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spk05: Good day and welcome to the Parago third quarter 2021 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch-tone phone. To withdraw your question, please press star then two. Please note this event is being recorded. All right, but now let's turn the conference over to Brad Joseph, Vice President of Investor Relations. Please go ahead.
spk06: Thanks, Tom, and good morning, everyone, and welcome to Parago's third quarter fiscal 2021 earnings conference call. I hope you all had a chance to review the press release we issued this morning. A copy of the earnings release and presentation for today's earnings discussion are available within the investor section of the Parago.com website. Joining today's call are President and CEO Murray Kessler and CFO Ray Silcock. I'd like to remind everyone that during this call, participants will make certain forward-looking statements. Please refer to the important information for shareholders and investors and safe harbor language regarding these statements in our press release issued earlier this morning. A few items before we start. First, unless stated, all financial results discussed and presented are on a continuing operations basis. They do not include any contributions from the divested RX business, which was accounted for as discontinued operations prior to its sale. In addition to the other non-GAAP adjustments as described in the appendix, adjusted profit measures, including adjusted EPS and adjusted operating income, exclude from the prior year period certain costs incurred to support the operations of the RX business, which were reported in continuing operations. See the appendix for additional details and reconciliations of all non-GAAP financial measures presented. Second, organic growth excludes acquisitions, divestitures, and currency in both comparable periods. And third, Murray's discussion will be focused solely on non-GAAP results. And with that, I'd like to turn the call over to Murray.
spk04: Thank you, Brad, and good morning, everyone. In Q3, we had major accomplishments, company-changing accomplishments, the kind that will secure Parago a bright year for years to come. Unfortunately, we also experienced some very significant challenges this quarter related to the global supply chain disruption experienced by many companies in multiple industries. I'll come back to those in a few minutes, but first I want to remind everyone that during the third quarter, we completed our transformation to a consumer self-care company by first closing the generic RX divestiture transaction for $1.6 billion and which dramatically lowers volatility and makes self-care our sole strategic focus. And second, announcing our agreement to acquire HRA Pharma and its leading portfolio of consumer self-care brands for 1.8 billion euros, which we estimate will add 400 million US dollars in revenue and 150 million dollars in operating income in 2023. During the quarter, we also dramatically reduced the tremendous uncertainty that has been an overhang on Parago for the last three years. This was accomplished by favorably settling the headline 1.6 billion euro Irish tax NOAA for a much smaller amount. And while we believe Parago had a very strong case, if the Tax Appeals Commission disagreed, this tax assessment could have cost the company $3 billion or more when including interest. We settled for 297 million euros in total, with cash payable of 266 million net after we received credit for prior payments. This issue is now completely resolved and behind us. And even better, we paid for this settlement from a 355 million Euro award we received during the quarter through binding arbitration arising from the Omega transaction. The result, Perigo is now a focused consumer self-care company poised for strong growth unencumbered by the major overhangs of the past. Our long-term future has never been brighter. Let's shift back to Q3 business performance. Results were below a year ago, mainly due to underabsorbed overheads and higher input costs. For net sales, supply chain disruption was the culprit. This led to an inability for Perigo to meet very strong consumer demand in the quarter. Absent the supply chain disruption, Net sales growth would have been in line with what we had projected. Higher costs for freight, other input costs, and lower operating efficiencies in the form of unabsorbed manufacturing overhead attributed to last winter's historically weak off-cold season also negatively impacted earnings. Let me provide a bit more detail. For net sales, as forecasted, the strong consumer takeaway in Q2 translated to higher factory orders in Q3. This was highlighted by a 21% year-over-year growth rate in our cough-cold sales in the U.S. and continued double-digit growth in e-com plus 36% year-over-year globally. Consolidated net sales increased 4% versus a year ago despite a supply chain disruption impact of $43 million, with the bigger impact in the U.S., $38 million, causing a 5.5 percentage point drag on CSCA's Q3 net sales performance. Had those orders shipped under normal patterns, CSCA's shipment growth would have been very close to the strong consumer takeaway growth observed in the quarter. Let's take a look at those market trends for CSCA. Importantly, category consumption grew briskly in the categories we compete in for all three of our U.S. business units. The total OTC category was up 18.1% versus a year ago. Total nutrition, which for us is infant formula and electrolytes, was up 29.9%, and oral care was up 9.7%. It's worth noting that total store brand OTC lost market share