ConAgra Brands, Inc.

Good morning, everyone, and welcome to the ConAgra Brands Fiscal 21 First Quarter Earnings Conference Call. All participants will be in a 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. To ask a question, you may press star and then one. To withdraw your questions, you may press star and two. Please also note today's event is being recorded. At this time, I'd like to turn the conference call over to Brian Carney, Investor Relations. Sir, 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 net sales, refer to measures that exclude items management believes impact the comparability for the period referenced. Please see the earnings release for additional information on our comparability items. The gap to non-gap reconciliations can be found in either 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, Please note that we expect to report our second quarter earnings in early January this fiscal year. We will issue a press release with the specific details later this calendar year.

With that, I'll turn it over to Sean. Thanks, Brian. Good morning, everyone, and thank you for joining our first quarter fiscal 2021 earnings call. I hope that you and your families are continuing to stay safe and healthy. Today, I'm going to unpack the quarter for you and then share our perspective on how the evolving consumer environment is shaping longer-term demand for our products. So let's get started. Building upon our impressive momentum at the end of last year, we're off to a strong start in Q1. We exceeded our expectations and saw broad-based strength across the portfolio. As we will detail today, we believe our business is well positioned to continue to deliver strong results, both in the near and long-term. The transformation we've undertaken over the past five years by following our ConAgraWay playbook to perpetually reshape our portfolio and capabilities for better growth and better margins has proven critical in enabling us to respond to the changing dynamics in the current environment. Our modernized portfolio, commitment to innovate, and agile culture have allowed us to respond to the increased consumer demand and changing preferences today and position us to deliver meaningful growth into the future. Our robust performance has also helped us to get ahead of our expected deleveraging cadence. As Dave will detail later, we expect to reach our net leverage ratio target of 3.5 times to 3.6 times by the third quarter of fiscal 2021. Paying down debt has been a capital allocation priority in recent quarters, But you also know that we are committed long-term to a balanced capital allocation approach. Given our progress on deleveraging, and because we remain confident in the long-term outlook for our business, our board has increased our quarterly dividend by 29% to $1.10 on an annualized basis. And, as I'll discuss more, we also continue to invest in the business. Our performance reflects the great work our team has accomplished during these challenging times. In particular, I want to recognize the thousands of hardworking ConAgra team members on the front lines. Your extraordinary efforts in simultaneously keeping employees safe and maximizing our supply have made it possible for us to continue to meet the needs of our communities, customers, and consumers, and I couldn't be prouder of them. Let's get into the business update. As the table on slide seven shows, Our execution in the quarter enabled us to exceed our expectations across the board. We delivered organic net sales growth of 15%, adjusted operating margins of 20.2%, and adjusted EPS of 70 cents. We ended the quarter with a net leverage ratio of 3.7 times compared to 4.0 times at the end of Q4. During the first quarter, we continued to drive significant growth in each of our three retail segments. Total ConAgra retail sales grew 12.9% year over year, driven by double-digit growth in snacks, frozen, and staples. Importantly, our higher margin, non-promoted volume contributed significantly to this growth. Not only did we grow at a great rate, we expanded our presence with consumers and gained share. We increased household penetration by 100 basis points and category share by 30 basis points. Slide 9 demonstrates how our investments in e-commerce over the last several years continue to yield results in the quarter. Strengthening our e-commerce capabilities has been an area of focus for us, and we're seeing the fruits of our labor. Our e-commerce retail sales have recently demonstrated impressive growth, and over the past five quarters have consistently outpaced total industry e-commerce growth. The first quarter also saw continued strong innovation momentum, Our steadfast commitment to the ConAgra Way playbook has enabled us to consistently exceed our goal of having 15% of total retail sales each year come from products launched within the past three years. And of course, as our overall sales continue to increase, this percentage of sales represents a larger absolute dollar amount. Even during these challenging times, we remain committed to delivering innovation to our customers and consumers. Our growth is rooted in innovation, and we are driving category performance. Slide 11 highlights two examples in big growth areas, frozen and snacks. Let's take a look at the frozen single-serve meals category. As compared to our fiscal 17, this category experienced a $575 million increase in retail sales during the 52-week period ended August 30th. Our innovation in frozen single-serve meals over the past three years is unmistakable. We've generated almost 100% of that category's growth over the same period. We've applied this proven strategy to our snacks portfolio and are seeing similar category-driving growth. Slim Jim has consistently gained share and has the top position in dollar sales for meat snack innovation. And to top it all off, our new Slim Jim Savage Thick has the number one velocity in all meat snacks. Given this track record, our innovation success has earned tremendous credibility with our customers. And our most recent slate of innovation is enabling us to further enhance that credibility. Slide 12 shows some of the highlights, offerings packed with modern food attributes and bold on-trend flavors. Some of these began launching in Q4 and were pleased with their early in-market performance. We will continue to roll these out throughout the year. We're also excited about the innovation shown here on slide 13. We're using our broad portfolio to extend high-growth brands beyond their legacy forms. By leveraging our existing capabilities, we're extending Gardein and Healthy Choice into attractive categories with large profit pools, soups, jerky, and salad dressing. And these two success stories are even going one step further. co-branding single-serve frozen meals. Slide 14 shows some examples of what else we have on deck for the balance of fiscal 21. Clearly, we are not slowing down on our innovation agenda. I'd now like to take a moment to touch on recent performance in our three domestic retail domains, starting with frozen. Slide 15 shows our impressive performance in total frozen during the quarter. This business is over $5 billion in annual retail sales and it grew 13.5% in the quarter, with double-digit growth in single-serve meals, multi-serve meals, and plant-based meat alternatives. With respect to frozen vegetables, recall that last quarter we were supply-constrained in bird's eye. Demand was in excess of our available capacity, exacerbated by a brief plant shutdown to keep our employees safe and healthy. I'm pleased to report that during the first quarter, our bird's eye plants were at full capacity And as the quarter progressed, we qualified external manufacturers to supplement our capabilities. While our consumption in frozen vegetables grew 0.7% in the quarter, our shipments grew at a much faster rate as retailers started rebuilding inventories. Sitting here today, Birdseye, which holds the number one position in the category and has over twice the category share compared to the closest branded competitor, is very well positioned as we enter the important holiday season. Turning to