% for the full year to just under 2.3 billion, helping to reduce the leverage ratio to 4.0 times at the end of fiscal 20. Let's start with the net sales bridge on slide 35. As you can see, Our 21.5% organic net sales growth in the fourth quarter was driven by 21% volume growth with price mix contributing half a percentage point. Divestitures were at 310 basis point headwind in the quarter. This headwind will diminish sequentially as we continue to anniversary the divestiture closing dates going forward. Barn exchange was a 70 basis point headwind in the quarter with the weakening of the Mexican peso representing about two-thirds of the headwind. This was a bit higher than we were expecting for Q4. Finally, the 53rd week added 810 basis points to the quarter, which was more of a net sales tailwind than we expected due to the elevated COVID-related demand at the end of the quarter, taking total reported net sales growth to plus 25.8% for Q4 versus a year ago. Turning to slide 36, you see our sales summary by segment. In the fourth quarter in the fiscal year, we saw strong growth across our three retail-focused businesses. Our grocery and snack segment reported very strong organic net sales growth of 40.4%. The grocery business proved to be a significant asset as consumers reengaged with convenient, shelf-stable products to facilitate and enhance the at-home eating experience. The refrigerated and frozen segment continued to perform very well in the quarter. The segment reported organic med sales growth in each quarter of this fiscal year and has now had positive organic med sales growth in 11 of the last 12 fiscal quarters. This consistency shows that our modernization efforts have been working and are sustainable. The international segment's 19.8% organic med sales growth was due to strong growth in Canada and better than expected growth in the Mexican and export businesses due to the pandemic. Food service reported an organic net sales decline of 31.5%, which was better than expected as many restaurants continued to serve consumers with curbside pickup, drive-through, or partial capacity. Slide 37 outlines the progress we've made on our Q4 adjusted operating margin versus the prior year. Throughout the quarter, our gross margin expansion levers, such as realized productivity, pricing, mix, and COGS synergies, continued to be effective. We also benefited from volume-driven operating leverage in the quarter, approximating 100 basis points. These tailwinds were partially offset by increased COVID-related costs, dilution from significant food service operating margin declines, and a 170 basis point headwind from inflation, resulting in a net gross margin improvement of approximately 110 basis points. Given the already increased demand for food at home, we chose to pull back a bit on A&P in the quarter. That coupled with increased net sales drove a 100 basis point improvement to operating margin. While adjusted SG&A expense increased 5.7% in Q4 versus a year ago, net sales grew much faster, resulting in a 180 basis point tailwind to operating margins. Turning to slide 38, you can see that our adjusted operating profit was $562 million in the quarter, an increase of 63.5%. Adjusted operating margin increased just below 400 basis points to 17.1%. This chart clearly summarizes the outstanding operating margin improvement during Q4 in our domestic retail and international segments. This was partially offset by our service segment, which has significantly lower operating profit due to the 32% organic net sales decline, unfavorable fixed cost leverage on that sales decline, higher inventory write-offs, and higher input costs. Turning to slide 39, We've summarized the various drivers of adjusted diluted EPS in Q4 versus a year ago. As you can see, our adjusted EPS increased 39 cents in the quarter, representing growth of over 100% from the same quarter last year. While the increase in EPS is primarily driven by the increase in operating profit associated with the net sales and margin increases, we also had higher income from Ardent Mills as COVID-related demand was a net benefit. We also estimate a 5 cent per share benefit from the 53rd week. Slide 40 summarizes the excellent progress we've made on our overall synergy capture from the acquisition of Pinnacle Foods in fiscal year 19. We realized 39 million of incremental synergies during the fourth quarter, bringing our total cumulative synergy capture since the close of the Pinnacle acquisition through the end of fiscal 20 to 184 million. exceeding our fiscal 20 goal of $180 