康尼格拉食品 (CAG) 2021 Q2 法說會逐字稿

Good day, and welcome to the Conagra Brands Second Quarter Fiscal Year 2021 Earnings Conference Call. (Operator Instructions) 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 5-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 continue 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've 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 remain 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 hard-working 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 '21 net leverage ratio target of 3.6x ahead of schedule.

During the second quarter, we continued 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 5 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 coming from products launched within the preceding 3 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 5 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 trial 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 post the #1 branded new item in frozen indulgent single-serve meals. Duncan Hines has delivered the top 3 highest velocity new items in single-serve baking and our modernized Hungry-Man brand is outpacing category growth by more than 2x. After a strong first half of fiscal '21, 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 4 main frozen categories. Importantly, our terrific frozen vegetables business returned to strong growth in the quarter as we brought on our additional capacity investment online.

Slide 13 digs a bit deeper into our largest frozen brand, Birds Eye. Birds Eye is a cornerstone of the important frozen vegetables segment, with a #1 position in the category and 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.

As 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. 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 3 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 2-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 as a -- primarily as a source of cash for us, but it hasn't been looked at as a growth engine, but Slide 18 shows how staples remain 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 5-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 result 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. To be 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 product will result in Conagra continuing to deliver long-term profitable growth.

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 in an even better position 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 '21 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 segment for the second quarter. On both a reported and organic basis, we saw continued significant growth in each of our 3 retail segments: Grocery & Snacks, Refrigerated & 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 Foodservice segment.

The Grocery & Snacks segment experienced strong organic net sales growth of 15.3% in the quarter. The segment's organic net sales growth outpaced its growth in consumption as retailers continue to rebuild inventories. Our Refrigerated & 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 & 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 Foodservice 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 outlines 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 Pinnacle Foods acquisition and fixed cost leverage combined to drive 440 basis points in 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 work 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 '22 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 3 retail segments, all operating profits increased 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 Foodservice 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 prioritized.

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 '19. 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 captured the last 2 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 '22 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 of fiscal '19 through the end of the second quarter of fiscal '21, 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 '21. 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 the continuation of elevated retail demand and reduced foodservice demand compared to historic pre-COVID-19 demand levels. We are currently seeing both of these trends continue in the third quarter to date.

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 in 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 impacts from the pending sale of the Peter Pan business. We are selling the business for approximately $102 million, and the expected annualized impact of the divestiture is a reduction of approximately $110 million of net sales and $0.03 of adjusted EPS.

Lastly, we are reaffirming all metrics of our fiscal '22 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.

(Operator Instructions) The first question today comes from Andrew Lazar of Barclays.

I guess, today, Conagra reaffirmed the fiscal '22 financial goals, and those have obviously been a key milestone for the company ever since the Pinnacle deal. And with fiscal '22, really, at this point, rapidly approaching as well as all the uncertainty around operating in the current environment, I guess, Sean, can you -- I mean what can you offer to sort of assure investors that Conagra can, not only reach its fiscal '22 targets, but I guess, more importantly, do it in a way that enables the company to deliver sustainable growth thereafter? As that's a question that I know I've been getting quite a bit these days.

And 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 a pattern of -- is that pattern of some reinvestment one that we should expect more of moving forward? So those are kind of combined. And then I've 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 it is one of the most progressive and effective approaches in our space. The goal, obviously, in brand building is to create a powerful connection between our consumers and our brands. And in the simplest sense, in our eyes, 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. And 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 are seeing that they are not tethered to a television that is broadcasting mass market advertising. You know when I was 5 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 we're 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 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. So 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, the last part of your question, our total brand investment already is, it 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. And then, Dave, just a 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 commodity or 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%, 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 double-digit increase in A&P in the third quarter versus a year ago. So they're really the factors. And with that though, we still, with our guidance, we're implying a 30 to 80 basis point improvement in operating margin in the third quarter.

Next question comes from Ken Goldman of JPMorgan. Apologies. It looks like David Palmer is the next question.