snacks, the snacks business delivered another impressive quarter of growth, 14.6% versus the previous year and 22.7% on a two-year basis. In meat snacks, we are working to maintain our growth and capabilities by investing in expanded capacity at our Troy, Ohio plant. To be clear, this investment is not a reaction to the near-term environment, but a decision made pre-COVID and rooted in our longer-term outlook for the business. Our meaningful Staples results, as shown on slide 17, demonstrate that this domain remains extremely relevant. Our Staples business grew retail sales 11.6% year over year, with strong performance across our portfolio of iconic brands. I'd now like to turn to our perspective on the evolving environment and what we see going forward. While we hope and expect that the most acute and severe impact of COVID-19 is behind us. We believe that recent shifts in consumer behavior, coupled with macroeconomic trends, suggest that at-home eating will remain elevated for some time. We also believe that we are very well positioned to capitalize on this opportunity. I'll unpack these points a bit more, but we see consumers experiencing and making lifestyle changes driven by COVID-19 that suggest the arrival of a sustained shift in eating habits. We also know from prior recessions that an economic downturn typically leads to a permanent increase in at-home eating, even when economic growth returns. These consumer trends affect everyone in our industry, but we believe that ConAgra is uniquely positioned to benefit substantially from this environment. Our portfolio is well developed in the eating occasions that have seen the most significant and sustained shift to at-home eating, and our portfolio delivers against the cooking behaviors that consumers are adopting. We're attracting more new buyers than our peers, and consumers are choosing to stick with ConAgra and come back for more. With our proven track record of innovation, we believe we will continue to attract new consumers and deliver food that meets their evolving needs. Let's drill down on some of the proof points that underpin these expectations, starting with why we believe at-home eating will remain elevated. As you know, the vast majority of our sales are sourced from the United States, and unfortunately, the U.S. economy has been greatly affected by the pandemic. Unemployment in the U.S. remains high, the pace of new job growth is decelerating, and many U.S. households have limited savings. To understand how this recession may impact Americans' eating habits going forward, we looked back at how behavior changed in the wake of the last recession. Slide 20 shows the percent of eating occasions that have been sourced at home in the U.S. since 2007. As you can see, the 2008 recession was a catalyst for a 200 basis point increase in at-home eating occasions from 80% to 82% over the course of four years. Importantly, that rate held steady long after the recession ended, even when the economy returned to growth and employment hit record levels. With the COVID-19 disruption, we've already seen another 200 basis point increase to 84% in just the four months from March to June 2020. History is a guide. The increased percentage of at-home eating occasions should persist, even when economic growth returns. And, as slide 21 shows, as consumers are saving money in their food budgets, they are using their dollars and time differently. They're preparing to be at home for an extended period of time. Consumers are investing in their houses, their home gyms, their entertainment systems, and their kitchens. In the chart on the right, you can see that consumers are also spending more time cooking. Data is showing that consumers are tackling more complex meals. In other words, they're upgrading their culinary skills. We don't expect these upgrades to homes, at-home entertainment, kitchens, and cooking skills to go away anytime soon. This all leads to one conclusion, more time at home, and as a result, more consumption of food at home. The pivot to remote work is also a meaningful development. Significant workplace disruption we've experienced over the past several months has given way to a new normal remote workforce. The chart on the left of slide 22 shows how even baseline projections see office vacancies remaining elevated over the coming years. Furthermore, on the right, we can see how remote workforce adoption has significantly increased. More working from home means more lunches eaten at home and real opportunity for a portfolio like ours. And while we're well past the initial spike of stock-up behavior when COVID first emerged in the U.S. in March, at-home eating occasions have remained elevated, even increasing over the most recent two weeks of data. As the chart on slide 23 shows, we're continuing to see a double-digit percent increase in total industry sales at retail versus the prior year. During our first quarter, food and beverage industry sales rose an impressive 14%. While we don't know exactly how these growth rates will trend going forward, we do know that we're entering the cold and flu season and that winter weather could limit the appeal of outdoor restaurant dining in many parts of the country. All of these factors give us reason to believe that the elevated levels of at-home eating should persist. We also believe that ConAgra is uniquely positioned to benefit. Let's start with slide 24. Total at-home meals have increased almost 6% in the three months ending July 2020. That's almost 7 billion meals. When you take a closer look at this growth by day part, the increases in meals and dollars are skewing toward lunch and dinner. And as you know, ConAgra is well-developed in both of these day parts. The chart on the right shows that, in fact, our portfolio over-indexes in dinner and is almost at parity for lunch compared to the overall mix. And whether a consumer wants to cook from scratch to put those newly developed culinary skills to the test or heat and eat, ConAgra's diverse portfolio can deliver a solution for every need in every day part. So we are very well positioned for when and how people are eating more at home. On slide 25, you can see the benefits. Over 80% of our categories have been growing in line or faster than the industry. And, as I mentioned earlier, we've been gaining share within those categories. This is further demonstrated by slide 26, which shows we're attracting new buyers at a faster rate than any of our peers. Slide 27 shows that the buyers we're attracting over-indexed to the coveted millennial Gen X generations. As you might expect, we're seeing substantial millennial expansion in frozen, but just as importantly, we're seeing their expansion in snacks and staples as well. Because of this, we're creating the groundwork for future growth above the category and above our peers. We're attracting younger generations and building superior consumer lifetime value. And not only are more consumers trying our product, they're liking them and coming back for more. Take a look at the chart on slide 28. New trier repeat rates for our consumers whose first trial was in March or April have remained steady at above 50%. That stickiness can be seen further in the chart on slide 29. Not only are repeat rates sustaining, but the depth of repeat is improving. More consumers are choosing to repurchase a ConAgra product two or more times compared to where we were a year ago. When you compare us to our peers, we are at the front of the pack. Slide 30 shows that we rank above nearly all of our peers in the total percentage of repeat purchasers, demonstrating the improved stickiness of our brand loyalty. So in summary, executing our disciplined ConAgraWay playbook over the last five years has grown our portfolio, grown our capabilities, and positioned us to meet the evolving needs of our consumers while earning the confidence of our customers. We believe that at-home eating will remain elevated for some time as consumers seek affordable and convenient meals that meet the needs of their new normal. And we are confident that ConAgra is well-positioned to see sustained benefit. With that, I'll turn it over to Dave.