to national brands during the third quarter, about 1.5 share points. But this is not a reason for concern. The share loss was attributed to buyers of national brands increasing consumption rather than buyers of store brands switching to national brands. I repeat, the growth did not come from private label buyers switching to national brands. And that's good news. As the national brands drive category growth, it becomes a revenue source for us in the future. In our CSCI division, market share was stable in Q3. Like the U.S., the categories we competed in showed a very strong rebound in consumer takeaway, and they grew briskly. Total CSCI consumer takeaway was up nearly 10 percent over a year ago, but CSCI factory shipments lagged consumer takeaway and were basically flat for the quarter. We believe this trace to a light pre-coff cold season buy-in by pharmacists across Europe who were worried about getting stuck with too much inventory if the cough cold season doesn't rebound. But that worry appears unfounded as the cough cold season in Europe is in fact off to a very fast start. Consumer takeaway was up 36% in Q3. We expect this to translate to strong cough cold sales in Q4 as pharmacy inventories are low, as I just stated. And we already saw that begin to occur in the month of October. That is strong cough cold sales. Turning to the third quarter earnings, EPS fell short of our internal projection and was 15 cents below a year ago. Supply chain disruption negatively impacted EPS by an estimated 8 cents. Lower operating efficiencies and higher input costs impacted by 17 cents. And separately, we had two product recalls that had a 5-cent negative impact. Tight management of expenses offset some of these negatives. Looking towards updated guidance, we expect consumer demand to remain very strong in Q4. However, we also expect higher input costs, supply chain disruption, and the impact from underabsorbed overheads to continue. Based on Q3 results and those continuing trends, We've lowered our EPS guidance range for the year to $2 to $2.10. This new annual estimate includes a total year negative estimate of 79 cents per share for COVID-19 related external factors, which is obviously quite significant. And again, that's what we experienced so far plus the fourth quarter estimate. I placed these factors into three buckets as follows. First, cough cold. The impact of a historically weak season significantly impacted our first quarter net sales and earnings, as well as continuing to have a negative impact on manufacturing efficiencies through under-absorbed overhead for the balance of the year. Total impact estimated at 49 cents. Higher input costs is the second factor, a spike in cost that has progressively escalated throughout the year, including freight and other input costs. are estimated to have a total impact for the year of $0.09. And then finally, supply chain disruption, both inbound and outbound logistics that became a major issue beginning in Q3 is estimated to have a full year total impact of $0.21. We believe this large reduction in 2021 net sales and EPS from these three factors is not indicative of the underlying progress the company has made and that they can progressively be recaptured over the next two years. Let me address each bucket one at a time to explain how we believe that will happen. First, the historically weak cough cold season that dramatically impacted Q1 net sales was clearly a one-off. Illnesses are up according to IQVIA. Cough cold consumer takeaway was up 61% in the US and 36% in Europe during Q3. and October cold cough sales for Perigo remained robust. While we aren't yet forecasting a full recovery to the 2019 level, cough cold sales are expected to be up dramatically in the first quarter of 2022 versus 2021. As that higher volume runs through our plants, the negative absorption impact will come back to us, albeit that'll take 12 to 18 months to play out. but we have a very high confidence in getting this full 49 cents back. Second, the 21-cent impact from supply chain disruption is also expected to be temporary. The global supply chain is forecasted to gradually improve by mid-next year, but in the meantime, we've taken a series of actions to improve the current situation, including outsourcing highly complex product lines to a third-party logistics provider allowing more room on our trucks for higher-profit OTC products, also adding regional carriers for challenge shipping lanes, hiring additional distribution center personnel, which allows us to change our order delivery schedule to account for the many no-shows we've experienced, and finally, increasing the purchase cycle for ingredients and packaging and the like from 30 to 90 days to make sure we have sufficient lead times for delivery. These actions have resulted in a 25 percent increase in daily shipments for the month of October as compared to the third quarter average. And not all of the actions have even been fully implemented yet. Some of these changes will remain in place until the larger U.S. supply chain normalizes. Some of these changes we intend to leave in place as a hedge against future disruption. And third, as for the input costs, nine cents from the second half of this year And any flow-through impact in the first half of next year will be addressed by raising prices on 70% of our product lines in CSCI and 75% in CSCA. U.S. retailers have been more accepting than usual of price discussions as they understand the massive cost increases we and, frankly, everyone else are facing, and national brands are also raising price. And we will continue to maintain a tight focus