Good day, and welcome to the Conagra Brands Second Quarter Fiscal Year 2021 Earnings Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Brian Kearney from Investor Relations. Please go ahead.

Good morning, everyone. Thanks for joining us. I'll remind you that we will be making some forward-looking statements today. While we are making those statements in good faith, we do not have any guarantee about the results we will achieve. Descriptions of the risk factors are included in the documents we filed with the SEC. Also, we will be discussing some non-GAAP financial measures. References to adjusted items, including organic net sales, refer to measures that exclude items management believes impact the comparability for the period referenced. Please see the earnings release for additional information on our comparability items. The GAAP to non-GAAP reconciliations can be found in either the earnings press release or the earnings slides, both of which can be found in the Investor Relations section of our website, conagrabrands.com. With that, I'll turn it over to Sean.

Thanks, Brian. Good morning, everyone. Happy New Year, and thank you for joining our second quarter fiscal 2021 earnings call. Today, Dave and I will discuss our strong second quarter results as well as our perspective on how Conagra is positioned to continue to succeed in both the current environment and beyond. So let's get started. I'm very pleased with our strong results for the second quarter. Our business continued to perform well both in the absolute and relative to peers. Our success to date in fiscal 2021 is not only a testament to our team's ability to adapt to the current environment, but a reflection of the work we've done to transform our business over the past five-plus years. Our ongoing execution of the Conagra Way playbook, perpetually reshaping our portfolio and capabilities for better growth and better margins, has enabled us to rise to the occasion during the COVID-19 pandemic, and that has positioned the business to excel in the future. During the second quarter, we continued to build on our momentum and our Q2 results exceeded our expectations across the board. We had strong, broad-based sales growth. Our margin expansion is ahead of schedule, and I'm proud to announce that we reached our deleveraging target earlier than originally planned. In keeping with our Conagra Way playbook, we continue to optimize the business for long-term value creation during the quarter. We made targeted investments in both production capacity and marketing support to drive the physical and mental availability of our products. We also remained committed to sculpting our portfolio through smart divestments with the agreement shortly after the second quarter closed to sell Peter Pan peanut butter. Peter Pan is a very good business, but it's not an investment priority for Conagra given our other portfolio priorities. Finally, we are reaffirming our fiscal 2022 guidance for all metrics. And none of this would be possible without our exceptional team, particularly our frontline workers. So before we dive into the details of the quarter, I want to recognize everyone responsible for the continued extraordinary work of our supply chain. I'm extremely proud of the thousands of hardworking Conagra team members whose dedication has enabled our industry-leading performance. We remain focused on keeping employees safe, while meeting the needs of our communities, customers and consumers. And I'd like to thank everyone at Conagra for making this possible. With that, let's get into the business update. As the table on Slide 7 shows our second quarter results exceeded our expectations across the board. We delivered organic net sales growth of 8.1%, adjusted operating margin of 19.6% and adjusted EPS of $0.81. These results enabled us to reach our fiscal 2021 net leverage ratio target of 3.6x ahead of schedule. During the second quarter, we continue to drive significant growth across our retail business. Total Conagra retail sales grew 10.4% year-over-year, with strong growth across each of our snacks, frozen and staples portfolios. Our results were driven by continued success in expanding our presence with consumers and gaining share. Total Conagra household penetration grew 14 basis points versus a year ago and our category share increased 26 basis points. Critical to our ability to sustain our growing relevancy with consumers is the physical availability of our products, whether through brick and mortar or online. And Slide 9 demonstrates how our ongoing investments in e-commerce have continued to yield results. In the chart on the left, you can see the step change in e-commerce growth for total edible that has occurred since the onset of the pandemic. But what's really impressive about this chart is the sustainability of our e-commerce performance. We've retained a massive portion of the e-commerce sales we gained at the onset of the pandemic, and our results have outpaced total edible e-commerce growth each quarter. As a result of our sustained success, e-commerce continued its recent trend of steadily increasing as a percentage of our total retail sales as you can see on the right. While e-commerce growth both on an absolute basis and as a percent of overall sales is not a new dynamic for Conagra, this growth has accelerated during COVID-19. In addition to our continued progress in e-commerce, our new innovation generated strong performance during the second quarter. When we began this journey over five years ago, we recognized that we had a lot of latent potential in the portfolio; it just had to be modernized. So we set out to aggressively do just that. And you'll recall that we established a goal of having 15% of our annual retail sales come from products launched within the preceding three years. As you can see on Slide 10, our innovation performance has continued to exceed our 15% goal. What's equally important is the consistency of our innovation performance. Investments we've made over the last five years in our innovation capabilities enabled us to continue launching new products since the pandemic began. Customers trust our innovation track record and rely on our new products to drive consumer trials and