PERRIGO Co plc Q3 FY2022 Earnings Call

Good morning and welcome to the Perrigo Third Quarter 2022 Financial Results Conference Call. 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 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 strong double-digit growth in the third quarter compared to last year, both in constant currency for top and bottom lines, and discuss the solid fundamentals driving that growth. Then I will address the macroeconomic factors that led us to revise our adjusted EPS guidance, and finally, I will share some exciting updates on our strategic initiatives that will help us stay aligned with our 2023 financial objectives despite ongoing macroeconomic challenges. After my remarks, Eduardo will provide details on our Q3 financials. Third quarter results for Perrigo were solid across the board. Constant currency net sales rose by 12% in the quarter and 14% year-to-date. Organic net sales growth exceeded our long-term target of 3%, showing an increase of 8% in the quarter and 11% year-to-date, excluding the organic growth from HRA, which also saw double-digit growth during this timeframe. The top line growth in Q3 was largely attributed to the benefits of the HRA acquisition, offset by the divestitures of Mexico and ScarAway. We gained market share across all of our US business units as store brands continued to outperform national brands. Our European business also gained market share, especially with the newly acquired compete brand, along with strong growth in e-commerce and a positive impact from strategic pricing actions across our global portfolio. It's important to note that the consolidated organic growth was achieved through both favorable volume and price increases of 2% and 6%, respectively. Gross margin improved by 210 basis points compared to last year, leading to a constant currency adjusted operating income growth of 32% despite a $36 million rise in input costs due to inflation and other macroeconomic factors. The constant currency diluted EPS for the quarter was $0.65, a 44% increase year-over-year, which reflects higher interest expenses and a slightly larger share count. Let's discuss the business fundamentals. The robust top line growth we're experiencing, whether in total or organically, is consistent and not a temporary anomaly. For context, net sales, excluding currency fluctuations, increased by 7%, while organic sales grew more than 4% on a three-year compound annual growth basis, despite the business volatility stemming from the COVID pandemic. Diving deeper into the revenue for the quarter, growth was influenced by both CSEA and CSCI as well as contributions from HRA. We saw strong growth across our main product categories, with some highlights being a 100% increase in women's health, largely due to the addition of HRA brands and increased demand for emergency contraception related to public concerns surrounding the Roe v. Wade ruling. Skincare rose by 28% thanks to Compeed and Mederma, along with the ongoing growth of our ACO brand in Europe. Upper respiratory sales grew by 19%, driven by higher instances of cough and cold in Europe and market share gains against national and other store brands in the US. Sales in the cough and cold category could have been even stronger if not for labor shortages that hindered our ability to meet elevated demand. In allergy, US share gains from the launch of Nasonex24HR contributed to top line growth, despite a decline in the total affected population. Our nutrition business saw an 18% increase driven by heightened demand for infant formula due to a national shortage. We had been operating our facilities at 117% of normal capacity to help alleviate this shortage, but this led to a higher number of formula products placed on quality hold during Q3, prompting us to pause one of our facilities for maintenance. This was one of the main reasons we acquired the Gateway facility from Nestle, which I'll discuss shortly. Oral care sales increased by 8% in the quarter, rebounding from earlier supply chain disruptions caused by freight delays and rising costs. Fortunately, we have received a substantial amount of back-ordered inventory, allowing the oral care segment to ship without constraints, resulting in significant market share gains. Moreover, we're pleased to report that ocean freight costs have returned to pre-COVID levels. While oral care faced profitability challenges this year, it is expected to recover significantly in 2023. Perrigo's market share grew globally across nearly every category we participate in. We increased share in total US OTC, US store brand OTC, US eCommerce, European eCommerce, US oral care, US nutrition, and total European OTC. Another positive trend this quarter was consumers switching from national brands to store brands in US OTC, reminiscent of our patterns during past times of economic uncertainty. However, it is important to mention that the total growth rate in the largest category we compete in, total US OTC, has returned to normal pre-COVID levels. In the first half of this year, total US OTC grew by 13.4%, while Perrigo's US OTC grew by 9.1%. In the latest 