on discretionary costs and remain focused on achieving at the least the final $30 million of project momentum cost savings. Several other actions have also been put in place to get earnings growing again. We've made several management changes in the U.S. to refocus the team on core OTC market opportunities, of which there are many and of which have already resulted in some significant customer wins. Second, our successful and growing e-com business, which is up 25% year-to-date, remarkably on top of last year's more than 100% growth, has been reorganized internally to allow focus and added resources to further accelerate growth. And, of course, the previously announced acquisition of HRA will have a dramatic positive impact on financial results and the growth trajectory of Perigold. The transaction remains on track to close mid next year. So to reiterate, despite the best efforts of my Parago colleagues, and they've been remarkable, the COVID-19 pandemic has raised successive challenges, which began in 2020 and continued through 2021. The impact has been real and our response has been real as well. We believe that the negative business impact of the big three drivers in 2021 a historically weak cough cold season, supply chain disruption, and higher input costs will be mostly recovered and or be offset with pricing and project momentum cost savings. And we reign on track to close HRA mid-next year, which will substantially increase net sales, operating income, and margins for years to come. We therefore still believe we can get at least close to our original 2023 EPS targets we shared with you back in May 2019 and again during the HRA announcement just a few months ago. So from our perspective, this is not a reset. It's just a very big bump in the road. In conclusion, we've come a long way over the last three years with the most massive elements of the transformation plan having come to fruition in this most recent quarter. The volatile generic RX division has been divested. The HRA acquisition is on track and is expected to add approximately a dollar of EPS in 2023. And the Irish NOAA and the uncertainty it created over the last three years is gone. Perigo is now a focused consumer self-care company determined to be a world-class consumer self-care company that consistently delivers profitable growth over the long term. consistent with industry peers. And while COVID-19 has created many unforeseen challenges in 2020 and 2021, big challenges, we work through them as they occur, and we will not let them deter us from making our vision a reality, nor hitting the ultimate growth plans we originally established. With that, I turn the call over to Ray Silcock, our Chief Financial Officer, to discuss the financials in more detail. Ray? Thank you, Mari.
spk02: And good morning, everyone. Firstly, with respect to the major strategic initiatives completed this quarter and outlined in this morning's press release, I'd like to reiterate Murray's comments that these achievements do indeed lay the foundation for our bright future. But as Murray also said, the operating environment in Q3 was challenging and had a significant adverse impact on our quarterly results. So I would like to thank the team at Perigo for all their hard work navigating through them. With that, let us take a look at our third quarter results in greater detail. First, let's review our gap to non-gap adjustments. On a consolidated basis, the company reported a gap loss from continuing operations of $54 million for the third quarter of 2021, a loss of 40 cents per diluted share. On an adjusted basis, consolidated net income was $61 million, and adjusted diluted EPS from continuing operations was 45 cents per share, a 25% decline compared to prior year. The adjusted EPS decline versus last year is primarily due to one, lower operating efficiencies, primarily overhead under absorption as a result of lower manufacturings from the week 2020-2021 cough cold season. Two, higher freight and materials costs due to global supply chain disruptions. And three, the impact of two product recalls, one in Europe and one in the US. Pre-tax non-gap adjustments this quarter totaled $311 million. Primarily, these were from our excluding the positive benefit of the $395 million Belgian arbitration reward we received in Q3. We also added back $53 million of amortization expense, as we always do, and $25 million in acquisition and unusual litigation expenses. Full details of these and other adjustments can be found in the non-GAAP reconciliation table attached to this morning's press release. The principal non-GAAP tax adjustments for the quarter were the $309 million Irish NOAA settlement and $108 million in tax arising from intra-entity transfers of intellectual property due to the RX divestiture. These led to an adjusted effective tax rate for the quarter of 21.3%, down from Q3 last year's adjusted effective tax rate of 24.6%. The reduction in our adjusted effective tax rate was primarily due to the release of state uncertain tax position reserves, partially offset by beat tax expense this year. From this point forward, all dollar numbers, basis points, and margin percentages will be on an adjusted basis unless stated otherwise. Consolidated net sales for the quarter increased 4%, driven by e-commerce, by contract sales to our recently divested RX business, from price increases, and also from improved US cough cold season sales which have started to turn around in Q3 as compared to Q3 2020, but are still down versus last year on a year-to-date basis. Net sales also benefited from $9 million of favorable currency and $5 million from