overall category growth. Slide 11 drills down on the strength of our recent innovation performance. Compared to last year's first-half launches, the products we introduced in the first half of this year have achieved 37% more sales per UPC and 28% more distribution points per UPC during the comparable time period. Product performance highlights include Marie Callender's, which boasts the number one branded new item in frozen indulgent single serve meals. Duncan Hines has delivered the top three highest velocity new items in single serve baking and our modernized Hungry-Man brand is outpacing category growth by more than two times. After a strong first half of fiscal 2021, we will introduce even more new products that will build distribution in the second half. Expect to hear more about our upcoming product launches at CAGNY next month. Turning now to Slide 12, total Conagra frozen retail sales grew an impressive 8.3% versus a year ago, thanks to strong growth in each of our four main frozen categories. Importantly, our terrific frozen vegetables business returned to strong growth in the quarter, as we brought on our additional capacity investments online. Slide 13 digs a bit deeper into our largest frozen brand, Birds Eye. Birds Eye is a cornerstone of the important frozen vegetable segment with a number one position in the category, more than twice the category share of the closest branded competitor. Recall that Birds Eye previously faced some supply constraints as we worked to bring new capacity online. And last quarter, I noted that shipments for the brand were a bit ahead of consumption as retailers started rebuilding their inventories. You can see in the charts on Slide 13, Birds Eye returned to form in Q2 as expected. In addition to strong retail sales growth of 7.2% in the quarter, Birds Eye gained an impressive 261 basis points of share from Q1 to Q2. Continuing to Slide 14, you can see how Birds Eye has attracted and retained more new buyers than our competition since the pandemic began. The frozen vegetables category remains highly relevant to consumers, and we believe the steps we've taken over the past several quarters to modernize the Birds Eye brand and expand capacity have positioned us well to build on our category leadership. Turning now to another area of strength, our leading portfolio of frozen single serve meals had another terrific quarter. As you can see on Slide 15, Conagra has outperformed peers, driven category growth and attracted new buyers since the start of the pandemic. As the chart on this slide shows, we have three of the top brands in this category from both a trial and repeat perspective. Our snacks business also continued to see strong growth in the quarter. As you can see on Slide 16, we delivered double-digit retail sales growth on a year-over-year and two-year basis in snacking, led by impressive results across popcorn, sweet treats, and meat snacks. We're not just growing; we're winning versus the competition. Slide 17 shows how we grew share year-over-year in popcorn, meat snacks, hot cocoa, and ready-to-eat pudding and gelatin in the quarter. Our staples portfolio also delivered solid results in Q2. Historically, this portfolio has served primarily as a source of cash for us, but it hasn't been looked at as a growth engine. Slide 18 shows how staples remained highly relevant to consumers in the quarter as people continue to rediscover cooking, and the utility, relevance and value of products in our portfolio. Our basket of the total staples category grew retail sales by 12.7% in the second quarter. People are returning to their kitchens during the pandemic, and new, younger consumers are discovering the joy of cooking. Many of the brands on this slide including Pam, RO*TEL, and Hunt's are cooking utilities and ingredients. As we've discussed before, the current environment has resulted in consumers trying or reengaging with our products and coming back again and again. And that takes us to what we see going forward and how our business is uniquely set up to win. Our execution of the Conagra Way playbook over the last five-plus years enabled us to deliver strong performance prior to the onset of COVID. And we firmly believe that our reshaped portfolio, modernized products, and enhanced capabilities have been foundational to our ability to excel during these highly dynamic times. We all know that the COVID pandemic has driven an increase in at-home eating overall. But for Conagra, it has also meant an acceleration of the consumer trial, adoption and repeat purchase rates of our products. Our results have been strong on both an absolute and relative basis. These dynamics have driven meaningful levels of incremental cash flow for our business. They've also enhanced the ROI of our previous disciplined investments in portfolio, capabilities, and the physical and mental availability of our products. Importantly, the Conagra Way is perpetual; while we've adapted to the current environment and delivered superior results, we also continue to look to the future and make smart investments to further strengthen our business. Our investments include continuing to modernize our products and packaging, increasing production capacity when category dynamics warrant, supporting on-shelf availability and increased e-commerce share, and raising consumer awareness. We are clear: these investments are not a reaction to the near-term environment, but decisions rooted in our longer-term outlook for the business and our disciplined execution of the Conagra Way. We believe that Conagra is in a strong position to continue to win, now and for years to come. We expect that our investments, coupled with consumer adoption and the proven stickiness of our products, will result in Conagra continuing to deliver long-term profitability. In summary, we continue to see solid execution across our portfolio aligned with the Conagra Way playbook in Q2, which enabled us to deliver results that exceeded our expectations. Our business remains strong in the absolute and relative to competition, and we expect Conagra to be even better positioned post COVID as a result of our ongoing disciplined approach to investment and innovation. And with that, I'll turn it over to Dave.