13-week period, which corresponds with our third quarter, total US OTC growth slowed from 13.4% to 2.3%, despite significant retail price increases. We estimate national brand price increases around 8% to 9% this year, leading to an estimated 6% decline in total OTC volume. Perrigo's retail growth also slowed but outperformed the category at 5.8%. The pricing for Perrigo was up 6% in the quarter, with retail volume remaining relatively flat year-over-year. We had anticipated US OTC growth to maintain first half levels, which did not materialize in the third quarter. However, we did notice a rebound at the end of the quarter, with total OTC up 7% in the last four-week period, supporting our fourth quarter estimates. Like other multinational companies, unfavorable currency translation has been a significant challenge for Perrigo this year. We anticipate that a strengthening US dollar will negatively impact our full-year net sales by approximately $230 million and adjusted operating income by over $43 million by year-end. In addition, we expect gross inflation to affect our cost of goods sold, labor costs, and distribution expenses by more than $210 million for the full year, with our oral care and nutrition business units in the US being the most affected. We have worked diligently to mitigate the majority of these inflationary impacts through strategic pricing and cost-saving measures. Nonetheless, we will need to implement further pricing adjustments to cover ongoing cost pressures. Regarding guidance, we have reaffirmed our net sales and organic net sales forecasts. Our revised 2022 adjusted EPS outlook of $2 to $2.10 reflects a negative $0.10 impact from further unfavorable currency movements and a negative $0.15 impact from our business performance, inclusive of the infant formula acquisition compared to our previous estimate. Now, let's discuss HRA synergies and two other strategic initiatives we believe will drive strong growth in 2023. The integration of HRA remains essential to our growth strategy, and since closing the acquisition in May, the business has thrived, achieving double-digit growth. We're raising our total synergy estimate to €50 million by the end of 2024, up from previous estimates of €40 million and €30 million at the time of the deal. Eduardo will provide further details, but we foresee a $0.18 impact to 2023 adjusted EPS, equaling around $30 million in operating income for a one-time cost, which will not be included in your current forecasts. This cost relates to inventory sales returns as we transition HRA from third-party distributors to our direct sales force and does not affect the robust fundamentals of the HRA business. Our gross margin expansion expectations align with our overall strategy; Perrigo's gross margin has improved throughout the year, and while we saw relatively flat performance in Q3 versus Q2, we still anticipate exiting the fourth quarter with a margin above 37%. Our third strategic initiative involves a supply chain reinvention program, which we expect to yield $50 million to $70 million in additional operating income next year, primarily driven by the Gateway and Good Start brand infant formula acquisitions, along with our portfolio design and SKU optimization efforts. To reiterate, we expect the incremental operating income from these strategic initiatives in 2023 to compensate for the lost operating income we experienced in the second half of 2022, excluding the one-time costs for achieving HRA synergies and any further currency impacts. Regarding infant formula, our nutrition team has been actively addressing our capacity constraints for several years. You may recall that in 2018, the Perrigo board authorized an investment of up to $300 million to expand our formula capacity through a greenfield project, which ultimately did not proceed. The Gateway facility acquisition effectively resolves the capacity issue at a significantly lower cost. To summarize this transaction, we are making a $170 million strategic investment in our infant formula network, having spent $110 million on the Gateway manufacturing facility and the US and Canadian Good Start branded businesses. These investments are crucial not just for Perrigo but also for enhancing the US infant formula manufacturing industry by increasing overall capacity by 7 million, equivalent to over 100 million eight-ounce bottles, within the next 18 months. This acquisition is expected to deliver over $50 million in operating profit contribution in 2023, split between the Good Start brand and additional volume through our network to support our current customers. In summary, I am optimistic about our future. Our fundamentals are solid and improving as we continue to capture market share, expand gross margins, and make the necessary strategic investments to foster profitable growth in 2023 and beyond. To be clear, aside from the one-time costs related to bringing HRA distribution in-house and the effects of foreign currency translation, our 2023 adjusted EPS target remains unchanged. With that, I will turn the call over to our CFO to provide more detailed financial insights.