acquisitions. On an organic basis, excluding the effects of currency and acquisitions, net sales grew by 2.6%. Consolidated gross profit in the quarter was $35 million lower than last year, primarily as a result of lower operating efficiencies and higher material and freight expenses, as well as the $9 million cost of two product recalls, all partially offset by $6 million in favorable currency and acquisitions. Consolidated gross margin in the quarter was 34.4%, 480 basis points lower than prior year, driven by the same factors. Consolidated operating income in Q3 was $112 million, $29 million down from last year. Operating expense reductions, including project momentum savings, helped partially offset the unfavorable gross profit flow-through. Measured as a percent of net sales, consolidated gross profit in Q3 was 34.4%, down from 39.2% for the same period last year. Global supply chain disruptions, which caused higher material and freight costs, were 130 basis points of this impact, while overhead under absorption from the historically weak 2020-2021 cough-cold season, principally in the first and second quarters, were another 150 basis points. In addition, we experienced those two product recalls which cost 80 basis points. These headwinds, together with unfavorable mix in our base business, driven by contract sales to the recently divested RX business, and lower sales in CSCI's weight loss category, resulted in a year-over-year gross margin decline of 400 basis points in the quarter. Lower operating expenses of 80 basis points partially alleviated these effects. We expect the gross profit headwinds to gradually reverse over the course of the next year or so as the cough cold season returns to its historical levels and overhead absorption levels in our plants normalize and supply chain disruptions ease. Now let's turn to the third quarter segment results, starting with consumer self-care Americas. Net sales for the quarter increased 4.6%, driven by e-commerce, third-party sales to the divested Rx business, and better cough-cold sales. Excluding favorable currency of $2 million, organic net sales grew 4.2% in the quarter. Gross profit in the quarter was $193 million, $29 million below last year, driven by unfavorable plant overhead absorption, higher material and freight expenses, and a product recall in the energy category. These factors led to a year-over-year gross margin decline of 570 basis points. Operating income for the quarter was $106 million, $28 million lower than prior year, driven by unfavorable gross profit flow-through partially offset by operating expense reductions, mainly R&D and administrative costs. Moving on to consumer self-care international, net sales grew 2.8%, driven by favourable currency and acquisitions, performance in the UK store brand business, greater demand for our smoking cessation products and improved pricing. Excluding the benefits of currency and acquisitions, organic net sales decreased 0.6%. CSCI gross profit was $166 million, 3% down from last year, a 280 basis point decline in gross margin. Unfavorable mix from lower sales in the weight management category, together with the cost of the recall, were only partially offset by favorable currency and acquisitions. operating income was $46 million, $6 million lower than prior year, primarily due to the impact of the product recall. Moving now to the balance sheet and operating cash flow. Cash on the balance sheet as of October 2nd was $2.1 billion and included $1.6 billion from the RX divestiture plus $418 million from the Belgian arbitration award. Operating cash flow in the quarter was was $350 million, including the Belgian arbitration award. As a reminder, the cash outlay for the Irish tax settlement and the legal fees for the Belgian arbitration award were made after the end of the quarter. In closing, our third quarter results were significantly impacted by the macro environment in which we operate, which is reflected in our updated fully-adjusted EPS guidance in the range of $2 to $2.10. We remain confident in our plans to deliver long-term profitable growth as we recover from this quarter's temporary adverse impacts and move forward with successfully closing and subsequently integrating the HRA acquisition. Operator, can you open the line for questions, please?
spk05: We will now begin the question and answer session. To ask a question, press star then one on a touch-tone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. At this time, we will pause momentarily to assemble our roster. And the first question comes from Elliott Wilder with Raymond James. Please go ahead.
spk00: Good morning, Elliott. Thanks. Good morning. Murray, despite all the cited factors over the last couple of quarters, that explain various aspects of the company's performance. No one can figure out what's going on with gross margins. I've followed this company for a long time, and frankly, I feel a little bit lost right now. I don't know where the bottom is, and we keep coming in well short of the company's expectations. So, you know, clearly it seems to be something beyond just merely supply chain issues and, you know, logistics issues. because obviously over the course of the pandemic, numbers have been volatile, yet margins have been certainly relatively close to historical standards and certainly well above where we are today. It would be very helpful if the company could somehow provide a bridge between gross margin performance, CSCA, in the current quarter relative to historical levels so we can have sort of some understanding of what's happening kind of outside of these one-time issues?