A bit of a follow-up to Andrew's question. You mentioned slides that Conagra is investing behind and executing the Conagra Way, and you mentioned 5 years. So I'm wondering if you could maybe give us that 5-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, David. Well, if you go back 5 years, the company 5 to 5.5 years ago, it didn't look anything like it looks today, right? 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 3 spaces: frozen, we play in snacks, and it's a very unique snack business with a lot of neglected coves as we call it. And we play in staples, and that's pretty much the portfolio. And over the last 5 years, the heavy lift was in the early days where we had to tackle value over volume, and that was painful but necessary to go through 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.

And we started, as you know, with frozen, and 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's success.

And as I pointed out in CAGNY last year, when you look at the demographic tailwinds we have from millennials as they form households, and they -- we know they're already big users of frozen, but then when they form households, have their first child and then additional children, the per capita consumption of those household goes up and up and up again, so that's frozen.

Our snacks business, we really rebased that a couple of years ago, and we said we're going to stand as a snack company. We run it like a snack company. And the performance there has just been outstanding. It's been both organic and it's been through M&A. And 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. So that will also continue, and that remains the other, probably our second priority in terms of investment. And again, these investments come below the line and above the line. It's all about the combination of physical and available -- mental availability, meeting people where they are, as I just pointed out.

But the third piece is one of the more interesting pieces during and post pandemic, which is our staples portfolio, about 1/3 of our retail business in staples, which historically was a cash managed for cash type of business. But these products here are not -- there are a lot of products that are not fundamentally different from what you might see at some of our peer companies like a McCormick, where spices are utilities in the cooking process, no differently than a can of RO*TEL or PAM cooking spray is a utility in the cooking process.

And to some degree, those products go as cooking goes. And what's happening right now is cooking is in a very, very good place, not just because of the older generations who've always been more established in terms of cooking behavior, but the fact that these younger households have learned to kind of be comfortable in their own home, have explored their culinary and built their culinary skills out and are absolutely enamored with recipes and cooking right now.

So a lot of our staple products, be it products like Hunt's tomato, RO*TEL, our salsa business, our dressing businesses. These are businesses that are playing a meaningful role during the pandemic, and we believe because of some of these demographic tailwinds will continue at an elevated level post-pandemic.

So very strong up 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 say that really sits on top of all that is the investments we've made in supporting e-commerce capability, right? If you look at investments in the supply chain, kind of our new -- our approach to modern marketing, retailer investments, analytics, all of that capability we invested in early on, which we're now seeing the benefits of that is with COVID and the acceleration of e-commerce. So I would add that, that really applies to everything, both legacy and innovation volume.

Your question, David and Andrew's question for, obviously, a lot of this, and obviously, the key question on investors' minds right now has a lot to do with this stickiness thing.

One of the things I shared last quarter that I might point into our investors' attention back to was a slide that showed that after the previous recession in 2008, we saw a permanently elevated level of at-home eating occasions. And what was more interesting about the first 6 months of this pandemic is the level of elevation we saw this year or this past year was twice what we saw in 2008. And that was just a -- this is in a very short period of time. So there is previous evidence of stickiness post the adversity. And I think this time we see not just a similar level of stickiness occurring but a higher level.

The next question is from Ken Goldman of JPMorgan.

Can you hear me this time? Sorry about that. Two questions for me. Number one, I 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, but you're guiding to a deceleration in organic sales growth from 8.1% to that range of 6.8% again. I'm just -- I guess 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 slowdown on a 2-year basis. So just curious what some of those headwinds might be.

Yes, Ken. This is Dave. Let me -- so overall, when we look at Q3, we look at it very similar to Q2. So we expect shipments to be roughly in line with consumption. There are some puts and takes there. The third quarter can be a time where you see some retailers reduce inventory levels historically. But we have such strong demand right now that we are seeing orders that are strong because we're replenishing to be able to have the right stock to support the demand, so there's a lot of dynamics going on in this third quarter that we haven't seen in prior third quarter. So our planning posture is we feel good about our consumption cost. 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, and there's going to be some puts and takes between the different segments. But that's our planning posture right now, just given all the dynamics that are going on in Q3. Sean, anything you want to add to that?

No, I think that summarizes it.

Okay. And then I wanted to ask a quick follow-up. Sean, you've been more -- one of the more confident CEOs in our space when it comes to that stickiness of demand after the crisis is over. I think you gave some very compelling reasons today why that stickiness will be there. But if that sustainable growth is already here, can you talk about -- and I guess this is for Dave too, how should you think or how should we think about your desire to kind of 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 perhaps being sticky, that your plants will need a little more expansion to kind of support the -- what's out there in the consumer world?

