Perrigo Company plc

Good morning and welcome to the Parago third quarter 2022 financial results conference call. All participants will be in listen-only mode. Should you need assistance, please signal conference specialists 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 then one on your touchtone phone. To withdraw from the question queue, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Brad Joseph, VP of Investor Relations. Please go ahead.

Thank you, Anthony. Good morning, everyone, and welcome to Parago's third quarter 2022 earnings conference call. I hope you all had a chance to review the earnings press release we issued this morning. A copy of the earnings release and presentation for today's discussion are available within the investor section of the Parago.com website. Joining today's call are President and CEO Murray Kessler and CFO Eduardo Becerra. 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 state harbor language regarding these statements in our press release issued earlier this morning. A few quick 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 a discontinued operations prior to its sale. In addition to 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 ARIS business, which were reported in continuing operations. See the appendix for additional details and for reconciliations of all non-GAAP financial measures presented. Second, organic growth excludes acquisitions, divestitures, and currency in both comparable periods. And third, management's discussion will focus solely on non-GAAP results, except as otherwise expressly noted, All comments related to constant currency remove the impact of currency translation versus the prior year by applying the exchange rates used in the comparable measurements in the prior year's financial statements. And with that, I'd like to turn the call over to Murray.

Thank you, Brad, and thank you, everyone, for joining us this morning. On today's call, I will first highlight Parago's double-digit third quarter constant currency top and bottom line growth versus a year ago, and the strong fundamentals on our business that drove that growth. Then I'll dive into the macroeconomic factors that required us to update our adjusted EPS guidance, and finally provide some exciting updates on our strategic initiatives that will keep us basically on track with our 2023 financial goals despite the continued volatility in the macroeconomic environment. Following my comments, Eduardo will walk you through details of our Q3 financials. Third quarter and year-to-date results for Perigo were strong across the board. Constant currency net sales increased 12% in the quarter and 14% year-to-date. Organic net sales growth continued to grow well above our 3% long-term target, growing plus 8% in the quarter and plus 11% year-to-date, And that excludes the organic growth of HRA, which grew double digits during the same periods of time. Third quarter top line growth was driven by the net benefit of the HRA acquisition, less the divestitures of Mexico and Scaraway. Market share gains across all of our U.S. business units and major categories as store brands continue to gain share from national brands. market share gains in our European business, led by the newly acquired Compede brand, strong growth and share gains in e-commerce, and the positive impact of strategic pricing actions across the global portfolio. It's worth pointing out that, once again, consolidated organic growth was driven by a combination of both positive volume and price, 2% and 6%. Gross margin increased 210 basis points versus a year ago. Gross profit flow-through led to constant currency adjusted operating income growth of 32%, despite a $36 million increase in input costs driven by inflation and other macroeconomic factors. Constant currency diluted EPS for the quarter was 65 cents, were up 44% versus a year ago, which included higher year-over-year interest expense and a slightly higher share count. Let's spend a few minutes on the fundamentals of the business. First, the strong top-line growth we are seeing adjusted for currency, whether in total or organically, it's not a one-off. It's been a consistent trend. For perspective, net sales X currency grew 7%, while organic sales grew more than 4%, both on a three-year compound annual growth basis. And that growth came despite the volatility on our business from the COVID pandemic. Taking a closer look at revenue for the quarter, growth was driven by both CSEA and CSCI, in addition to