spk04: Sure, but it's primarily, I mean, these are massive one-time issues, and most of them come back. But, you know, listen, I get it, right? I mean, but inflation freight materials, 180 margin points this quarter. Under absorption, 150 basis points this quarter. That's 330 by themselves. We sold the RX division. We get credit for the sales. That's not a real margin deterioration. Like, we just have to report what was contract sales that we had to profit before you lose 100 basis points on that. I mean, that really comes off, but it's no change to the profitability of the company. And you had a little bit of an offset of 50 basis points on price and sales. And, you know, we picked up 100 basis points on the operating margin line from cost savings, primarily, you know, in tight management of operating expenses. But, I mean, the big issue is you have 300, 400 points that came on roaring on strong from having no-cost cold season and from massive supply chain disruption and massive increases in freight. You know, I mean, we have, you know, you've got to, big business like oral care that, you know, buys a lot of its product from China and a container was $6,000 is now $26,000. You know, I mean, hopefully, you know, and we, everyone believes that'll come back again, but those are, you know, when you translate that out over a longer period of time that, you know, those are big numbers. The good news is we're out and been able to put in pricing. So I think when you recover the cough cold, which we're clearly doing already. That's real. You're going to get that back. You're going to get that overhead back. Supply chain we'll pay more for, so it'll hurt for a little while until prices start to come down again. Input costs offset by pricing. We've gotten more pricing approved and into the marketplace. I don't know when the last time that's happened for the company, but our customers recognize that. But it's not like, you know, a national branded business when you take the price increase on Friday and it goes up Monday. We have contracts and that, you know, that gets filtered in. But we have, you know, 75% of the business being, you know, a price increase over the next period of time. So, you know, it was clearly a hit to gross margins. I get it. I just think these short-term hits undermine the great work that had been being done to you know, on product mix, on discontinuing unprofitable products, on SKU rationalization. I mean, we're focused on margins, but, you know, I get it. From where you're sitting, you don't see it right now, but I think you will.
spk00: No, I don't see it, and it's difficult to see, and I think it would be helpful for the company to, you know, shed some additional light and put some additional clarity around, you know, all the, you know, key items that you said is positive and obviously kind of what we're seeing in the reported numbers. But again, I mean, even if I gave you the benefit of 300 basis points in terms of some of these one-time issues, I mean, you're still looking at, you know, gross margins in the CSEA business, which are 30.8%, and that's still 150, 200 basis points below what people believe was sort of the bottom here. So I think this issue needs some additional clarity going forward. I do want to ask about the absorption issue and the impact in the quarter. It just seems like with cough cold clearly bouncing back at least in the quarter to 2019 levels and presuming that you're continuing to see relatively high order rates, I'm a little surprised, I guess, that absorption seemed to have the impact at least in the quarter that you've cited. I'm not sure necessarily why that would occur if it's just product being produced in the warehouse but not put on trucks, I would assume a lot of that unabsorbed overhead is in fact actually allocated to product costs and is not impacting unabsorbed overhead. And we're also not seeing that necessarily in terms of inventories increasing. I understand there's a lot of moving parts there that could impact the inventory line, but inventories were actually down in the quarter. So I'm trying to reconcile a couple of these.
spk04: But you're selling the inventory that you made expecting a down but not a non-existent cough cold season. So when those, you know, you're paying for the unabsorbed inventory now for what happened last January and February, right? So it gets put onto that inventory as it gets put up. And then as you work it down, you're working down inventory with a higher cost to it. And then, you know, it's like a six-month lag in our costing system that that works through and you know, it'll continue on through the fourth quarter a little bit into next year, and then it'll slowly start to reverse itself, and all of a sudden you'll get huge windfalls.