Yes. Well, we're already doing that, Ken. And if I just use Slim Jim as an example. And first of all, let me just say, you're 100% right. When we think about ROIC, when we deploy our capital against organic growth opportunities, we see oftentimes some of the very best returns, and we have done that. So on 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 and utilizing that capacity, we're on the precipice of doing that again. And so those types of capital investments are clearly on our radar and are priorities for us. But we have other capital allocation options as well, and that is all part of our balanced approach to capital allocation. Dave, do you want to pick up on that a little bit?

Yes. Yes. Just to give you some examples. So if you look at the first half, our CapEx spending is up over 50%, right? So we're investing in CapEx now. Some of the big drivers there, there's a lot of things. We have 2 big network optimization projects, one in grocery, one in refrigerated frozen that drives strong ROI and continues to help drive our margins. And then we have a big investment in Birds Eye to build capacity for the long term.

So as Sean said, we look at the capital allocation on a balanced basis, but we feel really good about the investment opportunities we have in CapEx. And so 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. Yes. And you'll see in our 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.

I just had a question for you. And when I look at the divisions, and this is in relation to my expectations, you had really strong leverage in the Refrigerated & Frozen division. And then less leverage, I’m going to say, that way in the Snacks & Grocery division, and that was a little different than what I expected for the quarter. I just wanted to understand maybe the nuances between those 2 divisions. And I guess the degree to which using third parties, for example, for manufacturing that could be limiting the margin expansion in, say, the Grocery & Snacks division as an example.

Yes, Chris. So when you look at this quarter, Grocery & Snacks was really hit harder in 2 areas relative to Refrigerated & Frozen. One, more of the COVID-related costs hit Grocery & Snacks. So our COVID costs include additional transportation costs, all the kind of PPE stuff, [co-mans] that we use. So more of that hit Grocery & Snacks in the quarter.

And then secondly, inflation. More of our overall inflation for the quarter hit the Grocery & Snacks business relative to Refrigerated & Frozen. So there are really 2 of the drivers when you look at the 2 segments side by side.

Okay. And then just maybe a bit of a follow-on. In terms of your input costs, you also called out transportation costs as incremental cost for them. And you mentioned before, Dave, that input costs are up and it sounds like the upper 2s, maybe 3% type range. They're going to be higher in Q3. When you give that figure, is that incorporating COVID-related costs as well? Is that kind of the total cost basket? And if so, I'm just curious if that's the right number, kind of 3.5% all in for the third quarter?

Yes. No. And you'll see in our bridge, the COVID-related costs are separate than inflation. So we'll look at our commodities and packaging inflation, transportation, that's separate than COVID. The COVID things are just specific costs related that we're incurring because of the COVID environment. So yes, for this quarter, inflation was 2.9%. That translates to the 200 basis point headwind in operating margin you see on the bridge.

But then you'll see another bridge item, which is a 100 basis point headwind, that's COVID-related costs. So we break those out separately. So yes, I said for Q3, we expect that inflation number to be more around 3.5% versus the 2.9% that we saw in Q2.

Okay. So therefore, a little heavier hit to gross margin in the third quarter, right? I see that in the bridge here.

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

The next question is from Bryan Spillane of Bank of America.

So my question is just around inflation. We've seen some increases in the last month or 2 in some of the agricultural commodities and certainly freight energy, just the overall even economists' macro views seem to be pointing towards more inflation. So I guess 2 questions related to that. One, how are we hedged? Or how should we be thinking about inflation and managing it as we move into fiscal '22? And maybe what's contemplated in the '22 targets that you reaffirmed this morning?

And then Sean, I guess, second to that is just given how the retail environment's changed a bit, is there anything different in terms of the way that you might approach inflation and pricing with retailers today than maybe would have been the case pre-COVID?

Yes. So why don't I start with that. So yes, we are seeing inflation. From a procurement perspective, our procurement department is very experienced, and we're looking at every area, every commodity, and we're taking positions where we feel like there's opportunities to do that. So that's really part of our ongoing kind of process. So at this point, obviously, we're looking at fiscal '21, but we'll even have positions that go into fiscal '22. So that's all part of our internal process that we always have.

