PERRIGO Co plc Q3 FY2021 Earnings Call

Good day and welcome to Perrigo's third quarter 2021 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist. After today's presentation, there will be an opportunity to ask questions. To ask a question, please press star then one on your touchtone phone. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Brad Joseph, Vice President of Investor Relations, please go ahead.

Thanks, Tom. And good morning, everyone. And welcome to Perrigo's third quarter fiscal 2021 earnings conference call. I hope you all had a chance to review the press release we issued this morning. A copy of the earnings release and presentation for today's earnings discussion are available within the Investor section of the Perrigo.com website. Joining today's call are President and CEO Murray Kessler and CFO Ray Silcock. I'd like to remind everyone that during this call, participants will make certain forward-looking statements. Please refer to the important information for shareholders and investors and Safe Harbor language regarding these statements in our press release issued earlier this morning. A few items. Before we start, first, unless stated otherwise, all financial results discussed and presented are on a continuing operations basis. They do not include any contributions from the divested Rx business which was accounted for as discontinued operations prior to its sale. In addition to the other non-GAAP adjustments as described in the appendix, adjusted profit measures, including adjusted EPS and adjusted operating income, exclude from the prior-year period certain costs incurred to support the operations of the business, which were recorded in continuing operations. See the appendix for additional details and reconciliations of all non-GAAP financial measures presented. Decade organic growth excludes acquisitions, divestitures, and currency in both comparable periods. And third, Murray's discussion will be focused solely on non-GAAP results. And with that, I'd like to turn the call over to Murray.