spk00: Okay. Understood. Thank you. And I guess just sort of on, you know, last question is, you know, given some of the changing dynamics in the OTC space and taking pricing and the like, could you just talk about sort of where the company's relative market share position is kind of across the private label segment, where you're gaining share, where maybe share has slipped a little bit, whether or not you think that the price increases will, in fact, have a negative effect on share, but you can more than make it up for in margin. Just, you know, try to understand what some of the moving parts there are in terms of, you know, in terms of competition from other private label players, as small as they may be, versus just changing share dynamics versus national brands. Thanks.
spk04: Yeah. That's a great question, by the way, Elliot, because, you know, at first glance, people are going to look at the, the national brand or the store brand level, and I gave you the panel data that shows that's just from them advertising more and getting consumers to buy more. And that has no effect on our business right now. Within store brand, we had some big challenges that we got hit with last year. Nicotine, some competition in lozenges, and then some A&A approvals in Omeprazole, and that resulted in some share loss this year. Now, our businesses across the board were still up and growing across those, but they could have gained more. And I don't accept ever losing share. It's not, you know, when it's actually sourced and coming from you. I would tell you that, you know, I made some changes in management and some other structural areas. And we have won a lot of business in the last 30 days. So did we lose some short-term share within store brand? To the extent that we can read it, right, you know, store brand gets provided. And we told you, you know, a few months ago, we were able to start to break it out ourselves. It's not something that has historically reported by IRI. We are now starting to get that data. And as soon as I'm comfortable with it, Probably in the next investor conference we will do, we'll really break that out for you, but your point is a correct one. Where do I think we got hit on some? A little bit on digestive health, a meaningful competition in nicotine replacement. I will also tell you that those are the areas where we've had the most wins recently and where we have a lot of innovation coming. But great question. Those are normal things. Those are the things I'd like to be talking about on a conference call, not shocked that we had unbelievable orders and all of a sudden we couldn't ship them because we wouldn't be having half the discussions we're having right now had we just been able to ship the orders that we had. But good questions.
spk05: The next question comes from Chris Schott with J.P. Morgan. Please go ahead.
spk03: Great. Thanks so much for the questions. I know you addressed a little bit of this in the prepared remarks, but I'm still just trying to get my hands around kind of bridging from the $2 to $2.10 this year to those 2023 goals. So I guess the heart of it is beyond cold cough demand normalizing. What else really has to happen to get to that 2023 target to give you confidence to still be sticking with that, just given the results we're seeing here? I want to make sure I'm clear. It feels like this is mostly called cough normalizing, but just help me walk through the other kind of key assumptions, I guess, that go into that bridge over the next few years and then a couple of follow-ups from there.
spk04: Okay, well, listen, I've got work to do to finish it, Chris, but let's oversimplify it. If you're 2 to 210... and you get back $0.49, $0.50 on cough cold, which we believe, which is the combination of the volume impact and the absorption of the manufacturing efficiency. Now you're at $2.50 to $2.60, and you're at $1 for HRA. You're at $3.50 to $3.60, and the numbers were $3.65 to $3.95 that we were originally talking about, So at the bottom and end of that range, you're off $0.10 or $0.15, and you say, okay, excluding cough cold, the rest of the world, the rest of the business, the other 80%, if you can grow that in sort of the 5% to 10% or you can recover some of these other costs with pricing, et cetera, cost savings, you're only $0.15, $0.20 short, right? So, I mean, big components. 2.05 out of buck, 3.05, get back to 50 on cough cold, 3.55, 3.60, and you got to get 15, 20 cents out of the rest of the business over two years.
spk03: Okay, perfect. And then just, I don't know if you can quantify, I think you mentioned you're taking price on a good percent of the portfolio. I know that's something you historically haven't been able to do as much. Just any flavor on just how much price are you able to get on the portfolio just to help offset some of these supply chain pressures that you're seeing?
spk04: Well, I mean, historically, I've been out there saying in the U.S. that there had been 2% to 3% erosion. We've been able to improve that to 2%. And then last quarter, that had flattened out in this quarter for the for the first time it was positive. So we had obviously swung it by a couple percentage points because it really wasn't mixed. And that was only with, you know, a third or so. You know, I don't know, Brad, if we have a specific forecast yet, Chris, because the way we go out with – again, this is very different than a national brand that just takes a price increase. And then you have a – you have to say, well, what's going to stick relative to consumers buying it, right? What's the price elasticity impact on the volume? Here it's different. We have no impact on the retail price. That's a retailer decision. And there's massive gaps, and the national brands are taking, in many cases, prices. Then the retailers will make their decisions on price gap, will suggest things. But this is a question of our cost to them. And then there's negotiations, and we'll see what percentage. But so far, it's all gone very well, albeit there's a lag for when that actually gets into the marketplace. But I don't know if I could quantify today whether that's 2%, 3%, 3%, somewhere in that range.