contributions from HRA. Growth was also strong across our major product categories. A few notable highlights are One, women's health grew 100% due mainly to the addition of HRA brands, which benefited from the increased emergency contraception demand spurred by public concerns surrounding the Roe v. Wade decision. Two, a 28% increase in skin care related to the addition of Compede and Mederma and continued growth of Araco brand in Europe. Three, upper respiratory growth of 19% was driven by higher instances of cough cold in Europe and market share gains against national brands and other store brand competitors in the U.S. Our cough cold sales could have even been stronger, but for U.S. labor shortages, that made it difficult for us to keep pace with elevated demand. In allergy, U.S. share gains in the launch of Nasonex 24-hour contributed to growth in the top line, even though the total allergy-affected population was down 11%, compared to the prior year, according to IQVIA fan data. Fourth, an 18% increase in our nutrition business was driven by heightened infant formula demand, resulting from a national brand infant formula shortage. We had been running our facilities at 117% of normal output to do our part, helping to make up for the shortfall. Unfortunately, running this older equipment that hard for that long resulted in an abnormal amount of formula placed on quality hull during Q3, as it does not meet our rigorous standards. To remedy the situation, we paused the Vermont facility for three weeks to do proper maintenance. The facility is back up and running, but Q3 shipments could have been higher without this constraint. By the way, this is one of the main reasons we acquired the gate wave facility from Nestle, and I'll talk about that in just a couple minutes. And lastly, oral care sales were up 8% in the quarter. You may recall that earlier this year, this business was impacted by supply chain disruptions due to ocean freight delays from China, along with a substantial rise in the cost of inbound freight and higher demurrage fees. I'm happy to say that over the last few months, we have received a significant amount of backordered inventory from China, allowing Parago Oral Care to begin shipping unconstrained. As a result, the business gained significant share in the quarter. Also good news here is that ocean freight rates have returned to pre-COVID levels. So while Oral Care took a hit in profitability this year, it appears to be on track and expected to recover substantially. in 2023. Speaking of market share gains, Perigo grew share globally in almost every category or segment we compete in. We gained share of total U.S. OTC. We gained share of U.S. store brand OTC. We gained share of U.S. e-commerce, and we gained share of European e-commerce. We gained share of U.S. oral care, and we gained share of U.S. nutrition, and we gained share of total European OTC. Another positive trend in the quarter included consumers switching from national brands to store brand in USOTC. And this is similar to our experience in previous periods of a looming recession or high inflation. While we are gaining market share, it is worth noting that the total growth rate of the largest category we compete in, total USOTC, has slowed back to more normal pre-COVID levels. For perspective, in the first half of this year, total USOTC grew 13.4%, and total Perigo USOTC grew 9.1%. Looking at the latest 13 weeks, which coincides with Perigo's third quarter, total USOTC omnichannel dollar growth slowed from that 13.4% to 2.3%, despite significant retail price increases. We estimate national brand price increases of approximately 8% to 9% this year, suggesting a 6% volume decline in total OTC. Perigo retail growth also slowed, but outpaced the category and was up 5.8%. Perigo pricing of 6% in the quarter and refers that our volume at retail was relatively flat year over year. We had previously forecasted growth in US OTC to remain at the first half levels, which did not happen in the third quarter. Encouragely, we did see a bump back up again at the end of the quarter with the total OTC category up 7% in the final four-week period of the quarter, and that supports our fourth quarter OTC estimate. Turning to slide 11, like all multinational businesses, the impact of unfavorable currency translation has been a major headwind this year for Parago. We expect the strengthening U.S. dollar to adversely impact full-year 2022 net sales results by approximately $230 million and adjusted