TreeHouse Foods Inc. (NYSE:THS) Q3 2022 Earnings Conference Call November 7, 2022 8:30 AM ET
Company Participants
P.I. Aquino – VP of IR
Steve Oakland – President, CEO and Director
Pat O’Donnell – CAO
Conference Call Participants
Andrew Lazar – Barclays
Jon Andersen – William Blair
Chris Growe – Stifel
Bill Chappell – Truist Securities
Rob Moskow – Credit Suisse
Connor Rattigan – Consumer Edge Research
Hale Holden – Barclays
Operator
Welcome to the TreeHouse Foods’ Third Quarter 2022 Conference Call. All participants will be in a listen-only mode. After today’s presentation there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded.
At this time, I would like to turn the call over to TreeHouse Foods for the reading of the Safe Harbor statements.
P.I. Aquino
Good morning. Thanks for joining us today. This morning, we issued our earnings release, which is available, along with the slide deck, in the Investor Relations section of our website at treehousefoods.com.
Before we begin, we would like to advise you that all forward-looking statements made on today’s call are intended to fall within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and projections and involve risks and uncertainties that may cause actual results to differ materially from our forward-looking statements. Information concerning those risks is contained in the company’s filings with the SEC.
On August 11, we announced the sale of a significant portion of our Meal Preparation business. On October 03, we completed the divestiture of that business now knows as [indiscernible] for a base purchase price of $950 million. For the purposes of our discussion today, we will first cover our third quarter results on a whole company basis as we own the divested business through the entirety of the quarter.
Results for the quarter are provided on a continuing and discontinued operations basis in the press release. However, the majority of our discussion today around our operating and financial results will center around performance on an adjusted continuing operations basis. We have provided recasted historical financial for TreeHouse continuum operations for 2019 and 2020 on an annual basis and 2021 and 2022 on a quarterly basis, so that you can best compare past and future operating performance. Please note that these financial statements differ from the GAAP pro forma financials filed shortly after the transaction closed because they take into account historical onetime adjustments and certain costs associated with the divested business, as well as certain pro forma adjustments only required by SEC rules. A reconciliation of non-GAAP measures to their most direct comparable GAAP measures can be found in the release and the appendix table of today’s earnings deck.
With that, let me now turn the call over to our CEO and President, Mr. Steve Oakland.
Steve Oakland
Thank you, P.I. and thank you all for joining us today. It’s been a very busy few months since we last spoke. We reached a strategic milestone having completed the divestiture of a significant portion of our meal prep business in early October. The transaction is a major step in our strategic transformation to drive greater focus, simplification and growth across our portfolio and reflects the culmination of the board’s strategic review process launched literally a year ago.
The $950 million transaction comprised of $530 million in cash and a $420 million note receivable represented a compelling value of $13.6 times 2022 adjusted EBITDA for the divested business. I want to express my gratitude to our teams. I’m proud of all that we have accomplished to date.
Over the last month, I’ve been to several plants, met with leaders at key customers, and spent time in person with our leadership teams across the organization. As we embark on this journey as a new TreeHouse, the outpouring of enthusiasm and ideas has been energizing, further building my confidence in our future. Today, we are a simpler business having divested 11 categories and 14 plants. Our portfolio is now more focused around snacking and beverages, and on Slide five, we’ve listed many of our categories.
We operate across attractive growing categories fueled by strong consumer demand trends. We have positioned ourselves to capture the continued momentum in private label and improve the consistency of our execution to drive more profitable growth. We plan to come back to you in 2023 with an Investor Day to provide more detail around our future plans.
Slide six gives you a sense of the historical private label growth rates for the categories across our portfolio today. While 2020 and 2021 were unusual years due to COVID, over the longer term, we expect these categories to grow in the 3% to 5% range. As a result, we now have a stronger financial profile with healthier margins. Pat will get into this in more detail, but we also have a stronger balance sheet following the transaction. After the close in October, we used $500 million in proceeds to significantly our debt.
Let me now turn to Slide 7 and say a couple of words about the macro environment, private label, and the third quarter before I turn it over to Pat to walk you through the financials. Today, 65% of consumers have a high level of concern about the economy as seen in the first chart. Inflation is up over 8% and personal savings has declined.