spk03: But sequentially, it can continue to get a little bit better than what we're seeing even now?
spk04: Yeah, yeah. We're out there with a fair amount. I mean, it's... You know, it's got to offset those higher input costs and freight costs because I can't continue to have that be negative for that little formula that I just worked for you, right? Pricing plus cost savings has to offset future negatives because we're only six months through it, right? So I've got to offset that any first half impact with that to hold the 2 to 210 and then add the dollar and then get some growth.
spk03: And then the final question, which I just want to make sure I'm fully understanding it, is you're talking about 49 cents from weak cold cough. I'm just trying to understand how much of this was, I guess, already known in 2Q when you guided to the lower end of the range versus kind of what's new here. In high level, it seems like kind of demand is back. So I'm just trying to understand, and I totally get that there's some offsets of lower utilization, et cetera, from what happened earlier in the year. But I'm just trying to understand why the impact seems to be kind of growing versus your expectations in 2Q, given the volumes we're seeing. So walk me through a little bit of what is going on this quarter versus what you had line of sight on, I guess, as of the August guide.
spk04: We had line of sight on the unabsorbed. The unabsorbed was already baked in. And when I sat there, hell, when I sat there on the HRA announcement, I thought we had the quarter. We were roaring in orders. I mean, we were You know, the shortfall that we had in the second quarter, which was, you know, we had talked about inventory and said, you know, mathematically it had to came back. It came back. We had, you know, every day the orders were record orders above levels that we were seeing in demand during some of the spikes of COVID. And, you know, by mid-August, I thought I had the quarter. And then all of a sudden, you know, logistics is coming in and, you know, you're not shipping it, you're not shipping it and digging into it. And, you know, if we normally are shipping 55 trucks a day, all of a sudden, you know, we're having between customers not showing up to pick up or customers not coming for their pickups or drivers who were scheduled not coming, 10, 12 trucks every single day. not showing up, and we exit the quarter with the highest on-ship balance in the company's history. I mean, you had $45 million. That's another $45 million, 10, 12 cents on top of that. And, you know, there was a big spike in freight costs that hit us as well. So what didn't we have line of sight is the supply chain disruptions. the inability to get the inbound product to fill customer orders, and dramatically higher freight costs. But the unabsorption was baked into the forecast in August.
spk03: Okay, great. I appreciate all the color. Thank you.
spk05: Again, if you would like to ask a question, press star then 1 to join the queue. The next question comes from David Steinberg with Jefferies. Please go ahead.
spk01: Hey, David. Thanks. Hey, David. Hey, Murray. Thanks, and good morning. A couple questions, just continuing on with gross margins. I know you said that you're repricing, I think, 75% or 80% of the portfolio, but it'll take some time because there are contracts in place. So in thinking about the bridge to 2023, could you give us some sense of what you're thinking about gross margins in 2022? I assume that will include A lot of the price increases you mentioned, would those gross margins be perhaps closer to this year, you know, on the weak side, or more of what you're thinking for 2023? My second question relates to tax. Can you provide an update on all the ongoing tax issues? I know you settled the Irish tax liability case, but there's also an IRS case, which is linked to that, relates to the old Elon-Athena deal. acquisitions, so could you comment on the IRS tax case as well? Thanks.
spk04: Yeah, I mean, on the gross margin, Ray, I'm going to turn this cold to Ray, but I mean, I don't want to, I haven't seen the fully baked out plans because a lot has changed in a month and the teams are working through it, but a lot of the, you know, get gross margin benefit as the absorption comes down and the volume runs through the plant later in the year, but you should get cough cold volume benefit and sales benefit in the first half. But I don't have a final plan in front of me yet for 2022.
spk02: Yeah, we don't have our final plan yet, but what Murray said is basically correct. We're going to see the effect of the cough cold season being reinstated. That was really hit us hard in the first quarter, quite frankly, more even than the second quarter. and we'll see that coming back in the first and second quarters. So I don't really have a number to give you, but I think that we see that most of the profitability coming back to us by the end of the year, but it will come back gradually at the supply chain disruptions ease. But also, we have to bear in mind that under our costing system, we have a it takes six months for variances to work through the system, meaning that our under-absorption in the first half of this year, we're still feeling it now, and we'll continue to feel it into the first quarter or so of next year.