million. Importantly, we remain on track to deliver our total synergy target of $305 million by the end of fiscal 22. As a reminder, we have reinvested $20 million from our synergy realization to date into longer-term business opportunities, such as product and packaging improvements and innovation-related retailer investments. As I stated on our last earnings call, We expected stronger cash flows in Q4 due to the normal seasonality of our business and the expected increase in retail demand from COVID-19. As a result, we updated our free cash flow expectations to be north of $950 million for fiscal 2020. Fiscal 2020 ended with the company generating approximately $1.47 billion of free cash flow, which was well above those revised expectations. Some of this benefit was timing related. Due to the significant increase in sales, we reduced our days of inventory on hand during the quarter, which positively impacted Q4 free cash flow. We expect to build that inventory back as we progress through fiscal 21, which will be a headwind to free cash flow. It is not yet clear as to the exact timing of the fiscal 21 inventory rebuild. Another timing item in Q4 was from federal tax payment deferrals, pushing payments from Q4 into Q1 of fiscal 21. We estimate the combined impact of these timing items on free cash flow between fiscal 20 and fiscal 21 to approximate $350 million. Turning to slide 42, from the close of the Pinnacle acquisition in Q2 fiscal 19 through the end of the fourth quarter in fiscal 20, we've reduced net debt by nearly $2 billion. In the fourth quarter, we reduced gross debt by $271 million and net debt by $725 million, improving our leverage ratio to 4.0 times at the end of Q4, down from 4.8 times at the end of Q3. What's not shown on the slide but is important to note is that we improved the funded status of our pension plans during fiscal 20 by $80 million, with the total underfunded status declining to approximately $50 million. For context, the pension plan's underfunded status were approximately $565 million at the end of fiscal 17, a reduction of over $500 million. This significant improvement was driven by planned pension contributions, lump sum payments to participants, and actual returns on plan assets exceeding expectations. In addition to the significant progress we made towards deleveraging in fiscal 20, we also further strengthened our liquidity position. We obtained a $600 million three-year senior unsecured term loan, which remains undrawn. This facility provides us with additional flexibility to repay debt maturity through fiscal 21, and positions us to refinance current fiscal 21 debt maturities at attractive rates with prepayable debt. As a reminder, we also have a $1.6 billion undrawn revolving credit facility. Given where we finished fiscal 20 from a net debt perspective, and given the continued momentum we expect in Q1 as outlined in our guidance, we are confident in our ability to achieve our targeted net debt to trailing 12 months adjusted EBITDA leverage ratio of 3.5 to 3.6 times by the end of fiscal 21. And importantly, we continue to remain committed to a solid investment grade credit rating. In addition, we continue to remain open to smart divestitures that can help sculpt top-line performance and generate cash flow to accelerate deleveraging. While we continue to evaluate portfolio actions, we will not pursue any divestitures that are not value creating for the long term. As we approach our targeted leverage ratio, we continue to evaluate opportunities to use capital allocation to drive shareholder value. Slide 44 outlines our guidance for the first quarter of fiscal 21 and our fiscal year 22 algorithm. We are expecting the elevated retail demand to continue into Q1 although at a lower rate than Q4, leading us to our Q1 organic net sales expectation of plus 10 to plus 13%. We continue to expect the favorable operating leverage from the elevated volumes in Q1 to offset the additional COVID-related costs. Therefore, we expect adjusted operating margin to be in the range of 17 to 17.5%. These operating margin increases with expected improvement in our below-the-line items lead to an expected EPS range for the first quarter of fiscal 21 of $0.54 to $0.59. As I already mentioned, we remain confident in our ability to hit our leverage ratio target of 3.5 to 3.6 times by the end of fiscal 21. And lastly, we are today reaffirming our fiscal year 22 algorithms. which is outlined on this slide and in the earnings release. Thank you, everyone. That concludes my comments. I'll now pass it back to Sean.

