Simply Good Foods Co Q3 FY2021 Earnings Call

Greetings and welcome to The Simply Good Foods Company Fiscal Third Quarter 2021 Conference Call. As a reminder, this conference is being recorded. I would now like to turn this conference over to your host, Mr. Mark Pogharian, Vice President of Investor Relations. Thank you, sir. You may begin.

Thank you, operator. Good morning. I am pleased to welcome you to The Simply Good Foods Company Earnings Call for the third quarter ended May 29, 2021. Joe Scalzo, President and Chief Executive Officer; and Todd Cunfer, Chief Financial Officer, will provide you with an overview of results, which will then be followed by a Q&A session. The company issued its earnings release this morning at approximately 7:00 a.m. Eastern. A copy of the release and accompanying presentation are available under the Investors section of the company's website at www.thesimplygoodfoodscompany.com. This call is being webcast, and the archive of today's remarks will also be available. During the course of today's call, management will make forward-looking statements that are subject to various risks and uncertainties that may cause actual results to differ materially. The company undertakes no obligation to update these statements based on subsequent events. A detailed listing of such risks and uncertainties can be found in today's press release and the company's SEC filings. Note that on today's call, we will refer to certain non-GAAP financial measures that we believe will provide useful information for investors. Due to the company's asset-light strong cash flow business model, we evaluate our performance on an adjusted basis as it relates to EBITDA and diluted EPS. Additionally, adjusted results exclude the mark-to-market effect of the treatment of private warrants for the SEC's April 12, 2021, statement related to accounting and reporting considerations for warrants by special purpose acquisition companies. We have included a detailed reconciliation from GAAP to adjusted items in today's press release. We believe these adjusted measures are a key indicator of the underlying performance of the business. The presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today's press release for a reconciliation of the non-GAAP financial measures to the most comparable measure prepared in accordance with GAAP. With that out of the way, I'll now turn it over to Joe Scalzo, President and Chief Executive Officer.