operating income by more than $43 million by year-end. In addition, we expect gross inflation to impact our cost of goods solds labor costs and distribution costs by more than $210 million also for the full year. Oral care and nutrition business units in the U.S. were the hardest hit in the quarter. We worked hard to offset the majority of these inflationary costs with strategic pricing actions and other cost savings. However, we will be taking additional pricing to cover significant cost pressures as we need it. Turning to guidance, we have reaffirmed our net sales and organic net sales guidance. Our updated 2022 adjusted EPS outlook range of $2 to $2.10 reflects a negative $0.10 impact from further unfavorable currency movement and a negative $0.15 impact from the rest of our business, including the infant formula purchase versus our prior estimate. All of that is in there. Now let me talk about HRA synergies and two other strategic initiatives that we believe will help us deliver very strong growth in 2023. The integration of HRA remains a cornerstone of our growth strategy, and since the acquisition closed in May, the business has performed beautifully and is growing double digits. We are now raising our total synergy estimate to 50 million euros by the end of 2024, up from 40 million euros previously and up from our original 30 million euro estimate at the time of the deal. Eduardo will go through the details, but we expect an impact to 2023 adjusted EPS of approximately 18 cents or 30 million in operating income for a one-time cost, and let me stress a one-time cost, which would not be included in your current forecast. This cost is related to the inventory sales returns from distributors as we switch HRA from distributors to our direct sales force. This cost has no impact on the strong fundamentals of the HRA business, its underlying trends, other than to facilitate the ongoing cost benefit. Moving to our gross margin expansion plan, in line with our expectations, Parago gross margin has increased throughout the year. And while flat, relatively flat, Q3 versus Q2, we continue to expect to exit the fourth quarter above 37%. Our third strategic initiative is the Supply Chain Reinvention Program, which we expect to deliver $50 to $70 million in incremental operating income next year. The gateway in Good Start brand infant formula acquisition is the primary driver, but our portfolio design and SKU optimization actions will also contribute. So, let me repeat myself. We expect the incremental operating income from these strategic initiatives in 2023 to replace the lost operating income from the second half of 2022. This excludes the one-time cost to achieve the HRA synergy and also excludes any further impact of currency. Now on to infant formula. My nutrition team had been working to solve our infant formula capacity constraints for several years. And you may remember that in 2018, the Perigo Board of Directors authorized and we announced that we would invest up to $300 million to expand our formula capacity with a greenfield project, which did not occur. The acquisition of the Gateway facility finally solved the capacity problem and at nearly half the cost. To recap the details of this transaction, we're making $170 million strategic investment in our infant formula network. We paid $110 million combined for the Gateway manufacturing facility and the US and Canadian Good Start branded businesses. These investments are not only important for Perigo as we harden our existing facilities, but also bolster the infant formula manufacturing industry in the U.S. by expanding industry capacity by 7 million pounds or more than 100 million 8-ounce bottle equivalents within the next 18 months. This purchase is highly accretive, with an expected operating profit contribution in 2023 of more than $50 million, part from the Good Start brand and an equal part From additional volume, we can now run through this network to support our current customers. Pulling all this together, I remain excited about our future. Our fundamentals are solid and getting stronger as we continue to win market share, expand gross margin, and make the strategic investments necessary to drive profitable growth in 2023 and beyond. To be clear, except for the one-time cost to bring HRA distribution in-house and foreign currency translation impact, our 2023 adjusted EPS goal remains unchanged. With that, I'll turn the call over to our CFO to discuss the financials in more detail. Eduardo?