The key part of this, and then I'll pass it to Sean and we've talked about this at Investor Day that we manage margins to offset inflation in a lot of different areas. And so we look at, obviously, we have our productivity programs and supply chain. We have our margin-accretive innovation, our pricing, trade optimization, our mix. And then the way we can sculpt margin through M&A. And so we're obviously looking at all those levers. And then more recently, obviously, with Pinnacle and the synergies that we're getting out of that, that's helping drive margin plus the fixed overhead absorption we're getting from the higher volumes from COVID. So that all comes into play as we think about margin from a macro level. Sean, anything to...

Yes. No, I think just reemphasizing integrated margin management, it's a capability we put in place a number of years ago. It is multifaceted. It is how we offset inflation. The only thing that I would point out that potentially different, Bryan, your emphasis is a bit different. Post-COVID is brand mix, specifically the staples business, which is stronger today and these cooking utilities that we expected may remain a bit stronger because of these millennials cooking at home. Those tend to be extremely relatively strong margins for us. So that is -- that's good brand mix for us. And that's just -- that's fortunate that, that piece of the portfolio and these younger consumers engaging in cooking habits and really liking our #1 brands in that space, that's a positive overall in terms of integrated margin management.

And Sean, can you remind us just in a period where there's just more general inflation across all parts of the economy, so it's not just agricultural. But if we're going to go into a position -- situation where with all the government spending, there's just going to be just more general inflation, which we haven't experienced in a really long time. Typically, that's an environment that makes it a lot easier for the industry to cover inflation. Is that right?

Well, within the 6 traditional levers that we lean on to kind of offset any kind of margin compression, the one that you're really poking at there is pricing. And the way -- the language we use internally is inflation-justified pricing. Our view is always that if inflation justifies it, we will seek to take pricing. And that's kind of always been our approach. It's never a joyous walk in the park, as you all know. But it is something that principally we, as manufacturers, have to do because we need to continue to make these investments in our innovation so that we can keep these categories growing and keep the retailers happy. And it's difficult to do that if inflation comes and you cannot take inflation-justified pricing.

The next question comes from Jason English with Goldman Sachs.

Congrats on a strong quarter. I wanted to -- I want to come back first to Bryan's question. As part of his question he asked you what was embedded, what inflation assumption is embedded in your fiscal '22 guidance. I didn't hear the answer to that. Can you provide us that answer?

Yes. We're not giving specifics on fiscal '22 as it relates to inflation right now, Jason. But it's -- we reaffirmed fiscal '22. So you can assume that we're looking at different ranges of outcomes for inflation, but we're not disclosing it at this point.

Okay. Understood. And Dave, you mentioned one lever is to sculpt margin through M&A. Can you go a little bit deeper on what you mean by that? And also talk about your M&A appetite now that you've effectively -- you hit your leverage target much faster than expected, does that open up more aperture? Is there appetite there for you to be back in the market pursuing acquisitions?

Yes. Jason, it's Sean. Let me just take it from the top in terms of kind of our philosophy on M&A. Obviously, we've been very active in the last 5 years with inbound stuff and outbound stuff. And when we do that, both ways, it is -- we do consider not -- we consider it as we're reshaping the portfolio for better growth and better margins. And so items that come in and brands that come in, not only need to be strategic, but ideally will help us in terms of our forward-looking growth rates and margins. Similarly, items that we divest sometimes can be things that have been a chronic drag on growth rates or margins. So by effectively managing kind of both the inbounds and the outbounds, remainco, so to speak, the remaining company going forward should look better. That's the ideal situation in terms of growth prospects and margin.

And we've got -- obviously, we've been active doing that. We'll continue to be active. We just announced the divestiture of Peter Pan. We've got this capital loss carryforward that we're well aware of, we talk about every day. And our principle there is pretty simple, which is if something is not a fit for us and somebody else wants to make an offer for an asset that is above what we see as the intrinsic value, then we're all ears on that kind of thing.