spk04: As it relates to the tax, we're not even, I mean, those are a very long way out. You know, the first The first portion of that IRS tax is, you know, it still comes down to double taxation from the company's perspective. And, you know, there is an agreement between Ireland and U.S. who has the right to tax. So that is a battle right now between Ireland and the U.S. That's in the competent authority's jurisdiction. I forget the name of. It's like the MSA or... And, you know, they have arguments and briefs on both sides, and that will, you know, occur over presumably the next year or so. And it will either completely go away or then we begin the arguments, and we think our arguments are very strong in those regards to whittle those down if they survive to a much smaller number. And I'm going to stand behind the success I had with Ireland on the massive one and my years in the tobacco industry of being able to work through these issues. I know we're challenged on gross margins on the business, but I think I've done a pretty good job here of taking out $2 to $3 billion of risk for the company, along with our strong legal team, and we'll work through these as well. I don't see these nearly of the magnitude that we were dealing with, and we'll get through those just fine, but it'll be a few years.
spk01: Okay, I just have one follow-up, and that regards the potential for new product flow. So many years ago, the company grew rapidly based on RxOTC switches and PPIs, cough, cold, allergy, and that kind of ground to a halt. And I know you've called out Nasonex coming up, but also the possibility of some other switches like Cialis, Glyce, Tamiflu. And I'm just curious – when you said that you hope to get back to your original 2023 forecast, are there any meaningful RX to OTC switches built into that, and do you think we're going to see any in the foreseeable future?
spk04: Yeah, you know, I just had a portion of this by the group. I mean, in the immediate term, I think we have – building out the Diclofen-X line, launching of Nasen-X, launching of the Sklyce product. Help me out if I'm wrong on that, Brad. There's probably nine others being worked on that'll phase in over the next three or four years, but the 2023 numbers don't depend on that. And then when we close the HRA deal, you have some massive ones, and that's one of the things I'm excited about. They just got the switch on um, a daily birth control pill in, in, um, in the UK, which, um, and they are in the process with working on the process with the, the FDA, which could be a, you know, uh, and they're well along the path could be a, you know, uh, just a, you know, a massive, um, opportunity for the company. And then the, um, And then the equivalent of LO1, which is not that particular molecule, is not approved in the U.S. That would probably be a bit of a harder fight, but is one that HRA has won in 35 countries around the world, which would represent another one, because Plan B is probably already on the market. That company has something like north of a 90%. They basically have a monopoly on the market. You know, it's one of the biggest SKUs out there in OTC and fast-growing, and that represents an opportunity. So, you know, I think you're going to see switches come back to be a very big and important part of our business going forward. But it's not critical to make that 2023 plan, recapturing the cost and the gross margin where this call has rightfully been focused. and the pushback is fair, that's where we need to recapture those numbers, get that volume through those plants, get the cost out of the system. I accept that feedback because that's where I look at the numbers and I see it the same way, but we believe we'll get all that back.
spk01: Thanks.
spk05: This concludes our question and answer session. I would like to turn the conference back over to Murray Tesler for any closing remarks.
spk04: I just want to thank everybody for their interest in Perigo. I fully understand that this was a bit of a punch in the stomach here relative to the cost situation. I don't think it's Perigo-specific. I think it is the macroeconomic trend that the world is facing, and it's real. The teams have responded. We'll be able to ship more products, and I've already seen that with a nice strong month of October, and we believe we'll recapture and get back to those 2023 numbers, and I'm not the type to back off those. We need to do that. But I don't want anybody to lose sight of the fact that You know, we just deployed $2 billion or in the process of that's going to add $400 million in sales to the company and over a dollar of EPS that we have, you know, shed what was the riskiest and most volatile business for this company. We made a $3 billion potential liability go away, and we did it for free with a $400 million arbitration win. So a lot of good things still happen for the quarter for the long term. These short-term issues, my team and I, we will work our way through it, get it done, and work our way through this COVID challenges. And with that, I will look forward to giving you updates in future quarters. Thanks. Thanks, everyone.
spk05: The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.
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