Thank you, Brad and good morning, everyone. In this quarter, we had major accomplishments, company-changing accomplishments, the kind that will shape Perrigo for a bright year for years to come. Unfortunately, we also experienced some very significant challenges this quarter related to the global supply chain disruption experienced by many companies in multiple industries. I'll come back to those in a few minutes. But first, I want to remind everyone that during the third quarter, we completed our transformation to a consumer self-care company by first closing the generic Rx divestiture transaction for $1.6 billion, which dramatically lowers volatility and makes self-care our sole strategic focus. And second, announcing our agreement to acquire HRA Pharma and its leading portfolio of consumer self-care brands for €1.8 billion, which we estimate will add $400 million in revenue and $150 million in operating income in 2023. During the quarter, we also dramatically reduced the tremendous uncertainty that has been an overhang on Perrigo for the last three years. This was accomplished by favorably settling the headline €1.6 billion Irish tax issue for a much smaller amount. While we believe Perrigo had a very strong case, the tax appeals commission disagreed. This tax assessment could have cost the company $3 billion or more when including interest. We settled for €297 million in total, with cash payable of €266 million net after we receive credit for prior payments. This issue is now completely resolved and behind us. And even better, we paid for the settlement from a €355 million award we received during the quarter through binding arbitration arising from the Omega transaction. The result is that Perrigo is now a focused consumer self-care company, poised for strong growth, unencumbered by the major overhangs of the past. Our long-term future has never been brighter. Let's shift back to Q3 business performance. Results were below year-ago mainly due to under-absorbed overheads and higher input costs. For net sales, supply chain disruption was the culprit. This led to an inability for Perrigo to meet very strong consumer demand in the quarter. Absent this, supply chain disruption, net sales growth would have been in line with what we had projected. Higher costs for freight, other input costs, and lower operating efficiencies in the form of unabsorbed manufacturing overhead, attributed to last winter's historically weak cold season also negatively impacted earnings. Let me provide a bit more detail. But net sales, as forecasted, the strong consumer takeaway in Q2 translated to higher factory orders in Q3. This was highlighted by a 21% year-over-year growth rate in our cough cold sales in the U.S., and continued double-digit growth in e-commerce, which was up 36% year-over-year globally. Consolidated net sales increased 4% versus year-ago, despite a supply chain disruption impact of $43 million, with the bigger impact in the U.S., $38 million causing a 5.5 percentage point drag on our CSCA Q3 net sales performance. Had those orders shipped under normal patterns, CSCA shipment growth would have been very close to the strong consumer takeaway growth observed in the quarter. Let's take a look at those market trends for CSCA. Importantly, category consumption grew briskly in the categories we compete in, for all three of our U.S. business units. The total OTC category was up 18.1% versus a year ago. Total nutrition, which for us is infant formula and electrolytes, was up 29.9%, and oral care was up 9.7%. It's worth noting that total store brand OTC lost market share to national brands during the third quarter, about 1.5 share points. But this is not a reason for concern. The share loss was attributed to buyers of national brands increasing consumption, rather than buyers of store brands switching to national brands. I repeat, the growth did not come from private label buyers switching to national brands. And that's good news. As the national brands drive category growth, that becomes a revenue source for us in the future. In our CSCI division, market share was stable in Q3. Like the U.S., the categories we compete in showed a very strong rebound in consumer takeaway and they grew briskly. Total CSCI consumer takeaway was up nearly 10% over a year ago. But TSC factory shipments lagged consumer takeaway and were basically flat for the quarter. We believe this relates to a light pre-cough cold season buy-in by pharmacists across Europe who were worried about getting stuck with too much inventory if the cough cold season doesn't rebound. But that worry appears unfounded as the cough cold season in Europe is in fact off to a very fast start. Consumer takeaway was up 36% in Q3. We expect this to translate to strong cough cold sales in Q4, as pharmacy inventories are low, and as I just stated, we already saw that begin to occur in the month of October. I expect strong cough cold sales. Turning to the third quarter earnings, EPS fell short of our internal projection and was $0.15 below year-ago. Supply chain disruption negatively impacted EPS by an estimated $0.08. Lower operating efficiencies and higher input costs impacted by $0.17. And separately, we had two product recalls that had a $0.05 negative impact. Tight management of expenses offset some of these negatives. Looking towards updated guidance, we expect consumer demand to remain very strong in Q4. However, we also expect higher input costs, supply chain disruption, and the impact from underabsorbed overhead to continue. Based on Q3 results in those continuing trends, we've lowered our guidance range for the year to $2 to $2.10. This new annual estimate includes a total year negative estimate of $0.79 per share for COVID-19 related external factors, which is obviously quite significant. And again, that's what we experienced so far, plus the fourth quarter estimate. I place these factors into three buckets as