Thank you, Murray, and good morning, everyone. I would like to first go through the details of our third quarter financial performance on a continuing operation basis, then give more details regarding our updated HRA synergies and one-time costs. Now looking at our financials, starting with our gap to non-gap summary, the company reported a gap loss of $52 million for the third quarter, or a loss of $0.39 per diluted share. On an adjusted basis, net income was $76 million and adjusted diluted earnings per share was $0.66 per share versus $0.45 per share in the prior year quarter. A few adjustments to the quarter pre-tax non-GAAP P&L totaling $100 million worth. Number one, amortization of $69 million. Two, restructuring charges of $20 million, primarily related to our supply chain reinvention program. And three, acquisition and integration-related expenses of $12 million, mainly related to the HRA acquisition. Full details can be found in the non-GAAP reconciliation table attached to this morning's press release. Non-GAAP tax adjustments for the quarter were $28 million, primarily driven by the tax effect of non-GAAP adjustments and the effect of interim tax accounting requirements. This led to an adjusted effective tax rate for the third quarter of 21.8%, slightly up from the third quarter of 2021. From this point forward, all dollar numbers, basis points, and margin percentages will be on an adjusted basis unless it's dated otherwise. Moving directly into gross profits, Q3 grew $43 million, or 22.3% on a constant currency basis, driven by inflation-justified pricing, higher sales volumes, and the absence of two product recalls that occurred in the prior year report. Growth was also driven by the addition of HRA. This increase more than offset higher costs driven by inflation, resulting in gross margin expansion of 310 basis points on a constant currency basis. Operating income increased $21 million or 32.2% on a constant currency basis, driven by favorable gross profit flow-through, which was partially offset by higher operating expenses due to the inclusion of HRA and higher distribution costs. These factors led to adjusted operating margin expansion of 190 basis points on a constant currency basis. For CSCA, segment net sales increased 4% or 7.3% organically driven by, first, inflation-justified pricing actions, second, strong performance in infant formula, third, the launch of Nasonex, and fourth, increased manufacturing capacity and demand for the store-branded version of Myralax, which benefited the digestive health category. Importantly, as highlighted by Murray, we achieved shared gains across all three businesses. Gross profit in the quarter increased $10 million, or 5.4%, as pricing and higher sales volumes offset cost of goods sold inflation and lower profitability of contract sales to the divested Rx business. Adjusted gross margin expanded 50 basis points versus prior year on a constant currency basis, and 30 basis points sequential. Operating income for the quarter was flat to last year, as gross profit flow through was offset by higher operating expenses, including the addition of HRA, a 30% increase in distribution expenses driven by higher logistics and the mortgage costs in our oral care business, and the impact of divested businesses versus prior year. The impact of these two items was $8 million on operating income. Moving into CFDI, reported net sales increased 8.4% on a constant currency basis, and we saw a significant increase of 28.6%, including $71 million from HRA. Organic growth was 8.3%, driven by continued demand for cough, cold, and skin care products. Constant currency gross profit grew 41.5%, driven by the addition of HRA, strategic pricing, and increased sales volumes. These factors drove a 480 basis points increase in adjusted gross margin versus the prior year. Operating income increased 66.8% on a constant currency basis as favorable gross profit flow through more than offset higher operating expenses, primarily driven by the inclusion of HRA and higher administrative and R&D expenses. Now moving on to cash flow. Cash on the balance sheet was $469 million at the end of the third quarter, down from $485 million at the end of the second quarter. Year-to-date operating cash flow was $121 million, a conversion of 68%, which is lower than we expected. Let me explain. Year-to-date operating cash flow included impacts of $79 million due to increased inventories, primarily in U.S. oral care business and CSCI segments. and $19 million from restructuring expenses. Given this impact, we're now projecting 75% operating cash flow conversion to adjusted net income for the full year. In addition to these operating cash flow movements, we also invested $70 million in capital expenditures and returned $107 million to our shareholders through dividends during the first nine months of the year. Although the acquisition of the Gateway Infant Formula Plan took place after the quarter closed, I wanted to provide a bit more detail regarding how we funded that $120 million transaction. When we refinanced our debt ahead of closing the HRA acquisition early this year, we borrowed the US dollars and we used cross-currency swaps for EROs. Given the strengthening of the US dollar this year relative to our swap positions, we were able to recoup on these swaps and generated approximately $100 million in cash, which was used for the gateway purchase. As stated, we have increased our cost synergy target for HRA to a benefit of approximately 15 million euros to operating income by the end of 2024. We expect to achieve roughly half of this target by transitioning from HRA's external distributors throughout Europe to our internal CSCI sales force. As a reminder, we have 1,200 sales and marketing colleagues in our CSCI business with approximately 100,000 pharmacy and drugstore partnerships across Europe. The remainder of the cost synergies is expected to be captured from a reduction of fixed costs. To achieve the 50 million euros, we estimate one-time costs of approximately 60 million euros, or 1.2 times the ongoing synergy benefit. Of these one-time costs, Approximately half are related to expected inventory sales returns as part of the distributor transition from HRA external distributors to internal CSCI sales force. The one-time impact of these sales returns will be included in our adjusted non-GAAP results, while the remaining costs are expected to be excluded from our adjusted results consistent with our historical treatment of integration and restructuring costs. We will provide updates on a quarterly basis of the progress of these two areas, both synergies and one-time costs. In closing, I'm excited about our business and would like to thank our colleagues around the world for their continued efforts while navigating through a very dynamic microeconomic environment. We continue to make progress towards delivering on our strategic initiatives, strengthening our business, and delivering meaningful growth in 2023. With that, operator, can you please open the line for questions?