Thank you, Mark. Good morning, and thank you for joining us. Today, I'll recap Simply Good Foods' third quarter results and provide you with some details on the performance of our brands. Then I'll turn the call over to Todd, who will discuss financial results in a bit more detail, and we'll wrap up with a discussion of our revised outlook before opening it up to your questions. We had a strong third quarter with net sales up 32% as consumer mobility improved faster than our expectations. In addition to mobility improvements, shopper traffic within brick-and-mortar retailers improved, especially in the large mass channel, which is an important class of trade for our business and our category. An increasing on-the-go usage occasions resulted in nutrition bar consumption greater than our estimates. Adjusted EBITDA in the third quarter increased 55.6% due to the strong sales growth, general and administrative cost controls, and Quest acquisition synergies. This more than offset higher marketing investments and incentive compensation. An improving bar performance, as well as a favorable consumer mix in the brick-and-mortar channel, resulted in solid gross margin expansion. Total Simply Good Foods Q3 retail takeaway increased 29.1% in the U.S. measured channels of IRI Multi-Outlet and Convenience stores and outpaced the category. Our Atkins and Quest brand performance was solid across all forms, particularly bars, due to increasing consumer mobility. Throughout the pandemic and now into the recovery, we've executed well and remain committed to doing the right things over the long term for our business. In June, we notified customers of a price increase effective in September as we will begin to experience higher raw material and distribution costs in this fourth quarter. As we look to fiscal 2022, we believe pricing, as well as productivity, will enable us to maintain gross margins and continue to invest in initiatives to drive growth. In the first half of fiscal 2021, the nutritional snacking category declined low single digits due to COVID-19-driven movement restrictions. In the third quarter, the nutritional snacking category increased about 26% as the category lapped weaker year-ago performance. Importantly, Simply Good Foods gained market share across all time frames, as did each of our brands in their respective subsegments of weight management and active nutrition. We were also pleased with the performance in the mass channel, which rebounded during the quarter, driven by improved shopper traffic. And e-commerce growth continues to be solid and was in line with total measured channel performance. The active nutrition segment of the category, which includes Quest, increased over 30% in the quarter. As it has done all year, Quest outperformed the segment. Note that the IRI Multi-Outlet and Convenience store universe represents about 70% of Quest's total retail sales. The weight management segment, which includes Atkins, increased low teens in the third quarter on a percentage basis versus the prior year. As has been the case all year, Atkins continued to outpace the weight management segment. Atkins Q3 U.S. retail takeaway in measured channels increased 15.6%. Increasing mobility, improving shopper trips, particularly in the important large mass channel, and continued buyer growth resulted in solid retail takeaway across all forms. In Q3, bars and shakes increased about 5% and 20%, respectively, and improved sequentially versus the first half of the year. Atkins' confection momentum continued and increased about 27% in the quarter. We're pleased with the performance of the confection products as well as the innovation we've launched over the last year. Improving shopper traffic at the mass channel was strong and, combined with increased levels of distribution and display, resulted in Q3 point-of-sale growth of about 25% in this channel. We continue to be pleased by buyer flows on Atkins and growing consumer interest in weight management as the U.S. emerges from COVID-19 mobility restrictions. The strong growth in buyers has fueled consumption improvements for the brand during the fiscal year. Atkins' buy rate remains the single biggest growth opportunity for the brand as it is currently below historic levels. You may recall that Atkins bar consumption is highly correlated to return-to-work. Based on that, we believe as consumer mobility continues to improve, the buy rate of Atkins bars will follow. We anticipate continued improvement in consumer mobility, although, as we enter Q4, the point-of-sale growth rate is affected by more difficult year-ago comparisons. As such, we expect overall Q4 retail sales to be similar to Q3. We expect continued improvement in the mass channel, and I'm pleased with the Atkins e-commerce business, although the growth rate is expected to moderate given strong year-ago comparisons. Lastly, in Q4, we have solid marketing, improved distribution, and new innovation that should enable us to continue to build on our year-to-date buyer trends. Now let me turn to Quest, where Q3 retail takeaway increased 56.2% in the measured IRI Multi-Outlet and Convenience store universe. Growth was driven by improving shopper traffic in the mass channel, an increase in consumer mobility, and greater on-the-go consumption, as evidenced by the strong rebound of Quest bars. Quest Q3 bars retail takeaway increased 38%, more than double the segment growth rate. Recall, Quest bars account for about 60% of total Quest retail sales. The snackier portion of Quest products continues to do well and increased nearly 150% in Q3, driven by chips and the launch of new confection items earlier in the year. In addition to increased foot traffic in the mass channel, we were pleased with the performance in convenience stores. Combined, the mass and convenience store channels represent about 30% of Quest retail sales, and in Q3, growth in these two channels was over 60%. Quest's e-commerce business, which accounts for about 20% of total Quest U.S. retail sales, continues to do well, with retail takeaway up 43%. Our business in Amazon remains robust, and growth was strong against all major forms. The specialty channel, while a small total percent of Quest sales, returned to growth in the quarter. In Q4, we anticipate trends by form will continue and will result in total Quest retail dollar sales similar to the third quarter. We expect that the demand for Quest chips and confection items will remain strong and that supply will be pressured. As such, we have taken actions to ensure there are no disruptions at retail, and we'll be dialing back trade promotions and programming on these items. And we'll continue to invest in marketing and innovation that drives greater levels of consumption and new consumers to our brand. In summary, we're pleased with our third-quarter results that were better than our expectations due to improving mobility and increasing shopper traffic in the mass channel. In Q4, we anticipate retail dollar sales to be similar to Q3. Raw material and distribution inflation is expected to be a headwind in Q4, offset by continued improved product and channel mix. The price increase we announced a few weeks ago, as well as productivity, should offset fiscal 2022 supply chain inflation. We believe pricing as well as productivity will enable us to maintain gross margins and continue to invest in initiatives that drive growth. We're executing well against our plan and delivering on our financial objectives with the flexibility to invest in the business as a path to increasing shareholder value.