Shelf prices for total edibles on the bottom left have continued to increase. As a result, shopper behavior is shifting. You’ve heard this from several retailers. Consumers are recognizing the strong value proposition of private label. In the third quarter, private label continued to post share gains.
On the left of Slide 8, you see price gaps to national brands remain wide at 27%, which is at the high end of the historical range of 21% to 24% for the categories within the new TreeHouse. As I’ve said before, this combination of high shelf prices and wide price gaps translates to a basket of private label goods that represents significant savings for the consumer.
On the right, we’ve taken a shopper basket of national brand goods across our categories and compared it to that same basket for private label. We estimate the absolute dollar savings for just this one shopping trip is about $20. The private label value proposition has never been greater on a dollar basis.
On Slide 9 on the left, is sales and volume growth for total edibles. Units for private brands outpaced national brands by 400 basis points. Narrowing the dataset a bit further, the right hand chart indicates the performance in our new TreeHouse categories. Here, the margin by which private brands outpaced national brands was more than double about 900 basis points in the third quarter, demonstrating that our new portfolio is advantaged.
While demand is strong, service was 96% in October. Service continues to improve sequentially, but it’s still not back to where we need it to be for us to take advantage of the full opportunity. We continue to make progress in our efforts to mitigate the disruption and anticipate that service will continue to improve over the next few quarters. But we do face the challenges in the operating environment, which are impacting our industry.
I’m also pleased by our efforts around continuous improvement across our network, which we believe will improve not only capacity and production in the near term, but will drive savings and profit improvement well into the future.
With that, let me turn it over to Pat to take you through the quarter, our recast financials and guidance and I’ll come back at the end to wrap it up and talk about the work we’ve done to position the new TreeHouse for the future. Pat?
Pat O’Donnell
Thanks Steve, and good morning, everyone. Let me start by providing our third quarter results on the basis of total TreeHouse inclusive of the divested business as seen on Slide 10. In the third quarter, we delivered top line growth of 18% [ph] and a sequential improvement of 130 basis points and adjusted EBITDA margin to 6.9%. This result was slightly better than we had anticipated in our guidance due to the more favorable customer and category mix.
With that, I’ll now focus our discussion on the results and outlook of the continuing operations starting on Slide 11. As P.I. mentioned earlier, we’ve provided the historical comparable information for the continuing operations in the press release and the appendix tables to today’s deck. Third quarter revenue grew 16.4% to $875 million. Pricing rose 20.7% as the impact of our pricing efforts to recover inflation continued to be realized. Volume declined 4.2% due to continued supply chain disruption, which constrained service. Additionally, we intentionally exited some low margin pickle business. Foreign exchange was unfavorable by 10 basis points.
Slide 12 covers our year-over-year adjusted EBITDA drivers. Third quarter adjusted EBITDA, total $77 million or 8.8% margin. This represents a sequential improvement of 220 basis points as we continue our efforts to address the labor and supply chain destruction that has pressured our margins over the past year. Volume and mix, including absorption contributed $8 million in the quarter. This was primarily driven by the positive mix from the lower margin business exit I mentioned earlier.
Pricing net commodities was positive for the first time in several quarters and contributed $33 million versus last year. Pricing is now catching up to the commodity inflation we incurred earlier in the year consistent with the lag effect we have discussed previously. Although we have seen several commodities retreat in the near term, the vast majority of our inputs remain elevated on a year-over-year basis.
Input cost inflation has continued across certain commodities such as coco, and we are also seeing the impact of higher input costs across non-trading commodities, such as boil blades and some commodity derivatives like corn syrup and casing.
Turning next to operations, labor and supply chain continues to be a persistent issue affecting the entire industry. On a year over year basis, our operations declined $41 million. We have several clients performing very well where the commonality is a stable workforce with teams actively engaged in continuous improvement efforts. We are working to build those common threads across more of our plants and redoubling our efforts around labor and line reliability.
Importantly, we continue to invest heavily in training, engagement and retention across the entire network, which are the right steps to improve efficiencies and returns over the longer term. The supply chain environment continues to be dynamic, but our teams have done a good job securing multiple new suppliers and either working with customers to adjust product specifications based on material availability or working with suppliers to ensure that they have the capacity to meet our needs.
