Good morning and welcome to the Perrigo Third Quarter 2022 Financial Results Conference Call. [Operator instructions] After today’s presentation, there will be an opportunity to ask questions. [Operator instructions] 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.

Good morning, everyone and welcome to Perrigo’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 Investors section of perrigo.com website. Joining today’s call are President and CEO, Murray Kessler, CFO, Eduardo Bezerra. 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 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 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 Rx 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 impact of currency translation versus the prior year by 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'll first highlight Perrigo'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 Perrigo were strong across the board. Constant currency net sales increase 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 US 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 compete 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% respectively. 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…

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 GAAP to non-GAAP summary, the company reported a GAAP 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 $0.56 per share versus $0.45 per share in the prior year quarter. A few adjustments to the quarter pretax non-GAAP P&L totaling a $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 press release. Non-GAAP tax adjustments for the quarter were $28 million, primarily driven by the tax effect of non-GAAP adjustments and the fact of entering 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 stated 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 products recalled that occurred in the prior quarter. Growth was also driven by the addition of HRA. This increased more than offset set higher costs driven by inflation resulting in gross margin expansion of 310…

We will now begin the question-and-answer session. [Operator instructions] Our first question will come from Elliot Wilbur with Raymond James. You may now go ahead.

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 like 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 enable you to capture? And then you mentioned the plant shut down 3 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 of others, too.

Okay. Listen, this is an important -- you're right on the right area, Elliot, because if I look at our gross margin progression, you're -- 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 Perrigo, at the first Board meeting, we had gone in and asked for, I think, of somewhere around $250 million and in the next Board meeting, we raised it 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 half years ago. We had a couple of 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 happened 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 worked through. At the same time, we were out -- we could not satisfy the volume of our key customers. So 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 have been challenged on those businesses, and we're looking at exiting. We had done some contract packing with them. They supplied some of our infant formula but…

Okay. And then I want to ask a question around the HRA business in the quarter as well. You mentioned double-digit growth. I'm wondering how that performed versus plan and versus your internal expectations? And if there's any color you can provide in terms of what the gross margin impact of that business was. I guess thinking about the disclosure last quarter and then relative to this period, I thought it might have a little bit more of an incremental lift to overall gross margins, but perhaps that's just a function of the other businesses. And then, Murray, there's been so much movement in FX and just changes, I guess, in the underlying velocity of the HRA business. Could you just remind us sort of what your 2022 targets were?

HRA is exactly on our deal model. It's -- we're right now forecasting for the year, 100% of it. It's massive increases and the difference in gross margin, Brad or Eduardo, you can help me a little bit, but was probably over 200 basis points in the quarter from HRA.

Yes.

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 [indiscernible] CSCI gross margin was -- that's going to be affected by...

58.7.

It's up 58.7?

Yes, in the quarter.

And that's -- it's up excluding HRA. So everything was up. So 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 over 25%. So where was the issue? The issue was Oral Care and Nutrition. We just talked about Nutrition. I have a throwaway product. I shut that facility down for 3 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. And 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, all right? So -- and then same thing with Oral Care was down over 1,000. It was like -- and that's all because of that inbound freight. So what's the good -- so it's very isolated. And well, let's keep in mind 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 is a little complicated because we have a little bit of -- excuse me, the Gateway facility and the Good Start brand's 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 we've -- I just told you how we have that solved, right? We're going to be running 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 on sales of $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 the big message is everything was going in the right direction. We had two hard hits in two business units, and they are both already solved.

No, it's just a correction. The number was 52.4% on CSCI gross margin. I think at extreme, .58 so...

You did.

I did.

Yes.

Okay. Maybe just one last question, I'll jump back in the queue here, and this 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 just -- is there may be 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? Total operating expense is 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?

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.

Yes. And regarding the debt, so I would say that we are the majority swapped to -- from floating to fixed interest rates. So we have our rates now between 4.1% and 4.4%. So we are pretty well coveraged there even with the sulfur increasing nominally there. So we do expect that 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 you exclude 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.