Before we open up for Q&A, I'd like to say a few words about diversity and inclusion at ConAgra. We are deeply saddened by the recent events we've seen unfold across our nation. It's heartbreaking and unacceptable that racism and racial injustices continue to exist around the world. Our goal at ConAgra is to work together in a constructive manner where everyone has a voice and has the opportunity to be heard. D&I is not only part of our value system at ConAgra, it's a business imperative. We serve a wide cross-section of the population, and therefore it makes clear sense our organization represents the consumers we serve. D&I has always been a focus for ConAgra brands, but like many others, we can and will up our game. We are working with an external diversity and inclusion consultancy to help us identify specific opportunities that will have the most impact. We're also hosting listening sessions with employees throughout the organization. Overall, we are determined to be part of the solution, and we look forward to continuing to share reports of our progress along the way. Thank you. Now let's open it up to Q&A.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your touch-tone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. Please limit yourself to one question and one follow-up. At this time, we will pause momentarily to assemble our roster. Our first question comes from Andrew Lazar with Barclays. Please go ahead.

Morning, everybody. Andrew, morning. I wanted to start off, if I could, with the company's reaffirmation of its fiscal 22 targets. Specifically, while I understand certainly the rationale for perhaps not yet providing full fiscal year 21 guidance, the fact that you're comfortable reiterating fiscal 22 EPS means, at least to me, that there should be some good progress in 21 versus 20 to be able to achieve 22 guidance in a reasonable way where I guess, you know, not all of the UPS growth needs to come in 22 versus 21, if you see what I'm saying. So any perspective you can add around that, whether I'm thinking about that in the right way, even though I understand not providing, you know, specific guidance for this fiscal year.

Yeah, sure. Andrew, here's how I think about this. Clearly, Since nobody can accurately predict what will happen with COVID and the range of outcomes is very wide, calling 21 with any accuracy is virtually impossible. But when you step back and you look at where we landed 20, if you look at the momentum of the business, the continued elevated demand, the new triers, the very strong repeat, and synergies remaining on track, you know, our view is that it would be hard to argue that we're not on a path to the 22 targets. And, you know, the real question for us is kind of you think about our prepared remarks today on trial and repeat is whether these dynamics that we're seeing currently offer incremental long-term upside beyond, you know, our 22 algorithm. Obviously, we're not going to comment on a longer-term algorithm, but Certainly, these are positive markers, and we have elected to invest behind that option, for lack of a better phrase.

That's helpful, and that's a good segue into my follow-up, which is certainly appreciate all of the data and the metrics on trial, household penetration, repeat rates, and the like. And, of course, none of us have a crystal ball regarding where consumption and growth rates for many of your key categories ultimately settle out. But in light, I guess, of the metrics you've discussed, I mean, would it be your expectation that for some of your key categories, ConAgra should see an elevated rate of growth versus, let's say, pre-COVID for a more prolonged period of time? You know, the investments that you discussed on the call with respect to incremental capacity and such would seem to support that thought process, but again, wanted to hear it from you and get some clarity. Okay.

Yeah, I think the phrase I used earlier was we see this as a unique window. Something is happening that is above and beyond what our normal marketing programs would do. COVID has introduced this dynamic where, as you saw in the slides earlier, consumers are legitimately rediscovering certain things in their house, whether it's their kitchens, their freezers, being together, and they like it. they're also discovering that some of the things that they thought existed actually have changed quite a bit. So, for example, the quality of frozen food. And as you know, we've spent the last five years dramatically transforming our products. So, you put both of those things together, and there is clearly an element of pleasant surprise that consumers have when it comes to cooking at home. And given the tremendous value proposition of cooking at home and that we are in a recessionary environment, you know, it's entirely plausible that these dynamics persist for some time, especially with, you know, the news changing hourly on COVID and what's happening with positive cases. And we believe that once people try our products, the data supports that we stand a very good chance they'll come back again and again and again. So we are investing today in order to maximize long-term value creation potential to this portfolio and and really sees any option that there is further upside beyond our current algorithm. Thanks so much.

Our next question comes from Ken Goldman with JP Morgan. Please go ahead.

Hi, good morning. Good morning. I think I need to check what was in my smoothie this morning because on slide 31, I thought I saw a unicorn llama. wearing sunglasses on a box of Act 2. I must be hallucinating. You did not.

Llamas are hot. I didn't know that. As is Act 2, Ken. You probably may not have known that either. Act 2 is on fire.

I didn't know that until I saw your slides, so I appreciate that. A couple questions for me if I can, and Dave, you may have answered this when you talked about not being clear on the timing of the inventory rebuild, but In your first quarter organic sales guidance, is there any benefit baked in there from an inventory load by retailers, or is that sort of what you expect consumption to be as well, roughly?