follows. First, the impact of a historically weak season significantly impacted our first quarter net sales in earnings, as well as continuing to have a negative impact on manufacturing efficiencies through under-absorbed overhead for the balance of the year, total impact estimated at $0.49. Higher input costs are the second factor, with spiking costs that have progressively escalated throughout the year, including freight and other input costs estimated to have a total impact for the year of $0.09. Lastly, supply chain disruption, both inbound and outbound logistics that became a major issue beginning in Q3 is estimated to have a full-year total impact of $0.21. We believe this large reduction in 2021 net sales and EPS for these three factors is not indicative of the underlying progress the company has made and that they can progressively be recaptured over the next two years. Let me address each bucket one at a time to explain how we believe that will happen. First, the historically weak cough cold season that dramatically impacted net sales was clearly a one-off. Illnesses are up, according to IQ via cough, cold consumer takeaway was up 61% in the U.S. and 36% in Europe during Q3, and October cold/cough sales for Perrigo remained robust. While we aren't yet forecasting a full recovery to the 2019 level, cough/cold sales are expected to be up dramatically in the first quarter of 2022 versus 2021, as that higher volume runs through our plants. The negative absorption impact will come back to us, albeit that will take 12 to 18 months to play out. But we have a very high confidence in getting this full $0.49 back. Second, the $0.21 impact from supply chain disruption is also expected to be temporary. The global supply chain is forecasted to gradually improve by mid-next year. But in the meantime, we've taken a series of actions to improve the current situation, including outsourcing highly complex product lines to a third-party logistic provider, allowing more room on our trucks for higher profit OTC products, adding regional carriers for challenging shipping lanes, hiring additional distribution center personnel which allows us to change our order delivery schedule to account for the many no-shows we've experienced, and finally, increasing the purchase cycle for ingredients and packaging alike from 30 to 90 days to ensure we have sufficient lead times for delivery. These actions have resulted in a 25% increase in daily shipments for the month of October compared to the third quarter average. And not all of these actions have even been fully implemented yet. Some of these changes will remain in place until the larger U.S. supply chain normalizes, while some we intend to leave in place as a hedge against future disruption. Lastly, regarding input costs, we anticipate addressing the $0.09 impact from the second half of this year and any flow-through impact in the first half of next year by raising prices on 70% of our product lines in CSCI, and 75% in CSCA. U.S. retailers have been more accepting than usual of price discussions, as they understand the massive cost increases we, and frankly everyone else, are facing. National brands are also raising prices. We will continue to maintain a tight focus on discretionary costs, and remain committed to achieving at least the final $30 million of Project Momentum cost savings. Several other actions have also been put in place to get earnings growing again. We've made several management changes in the U.S. to refocus the team on core OTC market opportunities, of which there are many and which have already resulted in some significant customer wins. Second, our successful and growing e-commerce business, which is up 25% year-to-date, remarkably on top of last year's outstanding growth, has been reorganized internally to allow for focus and added resources to further accelerate growth. And of course, the previously announced acquisition of HRA will have a dramatic positive impact on financial results and the growth trajectory of Perrigo. The transaction remains on track to close mid-next year. So, to reiterate, despite the best efforts of my Perrigo colleagues, and they've been remarkable, the COVID-19 pandemic has raised excessive challenges that began in 2020 and continued through 2021. The impact has been real and our response has been significant as well. We believe that the negative business impact of the big three drivers in 2021—a historically weak cough cold season, supply chain disruption, and higher input costs—will mostly be recovered or offset with pricing and Project Momentum cost savings. And we remain on track to close HRA mid-next year, which will substantially increase net sales, operating income, and margins for years to come. We therefore still believe we can get at least close to our original 2023 EPS targets shared with you back in May 2019 and again during the HRA announcement a few months ago. So, from our perspective, this is not a reset; it's just a very big bump in the road. In conclusion, we've come a long way over the last three years with the most significant elements of the transformation plan having come to fruition in this most recent quarter. The volatile generic Rx division has been divested. The HRA acquisition is on track and is expected to add approximately a dollar of EPS in 2023. And the Irish tax issue and the uncertainty created over the last three years is gone. Perrigo is now a focused consumer self-care company determined to be a world-class consumer health company that consistently delivers profitable growth over the long term, consistent with industry peers. While COVID-19 has created many unforeseen challenges in 2020 and 2021, we will not let them deter us from making our vision a reality, nor hitting the ultimate growth plans we initially established. With that, I'll turn the call over to Ray Silcock, our Chief Financial Officer, to discuss the financials in more detail. Ray.