Our next question will come from Chris Schott with JPMorgan. You may now go ahead.

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? It sounds like maybe some of these freight headwinds you were running into are starting to ease. You've obviously had some supply change initiatives. I'm just trying to see like 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, we -- 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 -- in CSCA, we're back now up 30.5% on the biggest portion of the business on OTC and forecasting that to stay. I know you need to tie it at CSCI. And CSCI is when the third quarter was back, 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 as 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 I -- don't quote me exactly, but I believe when freight went from around 6,000 a container up to 25,000 of container, that 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 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 of days free after that, they start charging it pretty heavily, and that was in the quarter as well. But again, that will go away. It's -- the product is already going. It's in the -- where it needs to be now. It's not -- 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, we -- still carry a higher cost, right, because that's the product that's shipped about at least most of it at the higher cost. And as it comes in through the year, it will 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 of hundred basis points on gross margin? Or is it not going to be that significant looking out to next year or just a directional commentary?

We're having [ph] plans right now. 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, Murray, you were going to do an Investor Day here around late summer or September, October. I couldn't. I was negotiating on this deal and when it was going to 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, 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 ex that onetime HRA charge. I was waiting on that one. I alluded to it, and I always knew about the size of the number and EUR 60 million 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. Yes. And maybe just one more on this topic and 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 the stuff. I guess so 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 than $0.18 HRA charge. Just so we're all kind of level set here, like can you just 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, I know 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 $0.18 -- it's $0.28 lower than the target I didn't give you, which is -- but I would say that The Street is around $3. And that's roughly about what I was talking about. So as a first, you're not -- it's not our official guidance, it's going to be around the $3 less than $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/cough 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 of 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/cold 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 2 to 3 years in the making here. The way this cycle has come among liquids, we're running 24 hours a day, 7 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 5, plus 5 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've had, 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 when we got -- 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, 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 -- and because the forecast came in threefold, fourfold higher than the customers wanted, we are -- we had to play catch up, right? And it didn't slow down through the summer, it -- 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.

Our last question will come from Jacob Hughes with Wells Fargo Securities.

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 called out Oral Care improving in the fourth quarter, the Vermont issue, labor charges, then you also talk about, Murray, the labor issue has improved. So is 37% kind of the floor we should be thinking about? Is there some conservatism there? Maybe just if you could provide some color on that.

When we did the forecast, we believe in it. We have done our adjustments. It's kind of -- I don't know. I wouldn't say it's conservative or not conservative. It's what I believe it will be. Do you have any added, that's included. We know what the Gateway product is going to be. We -- it's -- we've got a month in here. We've -- pricing has come up. That's part of it, like 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 3- or 4-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 was -- 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 or...

No, I think that's consistent.

Major variance there. I think that's where we are.

Okay. And then what was the pricing in the quarter, 6%?

Yes, 6% up.

Okay. And then last one for me is just on the capital allocation, Murray, if you could kind of -- the 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 '23?

Well, our #1 priority, and we've said that right now is to reduce leverage, right? So we are committed to -- I think it's $800 million, $900 million by -- or that -- certainly, that bond that comes due at the end of '24, right?

So our objective is really to get around 3, 3x net leverage by the end of 2024. So that's our main priority that we have now.

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

And then a 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 case is that going to be?

Well, we always -- I mean, whether the Investor Day happens before our February earnings call or not, we always guide on our official guidance in February.

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

Sure. As I sit here on the business, I'm a little disappointed that we had take the base portion of the business down about $0.15 for the quarter. But I'm still as optimistic as I've ever been. I look at gross margins heading 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 3 years and gaining market share in every single category we compete in and a clear path of recovery of margins that's well under way, we hit the bottom in the beginning of the year, I'm very optimistic. And we're going to push it as hard as we can to keep it back on track to the additional -- to the initial promises we made literally almost 3 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 I had said something like 3 -- 43 50 almost 4 years ago. 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. So I'm excited about the business, and I appreciate your support. Thanks for your interest in Perrigo.

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