Thank you, Joe, and good morning, everyone. I will begin with a review of our net sales. Total Simply Good Foods third quarter net sales increased 32% to $284 million. The core North American business contributed 30.7% to total company growth, driven by strong Atkins and Quest volume across major forms and channels. Net price realization in Q3 was negligible. Q3 shipments benefited by about 2% from delays related to the winter storm disruption at the end of last quarter. Our core international business was a 2.3% benefit to sales growth, driven by strong gains in Australia for both Atkins and Quest. And the SimplyProtein brand divestiture and the European business exit were a combined 0.9% headwind. Gross profit was $121 million, an increase of 36.5% versus last year. Gross margin of 42.6% increased 140 basis points versus the year-ago period, driven by positive product form and favorable customer mix in the brick-and-mortar channel. In Q4, we anticipate supply chain costs to be higher; specifically, raw materials inflation will be a headwind, as well as freight and warehouse expenses as we begin transitioning to our new distribution center. As Joe mentioned, given the inflationary pressure we're seeing in both Q4 and fiscal 2022, we recently announced a price increase. The pricing action is effective in September, and we expect it will enable us to maintain gross margins and continue to invest in initiatives that drive growth. Adjusted EBITDA, which excludes Quest integration costs, restructuring expenses, and stock-based compensation, among some other things, increased 55.6% to $67.5 million, primarily due to greater-than-anticipated sales, cost control measures, and Quest acquisition synergies. SG&A expenses were greater than our estimates. Specifically, selling and working expense increased $6.3 million, driven by incremental brand-building investments on both Atkins and Quest. And G&A expenses increased $1.5 million as higher incentive compensation was partially offset by cost control measures and Quest acquisition synergies. For the full year, the company continues to anticipate that marketing expense related to its core businesses will increase at least in line with organic sales growth. Moving to other items in the P&L. Interest expense declined $0.3 million to $8 million due to the pay down of the term loan, although the additional debt pay down in the quarter resulted in greater noncash amortization expense of deferred financing fees. Our statutory tax rate in the third quarter was 27.0% versus 26.9% last year. Net income in Q3 was $5.9 million versus $48.1 million in the year-ago period. The decline reflects a noncash charge of $35.8 million related to the remeasurement of our private warrant liabilities. Year-to-date results are as follows: net sales increased 25.5% to $745.8 million, driven by the acceleration of the business in the third quarter and the full 39-week impact of the Quest acquisition. Gross profit was $305.3 million, an increase of 29.2%. Gross profit in the prior year was affected by a noncash $7.5 million inventory purchase accounting step-up adjustment related to the Quest acquisition. Recall, the noncash inventory purchase accounting step-up impacted year-to-date 2020 gross margin by 130 basis points. Excluding this amount, gross profit was $243.6 million last year, and gross margin was 41%. Year-to-date fiscal 2021 gross margin of 40.9% is essentially in line with the year-ago period. As I stated earlier, we expect supply chain inflation beginning in Q4 and anticipate gross margin for the quarter to be about the same as prior year. Adjusted EBITDA increased 35.9% to $158.8 million, primarily due to higher Q3 gross profit and the inclusion of 39 weeks of Quest results in the current year. Excluding Quest integration costs, restructuring expenses, and stock-based compensation, SG&A expenses increased $19.8 million. Specifically, selling and marketing expenses increased 18.4% to $82.1 million. The increase was driven by higher brand-building initiatives and the full year impact of Quest. G&A expenses increased about 12% or $7 million due to higher incentive compensation and the inclusion of Quest. Moving to other items in the P&L. The net impact of interest income and interest expense was an increase of $2 million due to the full 9 months of acquisition-related debt. Our year-to-date statutory income tax rate was about 27%. Net income was $22.6 million versus $104.9 million in the year-ago period. The decline of $82.7 million is primarily due to the noncash charge related to the remeasurement of the private warrant liabilities. Turning to EPS. Third-quarter reported EPS was $0.06 per share diluted compared with EPS of $0.17 per share diluted for the comparable period of 2020. In fiscal Q3 2021, we recorded a nonoperating noncash charge of $35.8 million due to the change in the fair value of the outstanding private warrants. Depreciation and amortization expense and stock-based compensation was $6.7 million, about the same as the year-ago period. Costs associated with Quest integration and restructuring were $0.4 million, $5 million lower versus last year. And we had a legal settlement gain of $5 million. Adjusted diluted EPS, which excludes the items just mentioned, was $0.43, an increase of $0.17 versus the year-ago period. Note that we calculated adjusted diluted EPS as adjusted EBITDA less interest income, interest expense, and income taxes. Year-to-date reported EPS was $0.23, while year-to-date adjusted diluted EPS was $0.97 versus $0.71 in the year-ago period. Note that the calculation of adjusted diluted EPS in Q3 and year-to-date period assumes fully diluted shares outstanding of 101.9 million and 101.1 million shares, respectively, versus 97.6 million and 97.2 million under GAAP. The difference versus GAAP is due to the exclusion of the private warrants and fully diluted shares outstanding under GAAP due to the private warrants being classified as a liability on our balance sheet. Please refer to today's press release for an explanation and reconciliation of non-GAAP financial measures. Moving to the balance sheet and cash flow. In May 2021, the company paid down $50 million of its term loan. And at the end of the third quarter, the outstanding balance was $506.5 million. In the third quarter, the company generated about $52 million of cash, resulting in year-to-date cash flow from operations of $91.8 million. As of the end of Q3, the company had cash of $90.2 million, and a trailing 12-month net debt-to-adjusted EBITDA ratio was 2.1x. Capital expenditures for the year-to-date period were $3.2 million. We still expect $5 million to $6 million of CapEx in fiscal 2021, driven primarily by equipment for our new warehouse. We anticipate interest expense to be about $31 million, higher than our previous forecast of about $30 million. The increase is the result of greater noncash amortization expense of deferred financing fees due to incremental paydown of the term loan. I would like to now turn the call back to Joe for closing remarks.