Slide 13 demonstrates the progress we have made thus far to restore surface levels and improve on time delivery. The divesture significantly reduced our complexity in terms of the number of plants and categories, which is better enabling us to focus on surface. On average this year we’ve seen a 50 basis point to 100 basis point improvement in service each quarter. During the third quarter, service averaged 93%, hosting improvement each month, and as Steve mentioned, our service in October was 96%.
Similarly, our on time delivery percentage is improving anywhere from 100 basis points to 400 basis points sequentially. Our teams have demonstrated great agility as we identify and creatively address disruption, and we anticipate continued progress sequentially improving margins as we finish the year and head into 2023.
Turning now to the balance sheet on Slide 14, we’ve finished the third quarter with approximately $1.9 billion in total debt. Shortly after the transaction closed, we used $500 million of the proceeds to pay down our term loans radically. Currently, total debt sits at about $1.4 billion, and we expect our debt covenant leverage to be comfortably below four times at year end.
As part of the transaction close, we reevaluated our liquidity needs. First, we reduced the size of our revolver by $250 million. Given that we are now a smaller company. Our revolver remains largely undrawn and total liquidity was just under $800 million at the end of the third quarter.
Second, that the condition of the transaction close, we reduced the amount of receivable sold under our receivable sale program, which impacted working capital by approximately $90 million. This had a one-time negative effect on our cash flow, which was recovered in October upon closing. Because we are now a smaller and simpler business with less sales and therefore less receivables, we anticipate significantly lower utilization of the AR program versus prior years.
Turning now to guidance on Slide 15, for the fourth quarter, we anticipate revenue growth of 22% to 24% over last year, driven primarily by pricing. Our assumption on the top line are as follows. As we discussed back in August, we took additional pricing that started flowing through late September and early October. We anticipate flavor and supply chain related challenges to continue, and while we are making good progress on service, we do face some production constraints. We think it will take some time before service returns to target levels. As a result, we anticipate volume to be flattish in the fourth quarter.
I’ll also note that beginning in Q4, we will have income related to the transition services agreement that will continue for at least the next year. The income will offset the related expenses for things like IT, HR and customer service, giving the domestic business time to establish its infrastructure. We are actively working with them to address these costs well before the related TSA services expire. We are guiding our fourth quarter adjusted EBITDA margin to be 10.5% to 12%, representing strong improvement both on a sequential business and compared to last year.
On Slide 16, we’ve also given you a way to think about what the earnings power of the business can be on a more normal, less disrupted basis. Beginning on the left, we’ve started with the full year 2022 EBITDA of $280 million, which when you do the math for the fourth quarter, represents the midpoint of the continuing operations guide.
The next bar is the net peanut lag effect in the 2022 calendar year, which totals about $80 million. We’ve had significant inflation this year and we’ve taken significant pricing as a result, but there is a timing delay in the recovery of those higher input costs.
As I noted earlier, in the third quarter, the pricing contribution began to recover the lag, so when you think about the timing of when we affected new pricing this year, not all of it will be realized in 2022 and some will wrap into next year.
The third bar represents our dollar estimate for this year of cost interruption due to the supply chain and service constraints and we think will recover over time, a total of about $40 million. The net impact of these factors totals $120 million. Over time, the environment will reach a new normal and we believe the earnings power of our business as it is now constructed, is about $400 million. We have the right action steps in place, but it will likely take several more quarters to get there.
Before I turn it back to Steve, I want to make sure I recognize the effort of our team members. We have not only been running the business day to day in a very dynamic environment, but we have completed a major divestiture at a strong valuation in a challenging financial market. We have been hard at work. I’m so proud of the progress we’ve made and grateful for the team’s contributions. I’m confident we’ll continue to deliver improvements in 2023, and I’m bullish about our prospects as a new TreeHouse.
With that, let me now turn it back to Steve.
Steve Oakland
Thanks, Pat. I want to close by covering two areas. First, how our new statement of corporate purpose supports our higher growth, higher margin, private label snacking and beverage company, and second, how we think about 2023 and beyond at a high level.