Yeah, so, Kenneth, you saw in Q4, we shifted consumption everywhere except refrigerated and frozen. That was really – driven by bird's eye. In this environment, it is difficult to predict exactly when retailers are going to build inventories. And so, you know, as we put our Q1 guidance together, clearly it started with demand. We tried to make some assumptions on will there be additional shipments to build inventory, particularly in frozen. But again, in this environment, it's difficult to predict just given the significant demand that's still there.

Just a comment on that too, Ken, just more broadly. Retailers are at some point going to rebuild inventories, I would imagine, in all their categories. And if you think of in the last several years, the focus on on-time and full, the focus we've talked about recently with retailers putting more facings against high velocities, retailers hate out-of-stocks. So that is not going to change. And at some point, I would imagine that inventory levels – would revert to kind of historical norms. The question, of course, is when will that happen? Because the way that happens is one of two things or both have to happen. Either demand has to slow or capacity has to increase. We've seen demand slow recently, but it's still at very, very high levels. You also heard me talk about how we are making investments to increase capacity, but there's an upper control limit to how we can do that. So for the foreseeable future, In the near term, we are running flat out, and much of what we make and leaves our plants is going straight through to the consumer. When that slows down and the inventory levels build back is one of the wild cards that's virtually impossible to predict. While I've got you, since you raised Act 2, I want to link your question on Act 2 back to Andrew's question, which is, you know, will any of what we're seeing now persist? Well, interestingly, one of the things that you're seeing now and you're reading about now is movie studios are going to direct release at home on demand. And there's, you know, there are some questions around what's going to happen with movie theaters going forward. As that happens, people will be watching movies as a group at home at a level we probably have not seen before. We're already experiencing this. And the shift in our microwavable popcorn business has been dramatic. reflecting that new behavior. That could very well be a persistent thing. But it may depend in part on what the movie studios ultimately choose to do. But those are the kinds of things that, you know, seem to be logically tracking in our favor. But we need to see how how long they persist.

Okay, that's helpful. Thank you for that. And then for my follow up quickly. we are hearing some rumblings in the trade that maybe retailers are considering getting a little more aggressive on pricing in the back half of calendar 20, just because of the, obviously, the economic environment, and maybe they'll ask some vendors to help out with that. But we're not seeing any hard evidence of this yet. I just wanted to know, from your perspective, are you hearing about any incremental pressure from your customers on that pricing front?

Not really, Ken, at this point. And I would say it's probably a function of two things. Number one, our portfolio, as you know, has a very strong value segment to it. Brands like Banquet and other already offer extremely favorable value that is and historically have proven very resilient in a recessionary environment. The other piece of it, too, is that in many of the categories, you continue to see out of stocks because the throughput is flat out and demand still exceeds that production availability. And therefore, you only exacerbate that problem when you price promote in that type of a category. So I think it'll be category specific. I will point out, though, that in our Q4, we did honor most of our promotional commitments. And you know, that's because those were longstanding commitments. We have a principle of not kind of backing out. But going forward, I would expect our average scan prices may move north a little bit near term because we are likely to see less discounting price promotion activity. However, I wouldn't want you to take that as less retailer investment because it's more likely to be a shift in retailer investments clearly the profile of the retailer spend than the absolute level. So less discounting, more brand building, more new habit creation. To give you a specific example, a good example would be creating loyalty on our frozen brands with millennials by making click and collect behaviors habitual by increasing our e-com spend with retailers. That's a positive constructive alternative in a supply constrained environment to more of a price promotion approach.

Very clear. Thank you.

Our next question comes from David Palmer with Evercore. Please go ahead.

Thanks. Good morning. Good morning, David. That fiscal 22 guidance, it's obviously closer than it's been before, and it's also above consensus, and it might be, hopefully, the first full year without this COVID issue So related to that, what are the key one or two variables that you'll be watching and thinking about that would make the mid to high end of that guidance possible? And I have a follow-up.

Well, I think, you know, the way I framed it up earlier is we have momentum on the business, and we are investing to maintain that momentum. And as we maintain that momentum – You know, we have a very good chance of continuing to bring more households into our portfolio and then converting them to multiple-time repeat purchasers. That's really the logic flow as to how you get, you know, right in the heart of that long-term top-line profile.