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 $100 million worth. Number one, amortization of $69 million. Two, restructuring charges of $20 million primarily related to our supply chain reinvention program, and three, acquisition and integration-related expenses of $12 million mainly related to the HRA acquisition. Full details can be found in the non-GAAP reconciliation table attached to this morning's press release. Non-GAAP tax adjustments for the quarter were $28 million, primarily driven by the tax effect of non-GAAP adjustments and the 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 higher costs driven by inflation resulting in gross margin expansion of 310 basis points on a constant currency basis. Operating income increased $21 million or 32.2% on a constant currency basis driven by favorable gross profit flow through which was partially offset by higher operating expenses due to the inclusion of HRA and higher distribution costs. These factors led to adjusted operating margin expansion of 190 basis points on a constant currency basis. For CSCA segment, net sales increased 4% or 7.3% organically driven by first inflation justified pricing actions. Second, strong performance in infant formula. Third, the launch of Nasonex, and fourth, increased manufacturing capacity and demand for the store brand version of MiraLAX, which benefited the digestive health category. Importantly, as highlighted by Murray, we achieved share gains across all three businesses. Gross profit in the quarter increased $10 million or 5.4% at pricing in higher sales. Volumes offset cost of goods sold inflation and lower profitability of contract sales to the divested RX business adjusted gross margin expanded 50 basis points versus the prior year on a constant currency basis and 30 basis points. Sequential operating income for the quarter was flat to last year as gross profit flow through was offset by higher operating expenses, including the addition of HRA, a 30% increase in distribution expenses driven by higher logistics and the emerging costs in our oral care business and the impact of divested businesses. The impact of these two items was $8 million on operating. Moving into CSCA report, net sales increased 8.4% on a constant currency basis, and we saw a significant increase of 28.6%, including $71 million. We saw a significant increase of 28.6%, including $71 million from three. Organic growth was 8.3%, driven by continued demand for cough, cold, and skincare promised constant currency. Gross profit grew 41.5% driven by the additional HRA strategic pricing and increased sales volumes. These factors drove a 480 basis point increase in adjusted gross margin versus the prior year. Operating income increased 66.8% on a currency basis as favorable gross profit flow through more than offset higher operating expenses, primarily driven by the inclusion of HRA and higher administrative and R&D expenses. Now moving on to cash flow. Cash on the balance sheet was $469 million at the end of the third quarter down from $485 million at the end of the second quarter. Year to date, operating cash flow was $121 million, a conversion of 68%, which is lower than we expected. Let me explain year-to-date, operating cash flow included impacts of $79 million due to increased inventories, primarily US oral care business and CSCI segments and $19 million from restructuring expenses. Given these impacts, we're now projecting 75% operating cash flow conversion to adjust to net income for the full year. In addition to these operating cash flow movements, we also invested $70 million in capital expenditures and returned $107 million to our shareholders through dividends during the first nine months of the year. Although the acquisition, the Gateway infant formula plan took place after the quarter closed, I wanted to provide a bit more detail regarding how we funded that $110 million transaction when we refinanced our debt ahead of closing the HRA acquisition. Early this year, we borrowed the newest dollars and we used currency swaps for IRIS. Given the strengthening of the US dollar this year relative to our swap positions, we were able to recoup on these swaps and generated approximately a $100 million in cash, which was used for the GateWay purchase. As stated, we have increased our cost synergy target for HRA to a benefit of approximately €50 million to operating income by the end of 2024. We expect to achieve roughly half of this target by transitioning from HRA external distributors throughout Europe to our internal CSCI sales force. As a reminder, we have 1,200 sales and marketing colleagues in our CSCI business with approximately 100,000 pharmacy and drugstore partnerships across Europe. The remainder of the cost synergy is expected to be captured from our reduction of fixed head costs. To achieve the €50 million, we estimate one-time cost of approximately €60 million or 1.2 times the ongoing synergy benefit. Of these one-time costs, approximately half are related to expected inventory sales returns as part of the distributor transition from HRA external distributor to internal CSCI sales force. The one-time impact of these sales returns will be included in our adjusted non-GAAP results, while the remaining costs are expected to be excluded from our adjusted results consistent with our historical treatment of integration and restructuring costs. We will provide updates on a quarterly basis of the progress of these two areas, both synergies and one-time costs. In closing, I'm excited about our business and would like to thank our colleagues around the world for their continued efforts while navigating through a very dynamic microeconomic environment. We continue to make progress towards delivering on our strategic initiatives, strengthening our business, and delivering meaningful growth in 2023. With that operator, can you please open the line for questions?

