Earnings Call Transcript - SMPL Q1 2022

Operator, Operator

Greetings, and welcome to The Simply Good Foods Company Fiscal First Quarter 2022 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. I would now like to turn the conference over to your host Mr. Mark Pogharian. Thank you. You may begin.

Mark Pogharian, Host

Thank you, operator. Good morning. I am pleased to welcome you to The Simply Good Foods Company earnings call for the first quarter ended November 27, 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 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. 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.

Joe Scalzo, CEO

Thank you, Mark. Good morning and thank you for joining us. Today, I'll recap Simply Good Foods' first quarter results and provide you with some details on the performance of our brands. Then Todd will discuss our financial results in more detail before we wrap it up with a discussion of our outlook and your questions. We had a good start to the fiscal year as our first quarter results continued our strong business momentum. First quarter net sales, gross profit, and adjusted EBITDA all increased double-digits on a percentage basis compared to last year and were slightly better than our expectations. Net sales increased 21.7%, driven primarily by volume. Additionally, we estimate that our September 15 price increase was about a mid-single-digit percentage point benefit to the total net sales growth. Year-over-year net sales growth benefited from improvements in consumer mobility and shopper traffic versus last year's COVID-19 restrictions. This resulted in retail takeaways that were slightly greater than our estimates due to growing household penetration from our marketing investments, improved distribution, and new product innovation. Note that the impact of pricing is expected to contribute more significantly to our growth over the remainder of the year. Total Simply Good Foods' first quarter retail takeaway increased 18.7% in U.S. measured channels of IRI MULO and Convenience Stores. First quarter net sales growth was slightly greater than consumption due to the timing of shipments at the end of last quarter and the typical seasonal inventory build related to distribution gains and New Year's retail programming. Adjusted EBITDA in the first quarter increased 34.7% to $65.6 million, primarily due to the solid sales growth, Quest acquisition synergies, and G&A leverage. This more than offset higher marketing investments. Gross margin increased 70 basis points compared to the year-ago period. As expected, supply chain costs were a headwind, but were more than offset by our price increase and favorable mix. Additionally, we experienced steady improvement in customer service performance during the quarter. As we stated in previous conference calls, we expected supply chain costs to be a significant headwind in fiscal 2022, largely offset by our price increase. However, our supply chain costs over the remainder of the year are now projected to be higher than our previous outlook, driven mostly by ingredient costs. Therefore, the full-year gross margin impact is greater than our prior estimates. That said, we are confident in our strong top-line growth and our ability to manage these higher costs and are increasing our full-year net sales and adjusted EBITDA outlook. We are focused on driving sales and earnings growth and competing effectively while navigating a challenging supply chain environment. We'll continue to execute against our strategies and believe we are well-positioned to deliver on the net sales and earnings growth that we expect to create value for all shareholders while doing the right things over the long term for our business, our customers, and our consumers. Simply Good Foods' retail takeaway in measured channels increased 18.7% in the quarter. Importantly, as has been the case throughout the pandemic, both our brands have outperformed their respective sub-segments of weight management and active nutrition. In the quarter, the Weight Management segment was up 4.4% and Atkins outperformed this segment with retail takeaway up 7.7% over the same period. Total Quest retail takeaway in measured channels in the quarter was up 36.2% and outpaced the Active Nutrition segment growth of 30.3%. Our ecommerce business continues to perform well as POS growth was similar to measured channels, even as we anniversary strong year-ago comparisons. Atkins Q1 U.S. retail takeaway in measured channels increased 7.7%. The year-over-year increase benefited from improvements in consumer mobility and shopper traffic, particularly in the mass channel versus last year's COVID restrictions, as well as continued total buyer growth. In the