Thanks, Todd. As consumer mobility increased in the third quarter, our business accelerated. As we emerge from the challenges of COVID-19, our business is stronger and our organization is more capable. As such, we remain confident in both our short- and long-term growth prospects. Over the remainder of the year, assuming there are no significant COVID-19-related disruptions in the United States, the company anticipates full-year fiscal 2021 net sales of about $995 million to $1.05 billion and adjusted EBITDA of $200 million to $205 million. As previously stated, the divestiture of SimplyProtein and the European business exit is about a combined 1.5 points headwind to a full-year fiscal 2021 net sales growth. The company's previous outlook for full-year fiscal 2021 net sales and adjusted EBITDA was $930 million to $940 million and $180 million to $185 million, respectively. Apart from the inventory purchase accounting step-up in the year-ago period, we expect full-year fiscal 2021 gross margins to be about the same as fiscal 2020. You may recall the company's previous outlook indicated full-year gross margins would be slightly lower compared to the previous fiscal year. As previously discussed, favorable product and channel mix in Q3 exceeded our expectations and resulted in solid gross margin expansion in the quarter. In Q4, we'll begin to see higher raw material and distribution costs and anticipate gross margins will be down versus Q3 and about the same as year-ago period, as inflation is offset by continued improved product mix. And due to solid cost control and acquisition synergies, the company continues to anticipate adjusted EBITDA margin expansion. Additionally, the company anticipates 2021 adjusted diluted EPS to be in the range of $1.20 to $1.25 versus $0.91 in the prior year. We have an advantaged asset-light, variable business model that enables strong cash flow from operations that provides us with the financial flexibility to invest in organic growth opportunities and participate in M&A. We continue to execute against our strategies to position us to deliver on our financial objectives with the ability to invest in the business as a path to increasing shareholder value over the long term. We appreciate everyone's interest in our company, and we are now available to take your questions.

Our first question comes from Jason English with Goldman Sachs.

Congrats on a strong quarter.

Thanks, Jason.

Welcome. I want to make sure that I understood your comments on the sort of retail sales expectations properly. I think you said quarter-on-quarter, flat as we go into the fourth quarter, which on my quick back-of-the-envelope math suggests that you may be expecting year-on-year growth to slow to something into the mid- to high teens. Do I have it roughly right?

Yes, you do.

Okay. That's still pretty darn robust relative to the comps because I think it actually implies that off of a 2019 level, you're actually going to expect a degree of acceleration from what we saw last quarter. But as I look at the model and the implied guidance for 4Q, you're suggesting a bit of a deceleration on the 2-year stack. I was hoping you could help me understand that, maybe unpack that. Was there a pull forward into this quarter? Clearly, there was a bit of a delta between retail sales or anything else in the comparison from last year that we should make a note of.

Yes. So obviously, Q3, as we stated, Jason, was held by the pull-in from Q2, the winter storms that inflated the Q3 numbers a little bit. The European shutdown is now fully in place. So that's going to affect Q4 more, along with the SimplyProtein divestiture, and that's been tracking about a 1 point headwind. That's now going to be a 3-point headwind in the quarter. And then from a shipment perspective, we just typically pull inventory out of the system late in the year. So we're anticipating that's going to happen again.

I didn't realize the higher SimplyProtein comparison in the fourth quarter, which is useful information. Changing topics briefly, Joe, you hinted at this. With the consumer focus on weight management, Weight Watchers has mentioned their expectations for an upcoming resolution season, which they anticipate will occur over the summer and especially in late fall. Are you starting to see this develop? And do you also expect something similar as we approach fall and the back-to-school, back-to-work time?