We will now begin the question and answer session. To ask a question, you may press star then one in your touch-tone phone. If using a speakerphone, please pick up your handset before pressing the keys. To withdraw from the question queue, please press star then two. At this time, we will pause momentarily to assemble our roster. Our first question will come from Elliot Wilbur with Raymond James. You may now go ahead.

Good morning, Elliot. Good morning. Several questions for you. First, with respect to the gateway acquisition, I may have missed this in your commentary or maybe it's in the deck and I just don't see it, but could you provide some... color into what the revenue run rate of that business is. And then as we think about integrating that with your existing operations, trying to think about what that actually does for you on a capacity basis, either in terms of units or dollars, how much of an incremental lift, I guess, to the existing business does the gateway acquisition do? enable you to capture. And then you mentioned the plant shutdown three weeks, some quality specs that maybe not hit. Can you just talk about whether or not that sort of triggered any major changes in terms of processes or level of investment associated with the Vermont facility? And I've got a couple others too.

Okay, listen, this is an important, you're right on the right area, Elliot, because You know, if I look at our gross margin progression, there's two areas you go to. Everything else is beautifully on track. And we have been facing challenges with very old equipment in Vermont for years. Like in my first month joining Parago at the first board meeting, We had gone in and asked for, I think it was somewhere around $250 million, and at the next board meeting, we raised it to over $300 million to build a facility, but we weren't able to build that because it didn't pass the environmentals, et cetera. But the reason we did it, it was equipment at the end of its useful life that kept having quality issues. I think three or four years, three years ago, three and a half years ago, we had a couple recalls. We've been constantly struggling. We spent Then we took the profitability of that business down by adding, I added 100 people, 30 in quality control and 70 in sanitation in order to make sure we didn't have what you saw happen this summer. We slowed the lines down and we added about an incremental 10 million in cost on an ongoing basis per year. So, I mean, all of that was just being, you know, worked through. At the same time, we could not satisfy the volume of our key customers. So, you know, with that in mind, we had looked at other alternatives. And we had gotten on to our discussions with Nestle. As you saw in their quotes, they had been challenged on those businesses and were looking at exiting. We had done some contract packing with them. They supplied some of our infant formula, but at a big price and hit our margins as well. The opportunity came to purchase that, and it sort of solved the entire problem. Now, this is not something that came up in the last month or so. We've been working on this for well over a year, long before the infant formula shortage. So to give you, if I can, try to give you the details that you're looking for on that total infant formula business, we have the Good Start Brands. Right? We did not purchase the WIC business. We will pack the WIC business for them. Those brands, and I, you know, and we'll see how our, you know, it's less important. It was, they had to completely rely on that to justify their investment in the facility. This will just be part of the business for us, but it's nice margin business. It had a bigger bump this year because of the shortage, but that'll be a part of the volume And it contributes about half of that 50 million I spoke about on an annual basis. The other half comes from the poundage that they were already packing for us now at cost instead of their margin comes back to us. And we can put millions of more pounds. We will also invest about 60 million into that facility. which will allow us to make more than the four products that we already make there. So I don't have to do any technical transfers. I can start feeding. There are our four biggest SKUs. We can start putting more poundage. We can get that. That allows us in Vermont or some of our premium national brand customers, we can now meet their demand because we're only satisfying about half of what they want or less than half of of what they want and we can do that. We can also slow the Vermont line down. We are putting an additional $20 million in that dryer. We've been doing this for years though, but it's band-aids. And then we will make additional decisions, but we'll be able to slow that. And when I say slow the line, you don't have to slow the line down. You just have to have more time for breaks for maintenance in order to, so that you don't have these quality issues and we can recover some of the costs. But this is, you know, listen, $170 million for 50 plus. I'm usually relatively conserved. $50 million plus in additional operating income is a big deal. And then just so you don't add it on to the numbers next year, that's pretty similar to the challenges we had in the back half of this year. So right now, that offsets the shortfall here in the back half. But for some more currency and that one-time HRA charge, which I told you about last fall, were at the same numbers.

Okay. Thanks. And then I want to ask you a question around the HRA business in the quarter as well. You mentioned the double-digit growth. I'm wondering how that performed versus plan and versus your internal expectations and if there's any color you could provide in terms of what the gross margin impact of that business was. I guess thinking about the disclosure last quarter and then, you know, relative to this period, I thought it might have a little bit more of an incremental lift to overall gross margins, but, you know, perhaps that's just a function of the other businesses. And then, I was going to say, there's been so much movement in FX and, you know, just you know, changes, I guess, in the underlying velocity of the HRA business. Could you just remind us, you know, sort of what your 2023 targets were?

