Simply Good Foods Co Q3 FY2022 Earnings Call

Greetings, and welcome to The Simply Good Foods Company Fiscal Third Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It’s now my pleasure to turn the call over to Mark Pogharian, Vice President, Investor Relations. Mark, please go ahead.

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 28, 2022. 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 AM Eastern Time. A copy of the release and accompanying presentation are available under the Investors section of the company's website. This call is being webcast, and an 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 in 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, year-to-date fiscal 2022 adjusted results exclude the mark-to-market effect of the treatment of the company’s private warrants prior to those warrants being fully exercised in January 2022. 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 measures prepared in accordance with GAAP. With that, I'll now turn the call over to Joe Scalzo, President and Chief Executive Officer.

Thank you, Mark. Good morning and thank you for joining us. Today, I'll recap our third quarter results and provide you with some perspective on the performance of our brands. Then, I will turn the call over to Todd, who will discuss our financial results in a bit more detail before we wrap it up with a discussion of our outlook, and answer your questions. In the third quarter, we delivered solid net sales and earnings that were slightly greater than our expectations due to better-than-anticipated retail takeaway and higher customer inventory that was not drawn down as expected during the quarter. Net sales increased 11.5%, including the previously discussed effects of the European exit and Quest frozen pizza licensing agreement. As expected, net price realization was a high single-digit percentage point contribution to net sales growth due to the price increase we implemented in the first quarter of fiscal 2022, and elasticity was relatively in line with our estimates. Third quarter net sales growth in North America, excluding the impact of the frozen pizza licensing transaction, was about 15%, in line with combined measured and unmeasured channel retail takeaway. As expected, gross margin of 37.5% was in line with estimates and sequentially improved versus Q2 gross margin of 36.6%. The 510 basis point decline versus the year-ago period was due to higher supply chain costs partially offset by pricing. Of note, in the year-ago period, gross margin of 42.6% was the highest since we acquired Quest. We have good visibility into our cost structure for the remainder of fiscal 2022, and there is no change to our gross margin outlook. We expect fiscal year 2022 gross margin to decline to about 250 basis points versus the previous fiscal year. Customer service was solid during the quarter as our supply chain team performed well in a very challenging environment. As expected, adjusted EBITDA in the third quarter was $63.3 million versus the year-ago period of $67.5 million, due to the aforementioned gross margin decline. We executed well against our priorities in the quarter and remained committed to do the right things for our brands, customers, and consumers. We're confident in the strength of our business and the diversification of our portfolio across forums, customers, and retail channels that provide us with multiple ways to win in the marketplace and deliver shareholder value. Simply Good Foods retail takeaway and measured channels increased 14.4%, and as has been the case throughout the pandemic, both our brands have outperformed their respective subsegments of weight management and active nutrition. In Q3, the weight management segment declined 4.7%. Atkins outperformed the segment with retail takeaway up 3.4% over the same timeframe. Importantly, Atkins' performance in unmeasured channels is outpacing measured; more on this in a bit. Total Quest retail takeaway and measured channels in Q3 increased 30.6%, and outpaced the active nutrition segment growth of 18.9%. We estimate U.S. retail takeaway in unmeasured channels, primarily the e-commerce and specialty channels, increased about 15% versus last year. As expected, e-commerce growth was more than offset by declines in the specialty channel. Atkins' Q3 U.S. retail takeaway in the IRI MULO and C-store universe increased 3.4%. Shopper trips tended lower in the quarter and were most likely a headwind to overall brand growth in measured channels. Atkins' Q3 retail takeaway on Amazon increased 39%, driven by strong growth in shakes. We estimate total unmeasured channel retail takeaway increased about 22% and is approximately 12% of total Atkins retail sales. Given the strong growth at Amazon, Atkins Q3 retail takeaway in the combined measured and unmeasured channel was up about 6% versus prior year, as fewer shopper trips in brick and mortar were offset by strong e-commerce growth. Atkins' growth in total buyers in the quarter remained strong, up double-digits on a percentage basis versus the year-ago period. However, the buy rate remains mid single-digits below historic levels, and going forward remains an opportunity for the brand. Atkins' third quarter measured channel retail takeaway for our core bar and shake business increased 3.5%, driven by solid shakes growth of 14.1%, partially offset by a decline in bars of 4.2%. Of note, bar consumption has been impacted by fewer at-work consumption occasions, as well as high substitution with Atkins shakes. Atkins' Q3 measured channel retail takeaway of other forms, including confections, cookies, and chips, increased 3.2%. Growth was driven by cookies that continue to do well and contributed about 2.7 points to total Atkins brand measured channel retail takeaway growth. We're excited by the potential of our recently launched Protein Chips. However, performance is too early to read with distribution in early stages of building. Confections POS was off 8.1% in the quarter, as we lapped last year's strong performance related to our dessert bars launch and lower consumer interest in keto confections. Atkins' all other snacks, including confections, cookies, and chips, are about 30% of total Atkins measured channel retail sales. We have a solid pipeline of innovation for the brand that we believe will enable us to provide consumers with new products, variety, and news to drive growth. Let me now turn to Quest, where third quarter retail takeaway increased 30.6% in the measured IRI MULO and C-store universe and outpaced the active nutrition segment. Growth versus the year-ago period was driven by increases in household penetration, strong consumption across all major forms, and success in new products. Quest's core bar business in the quarter measured channel retail takeaway increased 14.1% with solid growth across all major channels. The snackier portion of Quest products, including cookies, confections, and chips, continued to do well, with third quarter measured channel retail takeaway up 65%. Growth was strong across all forms and was driven by increasing household penetration of these forms, distribution gains, and marketing investments to drive growth. We have a solid pipeline of innovation and expect snacks to represent more than 40% of the total Quest measured channel retail sales, and we will continue to generate solid growth over the next year and long-term. We add another solid quarter of performance across all key retail channels, with growth that is similar across all major classes of trade. Quest's third quarter retail takeaway at Amazon increased 23%. As expected, e-commerce growth more than offset declines in the specialty channel, resulting in total third quarter unmeasured retail takeaway of about 12%. We estimate unmeasured channels to represent about 25% of total Quest retail sales. In summary, we're pleased with our third quarter results that were better than we expected. Consistent with our previous estimate, we anticipate low double-digit retail takeaway in the second half of the year, with fourth quarter retail takeaway estimated in the high single-digits on a percentage basis versus last year. We entered the fourth quarter with slightly higher customer inventory levels as we shift ahead of consumption for the fiscal year-to-date period. Therefore, in the fourth quarter, we expect retail takeaway growth to be better than net sales performance as customers adjust inventory to more normal fiscal year-end levels. We have good visibility into our cost structure and our costs are largely covered for the balance of the year. Therefore, there is no change to our fiscal 2022 supply chain cost inflation and gross margin outlook. Implementation of the price increase announced this April is primarily a benefit in fiscal 2023 and is progressing as planned. We're executing against our plans and we believe we're in a position to deliver another year of solid net sales and adjusted EBITDA growth as a path to increasing shareholder value. With that, I'll now turn the call over to Todd to provide you with some greater financial details.