Thanks, Sean, and good morning, everyone. I'll walk through our first quarter financial performance and outlook before opening the line for questions. Let's look at the P&L highlights for the quarter, which are captured on slide 33. As Sean discussed, we started fiscal 21 on a strong note. Elevated demand across our retail segments, coupled with effective execution, enabled us to exceed expectations for net sales, profitability, free cash flow, and deleveraging. Compared to the same period a year ago, net sales and organic net sales for the first quarter were up 12.1 and 15% respectively. Adjusted gross margin increased 244 basis points to 30.7%. Adjusted operating margin increased 450 basis points versus the same period a year ago, reaching 20.2% for the quarter. Adjusted EBITDA increased 34.5% to 647 million. And adjusted EPS increased 62.8% to 70 cents. exceeding our first quarter guidance. Slide 34 outlines the drivers of our first quarter net sales versus the same period a year ago. As you can see, the 15% increase in organic net sales was driven by a double-digit increase in volume as well as favorable impacts from price mix. Favorable pricing and sales mix both contributed to the growth in the quarter. Price mix also included a benefit of approximately 70 basis points from a favorable change in estimate associated with a prior period trade expense accrual. The organic net sales increase more than offset headwinds from divestitures and foreign exchange. As we pointed out in the past, the impact from divestitures continues to diminish sequentially as we anniversary the divestiture closing dates. Including the impact of the recently announced divestiture of HK Anderson, the full year impact of divestitures is expected to approximate 100 basis points. Turning to slide 35, you'll find a summary of net sales by segment for the first quarter. We saw continued strong growth in each of the company's three retail segments on both a reported and organic basis. The net sales increase was primarily driven by consumers increasing their at-home food consumption as a result of the COVID-19 pandemic, which benefited our three retail segments, but negatively impacted the food service segment. In the quarter, our grocery and snack segment reported organic net sales growth of 20.7%. This segment benefited as consumers continued to purchase convenient, shelf-stable products to enhance their at-home eating experience. Segment growth in shipments this quarter exceeded growth in consumption as retailers began rebuilding inventories on brands such as Hunt's, Pam, Duncan Hines, and Vlasic. The refrigerated and frozen segment also experienced strong growth in the quarter. The 19% increase in organic net sales is a testament to our innovation and modernization efforts and the role our portfolio plays in meeting the needs of today's consumers. This segment also experienced shipment growth greater than consumption growth in the quarter, primarily as a result of bird's eye. As Sean mentioned, we increased capacity in frozen vegetables during the quarter, enabling retailers to start replenishing their inventories. The international segment's 13.1% organic net sales growth came in stronger than we forecasted, with each of the segment's regions posting growth higher than projected, primarily from COVID-related demand. Our food service segment reported a 20.3% organic net sales decline, primarily driven by a volume decrease of 24.2% due to lower restaurant traffic. This marks an improvement from last quarter as some restaurant traffic began to rebound. Slide 36 outlines the drivers of the 450 basis points of adjusted operating margin expansion in the first quarter. Our margin levers, such as realized productivity, price mix, operating leverage, and synergies drove a 610 basis point increase in the quarter. The specific drivers of this increase are Supply chain realized productivity of 290 basis points, price mix of 250 basis points, cost of goods sold synergy of 90 basis points, and operating leverage of 60 basis points. Also, the net impact of divestitures, FX, and other items negatively impacted operating margin by 80 basis points. Cost of goods sold inflation was approximately 3.1% in the quarter, which negatively impacted gross margin by 220 basis points. We incurred approximately $34 million in cost of goods sold directly related to our COVID-19 response, which negatively impacted gross margin by 150 basis points. Our A&P rate was favorable by 20 basis points in the quarter due to the favorable sales leverage, as on a dollar basis, we spent approximately the same amount as last year's first quarter. Finally, Our SG&A rate was favorable by 190 basis points. Approximately 160 basis points was related to the combination of fixed cost leverage on higher net sales and reduced spending related to COVID-19 as employees worked from home and did not travel. The remaining 30 basis point improvement was driven by synergies, partially offset by normal SG&A inflation and increases in stock-based compensation expense. We have certainly seen a margin benefit driven by the current environment, but it's also clear to see that we have made great progress in proving the underlying operating margin of the business. Slide 37 shows our adjusted operating profit and margin summary by segment in the first quarter. Our total company adjusted operating profit increased 44.2% to $541 million in the quarter. Importantly, All four of our segments reported margin expansion in the quarter. These results demonstrate the tremendous operating margin improvement in our domestic retail and international segments. While the food service segment saw a decline in operating profit dollars, the segment reported a 28 basis point increase in adjusted operating margin. This was aided by lower inventory write-offs and less trade spending in the quarter. Slide 38 highlights that our adjusted EPS increased 62.8% to 70 cents in the quarter, primarily driven by the increase in adjusted operating profit associated with the net sales increase and margin expansion. Turning to slide 39, you will see a summary of our synergy capture since the close of the Pinnacle Foods acquisition in fiscal 19. After exceeding our fiscal 20 goal of 180 million, we have continued our strong synergy progress in the beginning of fiscal 21. In Q1, We captured an incremental $35 million in savings, bringing total cumulative synergies through the end of the first quarter to $219 million. To date, the majority of our synergies have been in SG&A, and we expect the majority of the remaining synergies to be reflected in cost of goods sold. We're very pleased with our progress and are confident that we will continue to deliver on our commitments. Slide 40 shows the strong progress we've made to improve our balance sheet and cash flow. From the close of the Pinnacle acquisition in the second quarter of fiscal 19 through the end of the first quarter of fiscal 21, we have reduced total gross debt by more than $1.9 billion, resulting in total net debt of $9.2 billion. As of the end of the first quarter, our net leverage ratio was 3.7 times, down from four times at the end of the fourth quarter of fiscal 20. Given our momentum, we are confident in our ability to achieve our targeted leverage ratio of 3.5 to 3.6 times by the third quarter of fiscal 21. In addition, we remain committed to solid investment-grade credit ratings. Also, our cash flow remains very strong. In the first quarter, our cash flow from operating activities increased 78 million, or 37%, compared to the prior year. At the same time, we increased our investment in the business by increasing CapEx by 39 million, or 36%. Supply chain investments in cost savings and capacity projects made up most of our year-over-year spend as we continue to optimize our network and drive brand growth. This has led to our free cash flow increasing 39 million, 38%, compared to last year's first quarter. As a result of our strong cash flows and progress reducing debt, we have greater financial flexibility to both invest in the business and return cash to shareholders. This, coupled with consistent, successful execution of our strategic priorities and our ongoing confidence in the long-term strength of the business, led our board to approve a 29% increase in the quarterly dividend to 27.5 cents per share or $1.10 per share on an annualized basis. This action is consistent with our commitment to maintaining a balanced approach to capital allocation. As we return cash to shareholders, we are also increasing our investments in the business as evidenced by the 36% increase in Q1 CapEx I just mentioned. Turning to slide 42, you will find a summary of our outlook. As you've heard both Sean and me share this morning, we believe there is much to look forward to in the quarters ahead. However, the dynamics surrounding COVID-19 continue to make forecasting with specificity a challenge. What we can share is that we anticipate a continuation of elevated retail demand throughout the second quarter. We are therefore providing second quarter guidance as noted in the release and on this slide. We expect organic net sales growth of plus six to plus 8% in the second quarter. We expect adjusted operating margin in the second quarter to be in the range of 18 to 18 and a half percent. Relative to Q1 operating margin, we expect less operating leverage benefit and we expect to increase our marketing support both above the line and below the line. We believe there are opportunities to increase brand building investments where capacity permits. Given these operating margin factors, along with expected improvement in below the line items, We expect to deliver second quarter adjusted diluted EPS from continuing operations in the range of 70 to 74 cents. We expect to reach our leverage target of 3.5 to 3.6 times by the third quarter of this fiscal year. Of course, our ability to achieve these targets assumes continued performance end to end by our supply chain. Finally, we are reaffirming all of our fiscal 22 targets this morning. Note that the impact of the HK Anderson divestiture is small enough that we will not be adjusting our fiscal 22 EPS targets for the divestiture. Thanks for listening, everyone. That concludes my remarks. I'll now pass it to the operator to open it up for questions.