HRA is exactly on our deal model. It's, you know, we're right now forecasting for the year 100% of it. It's massive increases and the difference in gross margin Brad or Duardo, you can help me a little bit, but was probably over 200 basis points in the quarter from HRA. So your point is correct. Let me just cut to the chase. We were up because of HRA. We were up everywhere. I don't have CSCI and Deuteronomy. CSCI gross margin was... that's going to be affected by 58.7. It's up 58.7? Yep, in the quarter. And that's, you know, it's excluding HRA. So everything was up. In the U.S., our biggest business, OTC, was up almost 400, over 400 basis points on a constant currency basis. And the operating income was up, you know, over 25%. So where was the issue? The issue was oral care and nutrition. We just talked about nutrition. I had to throw away product. I shut that facility down for three weeks. That quality hold product doesn't necessarily mean it's all bad. It means that you have to go through it and test it all, which is very slow. So that's the big driver of that, and you didn't get the volume all the way shipped that we were planning on getting shipped or could have shipped. I mean, we could basically ship everything we could make. But in nutrition, it was down 700 basis points versus a year ago on gross margin. And then same thing with oral care was down over 1,000. And that's all because of that inbound freight. So it's very isolated. And let's keep in mind that We were up 207 basis points versus a year ago in total despite those two issues. Good news on those two issues, oral care, the freight costs are all the way back down. We're expecting a significant recovery. I think the gross margin on oral care was a little under 18% in the quarter, and it should be at least mid-20s in the fourth quarter of this year. And on nutrition, nutrition's a little complicated because we'll have a little bit of, excuse me, the Gateway facility and the Good Start brands in there as well, but we'll have a significant increase. We were down 700 basis points versus a year ago on nutrition in the quarter. So bottom line is, And I just told you how we have that solved, right? We're going to be running that product at a lower cost, that operating profit that they were making comes back to us in margin plus additional volume from probably $35 million in sales and $10 million of operating income in the fourth quarter supplements the nutrition business. So I'm giving you a lot of numbers, Brad will go with it slowly, but You know, the big message is everything was going the right direction. We had two hard hits and two business units, and they're both already solved.

No, it's just a correction. The number was 52.4% on CSCI gross margin. I think I screamed out 58, so you did.

Okay. Maybe just one last question. I'll jump back in the queue here, and these will be for – Eduardo. Total operating expenses in the quarter were quite a bit less than what we had expected and what external expectations had anticipated. Is this a good baseline number to think about going forward, or is there maybe a lot of investment that didn't occur because of what you were seeing in terms of the top line and we shouldn't be thinking about annualizing this period's total operating expense as sort of a new run rate, accounting for some of the other issues you have in terms of the acquisition and full year of HRA and the like. And then just real quickly, on the debt, can you just remind us what the effective rate is and whether or not you have any exposure to rising rates, or are you essentially 100%... fixed cost on the debt? Thanks.

So first of all, talking about the operating expenses. So in the quarter, there were a couple of things there. So one is tied to the way we look into our incentives, right? So there was a timing between Q2 and Q3 and a little bit Q4. And also, given some of the softening that we saw in the third quarter, we saw lower advertising promotion happening in the quarter as well. Given that usually Q4 is an area that, because of the cough cold, et cetera, we need to invest more, we should expect an increase on operating expenses in the fourth quarter as compared to what we saw in the third quarter. Okay?

Got it.

Yeah, and regarding the debt, so, I would say that we are the majority swapped from floating to fixed interest rate. So we have our rates now between 4.1 and 4.4%. So we are pretty well coverage there, even with the sulfur increasing, you know, nominally there. So we do expect as an increase for 2023 in our interest expense as compared to what we're seeing now, I think the third quarter is an important reference there when it's through the other income that happened that's related to some of our other businesses. But what we see in the third quarter as interest expense, a good proxy of our run rate for 2023.

Okay.

Our next question will come from Chris Schott with JP Morgan.

You may now go ahead. Hi, guys. Just a few questions here. Maybe just first starting on gross margins. I guess relative to the greater than 37% 4Q target, can you just talk through a little bit about how we should think about gross margin progression in 2023? As it sounds like maybe some of these freight headwinds you were running into are starting to ease. You've obviously had some supply and change initiatives I'm just trying to see what magnitude of increase or how representative that 37% in 4Q is going to be as we try to think about next year.

Well, again, right now, the progression was exactly what we kind of forecasted to you, but for the nutrition hit. So we are back now up over on over the count on CSCA, we're back now up, you know, 30 and a half percent on the biggest portion of the business on OTC and forecasting. That to stay. I know you need to tie it to the tire at CSCI. And, you know, CSCI is when the third quarter was, you know, back, you know, or it had been in the second quarter as well in the 52% range, something close to that 52.4. and it's going to go up again a little bit in the fourth quarter. But the big change in the progression right now besides the longer-term plans of the entire supply chain reinvention, because I just gave you the very first piece, is I just told you we were adding $50 million into the nutrition business, which is massive, and will have a dramatic impact on that. Oral care, I think that Don't quote me exactly, but I believe when freight went from around $6,000 a container up to $25,000 a container, it cost us $23 million on a business that made roughly $50 million. As of exiting the quarter, that number came all the way back down to the $6,000 again. So we're going to recover that $23 million. million in freight costs. Unfortunately, you also had, and we'll recover this as well, you had a heavy demurrage cost when we couldn't get the product off the docks and into the distribution centers. And you get a couple days free. After that, they start charging you pretty heavily. And that was in the quarter as well. But again, that will go away. It's The product's already gone. It's in where it needs to be now. We're not paying the amount anymore. But the product that we're selling in the third quarter, probably a little bit in the fourth quarter, you know, we... You carry a higher cost. Right, because that's the product that's shifted, at least most of it, at the higher cost. And as it comes in through the year, it'll go down. I mean, there's a lot we're starting to see where we have a line of sight towards recovery, which is good.