Thank you, Sean. Good morning, everyone. Today, I'll walk through the details of our second quarter fiscal 2021 performance and our Q3 outlook before we move to the Q&A portion of the call. I'll start by calling out a few performance highlights from the quarter, which are captured on slide 22. As Sean mentioned, outstanding execution by our teams across the company enabled us to exceed expectations for net sales, margin, profitability, and deleveraging during the second quarter, while we continued to invest in the business. Reported and organic net sales for the quarter were up 6.2% and 8.1%, respectively, versus the same period a year ago. We continued our strong margin performance from Q1 as Q2 adjusted gross margin increased 139 basis points to 29.9%. Adjusted operating margin increased 250 basis points to 19.6%. Adjusted EBITDA increased 16.7% to $712 million in the quarter. And our adjusted diluted EPS grew 28.6% to $0.81 for the second quarter. Slide 23 breaks out the drivers of our 6.2% second quarter net sales growth. As you can see, the 8.1% increase in organic net sales was primarily driven by a 6.6% increase in volume related to the growth of at-home food consumption. The favorable impact of price mix, which was evenly driven by favorable sales mix and less trade merchandising, also contributed to our growth. The strong organic net sales growth was partially offset by the impacts of foreign exchange, and a 1.7% net decrease associated with divestitures. The Peter Pan peanut butter business is still part of Conagra Brands and thus included in our organic results. We expect the sale of Peter Pan to be completed in Q3, at which point it will be removed from organic net sales growth. I will discuss the estimated impact of this divestiture shortly. Slide 24 summarizes our net sales by segments for the second quarter. On both a reported and organic basis, we saw continued significant growth in each of our three retail segments: grocery and snacks, refrigerated and frozen, and international. The net sales increase was primarily driven by the increase of at-home food consumption as a result of COVID-19 which benefited our retail segments but negatively impacted our food service segment. The grocery and snack segment experienced strong organic net sales growth of 15.3% in the quarter. The segment's organic net sales growth outpaced at-home consumption, as retailers continued to rebuild inventories. Our refrigerated and frozen segment delivered organic net sales growth of 7.8%. This growth is a testament to our continued modernization and innovation efforts, and illustrates the increasingly important role refrigerated and frozen products play in meeting the evolving needs of today's consumers. Turning to the International segment, quarterly organic net sales increased 9.1%. This segment experienced particularly strong growth in both Canada and Mexico. This quarter, our food service segment reported a 21.4% organic net sales decline, primarily driven by a volume decrease of 25.3% due to less restaurant traffic as a result of COVID-19. Slide 25 outlined the adjusted operating margin bridge for the quarter versus the prior year period. As you can see in the second quarter, our adjusted operating margin increased 250 basis points to 19.6%. Strong supply chain realized productivity, favorable price mix, cost synergies associated with the Pinnacle Foods acquisition and fixed cost leverage combined to drive 440 basis points of adjusted operating margin improvement; more than offsetting the impact of cost of goods sold inflation and COVID-related costs in the quarter. Collectively, these drivers resulted in a 139 basis point increase in our adjusted gross margin versus the same period a year ago. A&P increased 4.7% on a dollar basis, primarily due to increases in e-commerce marketing. A&P was flat on a percentage of sales basis this quarter versus Q2 a year ago. Finally, our adjusted SG&A rate was favorable by 110 basis points, primarily as a result of fixed cost leverage on higher net sales, the Pinnacle cost synergies and temporarily reduced spending as employees worked from home and significantly reduced their travel. I want to give you some additional perspective on our margin expansion. As I just mentioned, operating margin expanded 250 basis points for the quarter well ahead of our expectations. Of this 250 basis point expansion in operating margin this quarter, approximately 60 basis points reflects our ongoing progress towards achieving our fiscal 2022 margin target of 18% to 19%. We also saw an approximate 180 basis point margin benefit from price mix in the quarter, primarily driven by mix and to a lesser extent, favorable pricing and lower trade merchandising. We expect to retain some of this benefit going forward, but exactly how much remains uncertain at this point. An additional 10 basis points of net margin expansion came from favorable fixed cost leverage across the entire P&L and COVID-related SG&A benefits mostly offset by COVID-related cost of goods sold. We do not expect this net benefit to repeat next year. Slide 26 summarizes