We will now begin the question-and-answer session. 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 did not hit. Can you just talk about whether or not that sort of triggered any major changes in terms of processes or levels of investment associated with the Vermont facility? And I've got a couple of others too.

Okay. You're correct, Elliot, to focus on this important area. Our gross margin progression highlights two main issues. Everything else is on track, but we've faced ongoing challenges with outdated equipment in Vermont for years. When I first joined Perrigo, we requested around $250 million for facility improvements, which later increased to over $300 million. However, we were unable to proceed due to environmental concerns. The equipment was at the end of its useful life and consistently caused quality issues, leading to recalls a few years ago. We've been dealing with these struggles, and to improve profitability, I added 100 staff members—30 for quality control and 70 for sanitation—to prevent similar incidents to what occurred this summer. We slowed production lines and incurred an additional $10 million in ongoing annual costs, which we've been managing. At the same time, we couldn't meet the volume demands of our key customers. Given this, we explored alternatives and began discussions with Nestle, who have been facing difficulties in those businesses and are considering an exit strategy. Although we had done contract packing with them and acquired some of our infant formula, it came at a high cost that impacted our margins. The opportunity to purchase their business emerged, effectively solving our issue. This has been in the works for over a year, even preceding the infant formula shortage. Regarding the infant formula business, we acquired the Good Start brands but opted not to purchase the WIC business; instead, we will pack those brands for them. While the WIC business is less crucial for us, it remains a decent margin opportunity. Its significance increased this year due to shortages, contributing about half of the $50 million annualized figure I mentioned. The remainder comes from the volume previously packed for us at their margins, which will now revert to us. We plan to invest approximately $60 million into the facility to produce more than the four products currently being made there without undergoing any technical transfers. We can immediately begin increasing our production volume on those key SKUs, allowing us to meet our premium customer demands from Vermont, which we have not been fully satisfying. We will also slow down the Vermont production line while investing an additional $20 million for ongoing improvements. We’ve been implementing fixes, but these are just temporary solutions. By allowing more downtime for maintenance, we can mitigate quality issues and potentially recover some costs. In terms of financial impact, the $170 million acquisition is expected to generate over $50 million in additional operating income, which is significant. Moving forward, any challenges we faced in the latter half of this year should not overly complicate our forecasts for next year, and excluding certain charges, we're targeting similar outcomes.

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. 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.

Your point is correct. Let's get straight to the point. Our performance improved because of HRA. We saw gains across the board. I don't have the details for CSCI, but its gross margin will be influenced by various factors.

58.7.

It's up 58.7, yes, it's up excluding HRA. Everything was up. In the US, our largest business, OTC, increased by almost 400 basis points on a constant currency basis, and operating income rose over 25%. So where was the problem? The problem was in Oral Care and Nutrition. We already discussed Nutrition. I had to shut down a facility for three weeks due to a quality hold product, which doesn't necessarily mean that it's entirely bad; it means we need to test it thoroughly, which is time-consuming. This was a significant factor, and we didn't ship as much volume as we had planned. Essentially, we could only ship what we were able to produce. Nutrition saw a decline of 700 basis points in gross margin compared to last year. Oral Care was also down over 1,000 basis points, primarily due to inbound freight costs. The silver lining is that these issues are quite isolated. Overall, we were up 207 basis points compared to last year despite those challenges. The good news is that freight costs for Oral Care have returned to normal, and we anticipate a significant recovery. The gross margin for Oral Care was slightly under 18% this quarter and should reach at least the mid-20s in the fourth quarter of this year. Nutrition is a bit more complex, involving the Gateway facility and the Good Start brand, but we expect a significant improvement. We had a decline of 700 basis points in Nutrition for the quarter. Bottom line is we've addressed these issues, and we will be producing products at a lower cost. The operating profit that was lost will come back to us in margin and additional volume, likely around $35 million in sales contributing to $10 million in operating income in the fourth quarter for the Nutrition business. I'm sharing a lot of figures, and Brad will break it down further, but the main point is that while we faced challenges in two business units, both have already been resolved.