I would just add to that just, you know, obviously the synergy number that we have, making sure that that stays on track. We feel good about it. We're on track. We affirmed it again, but making sure we deliver that and managing all our other core productivity programs to be able to offset inflation.

Yeah, that recall got us a long way there on the bottom line side of the long-term algorithm. That, alongside the additional volume and any operating leverage associated with it, is obviously a good thing for our portfolio.

And then just to follow up, the free cash flow conversion of earnings, obviously that relationship of CapEx to DNA, but how do you see that in 22, free cash flow versus that earnings target? Thanks.

I mean, we had guided to greater than 95%, I think, was our guidance. And that, again, shouldn't change. But I did comment that as it relates to fiscal 21, because we finished fiscal 20 with very strong free cash flow, and some of that was timing, right? So it was about $350 million of benefit that we received in Q4 due to basically inventory working capital benefits and some timing on tax payments that's going to flip into fiscal 21. So when you look at 20 versus 21, you're going to see a super high conversion in 20, That's going to come out in 21 for the 350, but 22, we should be back in balance.

Great. Thank you.

Yep. Our next question comes from Nick Modi with RBC. Please go ahead.

Thanks. Good morning, everyone. Just two quick questions for me. You know, when you think about the guidance that you provided for the upcoming quarter, I'm just Curious if you can provide some perspective on how you're thinking about demand. And I ask this only because, you know, obviously in recent weeks or recent days, the case surge has really mounted in very popular states, which I reckon would probably reaccelerate some of the at-home food consumption as a reopening slope. So I just wanted to get perspective on that. And then, Sean, maybe you could just provide some kind of perspective around innovation timing and how things – are shaping up with retail in terms of, you know, the next recess and just kind of how you're thinking about your innovation flow over the next six months or so. Thanks.

Sure. On the first piece, you know, if you go back to the beginning of this thing, Nick, what happened was we had this massive initial surge, right, with pantry stocking and the like. And, you know, that went a long way toward kind of depleting our inventories and really starting to deplete customer inventories. Since then, while we haven't been at the level of that initial surge, demand has been extremely high. So, you know, we've got categories where we've hit the ceiling, where we're just flat out. We've got categories where we've made some early progress and starting to kind of catch up. But, you know, with another surge, that's just going to put more strain on it. So, you know, we are focused. It's interesting that we are typically focused on optimizing demand. And now we're in this environment where where we are really heavily focused on optimizing supply because we're, you know, we're really up against it. And, you know, that has been the case, you know, in the early days of our Q1. And, you know, you can look at the scanner data has been pretty strong. And that's all pre this news of these upticks. So we've got to monitor it. We're doing everything in our power to add additional capacity so that we can you know, protect the upside to the best of our ability. But, you know, it is going to be – it's going to be strained near term, and, you know, we are investing to make sure that that happens. Did you have anything else to add on that point, Dave?

Yeah, just briefly, for organic net sales, we do expect strong growth from the domestic retail businesses. So, as Sean said, and you see in consumption, just to get a little color in the other segments, International is going to be relatively flat. We had a really strong Q4. We don't expect to see the organic net sales growth in Q1 to that level, and then continued declines in food service like we saw in Q4.

Now, with respect to innovation, let me, before I comment on forward-looking innovation, can you just give me a little perspective on Q4? Because recall at Cagney, we had talked about how some of our customer base had moved up their shelf resets in frozen. And I'm sure many of you are curious, you know, what happened with that with respect to COVID hitting? Well, you may be surprised to learn that the vast majority of our customers proceeded as planned in Q4 with their earlier frozen resets. And that's good news. We see our exciting fiscal 21 innovations on the shelf, and they look great. And we are hustling to try to keep them in stock because they're obviously getting good trials. And also, with respect to Q4 innovation in total, which includes the innovations we launched earlier in the year, Q4 innovation was up over 25% versus the prior Q4. And it definitely had some benefit in it versus the prior Q4 of shipments of the following year's innovation coming a little bit earlier, and that's because of those frozen shelf resets that we talked about. But the reality is, despite what you've heard about skew reduction to maximize throughput and things like that. We have continued to have strong, favorable reaction from our retailers on our new innovation, and we continue to feel super strong about the slate we've got out there and expect it to perform well this year. As you've seen in the last few years, every year's innovation has outperformed the prior years for the last several years, and there's no reason to expect this year wouldn't continue, albeit we have a few more wildcards that we are dealing with than in previous years.