Thank you, Murray, and good morning, everyone. Firstly, with respect to the major strategic initiatives completed this quarter and outlined in this morning's press release, I'd like to reiterate Murray's comments that these achievements do indeed lay the foundation for our bright future. But as Murray also said, the operating environment in Q3 was challenging and had a significant adverse impact on our quarterly results. So, I would like to thank the team at Perrigo for all their hard work navigating through them. With that, let us take a look at our third quarter results in greater detail. First, let's review our GAAP to non-GAAP adjustments. On a consolidated basis, the Company reported a GAAP loss from continuing operations of $54 million for the third quarter of 2021, a loss of $0.40 per diluted share. On an adjusted basis, consolidated net income was $61 million, and adjusted diluted EPS from continuing operations was $0.45 per share, a 25% decline compared to the prior year. The adjusted EPS decline versus last year is primarily due to lower operating efficiencies, primarily overhead under-absorption as a result of lower manufacturing from the weak 2020-2021 cough/cold season, higher freight and materials costs due to global supply chain disruptions, and the impact of two product recalls—one in Europe and one in the U.S. Pre-tax non-GAAP adjustments this quarter totaled $311 million. Primarily, these were from our excluding the positive benefit of the $395 million Belgium arbitration award we received in Q3. We also added back $53 million of amortization expense, as we always do, and $25 million in acquisition and unusual litigation expenses. Full details of these and other adjustments can be found in the non-GAAP reconciliation table attached to this morning's press release. The principal non-GAAP tax adjustments for the quarter included a $309 million Irish tax settlement and $108 million in tax arising from intra-entity transfers of intellectual property due to the Rx divestiture. These led to an adjusted effective tax rate for the quarter of 21.3%, down from Q3 last year's adjusted effective tax rate of 24.6%. The reduction in our adjusted effective tax rate was primarily due to the release of state uncertain tax position reserves, partially offset by the big tax expense this year. From this point forward, all dollar numbers, basis points, and margin percentages will be on an adjusted basis unless stated otherwise. Consolidated net sales for the quarter increased 4%, driven by e-commerce, contract sales to our recently divested Rx business, price increases, and also from improved U.S. cough/cold season sales, which have started to turn around in Q3, as compared to Q3 2020, but are still down versus last year on a year-to-date basis. Net sales also benefited from $9 million of favorable currency and $5 million from acquisitions. On an organic basis, excluding the effects of currency and acquisitions, net sales grew by 2.6%. Consolidated gross profit in the quarter was $35 million lower than last year, primarily as a result of lower operating efficiencies and higher material and freight expenses, as well as the $9 million cost of two product recalls, all partially offset by $6 million in favorable currency and acquisitions. Consolidated gross margin in the quarter was 34.4%, 480 basis points lower than prior year, driven by the same factors. Consolidated operating income in Q3 was $112 million, $29 million down from last year. Operating expense reductions, including Project Momentum savings, helped partially offset the unfavorable gross profit flow-through. Measured as a percent of net sales, consolidated gross profit in Q3 was 34.4%, down from 39.2% for the same period last year. Global supply chain disruptions, which caused higher material and freight costs, accounted for 130 basis points of this impact, while overhead under-absorption from the historically weak 2020-2021 cough/cold season, principally in the first and second quarters, were another 150 basis points. In addition, we experienced those two product recalls, which cost 80 basis points. These headwinds, together with an unfavorable mix in our base business driven by contract sales to the recently divested Rx business, and lower sales in the CSCI's weight loss category resulted in a year-over-year gross margin decline of 400 basis points in the quarter. Lower operating expenses of 80 basis points partially alleviated these effects. We expect the gross profit headwinds to gradually reverse over the course of the next year or so. Now let's turn to the third quarter segment results, starting with consumer self-care America's. Net sales for the quarter increased 4.6%, driven by e-commerce, third-party sales to the divested Rx business, and better cough cold sales. Excluding favorable currency of $2 million, organic net sales grew 4.2% in the quarter. Gross profit in the quarter was $193 million, $29 million below last year, driven by unfavorable plant overhead absorption, higher material and freight expenses, and a product recall. In the energy category, these factors led to a year-over-year gross margin decline of 570 basis points. Operating income for the quarter was $106 million, $28 million lower than prior year, driven by unfavorable gross profit flow-through, partially offset by operating expense reductions, mainly R&D and administrative costs. Moving onto consumer self-care International, net sales grew 2.8%, driven by favorable currency and acquisitions, performance in the UK store brand business, greater demand for our smoking cessation products, and improved pricing. Excluding the benefits of currency and acquisitions, organic net sales decreased 0.6%. CSCI gross profit was $166 million, down 3% from last year, a 280 basis points decline in gross margin. Unfavorable mix from lower sales in the weight management category, together with the cost of the recall, were only partially offset by favorable currency and acquisition. The operating income was $46 million, $6 million lower than prior year, primarily due to the impact of the product recall. Moving now to the balance sheets and operating cash flow, cash on the balance sheet as of October 2 was $2.1 billion and included $1.6 billion from the RX divestiture plus $418 million from the Belgian arbitration award. Operating cash flow in the quarter was $350 million, including the Belgian arbitration award. As a reminder, the cash outlay for the Irish tax settlement and the legal fees for the Belgian arbitration award were made after the end of the quarter. In closing, our third quarter results were significantly impacted by the macro environment in which we operate, which is reflected in our updated full-year adjusted EPS guidance in the range of $2 to $2.10. We remain confident in our plans to deliver long-term profitable growth as we recover from this quarter's temporary adverse impacts and move forward with the successfully closing and subsequently integrating the HRA acquisition.