Earlier this fall, we held our annual summit with our management team and our top leaders across the company. After a couple of years of COVID followed by many months of strategic review, it was great to get together to not only celebrate our accomplishments, but to position our teams in the best manner possible so that we could hit the ground running on day one.
Following the close, we spent time team building, generating ideas and acknowledging the challenges and opportunities as we evolve our organization design into one better suited to support not only a faster growing portfolio, but an organization with a new purpose. Our new corporate purpose statement is to engage and delight one customer at a time. And while you may initially think that by customer we simply mean retail customers.
Our intention is to go way beyond that to represent all of our stakeholders, retailers, consumers, employees, and shareholders, as well as the communities in which we operate. We have chosen the words engage and delight very purposefully. Engagement is about participating, it’s about listening, connecting and collaborating, and we define delight very simply to exceed our stakeholders expectations.
This comes to life in a very tangible way for our retail customers. Our goal is to bring these consumer advantaged categories to life in their stores under their brands. We’ll continue to collaborate with our customers and delight them by driving mutually profitable growth for our consumers.
As many of you know, there’s a real passion around a number of our products, whether it’s our chocolate peanut butter cups, our loft house, seasonal cookies, or everything seasoned crackers. Our products have the ability to generate consumer delight, excitement even further, and frankly build private label franchises.
As we succeed to engage in delight our customers and consumers, it assures our ability to grow the top line and expand profitability, enabling us to drive long term sustainable growth and shareholder value and for our employees and the communities in which we operate. I’ve said it before, people and talent are critical to our future.
We are focused on employee engagement and satisfaction. We are committed to making TreeHouse the employer of choice in the markets in which we operate. With that, I’ll turn our attention to slide 18. Pat walked you through the macro headwinds and their impact on our business this year. More importantly, he covered what the more normalized profitability for our business should look like.
I’d like to wrap up my prepared remarks with some final thoughts, more specific to 2023 as you digest today’s information and build out your models. First, we expect private label demand to continue to be strong next year, given the economic backdrop during historical downturns.
As consumers look to stretch their dollars, private label has benefited. Second, as I shared with you earlier, we have a faster growing higher margin portfolio pre pandemic. These categories grew between three and 5% per year, and although we’re not ready to provide formal 2023 guidance given next year’s wrap of pricing to recover inflation as well as healthy demand, we would expect revenue growth to be very strong.
Third, we will continue to aggressively address labor and supply chain disruption and focus on improving service. Having the labor back in our plants enables us to serve our customers and to deliver cost savings. We are making very good progress in each of these areas, and we expect that will be reflected in our adjusted EBITDA margin progress next year.
Finally, I’d like to point out that our net interest will be very different in 2023. Our 500 million debt repayment in October translates into roughly 20 million in interest expense savings on an annual basis. In addition, the interest income on the notes receivable from the transaction will total roughly 40 million next year, of which the first payment is expected in the fourth quarter, netting us a very efficient capital structure.
I’ll close my remarks today by saying again, we took a tremendous strategic step this year transforming the company. It will take some time to get back to a new normal, but I hope you share my excitement around our future, starting with our new purpose and looking ahead to 2023 and beyond as a simpler, faster growing higher margin snacking and beverage company.
With that, let’s open the call up to your questions.
Question-and-Answer Session
Operator
[Operator instructions] And our first question comes from Andrew Lazar from Barclays. Please go ahead. Your line is open.
Andrew Lazar
Great, thank you. Good morning everybody. Maybe to start off, Steve, thanks for sharing your thoughts on what you think the sort of normalized earnings power can be of the business as it’s currently constructed now and I realize this is not guidance for ’23 per se, but if we look at for starters, I think you mentioned in the prepared remarks for the first time in quite a while, right Peanock [ph] finally turned positive in the third quarter as pricing is sort of better caught up to costs.
So if we think about that $80 million in Peanock lag, right over the last year or so, I guess why would that be expected to be a drag at all in ’23, specifically if it’s already turned positive unless I guess you’re expecting incremental inflation from here for which you would need to take incremental pricing.
Pat O’Donnell
Andrea, this is Pat. I think the way to look at that is that’s the drag that we’ve sort of experienced to date, and so as we continue to normalize that drag or that lag would go away. And so I think you’re right. If there were incremental inflation that could be a drag on 2023, but that most of the pricing that we’ve taken to date is in market and effective and they’ll, we’ll lap a lot of that pricing into 2023 throughout the year.