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 11.5% to $316.5 million due to solid retail takeaway in the quarter. North American net sales increased 12.9%, driven by pricing—a high single-digit percentage point benefit in net sales growth. The March agreement to license the Quest frozen pizza business to Bellisio Foods was a 1.8 percentage point headwind to North America net sales growth. As expected, the International Business declined 25.1% due to the Europe Business exit. Core international net sales growth was 8.1%. The combined Europe business exit and Quest Frozen Pizza business licensing transaction resulted in a 2.9 percentage point impact on total company net sales growth. Moving on to other P&L items, gross profit was $118.6 million, a decline of $2.4 million versus the year-ago period. Gross margin was 37.5%, a decrease of 510 basis points versus last year and was in line with our estimates. Supply chain cost inflation in the third quarter of fiscal 2022 was partially offset by the previously discussed price increase implemented at retail in the first quarter of fiscal 2022. Net income in Q3 was $38.8 million versus $5.9 million in the year-ago period. Adjusted EBITDA was $63.3 million versus $67.5 million in the year-ago period. Selling and marketing expense increased 4.9% to $32.3 million driven by higher brand building initiatives on both brands. Note that we now expect marketing expense for the full-year fiscal 2022 to increase in the high single digits on a percentage basis versus last year, versus our previous outlook for a mid- to high single-digit increase. G&A expense excluding integration and restructuring expenses, as well as stock-based compensation increased 2.2% to $23.6 million. Lower costs related to the European business exit were offset by higher corporate expenses. Moving to other items in the P&L, interest expense declined $3.1 million to $4.9 million due to the re-pricing in the second quarter and pay down of the term loan. Our effective tax rate in Q3 was about 23%, slightly lower compared to 27% in year-ago period due to timing of equity compensation. Year-to-date results are as follows: Net sales increased 19.9% to $894.5 million. Gross profit was $343.7 million, an increase of 12.6%. Gross Margin of 38.4% declined 250 basis points versus the year-ago period. Adjusted EBITDA increased 15.3% to $183.1 million due to the higher gross profit and G&A leverage. Selling and marketing expenses increased 15.4% to $94.8 million. The increase was driven by higher marketing investments. G&A expenses increased 3.1% or $2.0 million. This excludes charges of $5.3 million related to integration costs, restructuring expenses, stock-based compensation, and other expenses. Moving to other items in the P&L, interest expense declined $7.8 million to $16.5 million due to the re-pricing and the pay down of the term loan. The year-to-date non-cash charge related to our re-measurement of our private warrant liabilities was $30.1 million versus $60.7 million in the year-ago period. Our year-to-date effective tax rate excluding the charge related to the warrant liability was about 24%. We anticipate the full-year fiscal 2022 tax rates to be in the 25% to 26% range. Net income was $78.4 million versus $22.6 million in the year-ago period. The increase of $55.8 million is largely due to the re-measurement of the private warrant liabilities. According to EPS, third quarter reported EPS was $0.38 per share diluted compared to $0.06 per share diluted for the comparable period of 2021. In fiscal Q3 2022, depreciation amortization expense was $4.8 million and similar to the year-ago period. Stock-based compensation of $3 million increased $0.8 million versus last year, and costs associated with Quest integration were $0.2 million. Adjusted diluted EPS, excluding items was $0.44, an increase of $0.01 versus the year-ago period. Note that we calculate adjusted diluted EPS as adjusted EBITDA plus interest income, interest expense, and income taxes. Year-to-date reported EPS was $0.78. And adjusted diluted EPS was $1.23. 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 year-to-date, net cash provided by operating activities was $67.4 million. This is affected by the timing of tax payments for the full fiscal year in addition to our decision to carry higher levels of inventory to facilitate better customer service levels. As of May 2022, the company has cash of $56.7 million. In Q3, the company repaid $25 million of its term loan, and at the end of the quarter, the outstanding principal balance was $406.5 million, and the trailing 12-month net debt to adjusted EBITDA ratio was 1.5 times. During the third quarter, the company repurchased $8.1 million of its common stock at an average cost of $37.16 per share. On April 13th, this year, the Board of Directors approved a $50 million increase to the existing stock repurchase program. As of May 28, 2022, approximately $69.3 million remained available under the stock repurchase authorization. We anticipate GAAP interest expense to be around $22 million for the full fiscal year including non-cash amortization expense related to the deferred financing fees. Capital expenditures in the third quarter and year-to-date were $0.4 million and $4.7 million, respectively. Full-year CapEx is expected to be about $6 million. I'd now like to turn the call back to Joe for closing remarks.