Ladies and gentlemen, at this time, we'll begin the question and answer session. To ask a question, you may press star and then 1 using a touch-tone telephone. If you wish to withdraw your question, you may press star and two. If you are using a speakerphone, we do ask that you please pick up the handset before pressing the keys to ensure the best sound quality. Once again, that is star and then one to ask a question. Our first question today comes from Andrew Lazar from Barclays. Please go ahead with your question.

Good morning, everybody. Morning. Hey, Andrew. Hey there. I guess first off, just so I get some clarity on this, you talked about obviously in some of your key segments, shipments exceeding what we would have expected around takeaway given some rebuilding of retailer inventory. Can you tell us about how much that might have benefited overall organic sales growth in the quarter? And I assume that's really just retailers getting back to more normalized levels as opposed to volume that you know, needs to sort of come out of future quarters.

Yeah, Andrew, let me take that as Dave. Yes, we came out at Q4. The retailer inventory levels were below historic levels. We talked about that specifically for Zai, but we also saw it in several of our grocery brands as well. So the shipments above consumption in the first quarter were clearly just getting the inventory levels back to the days of supply that they're looking for. As we sit here, as we ended Q1 and we sit here today, retailer days of supply are still below historic levels. So when you look at shipping above consumption, it wasn't now we're sitting here with heavy retailer inventories. We're still below historic averages. So it was a catch-up from where inventory levels were at the end of Q4.