quarter, consumption of bars increased 3.3% and was in line with recent trends. Bar buy rate remains below historic levels as there is a high correlation of bar consumption to being at work. Atkins shakes in the quarter saw retail takeaway up 12.9% and sequentially improved versus the fourth quarter of last year. Performance was particularly strong in the mass channel, up about 20%. Atkins' other product forms continue to show strong growth; these include confections and cookies as well as the just-launched Atkins Protein Chips. In Q1, Atkins' other retail takeaway increased about 9%, driven by cookies which contributed about 2 percentage points to total Atkins brand retail takeaway growth. Confections were up modestly as we lapped last year's successful dessert bar launch. First quarter POS growth increased across all channels and was particularly strong in mass, up about 10% driven by increased traffic. We are pleased with Atkins ecommerce performance. Amazon, Atkins' second-largest customer, saw Q1 retail takeaway increase in the low teens percentage-wise compared to the year-ago period. Total Atkins ecommerce POS growth in the quarter was similar to measured channels. Atkins' growth of total buyers remains strong. Buy rate remains mid-single-digits below historic levels due to the high correlation between consumption of bars in the workplace. Therefore, the improvement in Atkins buy rate remains an opportunity for the brand. Let me now turn to Quest, where first quarter retail takeaway increased 36.2% in the measured IRI MULO C-store universe and outpaced the Active Nutrition segment. Growth versus the year-ago period was driven by the increase in household penetration, improving shopper traffic, and rebound in bars and success of new product forms. Quest bars' first quarter retail takeaway in measured channel increased 22.8%. Recall Quest bars are nearly 60% of total Quest measured channel retail sales. The snackier portion of Quest products, about 40% of U.S. retail sales, continued to perform well and increased 106% in the quarter, driven by strong performance of chips, cookies, and confections. We continue to see robust demand for chips and are on track for incremental supply to come online as the year progresses. We had another good quarter of growth across all key retail channels. Increased foot traffic in the mass channel and convenience stores remained solid. Q1 POS growth in these channels were up about 50% and 40%, respectively. Quest ecommerce takeaway increased about 22% versus last year. As expected, due to strong performance in the year-ago period, the growth rate moderated somewhat. Our business at Amazon remained strong, and growth was solid across all major forms. In summary, we're pleased with our first quarter results that were better than what we expected. That said, retail takeaway growth in the first half of the year will be stronger than in the second half as comparables become significantly more challenging. We have a good balance of innovation as well as consumer and customer programming in place that we believe will drive solid retail takeaway and net sales growth throughout the year. Our customer service levels have improved during the quarter, and we are approaching more normal performance. We expect that supply chain costs will be a significant headwind during the fiscal year. Pricing and cost-saving initiatives are in place to mitigate the impact of inflation. However, as I mentioned earlier, supply chain costs remain high, and we now expect them to linger at elevated levels throughout this fiscal year and into fiscal 2023. Therefore, we are updating our previous view and expect total fiscal year 2022 gross margins to decline about 250 basis points versus last year. We believe our gross margin and overhead cost structure offer us the ability to invest in the future growth of our brands and organization. As we assess the impact of lingering supply chain cost inflation over the balance of this fiscal year and into fiscal 2023, we will consider all options available to us to protect our cost structure, including further pricing action. As we move into Q2, we expect retail takeaway growth to be similar to Q1. That said, we remain cautious about consumer seasonal participation and return-to-work trends due to the recent surge in COVID-19 cases from the Omicron variant. We're executing well against our plans, and we believe we are in a position to deliver another year of solid net sales and adjusted EBITDA growth as a path to increasing shareholder value. I'll now turn the call over to Todd, who'll provide you with some greater financial details. I'll then end our prepared remarks with details and assumptions related to our revised outlook.