We will now begin the question-and-answer session. To ask a question, press star then one on your touchtone phone.

Thanks. Good morning. Murray, despite all the cited factors over the last couple of quarters that explain various aspects of the company's performance, no one can figure out what's going on with gross margins. I followed this company for a long time. And frankly, I feel a little bit lost right now. I don't know where the bottom is, and we keep coming in well short of the company's expectation. So clearly, it seems to be something beyond just merely supply chain issues and logistics issues, because obviously over the course of the pandemic, numbers have been volatile, yet margins have been certainly relatively close to historical standards and certainly well above where we are today. It would be very helpful if the company could somehow provide a bridge between margin performance, gross margin performance, CSCA in the current quarter relative to historical levels, so we can have some understanding of what's happening outside of these one-time issues.

Sure. These are significant one-time issues, and while many of them will resolve, I understand the concern. This quarter saw a 180-point margin impact from inflation and freight materials, plus 150 basis points from under absorption, totaling 330 points. We sold the Rx division, and while that affects our reported profits, it shouldn't be seen as a genuine decline in margins. We need to account for the contract sales profit before factoring in the subsequent loss of 100 basis points. This adjustment doesn’t alter the overall profitability of the company. Additionally, we experienced a slight 50 basis point benefit from pricing, which helped us improve the operating margin by 100 basis points due to tight management of operating expenses. The main challenge came from a strong drop of 300 to 400 points due to the absence of a cough and cold season, compounded by severe supply chain disruptions and soaring freight costs. For example, a shipping container that used to cost $6,000 now costs $26,000. We hope to see these costs stabilize soon. The good news is we have been successful in implementing price increases, and as we begin to recover from the cough and cold market, which we already see happening, we expect that overhead to return. Although supply chain issues may persist for a while, we have managed to offset input costs with approved pricing. Our customers are aware of this, but the implementation isn't as immediate as it would be in a national brand context. Around 75% of our business will. likely experience a price decrease in the upcoming period. Clearly, these factors impacted our gross margins. I understand the situation, but I believe these short-term impacts overshadow the commendable progress we've made in product mix improvements, reducing unprofitable products, and rationalizing our SKUs. We are concentrated on margins, and while you may not see it now, I am confident that you will in time.

No, I don't see it, and it's difficult to understand. It would be beneficial for the company to provide more clarity on the key items that were positive, as well as the reported numbers. Even if I took into account the benefit of 300 basis points from some one-time issues, the gross margins in the CSCA business are still at 30.8%, which is 150 to 200 basis points lower than expected. We need more clarity on this issue moving forward. I also want to ask about the absorption issue and its impact this quarter. With cough and cold sales rebounding to 2019 levels and assuming high order rates, I'm surprised that absorption seemed to have impacted the quarter as mentioned. I'm unsure why this occurred if it's just products being stored in the warehouse but not shipped. I would assume that much of the unabsorbed overhead is allocated to product costs, not affecting overhead directly, and we aren't seeing an increase in inventories either. I know there are many factors that could affect inventory, but it actually decreased this quarter, so I'm trying to reconcile these points.

Sure, you are selling the inventory that you produced, expecting a decline but not an absent cough and cold season. So, currently, you are incurring costs for the unabsorbed inventory resulting from last January and February. This cost adds to your inventory as you manage it. As you reduce the inventory, you are depleting it with higher costs. Additionally, there is a six-month delay in our costing system that continues through the fourth quarter and a bit into next year. After that, it will gradually begin to reverse, leading to a significant increase in profits.

Okay. Understood. Thank you. And I guess just one last question is, given some of the changing dynamics in the OTC space and taking pricing and the like. Could you just talk about where the company's relative market share position is across the private label segment where you're gaining share, where maybe share has slipped a little bit, whether or not you think that the price increases will in fact have a negative effect on share, but could you could more than make it up for in margin. Just trying to understand what some of the moving parts there are in terms of competition from other private label players, as small as they may be versus just changing share dynamics versus national brands tax?

Yes. That's a great question, by the way, Elliot. Because at first glance, people are going to look at the national brand of the store brand level. I gave you the panel data that shows that's just from them advertising more and getting consumers to buy more, and that has no effect on our business right now. Within store brand, we had some big challenges. We got hit with last year, nicotine, some competition and dosages at an SMA and day approvals in omeprazole and that resulted in some share loss this year. Now, our businesses across-the-board are still a lot are growing, but they could have gained more, and I don't accept ever losing share when it's actually sourced and coming from you. I would tell you that I made some changes in management and some other structural areas and we have won a lot of business in the last 30 days. So, did we lose some short-term share within store brand to the extent that we can read it right? Store brands get provided. And we told you a few months ago we were able to start to break that out ourselves. It's not something that had historically been reported by IRR. We are now starting to get that data. And as soon as I'm comfortable with it, probably in the next investor conference, we will really break that out for you, but your point is a correct one. So, where do I think we gotten hit on some? A little bit on digestive health, meaningful competition in nicotine replacement. I will also tell you that those are the areas where we've had the most wins recently and where we have a lot of innovations coming. So, but great, great question. Those are normal things. Those are the things that I'd like to be talking about on a conference call. Not shocked that we had unbelievable orders and all of a sudden, we couldn't ship them, because we wouldn't be having half the discussions we're having right now. Had we just been able to ship the orders that we have. But good question.