Similarly, on inbound stuff, we're just now getting to the point where we're feeling -- our focus has been about delevering. Let's not -- let's be very clear on that. Ever since the Pinnacle acquisition, we've been 100% focused on delevering. We're now ahead of that cadence. So we can start to see our way toward other uses of capital going forward, what they could be share buybacks, they could be bolt-on acquisitions. They just have to make sense. Or could be investing in our business, as Ken pointed out in our own CapEx. So that's -- all of that's fair game. Dave, do you want to add anything to that?

No, you got it.

The next question comes from Rob Dickerson of Jefferies.

Great. So I just want to focus a little bit on the fiscal '22 targets. Obviously, as you said, we could see, right, the margin targets coming in ahead of plan, leverage target is coming in ahead of plan. But then we're also all kind of talking about the inflationary effects potentially this year.

And then it sounds like you think you can hold some of the pricing benefits you've already received. But then we have to combine that with some or, let's say, less fixed cost leverage as we think about next year. So it seems like kind of what's implied in all of it is our targets aren't changing, but the targets that we have are still slightly below where we've come in the first half of this year. So it sounds like just kind of where you sit now, your visibility, all things considered, you just pointed to this, Dave, in terms of your -- kind of your sensitivity analysis, right? As you look forward next year, all things netted out, you say, yes, we might have to give some of this back, we might have to give some of that back. But kind of net-net, relative to where we were last year, we feel just as good or maybe stronger about hitting those margin targets while at the same time as we continue to see kind of sales revised upwards.

So kind of net-net, what I'm asking is like why wouldn’t -- not just the margin piece, why wouldn’t kind of the operating profit dollars in fiscal '22 be higher than you even thought they would have been 1.5 years ago? Lot in there, but...

Yes. So let me take a shot at that, Rob. So obviously, starting at the top of fiscal '22, how we come out post-COVID and what the stickiness is obviously impacts the top line and that drives that -- the sales dollars and then the gross profit, operating profit dollars, right? So -- but if you kind of step back and you look at this quarter, and let me just take this Q2 and dissect it a little bit differently, so you get an understanding of kind of what's happening in margin. If you look at -- we improved operating margin 250 basis points this quarter, and there's 3 buckets, okay?

The first bucket is improvement that we got that's not going to stay with us. And that's 10 basis points of the 250. And what is that? That's all this COVID stuff. It's the COVID costs that are a bad guy. It's the lower SG&A from COVID because we're not traveling, which is a good guy. It's favorable absorption across the P&L, which is a good guy. You net all that stuff together, that's 10 basis points of benefit we got this quarter that's not going to recur.

The second bucket is what is going to recur, and that's our core productivity. That is our realized productivity from supply chain. That's our Pinnacle synergies and then that's inflation and business investments. For the quarter, the net benefit of that was 60 basis points and those programs will continue to go.

The third bucket is where we are still evaluating it in terms of the ongoing benefit is price/mix. We had 180 basis points of price/mix benefit in Q2. Now the majority of that was mix and a lot of that's from volume. So there is a part of that, that will not recur. But there's also a benefit from less merchandising and pricing in there. And some of that will recur, but we're not quantifying what amount of the 180 will recur. So I say it that way because it's hard to look at some of these numbers sometimes and really understand what's ongoing versus what's not. So hopefully, that's a little helpful kind of looking at this quarter and thinking how it could apply. But all that kind of goes into the mixture. Obviously, inflation, everything else we're looking at as we run scenarios to give us the confidence to reaffirm '22.

Okay. Got it. That's helpful. And then I guess, just quickly coming back to the cash piece and cash allocation, the leverage targets ahead of schedule ramp the dividend impressively. And then obviously, a lot of talk around capacity and CapEx needs. But just kind of given valuation of the stock and you're seeing maybe other companies within the space, continue to announce ongoing repurchase programs, and there's more activity in the space. Like why not be more proactive around buying your stock back? And that's all.

Yes, Rob, it's Sean. Obviously, buybacks have been part of our repertoire before and undoubtedly will be again, in any given window, it's all about the relative appeal of these capital allocation options and obviously, stock price factors into that one that you raised. So obviously, this is -- it's clearly an option for us and one that we will weigh against our 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. So as a reminder, this call has been recorded and will be archived on the web as detailed in our press release. The IR team is available for any follow-up discussions that anyone may have. Thank you for your interest in Conagra Brands.

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