Very helpful. Thank you.

Our next question comes from David Driscoll with DB Research. Please go ahead.

Great. Thank you. Good morning. Good morning. I wanted to start off with the grocery and snacks and the frozen and refrigerated. Slide 9, Sean, you've got nice metrics here, but what I want to get your impression of is you've made a comment repeatedly for years that your expectation is that frozen is going to be just a critical area of growth in the grocery store. When we just look at these 4Q results, obviously heavily affected by COVID, right, the staples piece is growing much, much faster than frozen here. There's that initial stock-up that's going on in there. What I was hoping you could do is just explain how you thought frozen would grow relative to that of staples on a go-forward basis. Should frozen be half as much as staples, as we see almost in this graph, or should frozen on a relative basis begin to be much stronger after we've kind of cleared through that first stock-up that occurred in March, April?

Well, you know, the slide nine that you referred to is actually pretty consistent with what I would expect having been in and around Staples products for a lot of my career. But whenever you see any kind of crisis hit, people will load their dry goods pantry, which has a tremendous amount of holding power. And actually, you tend to see more of a pantry load dynamic there because of the holding power of the pantry relative to the holding power of a freezer. Most freezers are actually incredibly limited in space, and that's one of the governors that you see on frozen. Interestingly, one of the things we didn't put in the deck is the sales rate of standalone frozen freezers. If you had gone to a Home Depot or a Best Buy in the last few months in search of a freezer, you would not have been able to find one. So clearly, consumers are recognizing there's a limit to what they can fit in their freezer. I know in my household, we were frustrated because you'd go to the store on the day shipments came and you want to buy stuff, but you had nowhere to put it because your freezer was full. So that's a governor you have there versus Staples. That said, while I might expect the two to converge more going forward, Staples, what you see in the Staples space is a super value proposition. So Chef Boyardee, and this may be more of a function of what does the consumer's household balance sheet look like going forward? How long does the recessionary environment persist? items like Chef are a tremendous value proposition and that kind of environment should continue to perform well. Furthermore, if people are learning to cook again and cooking from scratch, a lot of the staples products we have like Pam Cooking Spray or our beans business or our tomato business ought to remain elevated. And these are the kinds of things you can use in multiple recipes throughout the week that are different recipes as opposed to eating the same thing again and again. So, Yeah, I'm not going to try to forecast how these will perform relative to one another. The key point we wanted to make today is that all three of our consumer domains have been elevated and are enjoying this notion of rediscovery and discovery that I talked about.

That's helpful. Dave, I just wanted to follow up on SG&A. In the fourth quarter, as a percent of sales, the SG&A was down significantly. versus kind of what the trend rate that we had seen in the prior few quarters, what do you expect on a go-forward basis? Can you get that SG&A as a percent of sales to continue to be reduced for the next bunch of quarters? Any color there? I mean, I know you're not giving explicit guidance, but just any color on how you're thinking about SG&A as a percent of sales, very helpful.

Sure, Dave. So at a high level, obviously a lot of the synergy that we're getting from Pinnacle is SG&A. In fact, more than half of the synergy to date has been from SG&A. More will come in cost of goods sold moving forward. So that is starting to work its way in quarter by quarter into our actual results. So as I look to Q1, because we gave specific margin guidance in Q1, you know, a big part of the operating margin improvement versus the prior year is actually because of the leverage on SG&A. So the 17 to 17.5% a good amount of that improvement is the SG&A leverage. Gross margin, there's a lot of puts and takes with all the different costs, so there'd be more moderate improvement there, but it's mostly SG&A. So we start seeing that leverage in a bigger way starting in Q1, and you'll continue to see leverage going forward. I'm not going to give you specific numbers, but that's the color for Q1 for SG&A.