Todd Cunfer, CFO

Thank you, Joe and good morning everyone. I will begin with a review of our net sales. Total Simply Good Foods' first quarter net sales increased 21.7% to $281 million. North American net sales increased 24.5% and was primarily driven by volume. As Joe stated, due to the timing and implementation of the previously announced price increase, we estimate pricing was a mid-single-digit percentage point benefit to total net sales growth. Therefore pricing will be a greater contribution to sales growth over the remainder of the year. The International business declined 27.3% due to the European business exit. Core International net sales growth was 3% and the European business exit was a 1.6 percentage point headwind to total company sales growth. Moving on to other P&L items, gross profit was $116.6 million, an increase of 23.9%. Gross Margin of 41.4% increased 70 basis points compared to the year-ago period. As expected, supply chain cost inflation was a headwind this quarter. However, it was more than offset by the previously mentioned price increase, lower trade promotion, favorable product and customer channel mix, and carryover coverage of select raw materials. As Joe mentioned, we anticipate significant supply chain inflation in fiscal 2022 due to higher costs related to raw materials, packaging, and logistics. Pricing and cost-saving programs are in place to help offset these costs. Adjusted EBITDA increased 34.7% to $65.6 million due to the higher sales and G&A leverage. Selling and marketing expense increased 21.2% to $30.5 million driven by higher brand-building initiatives on both brands. Due to a large ramp-up of marketing expense in the second half of fiscal 2021, the majority of the increase in the fiscal 2022 marketing accrual will occur in the first half of the year. G&A expense, excluding Quest integration cost, restructuring expenses, stock-based compensation, and other costs were about the same as the year-ago period. Higher incentive compensation was offset by lower corporate expense and integration synergies. We anticipate solid G&A leverage this year and expect leverage will be greater in the second half of the year due to the timing of when we began to accrue incentive compensation in fiscal 2021. Moving to other items in the P&L, interest expense declined $2 million to $6.4 million due to the paydown of the term loan. In the first quarter of fiscal 2022, the noncash charge related to the re-measurement of our private warrant liabilities was $17.3 million. In the year-ago period, we recorded a noncash $20.5 million gain related to the warrants. Our statutory tax rate in Q1, excluding the charge related to the warrant liability, was about 25%. We continue to anticipate that our full-year tax rate will be approximately 27%. Net income in Q1 was $21.2 million versus $43 million in the year-ago period. Turning to EPS, the first-quarter reported EPS was $0.22 per share diluted compared to $0.23 per share diluted for the comparable period of 2021. In addition to the previously mentioned warrant liability impact, depreciation and amortization expense was $4.7 million and similar to the year-ago period. Stock-based compensation of $2.6 million increased $1.5 million versus last year, and cost associated with Quest integration and restructuring was $0.1 million versus $3.8 million last year. Adjusted diluted EPS, which excludes these items, was $0.43, an increase of $0.14 versus the year-ago period. Note that we calculate adjusted diluted EPS as adjusted EBITDA, less interest income, interest expense, and income taxes. Additionally, the calculation of adjusted diluted EPS in Q1 assumed fully diluted shares outstanding of 102.5 million versus 97.9 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 November 2021, the company paid down $25 million of its term loan, and at the end of the first quarter, the outstanding principal balance was $431.5 million. In the first quarter, the net cash used in operating activities was $7.3 million. Note that this was affected by the timing of working capital, tax payments, and an increase in incentive compensation payments versus the prior year. The company continues to anticipate full-year fiscal 2022 cash flow from operations will be greater than last year. As of November 27, 2021, the company had cash of $35.4 million, and the trailing 12 months net debt to adjusted EBITDA ratio was 1.8 times. Capital expenditures in the first quarter were $2.7 million. Full year CapEx is expected to be about $5 million to $6 million. We anticipate GAAP interest expense to be about $25 million, including non-cash amortization expense related to the deferred financing fees. I would now like to turn the call back to Joe for closing remarks.