Okay. Is it fair to think about there being like a couple hundred basis points on gross margin, or is it not going to be that significant looking out to next year, or just like directional commentary?

You know what? We're knee-deep in plans right now. You know, I can't talk to it that specifically. I will tell you, and I've had a lot of investors ask me the question. I thought, Maria, we're going to do Investor Day here, you know, around late summer or September, October. I couldn't, I was negotiating on this deal and when it was gonna happen or whether, and you know we signed and closed, we own it. So that all has to be, we just did that a few weeks ago, now we're building the plans, building all of that in, redoing all of the costs. Come February, if we don't do an investor day, and I'll target one in the first quarter now that we have all this information, you know, I'll be able to give you that. All right. So, but I don't have it right now. And I'm going to give it to you X that one time HRA charge. I was waiting on that one. I alluded to it and I always knew about the size of the number and, you know, 60 million euros to get 50 million in synergies is pretty spectacular. But I was I wasn't sure how much of that was going to be non-GAAP versus GAAP, and now we know all the answers to that. So we'll get to you. I'm not trying to avoid the question.

Sure, sure. And maybe just one more on this topic, whatever color you can give. I think we're all trying to get our hands around 2023 at this point, just given this really interesting gateway deal, HRA, inflation, all this stuff. I guess just so I'm 100% clear, I think you said you're basically – the 23 kind of EPS targets remain unchanged, less FX and less that 18 cent HRA charge. Just so we're all kind of level set here. Like, can you give us like a rough number of what we should be thinking about after we make those adjustments? I think we're just all trying to make sure we're in the right zip code of when you're making those comments.

But for those other, well, we haven't given an official target, right? I always refer to the goals going all the way back to May when I put that chart off of where I wanted to be by 2023. So I almost joked with Brad, our investor relations guy, who you know very well, that, listen, I'm not going to tell you what the target is, but it's adjusted by $0.10 for currency and $0.18 for HRA, which means it's $0.28 lower. than the target I didn't give you. But I would say that the street's around $3, and that's roughly about what I was talking about. So as a first, it's not our official guidance. It's going to be around the $3 less that $0.28 with a range around it.

Okay. Okay. That's helpful. And then the final question I had was just, It seems like we're heading into a strong kind of flu season. And I think you noted in the presentation that cold cloth inventories are low. Is the company at this point in a position to take advantage of potential volume gains there? Or I guess is the labor situation still and your inventory situation is still too tight to be able to take advantage if in fact we do see a very kind of strong season over the next kind of few months and quarters?

Unfortunately, the answer is the latter. Now, it depends where. I think we'll be able to take advantage of it fine in Europe, which they're also projecting, right? So, and that's a big cough gold business as well. I think in the U.S. as it relates to tablets, I think we'll be able to keep pace with that. But I will tell you that it's almost two to three years in the making here. the way this cyclist came on liquids. We're running 24 hours a day, seven days a week, and have been full out. Labor shortages hurt us there in the beginning, but we adjusted that. And that's a high priority, high margin product for us. But we are running flat out. So I am sure, well, I'm not, I'm more than sure. Our consumer takeaway in the third quarter was plus 14% on cough cold products. We shipped five, plus five, right? So we didn't keep pace with demand in the third quarter. And that sort of just pressured our inventories down even further. And you know why, but for some people who may not have followed the story as long as you have, Chris, the reason that this all occurred was because the business went away for COVID. retailers didn't order, didn't forecast the kind of season that we had this year. And they didn't buy in the way they normally did last year. When we had all the normal inventory, then we got to January or February of this year, a huge consumption increase. By the way, nobody wanted the inventory from the prior year because it was near the end of its shelf life. So we were actually throwing away cough cold product from the prior season that didn't happen. And then we had to eat. And because the forecast came in threefold, fourfold higher than the customers wanted, we are, you know, we had to play catch up, right? And it didn't slow down through the summer. It went right through the summer. So if you look at what our forecast from our customers and what the plan was for the year, we have shipped and sold and manufactured 15%, 20% more than that. But that's compared to what actually happened in the marketplace of way, way higher, probably 150% of that or 160% of that. So we'll eventually catch up, but no, we will not be able to fully take advantage of that. And listen, I estimate that probably cost us... $11 million of sales in the third quarter on cough cold.