our adjusted operating profit and margin by segment for the second quarter. Our three retail segments saw operating profits increase by double-digit percentages versus the same period a year ago. Each retail segment benefited from higher organic net sales and strong supply chain realized productivity. In the Food Service segment, however, operating profit decreased due to the COVID-related impacts of lower organic net sales and higher input costs that more than offset the impacts of favorable supply chain realized productivity and cost synergies. Overall, we're pleased with the continuation of the strong Q1 margin results into the second quarter, which are anchored by core productivity and benefits from the Pinnacle acquisition we expected to see. Turning to slide 27; we've outlined the drivers of our second quarter adjusted diluted EPS growth versus the same period a year ago. EPS increased 28.6% to $0.81. The growth in the quarter was primarily driven by the increase in adjusted operating profit associated with the net sales increase and margin expansion and also benefited from a decrease in net interest expense as we've continued to reduce debt as a priority. Slide 28 highlights our significant progress on the overall synergy capture since the close of the Pinnacle Foods acquisition during the second quarter of fiscal 2019; we captured an incremental $27 million in savings during the most recent quarter, bringing total cumulative synergies to $246 million. As a reminder, the majority of total synergies to date have been in SG&A. Cost of goods sold synergies have started to be a bigger portion of our synergy savings for the last two quarters, and we expect them to make up a majority of our synergies going forward. We remain pleased with the team's progress in capturing synergies and remain on track to achieve our fiscal 2022 synergy targets. Slide 29 shows the strong progress we've made to date to achieve our deleveraging targets. Since the close of the Pinnacle acquisition in the second quarter fiscal 2019 through the end of the second quarter of fiscal 2021, we have reduced total gross debt by $2.3 billion, resulting in net debt of $9.2 billion. We are pleased to report that at the end of the second quarter, we achieved our net leverage ratio target of 3.6x down from 5x at the closing of the Pinnacle acquisition and 3.7x at the end of the first quarter of fiscal 2021. Strong, consistent improvements in debt reduction, coupled with robust earnings enabled us to achieve this net leverage ratio target ahead of schedule. Looking ahead, we will continue to be focused on executing a balanced capital allocation policy. We remain committed to solid investment grade credit ratings as we continue to be opportunistic, using our balance sheet to drive shareholder value, such as our increased investment in CapEx and the recent 29% dividend increase. Slide 30 summarizes our outlook. As Sean and I have both said throughout this presentation, we believe in the strength of Conagra's future. While we're confident in the quarters ahead and that Conagra will continue to excel beyond the COVID-19 environment, the sustained impact of COVID-19 remains dynamic and continues to make near-term forecasting with specificity a challenge. We expect a continuation of elevated retail demand and reduced food service demand compared to historic pre-COVID-19 demand levels. We are currently seeing both of these trends continue in the third quarter today. For the third quarter, we expect organic net sales growth to be in the range of plus 6% to 8%. We expect Q3 operating margin to be in the range of 16% to 16.5%, implying a year-over-year increase of 30 to 80 basis points. This estimate includes an expected acceleration of our A&P investment and e-commerce marketing that we started in Q2, reducing the estimated year-over-year Q3 operating margin expansion. As a reminder, Q3 operating margins are historically lower than Q2 operating margins, given the leverage impact on the seasonality of sales. Given these sales and margin factors along with expected improvement in below-the-line items, we expect to deliver third quarter adjusted EPS in the range of $0.56 to $0.60. Our third quarter guidance also continues to assume that the end-to-end supply chain operates effectively during this period of heightened demand. As outlined in our earnings release, our third quarter guidance does not yet include any impact from the pending sale of the Peter Pan business. We are selling the business for approximately $102 million. And the expected annualized impacts of the divestiture are a reduction of approximately $110 million of net sales and three cents of adjusted EPS. Lastly, we are reaffirming all metrics of our fiscal 2022 guidance, which also excludes the impact of the pending sale of Peter Pan. We look forward to presenting again next month at CAGNY where we will provide another update on our progress in executing the Conagra Way. We hope you'll join us. Thanks for listening everyone. That concludes my remarks this morning. I'll now pass it to the operator to open it up for questions.