Thanks, Todd. Our solid year-to-date results position us well to deliver against our full-year targets. Looking at the key metrics of our full-year fiscal 2022 outlook, we expect net sales to increase 14% to 15% versus last year, including a two-percentage point headwind related to the European business exit and the licensing of the Quest frozen pizza business. Our previous guidance for net sales growth was 13% to 15%. There is no change to our gross margin outlook. As we stated earlier, we expect gross margin to decline about 250 basis points versus last year. Adjusted EBITDA is expected to increase slightly less than the net sales growth rate. Marketing is expected to increase in the high single digits on a percentage basis compared to last year, versus our previous outlook for a mid- to high digit increase. Additionally, we anticipate significant G&A leverage. And the decline in interest expense should result in adjusted diluted EPS growing faster than adjusted EBITDA. We are excited about the growth opportunities that exist within our business and our category. Atkins and Quest provide us with two uniquely positioned brands that are aligned around the consumer mega trend of wellness, snacking, convenience, and meal replacement. Consumer feedback indicates that these mega trends will become increasingly more relevant as consumers return to more normal post-pandemic routines. We’re executing against our strategies and increasing household penetration that should continue to drive short and long-term sales and earnings growth. A strong balance sheet and cash flow generation enable us to invest in our business, evaluate M&A opportunities, and to buy back shares of our stock as a path to increasing shareholder value. We appreciate everyone’s interest in our company. And now, we’re available to take your questions.

Thank you. We'll now open the floor for a question-and-answer session. Our first question comes from Chris Growe from Stifel. Your line is now active.

Thank you. Good morning.

Good morning, Chris.

Hi, I just had a quick question if I could for you in relation to the inventory levels. And obviously, this quarter did not show much of a change in the reduction inventory at retail. I guess my question, Joe, just be around your ability to control that. I mean at the end of the day, you have got retailers picking higher levels overall. Is this a matter of discussion kind of negotiations with the retailers? To what degree can you sort of influence that, if you will, here in the fourth quarter?

Yes, maybe a little bit of background will be helpful, Chris, to understand how the category and our business behaves on a typical year. We typically see a first-half inventory build timed around seasonal programming at retail. The amount can vary, but it’s been historically pretty consistent that we add inventory leading up to the kind of January, February, March merchandising. And then, almost immediately after that, we see that inventory start to burn off such that by the time we get to the summer, it’s typically back to pretty normal levels of inventory. So, nothing that we really have to do other than service customers in the build-up in support for the programming. So, it’s a normal cycle that we see in our business. We saw the inventory build mostly in Q2 of this year. We would have expected it to start coming out in Q3, that didn’t happen. We’re starting to see it now in June, and we’re pretty confident it will behave pretty similarly to how it has historically. My guess will be we will see it all out, and we will return to more normal inventory by the end of the summer.

Yes, I’ll just add on, Chris, just to give you a perspective as well. I mean, we typically have four to five weeks of inventory on average with retailers. We are now five to six. So, we’re not talking about a large amount of incremental inventory. We are talking about a week. So, as Joe said, we are starting to see it come out. There is no guarantee that it’s going to get out by the end of the year, but we are pretty confident we will manage through it.