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

You did. Yes.

Okay, I have one last question, and I'll return to the queue for Eduardo. The total operating expenses for the quarter were significantly lower than what we anticipated and what external estimates suggested. Should we consider this figure as a reliable baseline for the future? Or is it possible that there was considerable investment that didn’t take place due to the circumstances affecting the top line, implying we shouldn't annualize this period? Is the total operating expense a new baseline considering some of the other factors related to the acquisition and a full year of HRA? Also, could you remind us of the effective debt rate and whether you have any exposure to rising rates, or is all your debt essentially fixed cost?

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. Regarding the debt, we have largely converted our floating interest rates to fixed rates, resulting in our rates now being between 4.1% and 4.4%. This positions us well, even as sulfur increases nominally. We anticipate an increase in our interest expense for 2023 compared to current levels. The third quarter will serve as an important reference point when excluding other income linked to our various businesses. The interest expense reflected in the third quarter should be a good indicator 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?

The progression aligns with our forecasts, except for the impact on Nutrition. In CSCA, we have seen a 30.5% increase in our largest segment, OTC, and we anticipate this to continue. CSCI had a strong third quarter, similar to the second quarter at around 52.4%, and we expect a slight increase in the fourth quarter. A significant factor in our current progression is our long-term supply chain reinvention plan, including a substantial $50 million investment in the Nutrition business, which will greatly affect our results. For Oral Care, we faced considerable freight costs when prices rose from about $6,000 to $25,000 per container, leading to a $23 million expense for a business that typically generated around $50 million. However, by the end of the quarter, freight costs had returned to $6,000, allowing us to recover those $23 million in expenses. Additionally, we incurred heavy demurrage costs due to delays in moving products from the docks to distribution centers, but this will also resolve as our products are now being delivered. The products sold in the third and potentially the fourth quarter still carry higher costs due to the previous shipping conditions, but we are optimistic about seeing a recovery as costs normalize throughout the year.

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 are currently in the planning stages, and I can't provide specific details at this moment. I've had many investors inquire about whether we'll host an Investor Day around late summer or in September or October. Unfortunately, I couldn't make that happen because I was focused on negotiating this deal and determining its timeline. We've signed and closed, and we officially own it, which just occurred a few weeks ago. Now, we are constructing the plans and reassessing all associated costs. If we don't hold an Investor Day by February, I aim to schedule one in the first quarter now that we have more information to share. However, I don't have that information ready just yet. Regarding the one-time HRA charge, I was awaiting confirmation on that. I had an idea of the scale of the amount—€60 million to achieve €50 million in synergies is quite impressive. Initially, I wasn’t certain how much of that would be classified as non-GAAP versus GAAP, but we now have clarity on that front. I will provide the information soon, and I'm not trying to evade 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.

We haven't provided an official target yet. Instead, I refer back to the goals I set in May regarding where I aimed to be by 2023. I jokingly told Brad from Investor Relations that while I won't specify the target, it has been adjusted by $0.10 for currency and $0.18 for HRA. This means it is $0.28 lower than the target I haven't disclosed. I would say the estimate on the street is around $3, which aligns with what I was discussing. To clarify, this isn't our official guidance, but it's expected to be around $3, minus $0.28, with some range around it.

That's helpful. The final question I have is regarding the strong flu season we seem to be approaching. In your presentation, you mentioned that cold and cough inventories are low. Is the company prepared to capitalize on potential volume increases in that area? Or is the labor and inventory situation still too constrained to take advantage if we do encounter a particularly strong season in the coming months and quarters?