And just as part of that, would you expect the 6% to 8% organic sales growth in fiscal 2Q to be all in more in keeping with what consumption trends are or above what you anticipate consumption will be because of some continued, you know, retailer inventory built? And then I've just got a quick follow-up.

Yeah, right now we're forecasting that shipments will pretty much be in line with consumption for Q2. Okay.

And then you mentioned just recently stepping up marketing span both above and below the line. you know, where you have the capacity to do so to sustain some of these new consumers. I guess how do we think about maybe the magnitude of that step up as it relates to how much of the fiscal 1Q sort of earnings upside could well flow through to the full year? I guess I'm asking how much, you know, the company is willing to or it feels makes sense to commit to really stepping up marketing because it would seem a small price to pay in the end if you can hold on to some of these consumers longer term.

Yeah, Andrew, let me – give you some big picture perspective on how we think about this, and then we can talk a little bit about the year-to-go period, because I think it's important that you all understand what we intend to do, what we do not intend to do, and why. First off, before we ever contemplate an increase in our brand-building investments, two simple things have to be in place. One, the capacity to supply new demand generation, and two, evidence of a strong ROI. Now, on this latter ROI point, there are two types of investments where the evidence is quite strong regarding ROI. Investments to increase consumer awareness around our new innovations and investments to further build out our e-commerce business. So on new innovation, awareness, think of it this way, it's the precursor to trial. We do great at trial and at repeat, but you've got to get that awareness in place. So as you saw in the data, our repeat performance has been stepped up. On e-commerce, we've learned that what we get out of it is directly a function of what we put into it. We've also learned, though, that speed in supporting the business is very important because it enables you to build a beachhead in the e-tailing universe that helps us fuel future purchases. So if we were to seed this opportunity, someone else would build that beachhead. But overall, I'd say We believe that supporting innovation and e-commerce undoubtedly maximizes long-term value because it maximizes consumer penetration, which then converts to loyalty. But let's keep things in perspective about the level of support we're talking about. As you know, our A&P is very hardworking, but it's also very, very efficient. And the rate has hovered around 2% over the last year or so, working synergistically with our retailer investments. So, That's been our playbook. It works, and we will continue to do it. And this coming quarter, the spend is likely to be a bit higher than Q1 because we have more capacity and because it's usually higher in Q2 than Q1 because it's the holiday season. And as the stores get crowded around the holidays, we want to win at the point of purchase. And we know that if we create awareness, the rest will take care of itself, which sets up a good back half and a good fiscal 22. In terms of flow through to the year, as you know, we're not guiding to the year. And the reason for that today is the same as the reason a year ago, which is we're trying to manage this unpredictable environment quarter to quarter. We don't know what the back half will give us. So the key thing for us right now is keeping people healthy and keeping our plants running. Because if we can't do that, obviously it puts a limit on our ability to drive revenue, which then converts to profit. You know, we're just navigating this quarter by quarter right now.

Okay, thanks very much. Thank you.

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

Hi, good morning. I know it's difficult to be precise, but is there a way to think about what your operating margin might have been if not for the trade load and the accounting catch-up for 4Q's promo expenses? You know, Dave, I appreciate you mentioned that operating leverage added only 60 basis points to the margin this quarter. It's a bit less than I might have expected, but maybe your mix was also helped by the load, or maybe you're just using so many co-packers that the benefits of the margin from higher volume just wasn't that big. I'm just trying to get a sense for, you know, what the sort of underlying operating margin was, excluding some of those maybe non-recurring benefits.

Yeah, Ken, let me, to your point, we're not going to get precise with that. On my remarks, I tried to unpack it in a lot of detail so you could understand all the different components and drivers. And so you should be able to say, okay, this is more of a COVID-related type item. For example, we specifically quantified our COVID-related expenses. So you can look at that. What I will say is that You know, our realized productivity programs and supply chain are tracking very well. Our synergy capture, which is a big part of our margin improvement, is on track and continues to be on track, and we're confident that will continue. So when you look at those items and you compare to inflation and you strip it out at a high level, you know, we're seeing improvement in core operating margin performance as we expected to pre-COVID. I'm not going to give you an exact number, but, you know, generally I feel like we're on track. And the pinnacle synergies was an important part of that improvement.

Yeah, Ken and Sean, let me just recharacterize, too, the shipment perspective from Q1, because I want you to think a little differently than some of the language you used. I would characterize it as a partial replenishment. We exited Q4 with retailer inventories highly depleted. way below kind of normalized levels in terms of stock on hand. That began to rebuild in the quarter, which obviously will lead to shipments being ahead of consumption. But the net takeaway in terms of absolute status of inventories in trade right now is it's still later than it is historically in terms of days on hand. That's both because not every single category is flush with capacity on the supply side, but also because the takeaway is higher. So when the pull-through is more, your days on hand drop. So that's how I want you guys to think about the retail inventory dynamic.

It makes sense. Thank you. And then a quick follow-up. Can you update us, Sean, on how the Bird's Eye brand in particular is doing? You're doing so well with so many of your categories and brands. I don't mean to pick on this one. It's just at least what we're seeing in Nielsen data. It seems like this one's a little more sluggish, maybe private label's taking a little more share than what I might have thought. So I'm just curious if you can give us a status update on that brand in particular.

Yeah, happy to talk about Bird's Eye for sure. Bird's Eye, as you heard in the prepared remarks, is running flat out right now. We've got, you know, thankfully the plants are running well and we are growing. But what you're seeing in consumption, it can confuse because the natural level of demand is actually higher than that. But what you see going on right now is we are approaching the all-important holiday season for vegetables, and it is very, very important to retailers to have vegetable inventory during the holidays. So the supply constraints that you're seeing on Bird's Eye are not just those that we've had in terms of our ability to manufacture, but it's also some retailers prioritizing preserving holiday inventory above, call it, late-summer inventory. Because as you can imagine, when consumers go to buy their Thanksgiving dinner and vegetables and they can't get what they want, that becomes a very emotional, a very negative emotional event. And we don't want that, nor do our retailers.