Okay. And just a second question or follow-up in relation to the incremental or increase in marketing you expect now for the year. I guess the simple question is where are you focusing those investments? I've been impressed by the number of Atkins users you have added, but there is a little lower buy rate in this environment. Can the marketing change that consumer behavior? Is that where you are focused the dollars, or where are the dollars kind of going as you look at these incremental investments? I am finished there. Thank you.

Yes. Going to both brands based on return, and I think you hit on the right issue, we’re constantly focused on is marketing driving new consumers to our brands. And that has been a pretty positive story for us this year and throughout COVID. We’ve seen strong consumer interest as we built awareness, consideration, and trial. We felt particularly good about our ability to recruit buyers to our brand. And that’s why we are leaning in as we move through the fourth quarter. Thanks for your questions, Chris.

Thank you.

Thanks. Your next question is coming from Jason English from Goldman Sachs. Your line is live.

Good morning, everyone. I appreciate the opportunity to speak. Joe, regarding your comments on the Endulge and confection businesses, it seems there's a possibility that consumer interest in keto confections is waning. We're observing significant volume declines in both your confection and bars segments, which raises concerns. Are we potentially at the beginning of a downward trend? Is keto losing its appeal?

Let me take a step back. When I look at Atkins, it's important to see the whole picture rather than just focusing on one part of the business. Over the past 18 months, we have successfully increased the number of new buyers for Atkins. The demand for better-for-you snacks, particularly for those concerned about weight, has been strong for our brand, and we've consistently outperformed the category. However, while we are attracting more buyers, the purchase rate has not returned to historic levels. There are two main reasons for this. First, as you've noted, our bar business has experienced a decline because there are fewer snacking opportunities as more people are not working in offices compared to pre-COVID times. This has affected our bar sales the most. Second, since September and October, our confection business has slowed down, and the purchase rate has dropped. There are a couple of factors contributing to this. The first, and likely the most significant, is that we had a very successful dessert bar confection launch a year ago, and now we are comparing against those strong numbers. We generated a lot of customer interest and communication around that, so we're now on the downside of those comparisons. The second factor is that during and slightly before COVID, there was a surge of interest in keto products, particularly in the confection sector. Many new keto products that competitors launched tend to be confection-like. Currently, interest in keto has decreased significantly. This has affected our confection business, but I believe this decline will be temporary. I don’t see this as a long-term trend for the business. If we were losing interest in the brand, we would likely see a decline in buyers, which is not the case; instead, we're experiencing double-digit growth in our buyer base. I'm confident that we will overcome the issues with the purchase rates of bars and confections over time and return to more typical consumption patterns.

Got it. Okay, understood. Thanks. I’ll pass it on.

Right. Thanks, Jason.

Thank you. The next question today is coming from Ben Bienvenu from Stephens. Your line is now live.

Yes, hello. This is Jack Hardin filling in for Ben Bienvenu.

Morning, Jack.

Good morning. One quick question here; what does your product innovation pipeline currently look like?

We typically don’t discuss potential future developments in our business, preferring instead to focus on our past performance. I can confidently say we have a strong new product pipeline. Our recent history shows that much of our innovation is directed towards various snacking options. We view bars and shakes as central to our business. In the Atkins segment, we have a solid bar and shake line, and similarly, Quest has a robust bar offering. This is our core focus, and we consistently innovate in these areas to ensure we provide consumers with new choices and variety. Beyond that, our innovation efforts include strong salty snacks such as tortilla chips and a growing confection business across both brands. We are also developing a cookie business for both brands over time. Expect our pipeline to continue exploring these opportunities while also pursuing other snacking options to encourage more purchasing occasions.

Thanks. Your next question is coming from Alexia Howard from Bernstein. Your line is now live.

Good morning, everyone.

Good morning.

Hi. Can we ask about the gross margin trends from here? It looks as though this might have been the low point with the sort of big decline in the adjusted gross margin. Given your guidance for the full-year, and the fact that it's been down 250 basis points year-to-date, it looks this is sequential improvement next quarter. Is that because more pricing is kicking in? Is that because the cost situation is getting easier? Is it operating leverage? Probably isn't operating leverage because the sales are slowing down next quarter. So, I'm just curious about what's driving that and if we are at an inflection point?

Sure. There are a few factors to consider. First, last year’s gross margin was exceptionally high, marking the peak since we acquired Quest. We experienced a favorable situation last year, as we were able to bring bars back, and most importantly, Q3 was the last quarter without a significant increase in commodity costs. It was in Q4 that we began to see input prices rise. Therefore, Q3 represented the high point, and as we move into this year, we've seen some price adjustments. However, we are also comparing against a very high gross margin, while input costs, particularly ingredient costs, are up more than 20% year-over-year for this quarter. Total supply chain costs have seen a mid-teen increase year-over-year, which reflects the impact of last year's timing. This will be the low point in terms of year-over-year change sequentially. We expect actual gross margin to improve in Q4, and our guidance suggests an increase of around 200 basis points for that quarter.