First, I would say we’re really pleased with the growth of the Atkins business. The thing that’s, frankly, surprised us throughout the fiscal year is that despite movement restrictions and people not being out about, our buyer performance has been outstanding. So we’ve seen strong buyer growth throughout the fiscal year, even in the midst of COVID. So as we move through the summer and into the fall, I would tend to agree with Weight Watchers. There’s going to be a catalyst as people get out and about more fully that I think will drive renewed interest in weight management. We’re kind of gearing up. Todd mentioned that we’ve made in great marketing investments. We’ll continue to do that through the fourth quarter. And we’re kind of gearing up for kids back to school, folks back to work as kind of that catalytic event. So you should expect us to be ready as we kind of move through August, September, and October, expecting that and investing appropriately for it.

Our next question comes from the line of Chris Growe with Stifel.

I want to congratulate you on a great quarter and your outlook. I have two questions. First, regarding the consumer's return to the Atkins brand, particularly in the mass channel, are you noticing an increase in the number of new users trying the product, or are you seeing more frequent users becoming engaged again? I'm interested in your observations on Atkins as the consumer returns to the mass channel.

It's too early to make a quarterly assessment. We continue to observe strong participation from buyers, including both new and returning customers, which is positive for the brand. In particular, foot traffic in the mass category has noticeably improved. While they are facing softer comparisons, mass is beginning to reclaim market share across both categories. Our developments, especially with Atkins and in the mass channel, have benefited our business. We are currently experiencing various buyer dynamics, although the buy rate remains below historical levels due to fewer occasions than usual. It will be interesting to see how the mass dynamics unfold in the fourth and first quarters and the potential impact on the buy rate moving forward.

Okay. And then I just had a question also on bars. And if I heard right, I think you said maybe the bar category was up 15%. I think you said Atkins was up 5% and sounds like Quest gained share in bars. Just want to make sure I was correct on those numbers, number one. And number two, kind of what's behind those? Like what's driving Quest growth to gain share? And Atkins is a strong new product innovation. What's causing it to lag that category, if that number is correct?

Yes. Atkins is more dependent upon being back at work and being in transit than even we expected. And if you look at Quest, Quest got a few dynamics that are helping it. One, it was down more this time last year, so it’s comparable a little bit easier. Convenience stores rebounded, which is an important component to its business, and we’re even seeing specialty start to come back. Lastly, our sales team has done a really nice job of building distribution in to drug, mass, and bars. So that kind of – that triple threat has really helped accelerate Quest as we’ve kind of moved through the third quarter.

Our next question comes from the line of Faiza Alwy with Deutsche Bank.

Congratulations from me also. First, sorry if I missed this in the prepared remarks, but I was hoping you could give us a breakdown of Atkins versus Quest sales in the quarter?

Yes. You'll find the details in the quarterly report. In terms of sales, Atkins increased by about 15%, while Quest rose approximately 56%. I will follow up with the shipment figures for the candy as I don't have them available right now.

Okay. That's fine. I guess my second question was just as we look ahead to 2022, acknowledging that there's significant uncertainty, I'm curious sort of how you're thinking about the fall resets. You did mention that there is this anticipation that consumers will get back into the weight management category. So I guess I'm wondering, are retailers thinking about it similarly? Do you expect the category to gain incremental shop space? And maybe how are retailers thinking about big brands versus smaller new brands sort of in this new normal?

Let me clarify that. There are many aspects to consider. First, I want to express our confidence in our product pipeline. We have a strong research and development team along with excellent marketers. We believe the pipeline we had in spring and fall is very promising. While we prefer not to make too many forward-looking statements, I anticipate positive outcomes from our resets. Overall, COVID has shown retailers the significance of big brands. During the pandemic, attracting shopper traffic was crucial, and big brands played a vital role. We're observing retailers reengaging with larger brands and recognizing their importance for foot traffic. We happen to have two of the largest brands in our category, putting us in a favorable position with retailers. Additionally, we prioritize consumer focus and aim to increase our brand penetration. This concept resonates well with retailers as they see it as driving shopper conversion throughout the store. As we progress through fiscal '22, I believe we are well-positioned in terms of our brand's presence in the aisle. Regarding your question about the weight management category gaining space, those allocations are generally more stable than anticipated. There tends to be consistency between adult nutrition, active nutrition, and weight management, so shifts in allocation from one reset to another aren't common. Thus, changes within the aisle among these three segments are infrequent. Overall, I feel optimistic about our position as we head into the summer and fall resets.