Thank you. We will now begin the question-and-answer session. The first question today comes from Andrew Lazar of Barclays. Please go ahead.

Good morning, everybody, and Happy New Year.

Happy New Year, Andrew.

Great. Thank you. I guess, today, Conagra reaffirmed the fiscal 2022 financial goals and those have obviously been a key milestone for the company ever since the Pinnacle deal. And with fiscal 2022 really at this point rapidly approaching, as well as all the uncertainty around operating in the current environment, what can you offer to sort of assure investors that Conagra can not only reach its fiscal 2022 targets, but more importantly, do it in a way that enables the company to deliver sustainable growth thereafter? As part of that I saw A&P was up in the quarter. And you mentioned that we should expect that to continue into the fiscal third quarter. Is that pattern of sustained investment one that we should expect more of moving forward? So those are kind of combined. And then I just got a follow-up for Dave.

Okay. Well, there's a lot in that one. So good questions. Let me try to unpack each piece of that. Yes, of course, we can provide that assurance. We believe that what we are experiencing right now is the acceleration of product trial that in normal times would take years and hundreds of millions of dollars. Now as for what's going to sustain it through 2022 and beyond, in a nutshell, it is our people and our playbook. Now, I spoke about our people in my prepared remarks. But let me remind investors about our playbook, particularly with respect to brand building. We have spent years curating and optimizing our approach to brand building, and we believe that is one of the most progressive and effective approaches in our space. The goal of brand building is to create a powerful connection between our consumers and our brands. And in the simplest sense, to do that, you have to meet people where they are with modernized products and packages, and then you communicate information that is relevant and meaningful to them. This is really the heart of our approach. So first, we meet people where they are. And you can ask yourself, well, where are they these days? Well, these days, it's often, a, on their devices seeking entertainment or information, or b, shopping in bricks-and-mortar or online. But it's also important to understand where they're not. And increasingly, we're seeing that they're not tethered to a television that is broadcasting mass market advertising. When I was five years old, that was the place you would find a consumer, and you could communicate the information you had to share. But obviously, if that were our approach today and it were so monolithic, we wouldn't be finding a lot of consumers, especially not a lot of young consumers, who we are very, very focused on because there are significant sustainable demographic tailwinds there that I've spoken about before. So instead, we reach our consumers in a diversity of locales from online to in store to on TV to on radio and more. And then with respect to communicating the information that's relevant and meaningful to them; it starts, as you’ve all heard me talk many times, with a very modernized product and package design, and then a succinct, provocative message around the appealing product benefit. That's our playbook. It works and it will continue to work. And it's why our growth rates, our innovation performance, our trial, our repeat, our depth of repeat metrics are often outpacing our competitors. In the simplest sense, what we are asserting here is that modern, high-quality products with great online and in-store presence, supported by provocative and targeted messaging, will beat outdated lower-quality products with weak online or in-store presence but lots of broadcast media every single time. And then lastly, on your question about total brand investment: our total brand investment has been at a strong level and it remains strong. But yes, it is variable. And in any given quarter, we can flex it based on the circumstance of the quarter. So recall when supply was constrained, we dialed back. When supply is ample and we see good ROI opportunities, we can flex it up. And by the way, we can flex it above or below the line, as you've seen. But overall, I would say the level is in a good place. And I think the strong results that you're seeing not just in the absolute, but relative to competition shows that.

Great. Thank you for that. And then, Dave, just quick follow-up. Can you walk us through, again, how the operating margin goes from where it landed in fiscal Q2 to your forecast for Q3? As you mentioned, it represents a pretty substantial sequential step down and is that purely just the marketing aspect or are there other factors we need to take into account there and maybe it's commodities which have spiked a bit and things of that nature?