Joe Scalzo, CEO

Thanks, Todd. Our strong first quarter results are a good start to the year. Retail takeaway trends remain solid and we have marketing, customer programming, and new product plans in place to continue to drive growth. This gives us confidence to increase our full-year net sales and adjusted EBITDA outlook versus our previous estimate. Note that our forecast does not assume any meaningful changes in workplace mobility. Looking at the key metrics of our updated full-year fiscal 2022 outlook, we expect net sales to increase 12% to 14% versus last year, and this includes a 1 percentage point headwind related to the European business exit. As I stated earlier, higher supply chain costs versus our previous outlook, driven mostly by ingredients, remains a headwind in 2022 and will result in full-year gross margin contraction of about 250 basis points with the biggest impact in the second and third quarter. Adjusted EBITDA is anticipated to increase slightly less than the net sales growth rate. We continue to expect that marketing expense will increase versus last year, although at a lower rate than the net sales increase. Additionally, we anticipate benefiting from significant SG&A leverage. The decline in interest expense should result in an increase of adjusted diluted EPS greater than the adjusted EBITDA growth rate. We anticipate the net sales growth in the first half of the year will be stronger than the second half as the year-over-year comparisons are significantly more difficult as we proceed through the year. Additionally, we expect our retail takeaway growth rate in the second quarter of fiscal 2022 to be similar to the first quarter and due to higher costs, we expect Q2 adjusted EBITDA growth will be less than the net sales growth rate. We're excited about the growth opportunities that exist within our business in this category. We're executing against our strategies, and the increasing household penetration that is resulting in solid sales and earnings growth. Our strong balance sheet and cash flow generation enable us to invest in our business and evaluate M&A opportunities as a path to increasing shareholder value. We appreciate everyone's interest in our company and we're now available to take your questions.

Operator, Operator

Thank you. Our first question comes from the line of Chris Growe with Stifel. Please proceed with your question.

Chris Growe, Analyst

Hi, good morning, guys.

Joe Scalzo, CEO

Good morning, Chris.

Todd Cunfer, CFO

Good morning, Chris.

Chris Growe, Analyst

Good morning. I just had a question for you on this particular, a popular topic on many companies' calls, but inflation just seems to keep going and you took pricing and as a result, it's not totally offsetting the cost inflation, at least there's maybe some gross margin effect from that. I wonder if you could give me or if you could talk about the level of inflation you now expect? And then I guess, we're not looking for forward prospects here for pricing, but just in a world where you look to utilize the gross margin to reinvest back in the business, are you limited in that regard this year because of the gross margin outlook here for the business now?

Todd Cunfer, CFO

Yes, so I'll take that one, Chris. So first of all, just to be clear, we are very comfortable with our ability to navigate the P&L, even with this incremental supply chain cost. As you've heard, we raised both our top and bottom line guidance, and we feel terrific about that. Regarding levels of inflation, going into the year, we were seeing significant inflation. The inflation we were seeing was probably high single digits; it's now increased to low double digits for our total business. So that's – that's the new outlook for commodity costs, so it is significant. We love the shape of our P&L. We love our ability to invest in our business. You can count on us to increase marketing this year. It may not be at the same level of growth rate that we've done in the previous years. As you know, we've increased marketing substantially well ahead of net sales over the last several years. So we're close to 10% of net sales from a marketing investment, which we feel great about. We'll increase it. It may not be at the level and the growth rate we've done in the past, but you can expect us to continue to invest in our business.

Chris Growe, Analyst

And just to be clear on that Todd, do you have better visibility on those input costs? Should you have more coverage, I guess is the question that would allow you to have the comfort in that?

Todd Cunfer, CFO

Yes. And so we're about 75% covered for this year, so we do have a little bit of exposure, a little bit of risk to the rest of the year. But again, we do have levers in our P&L to manage that. We're very, very comfortable. And obviously, if this thing continues to linger, we will not hesitate to take some additional pricing action.

Chris Growe, Analyst

I have a quick follow-up on the Atkins brand. It seems the buy rate has remained mostly the same, but there are just more buyers. Was there any measurable change in that from the fourth quarter?