And Faiza, Atkins was up low 20s percent in the quarter, Quest in the 40s. So strong performance from both brands.

Our next question comes from the line of Wendy Nicholson with Citi.

First question in terms of pricing. Just order of magnitude, is there anything you can tell us in terms of how much pricing you'll take? Is it going to be on both Atkins and Quest? And is there any risk given just how fragmented, particularly the bars category is, do you think there's any risk of sort of elasticity when those prices go into the marketplace?

First, I want to emphasize that we incorporate elasticity into our pricing and inflation calculations. We have a strong grasp of this dynamic. Currently, we are implementing a mid- to upper single-digit price increase for both brands. The percentage differs because inflation affects the brands in varying ways. At this point, we are in the initial phases of discussions with customers. It's important to note that this isn't happening in a vacuum; manufacturers across the industry are adjusting their prices as well. Given the significant changes in inflation as we approach fiscal '22, we are confident that we can successfully navigate this with our customers and implement the price increase by September.

Terrific. And just sort of more broadly, on the Atkins sort of momentum, do you have a sense sort of for the demographics of the new customers that you're bringing into the brand younger? I know you've said it's an issue of mobility. But just in terms of demographics, specifically on Atkins, I'm wondering where you're taking those customers from.

Yes. Over the past year, we've focused on a specific target. Instead of emphasizing demographics, I’ll focus on psychographics. The changes we implemented in Atkins four years ago shifted our focus from rapid weight loss programs, which we estimated attracted about 8 million consumers in the U.S., to low-carb lifestyle weight management consumers, which number around 33 million. The shift shows that our new target audience is generally younger and more active, as they tend to focus less on immediate weight loss and more on healthier living solutions. I haven't received recent demographic breakdowns on our consumer improvements, but we can look into that and follow up with you.

Terrific. That’s great.

Our next question comes from the line of Rob Dickerson with Jefferies.

So Joe, just kind of a follow-up, I guess, on the last comment just in terms of the demographic makeup of that consumer, right, as you kind of chip away the original strategy, right, Simply. Atkins obviously very large brand, working well with retailers. Mass traffic is coming up. Atkins is very well, very large in mass. But as you think about the shelf resets, maybe it's not this fall, maybe it's next fall, are there opportunities you think such that you might be even able to replace some of the shelf you have with Atkins with some of the products from Quest, if Quest potentially seems to maybe be a broader base brand accepted by different types of demographics. Does that make sense?

Yes, Rob. The question makes sense. They tend not to be in the same section or even in the same aisle at times. So, no, we won't be swapping. For us, this isn't about how we allocate space between Atkins and Quest; it's really about how to increase our space in each segment and how we manage that allocation. When considering Atkins and growth, I focus on expanding our product portfolio beyond just bars and shakes. We've discovered during COVID that the occasions for consuming bars are largely tied to on-the-go and workplace situations. Additionally, from our Quest business, we've learned that the snack-sized portions and confections within Atkins are consistently consumed regardless of those factors. Therefore, you can expect us to develop other product forms to represent a larger segment of our portfolio. This approach provides some insulation against the return-to-work dynamics. It's also not surprising that Atkins confections are growing in double digits. Our confection business for Quest is also showing strong early growth, and our chip segment is performing exceptionally well. So, expect us to continue this direction, leveraging what we believe is our competitive advantage: the best R&D organization in the category.

All right. Super. That makes sense. And then I guess just coming back to Jason's original question just on the top line as you go into Q4, and then while I respect you probably don't want to give guidance for fiscal '22, there's some commentary on pricing and gross margin. So kind of take a shot on the sales side. If I look at the data set over the past 4 months, just even week by week, right, total dollar sales have been pretty consistent. It's been very strong, very impressive. If, just like you said on the Atkins piece, more correlated to work mobility, we're still in the summer, some people are going back to work more, but not everybody, not yet. There's not as much critical mass and probably that improves into the fall, while at the same time, as Jason pointed to, like there could be kind of an off-cycle resolution period. So kind of if I'm just thinking about the retail data sets, it seems as if there is still potential upside, obviously, to the guide because it would seem like retail data sets wouldn't necessarily be decelerating that much in the U.S. for ignoring the Europe piece, and then the storm was a couple of percent, but not that much. So I'm just trying to kind of gauge like off the commentary, just to be clear, Q3 very strong, maybe Q4 decelerates a little bit. But if we're all thinking about the first half of next year already, it would seem as if there could be increased momentum on an absolute dollar basis as we're coming out of Q4. Does that make sense?