Yes, Andrew, let me try to break that down. First, as I mentioned in my remarks, the normal cadence of operating margin from the second quarter to the third quarter always shows a step down as we exit the holiday season and lose some of the operating leverage from the lower overall sales dollars. Second, when you look at Q3 operating margin a year ago, there were some benefits from reduced incentive comp accrual and SG&A a year ago in Q3. Third, inflation for the third quarter is now estimated to be around 3.5%, whereas in Q2, it was around 2.8% to 2.9%. And then lastly, as we just discussed, we are accelerating our A&P investment in the third quarter to support increased e-commerce marketing that we started in Q2. So we expect a double-digit increase in A&P in the third quarter versus a year ago. So those are really the factors. With that, we still, with our guidance, are implying a 30 to 80 basis point improvement in operating margin in the third quarter year over year.

Great. Thanks very much, everybody.

Apologies. It looks like David Palmer is the next question. Please go ahead.

Thanks. A bit of a follow-up to Andrew's question. You mentioned in slides that Conagra is investing behind and executing the Conagra Way and you mentioned five years. So I'm wondering if you could maybe give us that five-year snapshot about where Conagra has shifted its investment in ways that is less obvious, because I think everybody sees advertising spending since it is broken out. Perhaps give us a feeling about what has worked best and what you think you might want to be adjusting going forward? And I have a quick follow-up.

Yes, sure. Hi, David, Happy New Year. If you go back five years, the company five, five-and-a-half years ago didn't look anything like it looks today. We were a global conglomerate. We were struggling in the world of private label. We were trying to be a lot of things to a lot of people. Today, we are a focused pure play, largely North American company and we play in three spaces: frozen; snacks, which is a very unique snack business with a lot of neglected coats; and staples. Over the last five years, the heavy lift was in the early days where we had to tackle value over volume. And that was painful, but necessary to purge out low-quality volume and establish a new foundation. But it put us in a position to then layer on outstanding innovation on a much stronger base. We started, as you know, with frozen. We have what we believe is the leading frozen portfolio in North America that has been growing incredibly robustly. It is a centerpiece of our investment and our innovation effort and that will continue, because we are in the early innings of frozen success. As I pointed out in CAGNY last year, when you look at the demographic tailwinds we have from millennials, as they form households and have children, per capita consumption of frozen tends to increase, which supports a long-term growth runway. Our snacks business we rebased a couple of years ago and said we're going to run it like a snack company. The performance there has been outstanding. It's both organic and through M&A. We think that playbook will continue. It's a high growth, high margin business and we've got extremely strong relative market shares in that space. That will continue and remains a priority for investment. The third piece is more interesting during and post pandemic, which is our staples portfolio. That's a third of our retail business in staples, which historically was primarily a cash management business. But many products in staples are cooking utilities and ingredients—for example, Pam, RO*TEL, Hunt's—and they become more relevant when cooking increases. Today, younger consumers are discovering cooking and rediscovering the utility and value of these products. A lot of our staple products are playing a meaningful role during the pandemic, and we believe because of some of these demographic tailwinds, they will continue at an elevated level post pandemic. So very strong forward-looking performance in frozen and snacks, and more optimism in terms of the growth potential out of staples than probably pre-pandemic is how I would put it. Dave, do you want to add anything to that?

Yes, the only thing I would add that sits on top of all that is the investments we've made in supporting e-commerce capability. If you look at investments in the supply chain, our approach to modern marketing, retail investments, analytics—all of that capability we invested in early on is now seeing benefits with COVID and the acceleration of e-commerce. So I would add that really applies to everything, both legacy and innovation volume.

The next question is from Ken Goldman of JP Morgan. Please go ahead.

Hi, can you hear me this time? Hey, guys, thanks so much for your patience. Sorry about that. Two questions for me. Number one, wanted to ask about the organic top line guidance for the third quarter. You'll be lapping the air pocket that you talked about last year; you have a much easier comparison in the third quarter versus the second quarter. You're guiding to a deceleration in organic sales growth from 8.1% to that range of 6% to 8%. I'm just curious can you walk us through some of the factors that are maybe leading to that slowdown? And again, it's a pretty steep slope on a two-year basis. So what are some of those headwinds?

Yes, Ken, this is Dave. So overall, when we look at Q3, we look at it very similar to Q2. We expect shipments to be roughly in line with consumption. Historically the third quarter can be a time where you see some retailers reduce inventory levels. But we have such strong demand right now that we are seeing orders that are strong because retailers are replenishing to have the right stocks to support the demand. So there are a lot of dynamics going on in this third quarter that we haven't seen in a prior third quarter. Our planning posture is we feel good about our consumption call; it will be very similar to what we saw in Q2. And we believe that shipments are going to roughly be in line with that. There will be some puts and takes between the different segments, but that's our planning posture right now given all the dynamics that are going on in Q3.