Andrew Lazar
Okay. So you would at least expect a good portion, and we don’t know exactly how much yet, but a good portion of that $80 million probably wouldn’t necessarily be a factor in in ’23, at least as we’re thinking of things here today. I know that can change.
Pat O’Donnell
Yeah, I think that’s right because I think that pricing’s been in market for some time now.
Steve Oakland
And Andrew, this is Steve. That was the purpose of that slide, right? I think we all thought a year ago that the world would be normalized. Now it’s not quite there. The pricing piece is in market. The labor and supply chain piece is getting better, but it’s getting better a little slower than we all thought. So we expect that to normalize over the next couple of quarters and hopefully we’ll have a little better look at that when we guide in early February.
Andrew Lazar
And the supply chain part, that is high, obviously very consistent with what we’ve heard from pretty much everybody, right? It’s persistent, it’s getting better, but it’s slow but it’s persistent. And I guess the second one would be, I realize it’s very hard to talk about sort of 4Q results as the portfolio was before the deal closed, but really just trying to get a sense of if the business is sort of clicking along as you would have initially anticipated relative to that, that initial guidance. And if I just look at, I guess, the difference in EBITDA for instance, pre and post the deal for 4Q of last year in the appendix there it’s like a 15% difference.
And I look at this year’s 4Q the difference between the EBITDA guidance you provided and kind of what the street was estimating, it’s like a 30% difference. So there could be seasonality or maybe the divested business was more depressed than the year ago period, but really just trying to gauge whether you were essentially on track to achieve this year’s guidance pre divestiture. As we’ve heard from others, there’s clues still supply chain issues that persist. Thanks so much.
Steve Oakland
Sure. Well, why don’t I start and I’ll have Pat, I’ll have Pat jump in. I would tell you that we are on track from a sales standpoint. We are we’re struggling a little bit with the external headwinds, right, the supply chain and inflation. So I do think that business had a softer last year. So yes, there’s a little more recovery in the business that we sold, but candidly the — we’re a little bit behind from a labor and supply chain piece. Those external headwinds in the fourth quarter are pressuring margins a little bit more than they are sales.
Andrew Lazar
Great. That’s helpful. Thanks so much.
Operator
Our next question comes from John Anderson from Franklin Templeton. Please go ahead. Your line is open.
Jon Andersen
Good morning. It’s Jon Anderson with William Blair. I was going to circle back on Andrew’s first question and just the bridge that you provided to the normal EBITDA of $400 million, I’m curious if you could talk a little bit more about the timeframe associated with closing the $80 million GAAP on Peenock [ph] and the $40 million gap on labor and supply chain and some of the mechanics of doing that.
It sounds like on the Peenock it’s just a matter of benefiting over time from the pricing that’s already in the market. Correct me if I’m wrong on that. But if there’s some more color around maybe the actions you’re taking and the progress you’re seeing with respect to labor and supply chain again. So it’s kind of the timeframe associated with it best that you can estimate at this point to close those gaps and some of the mechanics of making that happen. Thanks so much.
Pat O’Donnell
Yeah, Jon, I’ll start with the pricing. This is Pat. So you know, I think we took several different ways of pricing throughout the year. So I think each quarter we had sort of a wave of pricing that hit with the most recent sort of wave culminating here into Q4 and the Q3. And so you really won’t lap all that pricing, until you get into Q4 of next year and candidly we even have some pricing that’ll be effective in January on some business from that perspective.
So we’ll continue to see that throughout next year as we’ve had kind of ways of pricing each year from that perspective, but the more significant pricing from a dollar magnitude perspective was earlier than later, but certainly there was pricing throughout the year.
Steve Oakland
Sure. And I’ll touch on the labor and supply chain. Labor first of all is getting slowly, slowly better. You don’t hope for the economic situation to be slow, but if it is, I think that’ll continue to improve at maybe a little better pace. So we think the labor activation, both — it’s both wages and it’s a lot of other things. It’s scheduling, it’s a number of different things we’re doing to make TreeHouse that manufacturing employer of choice. Those actions are helping us. So I would expect that to improve over the next several quarters.