Yes, it does. There are a few variables to consider. In the fourth quarter, we expect retail volumes to remain similar to previous levels. We are comparing to stronger numbers from a year ago, especially regarding Quest, which makes the comparisons tougher this time. From a shipping standpoint, we tend to reduce inventory in the fourth quarter, which will impact sales. We'll see how things unfold and whether mobility continues to pick up, which remains uncertain. We do not expect that it will. Looking ahead to next year, we are still addressing the price increase, making it a significant variable. We will provide more details about next year's plan in the next earnings call. In broad terms, the first half of next year should be stronger than the second half because we are comparing against a weak first half affected by COVID in this fiscal year. Therefore, the first half should perform relatively well. Our goal is to maintain gross margins despite inflation. Ultimately, we are excited about the momentum of our business and will share more specifics next quarter regarding the upcoming year.

Rob, I also want to point out that we don't expect significant changes in consumer mobility from Q4 to Q3. It appears to be fairly consistent in the U.S. The notable shift occurred in Q3, which changed very rapidly, almost like a switch flipped. I believe things will remain steady. When kids return to school, that may be the key moment for movement. They will be taking buses back to school, and many businesses are planning for a return to office around post-Labor Day. Some of this is already happening, but I anticipate a considerable shift after Labor Day. In fact, I'm quite confident that this will be a turning point for people being out and about.

Okay. Fair enough. And then just quickly, Joe, on the M&A side. I think Todd saw it in the numbers. You mentioned you paid down the term loan, leverage staying a little bit better, good for cash flow, great Q3. So just in terms of kind of how you're thinking about the M&A pipeline, I'm not sure what you're seeing out there with kind of any kind of answer side, just trying to check the box as they do usually on the acquisition front.

Yes. We’re active that there is a pipe. There’s pretty good pipeline. We’re looking at things as we speak. As I said before, we love this category. We’d love to continue to get more scale in the category, and we’ll look at the assets that are in the space. Our screening process is pretty simple. We’re looking for strong consumer brands with unique positioning and some pretty good understanding of who the user base is, so we know how to recruit. I think our competitive advantages are that we can build distribution in food, drug, mass, small format pretty quickly. We understand how to build household penetration, so understanding the consumer dynamic, who that consumer is, what the brand positioning is, we feel like we’re pretty good at that, and we’re pretty good at innovation. So we’re looking where we can use those capabilities to accelerate the growth of assets that are out there. And if there’s an asset out there in our space of a decent size, you can bank on the fact that we’re looking at it.

Our next question comes from the line of Eric Larson with Seaport Research Partners.

Congratulations on the quarter, everyone. My first question is regarding your gross profit margins. I assume you are referring to percentage gross margins. Are you pricing your products higher to protect your dollar gross profit margins and possibly even more than that? To maintain percentage gross margins year-over-year next year, would that require a continued favorable product and channel mix? Is this the correct way to interpret your approach to gross margins?

Yes. To clarify, we are discussing percentages, not dollar amounts. Our aim is to effectively adjust prices in order to maintain our gross margin percentage and counteract significant inflation expected next year. As you noted, we've experienced a positive trend in the second half as bars and brick-and-mortar locations have bounced back. We anticipate seeing more of this in the first half of next year, after which it may stabilize. Our goal is to set prices that will offset the rising input costs we are facing, and to be specific, this is in terms of percentage.

Okay. And then my follow-up question is really on your indulgent brands, i.e., things like peanut butter cup who were very strong, I think, for both Atkins and Quest in the quarter. Are you seeing different buyers for those products? Are they same buyers? And are your buy rates actually better in your indulgent products? Curious as to more of the consumer demographic dynamics on the indulgent line.

I apologize for not having the data broken down by product form. We generally focus on the brand first. However, I can share that the success comes from different usage occasions. For instance, bars and shakes are typically consumed in the afternoon or early morning, serving as snacks or meal replacements. In contrast, the snack items in our portfolio are meant purely for snacking and are indulgent, often enjoyed after dinner. For example, the peanut butter cups and the entire Atkins lineup are consumed during after-dinner occasions. If we were to analyze the data, I wouldn’t expect to find different consumer dynamics; rather, there are just varying usage occasions and needs driving consumer purchases.

Our next question comes from the line of Jon Andersen with William Blair.