Great. And then, as a follow-up, can you give us any color on the ingredient cost breakdown? We know that dairy is important for you, but these are big numbers that we're talking about 20% this time around. What is it that's going up so much? Is it mainly dairy? Are there other ingredients that you're exposed to? Is it on the sweetness side as well?

Yes, it's mostly dairy protein complex. So, it's our proteins, whether it's any dairy products, soy, we're seeing significant price increases over the last 12 to 18 months on all protein. So, that is by far the largest driver.

Yes, Alexia, this is Joe. We don't sell sweeteners at all. We're anti-sweetener. So, we're low-carb, low-sugar. So, we have proteins, coatings, and fibers as our main ingredients, and they're all up.

Great, thank you very much. I'll pass it on.

You're welcome.

Thank you. Next question today is coming from John Baumgartner from Mizuho Securities. Your line is now live.

Good morning, thanks for the question.

Good morning, John.

Maybe first off for Joe, coming back to cookies, I mean, you've lapped one year in market, and I'd appreciate your thoughts regarding next steps here. I guess top of mind from me is ACV seems to be leveling off around 50%. How do we think about the manufacturing capacity available to grow the business going forward, new shelf sets, and competitively how are you seeing consumers engage with Atkins relative to some of the other low sugar, sugar-free products in that category?

Yes, so let me kind of unpack your questions. First of all, I think we're still in really early stages when it comes to cookies. So, you mentioned, I think you were referring to Quest, Quest is probably three years into its cookie launch. Conventional cookies were launched, protein cookies were launched about three years ago, we're continuing to build distribution on those. We have frosted cookies that just launched, and I think in the 40s percent ACV on those, still building, and those have so far performed really well in store. Atkins just launched its cookie. So, I would say we're kind of in early innings on cookies with Quest about three years old, but innovating on that platform. And look, I'm pretty optimistic about the format. I think there's a lot of innovation opportunities in that space in both the type of cookies, flavor, sizes, and textures. So, I think you should expect this to continue to innovate there and we're not going to stop distribution pushes until we start getting top items near 70% ACV at retail. So, we're pretty bullish. It's a very, the reason we're excited about it, is it's an incremental consumption occasion to our core bar business and shake business. So, you pick up more. The way to think about it is you can bring more people in from it. But you also can get buy rate because people will eat these at different occasions. So, we're pretty bullish about the segment, and we're bullish about our pipeline of products that's coming. So, we like it.

Great. And then just, I guess more broadly and as a follow-up on the saving of the merchandising and marketing this fiscal year, challenges of the ROI is pretty solid. You're pleased with consumer engagement and buyers based on Chris's question. But taking that further, might there be an argument to be made that the promo window, the larger investments in quality promo, should that extend later into the fiscal year as a normalized approach going forward? I mean, what's been the feedback from retailers as they're thinking about seasonal merchandise into these categories? Does it make sense to extend that out more regularly?

We're already in a great question. Historically, going back seven or eight years, the mindset in our category has been that if you win January, February, and March during resolution season, you win the year. We challenged that idea a long time ago, believing that the seasonality of the business is more influenced by how manufacturers invest their marketing dollars. We began to spread our marketing spending across different times, both in media and customer programming. Now, we have significant programs in January, March, May, and September, making our programming spending more balanced than ever before. This shift has reduced the seasonality of our business. From a media investment perspective, we strongly believe in year-round spending. Instead of focusing solely on January and March, we prefer to maintain on-air presence with consistent support throughout the year. This strategy has proven effective, as both of our businesses are now less dependent on seasonal sales than in the past. This success has been driven by good returns. If you focus on winning in January and March, you end up spending all your budget during that time, and the next marginal dollar spent yields diminishing returns due to all the competition for those funds. Spreading investments throughout the year leads to better returns in other periods. So, we continuously base our strategies on ROI insights. Our key metric for measuring success has been the number of weeks on air at a reasonable spending level, and that’s how we’ve directed our spending for several years based on marketing science. Does that answer your question?

Thanks, yes, absolutely. Thanks, Joe. Very detailed, appreciate it.

All right, yes. Have a good day.

Thank you. Next question is coming from Cody Ross from UBS. Your line is now live.

Hey, good morning, folks. Thanks for taking our question. In the Nielsen scanner data, we can see the price you implemented on a four-week basis. However, volume decelerated, largely driven by outright declines in the last two weeks; can you discuss the underlying demand that you're seeing right now? And then more broadly discuss your outlook for the elasticity of the brands?