With regard to supply chain, we put a slide in the appendix, and I apologize it doesn’t give actual numbers on it, but Slide 21 in the appendix. And it’s fair to say that our, the on time and full from our vendors is in the low seventies right now on an aggregate, we’re turning that low seventies into low nineties service levels, right?
And so that’s the disruption that, you know, you, you have when, when goods don’t arrive, you have to change schedules that you’re not as efficient at operator. You know, the commitment I have, I meet with the CEOs of, quite frankly our top four or five vendors on a monthly basis personally, right and that drives, recognition through our organization and their organization that we’re working together to get those, right. The commitments I’m getting is that that will continue to improve. So, so I would expect both of those to get pretty close to normal, and again, we’ll try to guide this better in February, but I would hope in the next several quarters.
Operator
Next question comes from Chris Growe from Stifel. Please go ahead. Your line is open.
Chris Growe
Thank you. Good morning. Hi. I had a question for you if I could first just understand the kind of the volume performance in your categories. And for the fourth quarter, you indicated that volume should be about flat and seems like a relatively similar rate of price, maybe up a little. So I just want to understand, you know, why is that better sequentially in the fourth quarter, and is there anything unique that weigh on the third quarter volume that led that decline that you mentioned? For example, walking away from a, from a contract in the pickle business, Anything else that’s worth noting for volume currently in the business?
Steve Oakland
Sure, Chris. You mentioned that and, and I think in Pat’s prepared remarks, we talked about a large, and that was a food service pickle volume. When we make volume comments in our, in our scripts, we, we use total company volume, right? Not retail, grocery, private label volume.
Our retail grocery private label volume was up a couple percent in the quarter, right? And we think that’ll be up in the fourth quarter as well. But a couple things, you know, we did exit a large pickle contract and food service. You know, our, our contract pack business, although small, it’s about 10% of our total business tends to be very upscale, premium branded items that we make for other people, and those businesses are down.
And so most of the impact on our negative volume is either places where we’ve chosen to apply that capacity against, much more profitable business or quite frankly, where there, there, there’s headwinds in their business.
I pointed Slide 12 in our deck, right? And you see that volume mix is positive on lower volume, right? That means that we are applying limited capacity against more profitable business. And so I give our teams a lot of credit for that, and I think reflects that our core business is pretty solid and we expect that to continue.
Chris Growe
Yep. That’s good. Good answer. Thank you for that color there. I just, one other question I wanted to ask in relation to the pricing you had something like 21% pricing in the quarter and that can cut across more than just, you know, retail businesses. And when I look at, you know, IRI data for your categories, I come out somewhere around 16%. Is that, so is that the retailers holding back on pricing? Are you seeing more of that flow through and to what degree is that 80 year volume performance as the pricing hasn’t pushed through quite at the rate in which you push through to the retailers? That makes sense.
Steve Oakland
You know, Chris, that’s a tough one because it’s so different by customer, by category, right? And we have categories where customers were way out ahead of us and took price ahead of us if the national brands were, and then we have categories where they really held it, and there’s a couple of retailers in the country that are gaining share in private label and using private label in this high inflationary environment to send a message to draw traffic, right?
So, it’s really a tough one to say, but I think in general our, the category pricing is up, right? I think the retailers have passed through in general. You could pick an individual category and that may maybe higher or maybe lower, but, but I think as we look across our, especially our major, our major customers, we track each one of those and I think most of them have passed our pricing through.
Operator
Our next question comes from Bill Chappell from Truist Securities. Please go ahead, your line is open.
Bill Chappell
Just a follow up on kind of the volume, maybe what any idea of how much the service levels and also the pickle business affect the volumes in the quarter and then kind of the expectations for the volume in 2023?
Steve Oakland
Sure. Bill, so I would say I would think about it as about half and half. So about half of the sort of volume is related to sort of the lag and service. And then the other half would be related to the pickle business. And, and I guess the way we try to think about the, the volumes is as we continue to make sequential improvement in service, right, we’ve said it’s slow bit steady. We, you know, we expect that to continue as we think about sort of the normalization of the, of the supply chain environment that we talked about, you know, headed into 2023.