Okay, thank you for that. And then I want to ask a quick follow-up, Sean. You've been one of the more confident CEOs in our space when it comes to the stickiness of demand after the crisis is over. I think you gave some compelling reasons today why that stickiness will be there. But if sustainable growth is already here, can you talk about — and Dave too — how should we think about your desire to grow CapEx over the next couple of years to support that heightened demand? You talked about free cash flow that wasn't changed. I'm just wondering if there's a chance that as you see demand being sticky that your plants will need a little more expansion to support what's out there in the consumer world.

Yes, well, we're already doing that, Ken. If I could use Slim Jim as an example: we've dramatically increased the size of the plant a year or so ago, and that business has performed so well that we are on the precipice of doing that again. Those types of capital investments are clearly on our radar and are priorities for us. But we have other capital allocation options as well. It is all part of our balanced approach to capital allocation.

Yes, just to give you some examples: if you look at the first half, our CapEx spending is up over 50%. So we're investing in CapEx now. Some of the big drivers are network optimization projects—one in grocery and one in refrigerated/frozen—which drive strong ROI and continue to help drive our margins. And then we have a big investment in Birds Eye to build capacity for the long term. As Sean said, we'll look at capital allocation on a balanced basis, but we feel really good about the investment opportunities we have in CapEx. It's a good situation because we have a lot of good things to invest in.

Just to be 100% clear, the free cash flow guidance that you have out there, that includes what you think will be necessary for CapEx to support the increased demand that's out there?

That's correct. And you'll see in our 10-Q that we file our estimate for the year for CapEx and that reflects that.

The next question today comes from Chris Growe of Stifel. Please go ahead.

Hi, good morning. I just had a question for you. When I look at the divisions, you had really strong leverage in the refrigerated and frozen division, and then less leverage in the grocery and snacks division. That was a little different than what I expected for the quarter. I want to understand the nuances between those two divisions and the degree to which you're using third parties for manufacturing that could be limiting the margin expansion in grocery and snacks, for example.

Chris, when you look at this quarter, grocery and snacks was hit harder in two areas relative to refrigerated and frozen. One, more of the COVID-related costs hit grocery and snacks. Our COVID costs include additional transportation costs, PPE, and other items we use, so more of that hit grocery and snacks in the quarter. And then secondly, inflation—more of our overall inflation for the quarter—hit the grocery and snacks business relative to refrigerated and frozen. So those are two of the drivers when you look at the two segments side by side.

Okay, thank you. And then just a follow-up in terms of your input costs: you also called out transportation costs as incremental. You mentioned before, Dave, that input costs were in that upper 2% to 3% range and are going to be higher in Q3. When you give that figure, is that incorporating COVID-related costs as well? Is that the total cost basket? Is 3.5% the right number all-in for the third quarter?

We separate inflation from COVID-related costs on our bridge. Inflation includes commodities, packaging and transportation, and is separate from COVID costs. For this quarter, inflation was 2.9%, which translated to about a 200 basis point headwind in operating margin on the bridge. Then you'll see another bridge item which is a 100 basis point headwind that's COVID-related costs. For Q3, we expect that inflation number to be around 3.5% versus the 2.9% we saw in Q2.

Okay, so therefore, a little heavier hit to gross margin in the third quarter. I see that in the bridge. So thank you.

Yes, that's included. That's part of our Q3 operating margin guide.

The next question is from Bryan Spillane of Bank of America. Please go ahead.

Hey, good morning and Happy New Year, guys. The question is about inflation: we've seen some increases in agricultural commodities and freight and energy. Two questions: one, how are we hedged? How should we think about managing inflation as we move into fiscal 2022? And two, what's contemplated in the 2022 targets that you reaffirmed this morning? Also, Sean, given how the retail environment changed a bit, is there anything different in terms of how you might approach inflation and pricing with retailers today than pre-COVID?

From a procurement perspective, our procurement team is experienced and looking at every commodity area and taking positions where opportunities exist. We're taking positions that can extend into fiscal 2022, and that's an ongoing part of our process. The key part of this is integrated margin management. We manage margins to offset inflation in many ways: productivity programs and supply chain, margin-accretive innovation, pricing, trade optimization, mix, and sculpting margins through M&A. We're looking at all those levers, and with Pinnacle synergies and fixed overhead absorption from higher volumes, that all comes into play as we think about margin from a macro level.