Joe Scalzo, CEO

We are still experiencing strong interest in the brand, as indicated by the increasing number of buyers. This growth in buyers continues. However, the number of snacking occasions for Atkins bars is being negatively affected by people not returning to work. The positive aspect is that our non-shake, non-bar business is performing very well. These consumption occasions are less dependent on being at work, and they are helping to compensate for the reduced buy rate.

Chris Growe, Analyst

Okay, thanks so much for your time.

Operator, Operator

Thank you. Our next question comes from the line of Jason English with Goldman Sachs. Please proceed with your question.

Jason English, Analyst

Hey, good morning folks. A couple of quick questions. First, quick back of the envelope math, it looks like you're cutting your gross profit forecast for the full year by around 2%. A, is this correct? And B, with EBITDA actually moving higher in context of gross profit and being lower, where are the offsets?

Todd Cunfer, CFO

Yes, so I think your math is generally correct. So first of all, we have significant G&A leverage in our P&L. The good news is when you're taking the volume up, not only do you get obviously incremental profits on the volume, but from a percentage basis, from a margin perspective, you get a nice kicker at the EBITDA margin line with G&A flat to growing very modestly for the year. And then as I talked about with Chris Growe’s question, look, we're going to increase marketing. We have the ability to toggle that back as, depending on where we see the gross margin come in, it will be an increase this year, but we're still at a very healthy level of marketing. So we have the ability to have some more modest increases in marketing if necessary.

Jason English, Analyst

So to put a finer point on your answer Todd, it sounds like you're planning to spend less marketing than you initially planned coming into the year. Did I hear that correctly?

Todd Cunfer, CFO

Probably a little bit, depending on how the year plays out. Yes, our initial guidance when we were having 8% to 10% net sales growth was for that to be basically in line, so implying kind of a high single-digit growth initially, it's probably going to be a bit lower than that.

Jason English, Analyst

Got it. You sounded very confident about your gross margin outlook last year, and now just a few months later, it seems like you are increasing your ingredient forecast by around 15% for the full year. From our perspective, the spot markets seem to be fluctuating slightly but mostly staying the same. What has really surprised you? What has changed so significantly in the last three months?

Joe Scalzo, CEO

It’s Joe. Our original view of the marketplace was that it would not stay at the sustained high levels that we were experiencing as we moved into the year. And our view of it now is that it looks like it's going to linger longer than what we expected. So it's not a matter of costs are going up. They're just not abating as what we expected. And frankly, that view is a pretty recent one. So we're just starting the process of stepping back and saying, okay, this is going to linger a while. In our prepared comments, we mentioned kind of the second half of the year, we expect them to linger into the next fiscal year. What are our options and what are we going to do about it? We've been pretty clear with the market from the very beginning. We think the shape of our P&L is a competitive advantage. Gross margins over 40%, marketing investment around 10%, EBITDA as a percent of sales around 20%. Right? So if these costs seem to be lingering, you can expect us to act to maintain our margin structure.

Jason English, Analyst

Got it. Understood, and congrats on the strong momentum by the way, I'll pass it on. Thank you.

Joe Scalzo, CEO

Thank you, Jason.

Operator, Operator

Thank you. Our next question comes from the line of Wendy Nicholson with Citi. Please proceed with your question.

Wendy Nicholson, Analyst

Hi, my first question is just on the supply chain. In terms of your availability on the labor side, in terms of the work you have with the co-manufacturers, are you seeing any challenges? I know you talked about strength in the Atkins shake business. Obviously, that's off a very low base because it's a new product, but can you talk about bars versus shakes if you're seeing any specific challenges in getting product in the door?