Yeah. And I would also take it back to a year ago, a, a year ago in the third quarter we had pretty solid service, right? That was the beginning. We started to get disruption on our factories, but our inventory levels were really good.
So I think service was like 97% to commit. And I think we, we said the prepared remarks, if we didn’t, it was 93 or so percent in in the third quarter this year. So, you know, we did not have those same supply chain headwinds a year ago. So we did have a better, better inventory base, but that started to decline pretty aggressively as we went into the, specifically the first and second quarters.
So we think the, the, the volume lap, given that we think service will be significantly better in the first and second quarters this year we also think the economic environment is going to drive demand. And so you add those two things together, we think there’s nice volume upside in the first two quarters. We’ll try to quantify that when we get closer.
Bill Chappell
Got it. And then just I guess on that pickle business, I just think of it as the, I guess, original business. So is it a one two point drag going forward? And then separately, a kind of accounting geek question as I look at that, I guess note receivable or seller’s note, how is that calculated into your leverage? Is that a contra item so that it’s an asset that offsets debt so your net leverage is actually lower, like it does on the interest expense line with interest income? Or does it not affect, you know, how we should be looking at your leverage ratio going forward? Thanks.
Steve Oakland
I’m going to let Pat off for one of those, but you know, Bill, that, that’s exactly the feeling that I have, right? We’ve got an asset out there a debt instrument paying us 10% interest, but unfortunately we don’t get to counted against our leverage. But that’s why we made the, the statements at the end of my remarks, right on interest, right?
The pay down in fact does affect our leverage ratio, but the reality is outside our leverage ratio, we’ve got an instrument paying us $40 million in interest, right? And so, you know, the net impact to the company is dramatically different than it was a year ago. And, and so the cash flow that we can invest in our business is very different this year than next. And so we’ve got constrained growing categories, we now have the resources to invest in them to take advantage of that. So I don’t know, Pat, if you’d like to comment any further?
Pat O’Donnell
No, Yeah, I think, I think the interest, the note will generate significant interest, will generate cash, right? And that, that cash will be used in sort of our net debt calculation and then the cash flow business, as Steve said. Yeah. But unfortunately, no, we don’t get to offset the two in our leverage calculation.
Operator
Our next question comes from Rob Moskow from Credit Suisse. Please go ahead. Your line is open.
Rob Moskow
Hi thank you for the question. Morning, Rob, Pat, I just wanted to make sure I understood what’s changed in the guidance for continuing ops. I, I thought that in second quarter you estimated EBITDA for continuing ops at 330 and the Slide 16 indicates that it’s now the starting point is 280. So have, have you, is that correct that you’ve lowered guidance by $50 million? And if so, can you give a little more color as to the labor challenges that you’re having that caused it?
Pat O’Donnell
Yeah. Hey, Rob, this is Pat. So, so I think, you know, the, the three 30 was, was sort of wasn’t really guidance, but was our sort of estimate of the, the business at the time that, that we completed the transaction. And, and I, I think your, your thoughts are, are right in that, you know, the, the fourth quarter guidance really reflects the current environment.
When we talked to you in August, the, the supply chain was recovering, you know, at a, at a reasonable pace, but it’s dynamic and, and that, that recovery hasn’t progressed as fast as we would’ve anticipated. You know, we are seeing good progress across many of our plants, but we do have a select few plants in certain markets where labor remains challenging. Line reliability is an issue, or we’re facing material shortages. Steve talked about sort of the supplier on time and full issue that we’re experiencing and, and how we need to try to convert that into more positive service.
I will say, being, a simpler, more focused company with a, a smaller footprint is benefiting us. So those handful of plants where we’re experiencing the greater disruption you know, we’re able to go focus more of our time and effort on those couple plants to help drive some of the improvement. And so we are seeing the benefits of that.
As, you know, I think you heard in our prepared remark service in October did take up to sort of 96% or so and while supply chain is a, is a big factor we’ve also seen some additional inflation and some of our non-trad commodities, things like boil lids other, you know, commodity derivatives like casing and corn syrup, you know, which we’ll price for as needed. But we’re making positive progress on a sequential basis this year and, and we’ve improved the profit meaningly since the beginning of the year.