Congratulations on the strong quarter. I wanted to ask, you talked a little bit about the success you've had acquiring new buyers, specifically, I think, relative to Atkins, but also the fact that the buy rate continues to kind of lag historical levels given the fact that you haven't fully returned on-the-go, pre-COVID on-the-go use cases. Could you talk a little bit more about the rate of new buyer acquisition and/or how far off the buy rate is today versus historical levels to give us a bit of a sense of the progress and opportunity that those two metrics represent?

Sure. I can provide an overview of how the algorithm functions. In a typical year, first-time buyers on Atkins purchase around 30 to 35 servings. In the second year and afterward, they buy three times that amount. We have many buyers who make purchases multiple times a week and retain them. The volume in any given year is largely influenced by retained buyers. New buyers serve as a reliable indicator of future performance since we retain a portion of them. Regarding our buyer growth this year, the buy rate is quite sensitive to total volume, particularly concerning retained buyers. At 100 servings, even a slight deviation in the buy rate translates to a significant impact on the total servings among retained buyers. This year, nearly all of our growth is attributed to the total number of buyers we have, both retained and new. This increase in buyer numbers has been beneficial for our business, although the buy rate has decreased around mid-single digits percentage-wise. However, we've managed to offset this decline with the rise in the number of buyers, which is encouraging news for Atkins as it suggests a strong buyer flow heading into fiscal '22. If there are improvements in the buy rate, which we anticipate as people return to work and bars improve, and as we enhance our product portfolio, we expect the buy rate to move closer to historical levels. It’s uncertain if that will happen next year, but we are optimistic about ongoing improvements. Does that clarify things?

That's very helpful. I appreciate the detail. I have a quick follow-up. You mentioned supply challenges for Quest in the fourth quarter. Is this just a temporary situation? How do we anticipate that impacting sales in the quarter?

Yes. All right. What I would say is in the chip business as well as the peanut butter cup business, our sales have approached what we would have considered best-case scenario. So supply in this category takes time to kind of build out. So we're in a period of transitory having to manage demand to supply until new supply comes on board. We have a pretty talented sales organization. They really like to sell stuff, but they've got experience in kind of tamping down demand, managing programs and promotions because we've had this situation before, it happened on Atkins. So we know what we need to do. We will do it as we move into fiscal '22. Our supply chain is working hard to bring on more capacity, and we'll manage that well over the next few quarters.

Our last question comes from the line of Pamela Kaufman with Morgan Stanley.

Congrats on the quarter.

Thank you.

So I wanted to understand how we should think about the degree of input cost inflation across the business. And to what extent you hedge your inputs and what that's like, what your hedging position is currently over the next year?

Yes. I'd say we hedge about half of our portfolio. Some of the major commodity inputs, we buy directly. Some of them are just direct pass-through with our co-manufacturers, but I'd say about half of our products where we have an active hedging program, and it's anywhere from 3 to 9 months. Our team did just an incredible job this year buying early, locking in prices before we saw the spike in the last few months. So we've been protected really nicely through the first three quarters. As we mentioned, we're going to start to see some of that come through in Q4 and obviously, a bigger amount next year. So we're going to see mid- to high single-digit inflation for next year. We'll continue to be opportunistic and lock in prices where we see value. But this is why we had to take a price increase of a similar magnitude to maintain those gross margins.

That's helpful. And I was wondering if you can give an update on Quest distribution expansion, and that was one of the rationales behind the acquisition. So just curious on where you are and where you see further opportunity for Quest?

Significant opportunities on Quest. If you think about our Atkins business, food, drug, mass, we're probably somewhere around 40 items in distribution, Quest is probably in half that. And so we're pretty experienced as a selling organization at building those out. As part of our sales team, we've inherited some pretty talented Quest folks, too, who are pretty good at that. So I would expect you're going to continue to see improvements. I think the year-to-date number on Quest is mid-teens approaching 20% distribution gains, and we're still in early innings. And the innovation pipeline is pretty good.

Can you comment on some of the innovation that you have planned for Quest and Atkins and visibility into gaining shelf space for these products?

No, I prefer not to do that. I’ll talk to you about it once it’s in the marketplace and performing.

Ladies and gentlemen, we have reached the end of today's question-and-answer session. I would like to turn this call back over to Mr. Joe Scalzo for closing remarks.

Thanks for your questions, and thanks for your participation on today’s call. We hope you’ll continue to remain safe and look forward to updating you on our fourth quarter results in October. Have a good day.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.