But the leverage does continue even if you don't give exact numbers. You're confident that the leverage continues in the following quarters?

Yeah, obviously it depends on sales, right? But, yeah, we took the SG&A cost out, and we're going to continue to see that benefit. Thank you.

Our next question comes from Robert Moscow with Credit Suite. Please go ahead.

Thanks for the question. Actually, a couple. I think Talking to investors, a lot of the controversy around ConAgra does still revolve around this long-term EPS range because it is so much higher than your fiscal 20 results. And I was wondering, in August, when your proxy gets published, do you think you'll get a peek at the three-year cycle for fiscal 20 to fiscal 22 and the EPS target that's in there for executive compensation? Because I think that would give people a better sense of how management's being incentivized in relation to the target that you've given us. I think that would be the first cycle that we'll get to see how executive comp is related to that range. Is that a fair assessment?

Yeah, Rob, the way I'd respond to that is big picture, our board has a very strong pay-for-performance philosophy. As such, the targets in our incentive programs are anchored in our annual and long-term financial plans and consistent with the guidance that we provide to investors. So, with respect to the 2020 proxy, we expect our disclosure to mirror that of past years. We will provide details on the fiscal 20 to 22 program overall, including the growth taggers that are in the program, and you'll see that Management and shareholder interests are aligned with respect to the 22 numbers.

Great. Okay. And a quick follow-up. I remember last year there was a lot of inventory deloading in the frozen section related to the shelf resets. Given what you've said now about the resets being done, is there going to be any kind of inventory reload in the first quarter? And is that part of your guidance? Or is your guidance really related to consumption and consumption will reflect shipment?

You know, I think near term, Rob, we're playing catch up. You know, we're trying to keep up with demand. Orders, you know, have continued to come in and, you know, and inventories have been depleted. And it varies, obviously, by category. So, As long as demand remains elevated, it's more of a flow through to consumption and pantries, I think, than a rebuilding an inventory. Now, that is going to vary by category because you don't see the same level of pull category by category. So you can almost model out categories with kind of more muted pull are probably rebuilding inventories, categories where pull remains extremely strong. we're probably continuing to run flat out and scanning a lot of what we're producing.

Got it. Great. Thank you.

Our next question comes from Brian Spillane with Bank of America. Please go ahead.

Hi. Good morning, everyone. Good morning, Brian. So just two quick ones, and I might have missed it, but Dave, capital spending for fiscal 21 given – I guess, what some of the commentary that's been made about investment, even if you can't give a pinpoint number directionally, would it be close to what it's been historically, or is it going to be higher than normal this year?

No, Brian, I did not mention it specifically, but as we look to fiscal 21, based on the investments that Sean outlined, particularly investments to shore up capacity and supply, we will be increasing our capex. Right now, our estimate is that we'd be about $100 million above where we landed fiscal 20 in terms of CapEx. Okay, great. Thanks.

And then maybe, Sean, as a follow-up to Rob Moscow's question about incentive comp, have you made any adjustments maybe with frontline employees or just organizationally to focus more on being in stock, keeping up with demand, I think, as you phrased it before, versus having to you know, previously really trying to stimulate demand. So I'm just trying to understand if you've had to kind of change the incentive mix a little bit to just ensure that you're going to be, you know, get these CapEx projects happening on time and really, you know, improving service levels.

Well, our short-term, for our salaried employees, our short-term incentives is really a function of sales, of profit and cash flow and, you know, employees are incentivized very clearly to maximize those. In the last quarter, the real focus area for us has been in our facilities. It's been in ensuring the health and safety of our employees because we've got to keep our plants running. And then also honoring those employees for being such heroes during this intense COVID period on the front lines. And we have made investments behind our front line employees to honor them accordingly. So, you know, that's really what's been in place. And as I mentioned earlier, I couldn't be more pleased with just this incredible refuse to lose attitude that we've seen, especially on the front line. Thank you.

This concludes our question and answer session. I would like to turn the conference back over to Brian Carney for any closing remarks.

Great, thank you. So as a reminder, this call has been recorded and will be archived on the web as detailed in our press release. The IR team is available for any follow-up discussions anyone may want. So thank you for your interest in ConAgra Brands.

The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.