Thank you very much.

Our next question comes from Jason English from Goldman Sachs. Please go ahead with your question.

Hey, good morning, folks. Congratulations on a strong start to the fiscal year. I know we're still early in this year, but my attention, I think a lot of people's attention is on your goals for next year for fiscal 22 targets, which increasingly look like they're more achievable than I think many of us thought they would be a few quarters ago. On the sales side of that, you're 1% to 2% CAGR. If I flatline the back half of the year, I've got to take 2022 organic sales down 9% or so to get that multi-year CAGR down to 1% to 2%. Obviously, That sort of reset in 22 contrasts with the narrative you guys built with a lot of really interesting data, by the way, on why some of this consumption may remain elevated. So how do I put those two? Or should I just step back and say, listen, you put the target out a while ago. You're not going to move it at this point in time. There may be some conservatism on the sales side.

Yeah, I think, you know, we're not going to try to speculate on that. what would we be looking like without COVID? But what we are dealing with is kind of what we've got. So the environment we've got, we believe, you know, sets us up well, as we laid out in the prepared remarks today. And it puts us in a position to reaffirm kind of where we are with 22 with our long-term algorithm. And, you know, that's really, that's all the commentary I think we've got on 22. Okay.

Okay. But you were confident you'd get there without it, and obviously you're expecting COVID to be a boost. So at least the sales side looks like it's more firmly in grasp. On the cost side, I appreciate the detail you ran through on the incremental COVID expense. You also mentioned there's COVID-related savings. Are those sort of net neutral or when the dust settles here? Will you have benefits of incremental costs falling away, sort of netted against the headwinds of incremental costs coming back in, or could it actually be net favorable, net headwind all in?

Yeah, so we laid out the $34 million in COVID-related costs in our margin bridge. SG&A includes savings just because, you know, people are working from home. There's just not as much travel and expense. But that's probably a third of the you know, 34 million in terms of the favorability.

But I think long-term, you know, one of the key points we're making today is, you know, the work we've done for five years then intersecting with COVID leads to a very positive long-term NPV because we are getting these new consumers into our brands. They are discovering all the innovations that we've launched really over the last four or five years, including the new stuff, they're liking it and they're converting to repeaters and their depth of repeat is strong. And that's, you know, we're going to be at 22 before we know it. And then we'll be thinking what comes beyond 22. And, you know, certainly all of we're trying to maximize that outlook.

Jason, can I just add one more, just so the 34 million is in cost of goods sold, which affects gross margin, the, you know, call it, you know, 9 million, 10 million of favorability as an SG&A.

Understood. Really helpful. Thank you guys.

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

Thanks. Good morning. Just to follow up on the topic of gross spending, you mentioned that you have the opportunity to reinvest, and you mentioned that working media will continue to be in that 2% of sales level, and you also mentioned investments in e-commerce. I'm wondering if you could talk about how much you are reinvesting away from the working media, whether it's e-commerce or other capabilities. on the expense line and how meaningful that reinvestment is or has been accelerating during this period, and I have a follow-up.

Keep in mind the A&P that we've got these days is almost all working A&P. A lot of the inefficiency that we found in A&P was in non-working dollars, survey data, market research, commercial production. things like that that has been really cleaned up. And what remains is very hardworking. But keep in mind also the vast majority of it is in digital. I think at Cagney we said over 80% of it was a digital spend. So that spans everything from e-commerce investments to digital social advertising, working direct-to-consumer messaging, all of that stuff. So we've hovered historically over the last number of quarters about This last quarter, we were below that because we were supply constrained. It didn't make sense to pour more A&P on top of a supply constraint. But now we're getting some flexibility there, and you'll see a more normalized level for what a Q2 usually is.

Yeah, let me just add to that, David, just to maybe help a little bit. So if you look at the Q2 guide for operating margin versus where we came in at Q1 at 20.2%, Let me give you kind of a few pieces here that will help you also on the marketing investment. So first, the trade change in estimate, that's about 40 basis points. So if you take that out, because that's a benefit to the first quarter, that's just going to stay for the year. The difference between Q1 and sort of the midpoint of the 2Q guide is about 150 basis points lower. That difference between Q1 and Q2 is roughly split among investments in A&P, a in above-the-line investments in merchandising and flooding, and then growth-focused cost-of-good sold investments to support our innovation and capital investments. So that's of the 150 basis points that kind of splits it into those buckets. So the Q2 A&P level will be up versus Q1, and it'll be more consistent with the level that we saw Q2 a year ago for A&P.

And just a quick follow-up. I know there's always limitations to how much you can comment on M&A, but there have been companies out there successfully selling stuff that they own to help their future growth and getting surprisingly good prices. I'm thinking of Hain Celestial here just for example. You have the tax asset. Things seem to be going slowly there on the divestiture front. Do you look at this as an opportunity-rich environment for you to perhaps reduce exposure to lower-growing categories that you know, might hamper your growth after COVID? Thanks.