Thank you for the questions. I understand you touched on some of this in your initial comments, but I'm trying to grasp how we move from $2 to $2.10 this year to reach our goals for 2023. Essentially, aside from the normalization of cold and cough demand, what else needs to occur for us to achieve the 2023 target? I want to ensure I understand correctly; it seems like the main driver is the normalization of cold and cough sales, but could you walk me through the other key assumptions that will contribute to reaching that target in the coming years? I have a few follow-up questions as well.

Okay. Well, listen, I've got work to do to finish it, Chris, but let's oversimplify it. If you are $2 to $2.10 and you get back $0.49 to $0.50 on cough cold, which we believe, which is the combination of the volume impact and the absorbed manufacturing efficiency. Now you're at $2.50 to $2.60, and you will add a dollar for HRA, so you're at $3.50 to $3.60. And the numbers were $3.65 to $3.95 that we were originally talking about. So, at the bottom end of that range, you're off $0.10 or $0.15, and you say, okay, out of excluding cough cold, the rest of the world, the rest of the business, the other 80%, if you can grow that sort of 5% to 10%, or you can recover some of these other costs with pricing, etc., you're only $0.15 to $0.20 short. So, the components would be $2.05 at about $3.05 that get back to $0.50 on cough cold, all $3.55 to $3.60. And you got to get $0.15 to $0.20 out of the rest of the business over two years.

Okay. Perfect. I was wondering if you could provide details on the pricing strategy. You mentioned raising prices on a significant portion of your portfolio, which is something you haven't often been able to do in the past. Could you share how much pricing you are able to implement on the portfolio to help mitigate some of the supply chain challenges you're experiencing?

Historically, I've indicated that in the U.S. there has been a 2% to 3% decline, which we've managed to improve to a 1% to 2% decline. Last quarter was the first time it flattened out and became positive. We shifted it by a few percentage points, and that was mainly with about a third of the portfolio. I’m not sure if we have a specific forecast yet because our approach is different from a national brand that simply increases prices. We need to consider how consumers will respond to those prices and the impact on volume. Here, we don't control the retail price; that’s determined by the retailer. There are significant gaps in pricing, with national brands increasing their prices, and retailers will then make their pricing decisions based on those gaps. We can suggest price adjustments, but ultimately, it's about our costs to them and ongoing negotiations, and we'll see how that plays out. So far, the results have been positive, although there is a delay before changes take effect in the market. I can't quantify whether the range is 2% to 3% at this moment, but it's somewhere around there.

Okay. Sequentially kind of continue to get a little bit better than what we're seeing even now.

We're out there with a fair amount. It's got to offset those higher input costs and freight costs, and give that. I can't continue to have that be negative for that little formula that I just worked for you, right? Pricing plus cost-savings has to offset future negatives because we're only six months through it, right? So, I got to offset that any first-half impact with that to hold it to grow, that $2 to $2.10 and then add the dollar and then get some growth.

I want to clarify my understanding regarding the $0.49 impact from the weak cold cough segment. I'm trying to determine how much of this was already anticipated in the second quarter when you provided guidance at the lower end of the range, and what new information we have now. Overall, it appears that demand is rebounding, but I'm curious about the reasons behind the increasing impact compared to your expectations in the second quarter, considering the volumes we are currently observing. Could you provide some insights into what is happening this quarter versus what you were aware of during your August guidance?

We were aware of the unabsorbed situation, which was already factored into our plans. When I was present for the HRA announcement, we were experiencing a surge in orders. The shortfall we encountered in the second quarter was related to inventory, and we had mentioned that it needed to recover, which it did. Daily orders were setting records, surpassing the demand levels we saw during some COVID spikes, and by mid-August, I felt confident about the quarter. However, logistics issues arose that hindered our shipping. Typically, we ship 55 trucks a day, but due to various factors such as customers not arriving for pickups and scheduled drivers not showing up, we were missing 10 to 12 trucks daily. We ended the quarter with the highest unshipped balance in the company's history, amounting to $45 million, which translates to an additional $0.10 or $0.12 in costs. Additionally, we faced a significant spike in freight costs. What we didn't anticipate was the supply chain disruption that affected our ability to receive inbound products and fulfill customer orders, along with the dramatically increased freight expenses. Nonetheless, absorption was included in our August forecast.

Okay. Great. I appreciate all the color. Thank you.