Unfortunately, the answer is the latter. It really depends on the region. I believe we can capitalize on this effectively in Europe, which is also what they're anticipating. That market includes a significant cough and cold segment as well. In the U.S., regarding tablets, I think we will manage to keep up with demand. However, I want to emphasize that this situation has been developing for nearly two to three years. The cycle we are experiencing with liquids has been intense, as we are operating around the clock and have been fully utilized. We faced challenges due to labor shortages initially, but we have made adjustments. This segment is of high priority and high margin for us, and we are operating at full capacity. I am confident in stating that our consumer sales for cough and cold products showed a 14% increase in the third quarter. We shipped an additional 5%, but we did not keep pace with the demand during that quarter, which put further pressure on our inventory levels. For those who may not be as familiar, the core issue was that the business declined during COVID. Retailers did not place orders or forecast the season correctly, which led to insufficient inventory when demand surged this year. Additionally, by January or February, we saw a huge rise in consumption, but customers were reluctant to accept inventory from the previous year due to its nearing expiration. Consequently, we ended up discarding cough and cold products that were unsold from the previous season. Because the forecast drastically exceeded what customers required, we had to play catch-up. This demand did not diminish over the summer. If we assess our shipping and manufacturing performance relative to the original customer forecasts, we have produced and sold 15% to 20% more. However, that figure is still far lower than the actual market demand, which is possibly around 150% or 160% of what we anticipated. Eventually, we will catch up, but we won’t be able to fully capitalize on this opportunity. I estimate that this situation likely cost us around $11 million in sales for cough and cold products in the third quarter.

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 made our forecast, we had confidence in it and made our adjustments. I wouldn't categorize it as conservative or aggressive; it's simply what I believe it will be. We understand the Gateway product and have had a month of data now. Pricing has increased, but we can't raise prices as quickly as our competitors. However, we have implemented the pricing changes throughout the year. There was likely a 3- or 4-month lag that contributed to this. The HRA business is factored in as well. There are numerous aspects to consider, and despite the complexities, it hasn't been overly challenging to predict. The main issue has been related to the Nutrition segment, where we had to halt production and manage quality holds, along with significant costs in Oral Care. Would you like to add anything, Eduardo?

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. My last question is about capital allocation. Murray, can you share your thoughts on the priorities as the levels are expected to decrease? Are there any additional strategic investments you foresee needing to make, similar to the infant formula deal you announced? How are you considering this as we move beyond 2023?

Our top priority right now is to reduce leverage. We are committed to achieving a reduction of around $800 million to $900 million, particularly with that bond maturing at the end of 2024.

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 that leaves enough room to continue investing in supply chain initiatives. I wish I could have had that Investor Day to show you the bigger picture. We have over $50 million from this first $170 million investment, of which $100 million was raised in cash, so that didn't come from our cash reserves. It's above normal maintenance levels, but it is expected to generate significant operating income returns over three years.

And just to confirm, are you considering providing guidance for 2023 at a potential Investor Day? What is the status of that?

We always provide our official guidance in February, regardless of whether the Investor Day occurs before our February earnings call.

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

Sure. I'm a bit disappointed that we had to lower the base portion of the business by about 15 cents for the quarter. However, I'm still very optimistic. I see gross margins improving where we previously fell short. This issue has been addressed, and I believe the recent supply chain changes are significant and will keep us on track for the long term. With my 35 years of experience in the consumer sector, I find it encouraging that our volume has consistently grown over the past three years, and we are gaining market share in every category we compete in. There's a clear path for margin recovery, which is already in progress—we reached the lowest point at the beginning of the year. I'm very optimistic and will do everything in our power to get back on track to fulfill the initial commitments we made nearly three years ago, despite challenges like COVID and inflation. Currency fluctuations are beyond my control, but I hope they will balance out over time. I mentioned a target of around 43 to 50 almost four years ago, and if we adjust for currency as we've discussed this year, we're approaching that target. I'm excited about the business and appreciate your support. Thank you for your interest in Perrigo.

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