I would reemphasize that integrated margin management is a capability we put in place years ago; it's multi-faceted. One emphasis that's different post-COVID is brand mix, specifically the staples business, which is stronger today. These cooking utilities that have benefited from increased home cooking tend to be relatively strong margin businesses for us. It's fortunate that this piece of the portfolio is doing well and these younger consumers engaging in cooking habits and really liking our number one brands in that space is a positive for integrated margin management.

And Sean, can you remind us: in a period where there's broader inflation across the economy, historically that's an environment that makes it easier for the industry to cover inflation. Is that right?

Within the levers we lean on to offset margin compression, pricing is a principal one. The language we use internally is inflation-justified pricing. Our view has always been that if inflation justifies it, we will seek to take prices. It's never easy, but it's necessary so we can continue making investments in innovation and supporting growth. If inflation occurs and you cannot take inflation-justified prices, it becomes difficult to sustain the necessary investments.

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

Hey, good morning, folks. Happy New Year and congrats on a strong quarter. I wanted to come back to Bryan's question. As part of his question he asked what inflation assumption is embedded in your fiscal 2022 guidance. I didn't hear the answer to that. Can you provide that?

We're not giving specifics on fiscal 2022 as it relates to inflation right now, Jason, but we reaffirm fiscal 2022. You can assume that we're looking at different ranges of outcomes for inflation, but we're not disclosing the assumptions at this point.

Understood. Dave, you mentioned one lever is to sculpt margin through M&A. Can you go a little deeper on what you mean by that? Also, now that you've effectively hit your leverage target faster than expected, does that open up more appetite for acquisitions? Is there more potential M&A activity?

Jason, our M&A philosophy is that inbound and outbound activity should reshape the portfolio for better growth and better margins. Assets that come in need to be strategic and ideally improve forward-looking growth rates and margins; assets that go out are often those that are a chronic drag on growth or margin. By managing inbound and outbound activity, the remaining company should look stronger. We've been active and will continue to be active. We've announced the divestiture of Peter Pan. Now that we're making progress on delevering post-Pinnacle, we'll see other uses of capital, which can be share buybacks, bolt-on acquisitions, or investing in our own business. All options are on the table but must make strategic sense.

No, you got it.

Our next question comes from Rob Dickerson of Jefferies. Please go ahead.

Great, thanks so much. I want to focus on the fiscal 2022 targets. You've said the margin targets are achievable and leverage is ahead of plan. But we also have inflationary effects potentially this year. You also mentioned you might retain some pricing benefits. Combined with less fixed cost leverage as we look into next year, it seems the targets are slightly below where you've come in the first half of this year. Why wouldn't the operating profit dollars in fiscal 2022 be higher than you thought a year and a half ago? In other words, why not expect higher operating profit dollars next year given current trends?

Rob, let me address that by examining the drivers of this quarter. We improved operating margin 250 basis points this quarter and there are three buckets to consider. First, improvement that won't stay with us: that's about 10 basis points, which is a net of COVID-related SG&A benefits, COVID-related costs, and favorable absorption; we don't expect this to recur. Second, what's going to recur: core productivity and realized supply chain productivity, Pinnacle synergies, and investments—this is about 60 basis points and that will continue. Third, price mix: we had about 180 basis points of price mix benefit in Q2. The majority was mix driven by volume, so part will not recur but some benefit from less merchandising and favorable pricing will remain. We're still evaluating how much of the 180 basis points will recur. Looking at these buckets helps explain why the targets look the way they do and how we built the confidence to reaffirm fiscal 2022.

Okay, got it, that's helpful. Just one quick follow-up on cash allocation: leverage targets are ahead of schedule, you've increased the dividend, CapEx is up, but given the stock valuation and activity in the space, why not be more proactive with share buybacks?

Rob, buybacks are part of our repertoire and undoubtedly will be again. It's about the relative appeal of capital allocation options. Stock price factors into that consideration. It's clearly an option for us and one we'll weigh against other options.

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

Great, thank you. As a reminder, this call has been recorded and will be archived on the web as detailed in our press release. Our team is available for any follow-up discussions that anyone may have. Thank you for your interest in Conagra.

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.