We implemented an average price increase of about 7% to 8%. We anticipated a direct correlation with volume, which has played out as expected. For instance, if your business grew by 7% in dollar terms, volume would remain flat, indicating that the growth was entirely driven by pricing. In the case of Atkins, looking at point-of-sale measured channels, we are observing approximately 5% growth. However, volumes have decreased by about 2%, and the remainder of the growth is attributed to pricing. This aligns with our predictions, showing no unusual trends in elasticity; the pricing adjustments are performing as anticipated, and the impact on volume aligns with our expectations.

Yes, I would just follow on to your point. POS and brick and mortar has lightened up a little bit, particularly on Atkins. I would say it's kind of twofold. One is we're just getting category, and we are just getting back to more normalized growth rates in total. Obviously, it was accelerated as we kind of lapped the COVID time period. So, we're kind of getting back to more of a sustainable growth rate. Atkins, we've seen tremendous growth as shopping trips with the impending consumer issues right now, shopper trips are actually down a little bit, they're starting to rebound. We're seeing a big shift particularly on Atkins through e-commerce. You've heard in Joe's comments, our e-commerce business, particularly on Amazon with Atkins has grown significantly over the last couple of months, and we're seeing that continue. So, we're seeing some volume shift from brick and mortar to online. In total, we’re happy with the performance, but yes, there’s between shopper trips and kind of a little bit of a channel shift. There's a bit of an impact.

Right, thank you. And if I can sneak one more in here, there's been a lot of discussion about Quest's ability to effectively compete in the snacks category, and I'll lump in Atkins with that too, without cannibalizing your existing business. We have many examples of brands' failed attempts to jump into adjacent categories. What is different about your strategy with Quest and Atkins that will make you successful in snacks? And what are some investors missing? Thanks.

Well, I think first of all, the track record is pretty good evidence that we can be successful in multiple forms. So, if you look at the Atkins business, about 20% to 25% of its in confections already, so core business bar and shake; we have a really strong confection business already. We ran that playbook on Quest with confections, peanut butter cups, clusters. It’s already a pretty strong business. Quest was, even before our acquisition, well down the path on chips, which has become for Quest a close to $200 million retail business already. So, I'd say that conventional wisdom around ability to innovate, I think is proven to be incorrect on these businesses; part of it is these are lifestyle brands; they stand for something other than just the product that they market. Therefore, in the case of Atkins, it's a nutritional philosophy; in the case of Quest, very similar active lifestyle with a kind of macronutrients philosophy around it to fuel that lifestyle, so those promises enable more than just a single product. As long as you're true to those promises, I think you have the ability to innovate. Now, I would say there are a few executional differences that we believe in. We believe in the strength of the brand and a brand block in the store and owning the aisle we're in. So, you're not going to see us for the most part playing in other people's parts of the store. I think that is difficult to pull off because you don’t have scale. You're not a major player in the aisle. There are people that are and you have difficulty controlling your brand in those other sections of the store. So, I would probably put into an addendum on your belief around innovation in other categories. The addendum would be if you start spreading yourself too thin around the different parts of the store, you can run into issues. Our meal bowl business on Atkins, our pizza business on Quest, we've licensed those products out. We didn't believe we had a competitive advantage in those aisles, and we put those brands in the hands of people that do and we stay focused on our own aisle and continue to focus on having strong brand blocks where we exist. I would just say third, I think the brand promises, the products are really unique and outstanding. If you take a look at our chip business, you're giving people what is a high-carb, really bad-for-you snack and you're giving them a really good-for-you snack, no carbs, high protein and it tastes pretty good. There’s almost not a trade-off. I think we follow that platform, peanut butter cups—what I would challenge you to do is take—do your own comparison with the full-blown, full-sugar peanut butter cup and tell me that you can taste the difference. I think the product matters, right? When we get great innovation that tastes really good that has great macronutrients, we've proven that we can be successful, and you can expect us to continue to do.

Great. Thank you for the detailed explanation. I appreciate it.

Thank you. Our next question today is coming from Steve Powers from Deutsche Bank. Your line is now live.

Hey guys, good morning. Thank you. Maybe more of a higher-level question. I guess, as you work through your planning and scenario modeling, I'm curious how you're balancing thoughts around normalizing mobility trends exiting the pandemic versus the risk of constrained mobility in a recessionary scenario. And I guess, more generally, how do you expect the business to hold up or shift and I can move into e-commerce as economic pressures, potentially or likely build on the consumer over the next six to 12 months?