Steve Oakland
Yeah. Rob, this is Steve. I would suggest that that the third quarter actuals and the guidance show the solid progress, but given the disruption that remains so those external headwinds that remained, we thought the guidance had to reflect that, we have the opportunity to get in the higher end of that guidance if that continue — if we can continue to mitigate that. But we thought it was prudent to put those numbers in there, if that continues.
Pat O’Donnell
Well, I guess it is a significant reduction in the guidance for the continuing ops business, isn’t it, for the full year and a significant improvement in the guidance for the divested business.
Steve Oakland
Yeah. I don’t think we can do that math Rob, because I don’t know that we know what Q4 for the divested business really looks like, in terms of that mix. So they, we don’t have a sense of how they’re performing relative to the original guidance we put out.
Pat O’Donnell
I don’t think we can’t comment on their progress.
Rob Moskow
Okay. Can you give us any kind of color on what percent of the portfolio you still need to take pricing on in January?
Pat O’Donnell
I think there’s a very small amount, Rob, that where we just have contracts that renew sort of in the January timeframe. And so we’ll put out that pricing in connection with those contracts.
Steve Oakland
And there’ll probably be some non-commodity pricing that happens in the fourth quarter. It’s very cumbersome with a lot of retailers to do pricing between Thanksgiving and Christmas, but that pricing will roll out right after that on some of the non-commodity things that Pat mentioned either in the prepared remarks or the remarks here on Q&A.
Rob Moskow
And when you say non-commodity, do you mean labor overhead?
Steve Oakland
No, it’s usually things like casing and corn starch and some of the — some of the derivative products of commodities have been priced pretty aggressively this quarter. They tend to be small percentages of formulas, but they are material increases and so those increases will roll in into the next year. We don’t see inflation anywhere near what we saw a year ago, but we do see inflation in the first quarter.
Operator
Our next question comes from Connor Rattigan from Consumer Edge Research. Please go ahead. Your line is open.
Connor Rattigan
Hey there. Good morning. Thanks for the question. So just stepping back and thinking about private label as a whole we’ve seen remarkable consumer resilience in the face of rising prices across CPG and with price cap versus branded products, largely widening savings, dwindling and seemingly a slowing economy.
It really seems like a perfect storm for a major step change in private label shifts, yet that’s really largely yet to materialize across many categories in retail. I guess could you just share some thoughts on maybe what’s taking so long for many consumers to take that plunge and trade down?
Steve Oakland
Connor, that’s a great question. We do have information, from some of our largest customers. Some of the, the discount retailers that service virtually all private label, their traffic is up dramatically. I think you heard in the Walmart called talked about the trade down in their mix and the new consumers walking into their stores.
So I would suggest that it’s happening. It may not be happening at the pace that it will, but if what we see the continued decline in the economic situation continues we’re convinced it’ll continue to happen. And I can tell you the retail is doing their best to position private label to drive trial, right?
They are forward to merchandising, they’re looking forward to promoting doing those things that they want to do. So we’re working hard with a number of customers. The supply chain is limiting our ability to do that in all cases, but where we can we’re positioning the business to do that. I don’t know if that’s helpful or not, but I think you’re right. I just think it’s going to happen over a little longer period of time.
Operator
Our next question comes from Hale Holden from Barclays. Please go ahead. Your line is open.
Hale Holden
Good morning. Thanks for taking the question. On the seller note from the divested business, I was wondering how long you guys were planning on holding that, or what type of marketing conditions you would look for to potentially monetize that into the market?
Pat O’Donnell
Yeah, this is Pat. It’s difficult to speculate on the state of the leverage loan market. So I don’t know that we can really comment on a timeframe from that perspective, I think, certainly the way that that note is structured and the interest rate that it derives, we’re sort of happy with the cash interest that that provides. And so, we’ll continue to monitor those markets to see what might make sense. But we’re sort of happy with where we sit right now in terms of the structure of that note.
Operator
And this will conclude our question-and-answer session. I would like to turn the conference back over to Steve Oakland for closing remarks.
Steve Oakland
Yes. I’d like to again, thank everybody for being with us today, and we look forward to all the follow up calls we’ll have in the future. So have a great day.
Operator
This concludes today’s conference call.
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