Well, I guess, David, the answer is it depends. And, you know, as you look back over the last several years, we've been fairly active both on inbound and outbound stuff. And we also are keenly aware we have this tax asset and it does expire at some point. But we've said pretty consistently from the beginning, it's not necessarily strategic to use the tax asset for the sake of using the tax asset. It's strategic if we use it to create value. And as we think about candidates that could be outbound, it always comes down to can we get a value for it that is above what we see as the intrinsic value. So we've made very good progress on our deludging, getting ahead of our expectations there. It's not as if we feel pressure such that we would ever liquidate an asset below its intrinsic value. We don't feel that pressure. But if a good valuation came along, We, as you've seen from our practices in the past, that would be something we would look at as well.

Thank you.

Our next question comes from Chris Grohe from Stifel. Please go ahead with your question.

Hi, good morning. Good morning. Hi, I just wanted to follow on a couple earlier questions just to get a sense of what you think the inventory rebuild added to the first quarter And then also to understand the perspective around 2Q and why inventories are not rebuilding back to normal levels. And I want to understand your production ability. It sounds like it has caught up. And can you keep pace with demand right now? Is that any sort of limitation to you building inventory in 2Q?

Well, the inventories have started to rebuild, Chris, but demand remains elevated. And it's really a category-by-category dynamic situation. in terms of pull-through takeaway versus capacity at the plant. So, as I pointed out, between manufacturing capacity overall and retailer inventories being light, we're still in catch-up mode. But some categories are in good shape, and those are the ones where we have the ability to really maximize demand. But it's not by any stretch normalized yet, because The lift, the demand remains very strong. And now, of course, we're going into a season where, you know, all the outdoor dining is going to go away in a lot of parts of the country and a cold flu season is upon us. So, you know, it's plausible that demand can even lift from here. You saw that in that one chart I showed on occasions, even the most recent weeks beginning to tick back up.

And then would you say what inventory added to the first quarter? Yeah, we shipped above – retail or inventory, you're talking about? Yes. How much your shipments were above consumption? Like, what that added to your sales growth in the first quarter?

Yeah, our shipments were – I think it was 600 basis points difference between shipment and consumption. Okay.

And then I just said – yeah, right, got it. Okay. And then just one other quick question on new product contribution. It's quite high. There are a lot of companies that have had to put off some new product, you know, launches recently. And I think now we're starting to get back to it. But I just want to understand, as I think about the next couple quarters, do you have a normal rate of new productivity that's occurring? And are you seeing that kind of delayed at all because of the environment that we're in and just the robust growth occurring at retail?

Yeah, I tell you, Chris, back when this all hit in March, April, I would have thought more customers would have wanted to delay some of the new innovations. But, you know, given our track record and given, you know, especially, you know, at Frozen and Snacks, the way our innovation-driven category growth and the way we've really accounted for almost all of the share in some of our key categories in terms of growth, the demand from customers for our new innovation remained extremely strong. So a lot of our products have been going out the door. We've got more yet to go out the door. And the performance of those products in Marketplace have been strong. So we've been doing... a combination to maximize supply of skew rationalization where it makes sense to do so on brands like Chef Koi RD so we can maximize the volume we're putting out there. But at the same time, we've been very strong on innovation and it has been working. So that's strictly a function of how well our innovation does in terms of velocities in the marketplace. You know, we've got, if you look at some velocities, just new stuff that we've got out there like Duncan Hines is a brand we don't always talk about. We've got these new keto-friendly cups. And this is brand new, and it's already got the number one dollar velocity skew in that segment. Our Slim Jim products, the velocity is just crushing it. Our Slim Jim Savage initiative is the number one velocity in all meat snacks, and it's been the number two velocity in all snacks overall in the last 13 weeks. So these new products are not only going out the door, they are really performing.

Thank you.

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

Yeah, thanks. Good morning, everyone. So I just wanted to touch on cost. You know, did you just give us an update on kind of how you see things playing out in terms of some of the key commodity costs? But more importantly, just wanted to get a sense on your thoughts around manufacturing costs and labor costs and kind of how you think about that as you forward over the next several quarters. Because we're hearing a lot from the industry, just, you know, people not showing up from work, and obviously consumption remains elevated, so COPAC usage is going up and transportation costs are going up. So just wanted to get your thoughts on just that whole bucket, if you could. Thanks.

Yeah, Nick, let me start, and then, Sean, you can jump in. So for Q1, our overall inflation was 3.1% for the quarter. As we look going forward, we estimate that that overall inflation rate is going to come down more to kind of the low to mid 2% if you look going forward. As you mentioned, there have been increases in spot rates for freight. Freight's about 10% of our overall cost of goods sold, but it's a very small piece of our business because we contract for our freight. So clearly going to be an impact, but on an overall weighted basis, we think it's manageable, and we have other favorability that we can offset that. In terms of supply chain, remember it's the end-to-end supply chain, so it's not just our manufacturing. It's our commands, but it's also our suppliers. So to the extent that certain regions get hit with COVID and then there's impacts on labor, it impacts the entire supply chain. And so we're on that every day, every hour of every day, making sure we understand kind of where we are with demand and then where we are with supply. We're manufacturing, you know, full out at all our manufacturing locations and we're really working closely with our suppliers to make sure we understand where they are with their lead times on ingredients and packaging and all the things that are critical for us to be able to make a finished product. So, Sean, anything? Yeah, I think you covered it.

Great. Thanks, guys.

Our next question comes from Steve Powers from Deutsche. Please go ahead with your question.

Yes. Hey, thanks. So not to belabor a topic you've already addressed in part, but can you just maybe take a step back and give us a bit more perspective as to how you landed at that 2% of sales A&P or working media level just being the right one? I think everyone would agree it's working well now, but I think a lot of investors watching your story from the outside and watching other CPG companies lean into today's demand with more elevated A&P investments carries some concerns about your top line having more headwinds when the music stops on at-home demand, so to speak. I appreciate everything you said about demand staying elevated for longer, potentially, but I guess it's important from what I hear to address that concern head-on because it's a question for would-be investors who like what you're doing on the innovation, on the trial, and near-term repeat fronts, but are more concerned about your brand equities being strong enough going forward to cement long-term loyalty.