Yes, we have conducted substantial research on consumer behavior during recessions. Looking back 15 years to the last recession, there is limited data in our category since it was still developing. We are currently assessing how businesses in this category and our brands might react during a recession. Generally, our brands attract consumers from higher socio-economic backgrounds, so we are less focused on lower-income households and more on affluent consumers. Reviewing the previous recession, we've noted that dining out was significantly more affected than grocery shopping. Some pandemic behaviors, like increased home dining, could be favorable for the grocery sector. Additionally, during the last recession, there was a shift in shopping behavior toward fewer stores, with consumers opting for discount retailers more than traditional grocery stores. In terms of snacking, both healthier and indulgent options remained more resilient compared to staple food categories. People tend to seek small indulgences, which are an affordable way to enjoy themselves in tough economic times. During the previous recession, private label brands gained popularity over national brands in center-store categories. This understanding is shaping our approach to the business. We are implementing a second price increase, which will bring us to unprecedented price points while considering the current economic situation. We will be cautious about our expectations for volume growth and instead focus on attracting consumers to our category. There may be a slight decline in purchase frequency, but we will concentrate our marketing efforts on recruiting consumers. We will address any potential impact on purchase frequency as it arises in the coming year. I am concerned, and I believe anyone in the food industry right now should be mindful of the challenges consumers face.

Okay. Thanks for that color. I appreciate it.

I think our portfolio category and our brands are well positioned relative to broad food to ride out there. If there's a recession coming, we're well positioned to ride it out. We have high levels of marketing support. We've got good product innovation, we've got momentum on shelf; I feel pretty good about our hand. Nonetheless, I'm concerned about what we're going to face over the next 12 to 18 months.

Thank you. Next question is coming from Eric Larson from Seaport Research Partners. Your line is now live.

Yes. Thank you for the question. So, two real quick items, number one, I don't think you talked about this metric, Joe, which, which is fairly critical to the Atkins brand, kind of return to work. Kind of the return to work metric and where we sit was that; and I know it's probably continued to improve in the quarter, but you didn't mention anything about that specifically. Where do we sit with that today?

Yes, it's better than it's been; not as good as it needs to be. There are fewer snacking occasions because not everybody's back to full work as they were prior to COVID. We also know that there's high levels—within Atkins, there's high levels of switching between our shakes and our bars, and particularly our meal bar. So, we're seeing strong growth in shakes right now, kind of mid-teens growth. It's been pretty consistent for the last three quarters and I think that's having an impact on our bar business. Our shakes tend to be a slightly different eating occasion, they tend to be more meal replacement than snacking, but they are used for snacking. I suspect we're seeing that; we're seeing some switching to shakes as a format. So, I think that the upside for our business continues to be bars back to full potential. We're paying attention to our ability to recruit new consumers that appears to be exceeding our expectations. I expect the buy rate to come back. I expect us to be starting to grow buy rates again as we move forward. I'm cautiously optimistic about our ability to do that over the next 12 months.

Okay, great. Thanks for that. And I just want to dive in a little bit on Alexia's question again, on gross profits. So, I know you were against a really, really difficult comp in this quarter. Your gross profit dollars were down about $3 million, give or take. I don't have the exact number finally, but I think we're at 121 last year, 118 or so this year. So, when you—and that was maybe a very difficult comp. So, I think I've asked this question in the past, when you put a pricing strategy together, you price to protect, I believe, gross profit percentage margin, which would be a more aggressive strategy than just to protect gross profit dollars. Is that the case? Given the rate of inflation, would you change the way you might price going forward given the inflation is so high?

In the long term, we are very pleased with the shape of our profit and loss statement. We view it as a competitive advantage; if we can achieve gross margins around 40% and allocate 9% to 10% for marketing while maintaining attractive EBITDA margins, we believe we have a strong sustainable model. This is the structure we aim for. Initially, we thought that after our price increase, we would be able to maintain margins closely, as prices were rising quickly. Unfortunately, prices continued to increase, which led us to lower our guidance for the year. I also had to announce another price increase in April, which will start affecting shipments in about a month. Inflation has clearly outpaced most forecasts; our long-term objective is to sustain gross margins and eventually return to 40%. Will that happen next year? Likely not. However, over our strategic planning horizon, we believe we can get back to 40%, and we are committed to doing everything we can to achieve this. Maintaining gross margins is crucial. This quarter was an anomaly, primarily due to the timing of commodity accelerations and last year's coverage, which resulted in a 500 basis point decline year-over-year. I previously mentioned that you can expect a decline of around 200 basis points as we move into Q4. We are navigating unusual times, but long-term gross margin and pricing strategies, along with the efficiencies we aim to achieve in our system, are essential for driving growth in the long run.

Okay, thanks Todd and Joe, I appreciate your comments.

Okay.

Thank you. Next question is coming from John Anderson from William Blair. Your line is now live.

Hi, good morning. Thanks for the questions. A couple of quick ones; one, spending, innovation, and growth, I guess, I'm curious to hear with the core categories and then some of the extensions you've done into the snack, your portions of the portfolio. It seems like you have certain day parts pretty well covered. The breakfast day part perhaps not as much; and so, as you think about innovation, more occasions, helping drive the buy rate, is that something that you think Quest and Atkins can play a role there as well, I mean, in terms of contributing over time? Thanks.