Hey, Murray. Thanks. And good morning. A couple of questions just continuing on with gross margins. I know you've said that you're re-pricing, I think 75% or 80% of the portfolio, but it will take some time because their contracts in place. So, thinking about the bridge to 2023, could you give us some sense of what you're thinking about gross margins in 2022? I assume that will include a lot of the price increases you mentioned. Will those gross margins be perhaps closer to this year on the weak side, or more of what you're thinking for 2023? My second question relates to tax. Can you provide an update on all the ongoing tax issues? I know you settled the Irish tax liability case, but there's also an IRS case, which is linked to that, relates to the old Athena acquisitions. So, could you comment on the IRS tax case as well? Thanks.

On the gross margin, I will turn it over to Ray. I haven't seen the complete plans yet since they are still evolving. However, a significant portion of the gross margin improvement will come as the absorption decreases with the volume processed through the plant later this year. You should see benefits from cough and cold volume, as well as sales, in the first half, but I don't have a final plan available right now.

We don't have our final plan yet. However, what Murray mentioned is essentially correct. We anticipate the impact of the cough and cold season returning in the first quarter, which significantly affected us in the first quarter and even more so in the second. We expect this to improve in the first and second quarters. While I don't have a specific number to provide, I believe we will see most of our profitability returning by the end of the year, albeit gradually as supply chain disruptions ease. It's important to remember that our costing system means it takes six months for variances to process, so we are still experiencing the under-absorption from the first half of this year, and this will likely continue into the first quarter of next year.

Regarding the tax issue, we are still some time away from resolution. The initial phase of the IRS tax stems from double taxation from the company's point of view. There is ongoing discussion between Ireland and the U.S. concerning who has the authority to address this, which is currently a matter before the respective authorities. I can’t recall the specific name of the agreement, but both sides have valid points and this discussion will likely continue for the next year. The situation could either be completely resolved or lead to further arguments, where we believe we have strong positions that could significantly reduce potential liabilities if they persist. I am confident in the results I achieved with Ireland on the major issue, drawing from my experience in the tobacco industry to navigate these challenges. We are facing some pressure on our gross margins, but I believe I have effectively mitigated risks amounting to $2 billion to $3 billion, with the support of our capable legal team. I don’t see these issues being as significant as what we previously encountered, and I am optimistic that we will manage these well, although it may take a few years.

Okay. I just have one follow-up, and that regards the potential for new products. So many years ago, the company grew rapidly based on RX to OTC switches and PPIs, cough, cold, allergy, and that kind of ground to a halt. And I know you've called out the upcoming prescription switches, but also the possibility of some other switches like CLS, Glides, Tamiflu, and just curious when you said that you hope to get back to your original 2023 forecasts. Are there any meaningful RX - OTC switches built into that? And do you think we're going to see any in the foreseeable future?

I just had a presentation from the group. In the short term, we are focusing on building out the Diclofenac line, launching Nasonex, and introducing our slice products, with several others in the pipeline for the next three to four years. However, our 2023 numbers are not reliant on these developments. I'm also excited about the HRA deal, which has significant potential. They are currently working on a daily birth control pill in the UK, which is in the process with the FDA. This could present a huge opportunity for the company. Additionally, HRA has a product that is equivalent to L1, although that specific molecule isn’t approved in the U.S. It will likely be more challenging, but HRA has it available in 35 countries, representing another opportunity. I believe we will see switches become a vital part of our business in the future, although they are not essential for achieving our 2023 plan. Our priority is to recover costs and improve the gross margin, which has been the focus of this call. The feedback regarding this is valid, and we recognize the need to recapture those numbers, increase volume through our facilities, and reduce costs. I understand this perspective, and we are confident that we will achieve that recovery.

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

I want to thank everyone for their interest in Perrigo. I understand this situation regarding costs has been difficult. It’s not just specific to Perrigo; it reflects the broader macroeconomic challenges we are facing. Our teams have responded well, and we are positioned to deliver more products. We've already experienced a strong month in October, and we believe we can recover and return to our 2023 numbers. I'm committed to achieving this. It's also important to recognize that we are deploying $2 billion, which is expected to generate $400 million in additional sales and over a dollar of EPS. We've effectively eliminated a $3 billion potential liability at no cost, thanks to a $400 million arbitration win. Many positive developments occurred during the quarter that will benefit the long term. My team and I will address the short-term challenges and work to overcome them. I look forward to providing updates in future quarters. Thank you.

Thank you, everyone.

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