Yes, Steve, happy to talk about that. I feel like I talk about this every quarter. My consistent encouragement to investors is to think about our brand building work holistically. It starts with the design of the product and the packages, and then it includes all the investments we make to create a connection between our consumer and the brands. Some of that connection happens in the grocery store. A lot of it happens on their phones. or on their computer or digitally. All of it works together, but a big piece of our first investment in how we get sustained growth is in designing the right products and the right packages. If you look at the single-serve frozen meal slide that I shared today, we are now multiple years into re-innovating that category, and it started with major investments in the food quality and the packaging And then on top of that, we layered investments in A&P and investment with our retailers. And when we got to year one of our success there, the question we got is, how are you going to wrap this? What's going to happen in year two when your competition sees this and they emulate you and you've got difficult comps? Well, now we've done it year after year after year, and we've retained just about 100% of the category growth in that space, which suggests that all the investments we make holistically in brand building from product to package, to retailer investments to A&P works very hard and is driving sustained performance. What sometimes trips people up is they get accustomed to thinking that all brand building resides on the A&P line and that a good rate of A&P, which is kind of an artifact of the industry from the past, is a 4% rate or something like that. If you dig deep within most of the companies that have had those kinds of rates, what you find is an extraordinary amount of non-working dollars, and then working dollars that are still used against traditional tools like inline TV media and things like that. We are far beyond those days, and we've purged out that inefficient spend, and we've converted the old analog spend to heavily digital. And what we find is when we put that profile together and we do it with the work we do with retailers in store, which by the way, as you know, is not just deep discounting. That's not really the ConAgra playbook anymore. It has been very successful for us. With respect to taking that investment up in any given COVID window, it kind of depends upon what brand we're talking about, because the last thing that would make sense would be to be spending a bunch of A&P on a brand that we're short on supply, and we're not doing that. But what we've said in the call earlier today is if we have available capacity and if we have evidence of good ROI, we'll absolutely increase the spend. So you look at the average and it doesn't tell you much, On some brands, the rate is much higher than that, and those are brands usually where we get tremendous responsiveness and we have available capacity.

Yeah. I think that's a comprehensive overview. I guess the only thing that I guess the follow-up I'd have is that in this environment, other companies are making incremental investments that they might not have been making in the in a more normal environment. And I guess, are you just saying that those incremental investments just generally are not going to have a good ROI or they're not happening in your competitive set or just how do we square that circle? Thanks.

I guess what I'm saying is give us credit for the incremental investments that we already had in our baseline. If you look at the slides today that show the sheer breadth and depth of the innovation we put out there, it's unmatched. So those are investments and those are investments that have already been in place and are already underway. And then on top of that, we layer investments to drive awareness of those new innovations. So, you know, the investment profile is holistic, and it includes building out one of the leading, if not the leading, innovation portfolios in all the industry and all the costs associated with doing that.

Very good. Thank you very much.

And our next question comes from Brian Spillane from Bank of America.

So just two quick ones for me. First, on the dividend, we've got to step up today, which in a sense kind of makes up for the time that the dividend's been frozen. So at this level, at this payout ratio, should we think of this now as kind of a normalized ratio and assuming there's growth going forward, we're at a level where we can grow the dividend consistently? And then the second one is just in terms of the outlook or the lack of outlook for this fiscal year, and kind of the question around visibility, is the lack of visibility more around cost relative to revenues? Because it seems like you've got a pretty reasonable amount of confidence in the environment and your ability to drive revenue in this environment. So just curious if the inability to give guidance is more driven by cost versus revenues. Thanks.

Brian, let me hit the dividend. So Sean and I communicated in our remarks our concerns Our cash flow, our deleveraging cadence are ahead of expectations, and we're confident we're going to hit the targeted 3.5 to 3.6 times leverage ratio in the third quarter. We're also confident in the long-term strength of the business as we reaffirm fiscal 22. So based on this progress and the board's confidence in a structurally higher earnings power for the company, the board approved a dividend from $0.85 to $1.10 annualized. moves us towards the longer-term historic payout ratio of 45% to 50%. So that's what I'll tell you related to the dividend. John, I don't want to hit anything for the second part on the long-term.

Actually, more related to fiscal 21, just trying to understand, not having guidance for the full year, is the lack of visibility more a function of visibility on the top line, or is it a function of cost?

No, I think one of the things you've got to keep in mind is we obviously are in the middle of a pandemic. So to some degree, the upper control limit on revenue is, you know, how much can we get out of the plants? And how much we get out of the plants is a function of how healthy we can keep people. So, you know, this is a very contagious disease. We're trying our best. We're doing a great job. But every day when we come in, we start our day at 8 o'clock in the morning going through a review of how healthy our people are in every single one of our facilities. and every day brings us new information, and the team's doing a great job of managing that. But it's a variable, and it's a variable that makes it very hard to, you know, predict how these quarters unfold, which is why we're taking this, at this point in time, quarter by quarter.

Oh, that's very helpful. Thank you.

And, ladies and gentlemen, with that, we'll conclude today's question and answer session. At this time, I'd like to turn the conference call 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 that anyone may have. Thank you for your interest in ConAgra Brands.

And ladies and gentlemen, with that, we will conclude today's conference call. We do thank you for attending. You may now disconnect your line.