Yes, I like the way you think; you want a job. No, I think, you look, you think about it the same way we do, which is where are occasions today, day part; and then what are the various snacking formats, right? So if you quite simply, we look at all the day parts, what's our development? Where might there be gaps? Core bars tend to be for the most part earlier in the day than later in the day, confections and chips tend to be later in the day, right? That’s you're thinking exactly the right way. And then I would say, if you walked around a grocery store and you looked at all the snacking categories that are low in good things like fiber and protein and high in bad things like carbs and sugars, where we think we can design a product that has no taste trade-off, that provides you a better-for-you experience, you can expect us to be trying to innovate in that space. And if we can get a product that we think consumers think tastes great, then you would expect us to start thinking about trying to innovate there. So yes, we divide the world up; part of it is how do you segment it? And then how do you go innovate against it across all the parts of the day? And then there are other categories that exist where there isn't a low carb, protein-rich proxy in the category that we think we can design a great-tasting product. And I just say, I don't like to talk about future innovation; our pipeline is exciting. We've got a lot of—we have a really talented R&D team, and we've got some fantastic products coming, right? So, stay tuned.

Okay. One quick one, the guidance, full-year guidance, I think implies it might be off on this, but implies a modest sales decline in the fourth quarter, I think on an organic basis, excluding the impact of licensing Quest. Can you just, are we accurate on that and step us through how that could be given the expectations for point-of-sale up high-single-digit in the quarter? And then if you could address the next price increase, it sounds like it goes into effect from a shipment standpoint early August. I don't know if you talked about the magnitude or are willing to talk about the magnitude of that. Thank you.

So, your last question, first, very little impact in this year. This is all about FY '23. So, very small impact to Q4 in the fiscal year for the price increase. Let me just run you through how the math works on Q4. So, at the high end of the guidance, it implies net sales growth of about 1%. So, just illustrative purposes here, regarding the high-single-digit, so if we're at 9% consumption in Q4, you take a point off for the pizza licensing, you're at 8%. We’ve built about $35 million worth of inventory through the first nine months of the year. Some of that was we were a little bit late as we exited the year, but most of it was higher, that extra week of inventory—that's $20 million to $25 million of extra inventory that's in our system right now. That was in the process of coming out. So, that $20 million to $25 million is approximately 7%. That’s how you get, if you've got consumption at 9%, you take a point off for pizza. I mean, you take 7% out for that one week of inventory; you get to the high end of 1%. Now, where are we going to end on inventory? It's always tough to know; we've got some people who can swing it back and forth. We're confident we can manage through it, but it's always a wildcard.

The only thing we would add is we saw a pretty heavy takeout in June. So, it's already underway. So, it looks like it was a little on a little bit of delay. We'll have a full week come out; hard to say, right? But your math is about right. We would expect to under ship consumption in the quarter based upon getting back to more normal inventory levels.

Okay, great. And just the magnitude of the second price increase, I know it's a fiscal 2023 benefit, but generally, we talked about the magnitude of it?

Yes, similar to the first one, on average around 8%.

Great, super helpful. Thanks so much, guys.

Thank you.

Thank you. Our final question today is coming from Pamela Kaufman from Morgan Stanley. Your line is now live.

Hi, good morning.

Good morning.

I just have a follow-up question on the last question on pricing. So, I guess what is your level of confidence around taking an incremental high-single-digit price increase? Has your tenure of your conversations with retailers changed at all over the last couple of months as you look to take more pricing?

We're proceeding as we expected to proceed. We expect the list prices to change, call it end of July, early August. We didn't expect it to be easy, and it isn't easy. How’s that?

Okay, that's helpful. And can you comment on how you're feeling about the current M&A landscape and any opportunities? Thanks.

Yes, happy to do that. I thought we were going to get through a call without an M&A question. So, there's been an adjustment to valuation expectations, and I think that market is paused. So, we're not seeing as much activity. Typically, the pipeline is pretty full; we're constantly looking at things. The pipeline is not so full right now. I think what's happening is with the IPO market kind of having disappeared, there's really not a lot of alternatives for private companies to transact other than to sell. So, I think there's conversations that are going on between sellers and bankers right now, lowering expectations on valuations, and that's kind of stalled things coming to the marketplace. That’d be our read. So, we're less busy than we've been pretty much anytime since we've been public right now.

Yes, I mean, look, we think long-term it's positive. We think valuations, especially for those growth-year assets that may not have the best profitability currently are getting kind of rebased. I think that will create opportunities for us over the next six to 12 months once those prices kind of get into the marketplace. But to Joe's point, I think sellers are trying to figure out what their value really is right now versus where they thought it was 12 months ago, and that's going to take a little bit of time, but long-term we're optimistic it's actually going to be a benefit for us.

Got it. Thanks. That's helpful.

Thank you. We reached the end of our question-and-answer session. I'd like to turn the floor back over for any further closing comments.

Yes, thanks for your participation on today's call. We hope you continue to remain safe and look forward to updating you in our fourth quarter results in October. Hope you all have a good day.

Thank you. That does conclude today's teleconference webcast. You may now disconnect your lines at this time and have a wonderful day. We thank you for your participation today.