Okay. Helpful commentary. Appreciate all the color.

Thanks, Chris.

Our last question will come from Jacob Hughes with Wells Fargo Securities. You may now go ahead.

Hey. Hey, good morning, guys. Good morning. I have a question on... Just your overall confidence level in the fourth quarter margin of greater than 30%. I mean, there's obviously a lot of moving pieces. You know, you called out oral care improving in the fourth quarter, you know, the Vermont issue, labor charges. But then you also talk about, Murray, you know, the labor issue has improved. So, you know, is 37% kind of the floor we should be thinking about? You know, is there some conservatism there? Maybe just if you could provide some color on that.

I mean, when we did that forecast, we believe in it.

We, you know, we have done our adjustments. It's kind of, I don't know, I wouldn't say it's conservative or non-conservative. It's what I believe it will be. Do you have any added that's included? We know what the, you know, the gateway product's going to be. We, you know, it's, we've got a month in here. We've, you know, pricing has come up. That's part of it. Like, we We can't take price increases as fast as our competitors, but at this point, the pricing has been implemented that we took through the year. It was probably a three- or four-month lag. That helped it. The HRA business is in the numbers now. That's part of it. So, I mean, there's a lot of pieces, and it hasn't been that difficult to predict. Despite all of the moving pieces, it hasn't been that difficult to predict. But for this nutrition hit on having to stop the plants and the quality holds and the demurrage costs that were pretty severe in oral care.

Anything you want to add, Eduardo? No, I think that's consistent. So, you know, there's major variance there. I think that's where we are.

Okay. And then what was the pricing in the quarter? Yeah, 6% up. Okay. And then last one for me is just on the capital allocation, Murray. The Dell levels are going to come down. How do you kind of think about your priorities there? I mean, is there additional strategic investments you think you're going to have to make similar to the infant formula deal you announced? Or how are you thinking about that beyond 2023?

Well, our number one priority, and we've said that right now, is to reduce leverage. Right? So we are committed, you know, I think it's 800, 900 million by, or certainly that bond that comes through at the end of 24, right?

So our objective is really to get around three times net leverage by the end of 2024. So that's our main priority that we have, yeah.

And then, you know, and that leaves enough room to continue to invest in supply chain initiatives, which You know, I wish I could have had that investor to show you the bigger picture. But, you know, we have $50 million plus from this first $170 million investment, of which $100, Eduardo was able to get the cash by re-couponing, right? So that didn't come out of our cash. And so, you know, it's above normal maintenance levels, but it all has significant operating income returns.

And it's over three, four years. And then the last one for me. So you guys, just to confirm, you guys are thinking about guiding for 23 at a potential investor day? Or what's the cadence of that going to be?

Well, we always, I mean, whether the investor day happens before our February earnings call or not, we always guide our official guidance in February.

Okay. Okay. Thanks a lot, guys. Thank you.

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

Sure. You know, as I sit here on the business, I'm a little disappointed that we had to take the base portion of the business down about 15 cents for the quarter, but I'm still as optimistic as I've ever been. You know, I look at gross margin settings the right way where we were short. It's isolated. It's already fixed. I think the supply chain moves that we just announced are significant and keep us on track for the long term. But I'm a 35-year consumer guy. So when I see your volume growing, consistently growing over three years and gaining market share in every single category we compete in, and a clear path to recovery of margins that's well underway. We hit the bottom in the beginning of the year. You know, I'm very optimistic and, you know, we're going to push as hard as we can to keep it back on track to the additional, you know, to the initial promises we made literally almost three years ago, despite COVID, despite inflation, despite everything else. Not despite currency. Currency I can't cover, but hopefully that in time, over time, will adjust for itself. But heck, I had said something like $340, $350 almost four years ago now, and when you adjust for currency with the way we're talking about it this morning and have been all year, you're pretty close to that. I'm excited about the business and I appreciate your support.

Well, thanks for your interest in Virago. The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.