Joe Scalzo, CEO

Yes, Wendy, that's a good question. As we mentioned in our prepared comments, our performance improved during the quarter. We fell short of our expectations for customer service, and it wasn't due to a single issue. We faced various challenges across the supply chain, from accessing customers' docks to securing products and ingredients from co-manufacturers. It felt like we were constantly addressing different supply chain issues. However, our supply chain team did an excellent job in the first quarter, tackling those challenges and enhancing our customer service. By the end of the first quarter, we were nearing our expected level of customer service performance. Are we completely past the supply chain difficulties? Not yet; I expect that we will continue to face daily challenges, and things are still not running smoothly. Nevertheless, our team has demonstrated the ability to navigate these issues, and we are quite confident moving forward.

Wendy Nicholson, Analyst

And on the Atkins shake business, obviously, protein shakes are a great category rapidly growing, but also very competitive. The Atkins brand obviously speaks for itself in terms of brand recognition, but just can you remind us kind of how is that positioned and how do you intend to carve out a niche in what is a very crowded category right now?

Joe Scalzo, CEO

Yes, so let me dispel that it's a category; it is not. So very unusually in this nutrition category, you've got products and forms that don't compete with each other. Let me give you the simplest example: Ensure and Boost, high protein, low carbs and sugar, source interact very little with Atkins and Premier protein because the consumer benefit is fundamentally different. Consumer targets are different, consumer benefits are different. So if you try to group anything that's a shake, that's high protein, low carbs, and low sugar together, you're actually making a mistake about how to think about the category. I think what's happening is, because people are home more, shakes are or they're more usage occasions of those shakes across the consumer targets and across the consumer benefits; I think you're seeing that. Second, if you can supply the product, you're getting preferential treatment among retailers. If you can service it, you can get display, and keep your shelf stock. We've not had issues with our shake business, and we're benefiting a little bit from that. But again, there's not a lot of interaction. It's very unusual. You've got identical products that do not interact with each other because their consumer targets and benefits are so fundamentally different.

Wendy Nicholson, Analyst

Fair enough. And then my last question was just one of the comments you made at the very beginning was about the shipments outpacing inventory a little bit in anticipation of sort of normal inventory build and New Year's promotions. But I guess my question is just in the first, you know, whatever, two weeks of the year with Omicron and whatnot, are you seeing any delay in purchases, people going back to the stores? I'm just wondering if there's that inventory build means there's going to be excess inventory on store shelves for some time to come.

Joe Scalzo, CEO

Yes, I think our prepared comments, to be clear, prepared comments had two factors in that first, we ended last year at a lower trade inventory level than what we would have expected. It had to do with our ability to flow products to customers, both on the customer side and our side. So we had some makeup to do in the quarter. And then second, you rightfully pointed out, the build-up for merchandising at retail in New Year's, really too early to call New Year's consumption yet right. So we haven't gotten that kind of first complete week of January from a POS standpoint. So it's hard to tell exactly what the consumer off-take is going to be in New Year's.

Wendy Nicholson, Analyst

Fair enough. Thanks.

Todd Cunfer, CFO

Thank you, Wendy.

Wendy Nicholson, Analyst

Yes.

Operator, Operator

Thank you. Our next question comes from the line of Kaumil Gajrawala with Credit Suisse. Please proceed with your question.

Kaumil Gajrawala, Analyst

Hi, guys. Good morning. If I can follow up a little bit on the supply chain commentary you just made, do you have a sense or an idea on the impact it might have had on overall top line, or was it as simple as just the customer service wasn't where you wanted it to be?

Joe Scalzo, CEO

First quarter, again, ability to service the customer impacts your revenue when you are out of stock, right? So if you miss a sale because somebody comes into a store and you're out of stock, that's the challenge of the business. We had out of stocks in the first quarter. So we saw those as the quarter progressed steadily get better. So obviously, we're a little bit more optimistic. Our service is better, out of stocks are being reduced, and the ability to flow product to the shelf is smoother than it was as we went into the quarter. That's all good news.

Kaumil Gajrawala, Analyst

Okay, great. And then, to talk a little bit more on household penetration in the context of market share, you benefited from mobility, but you've benefited from a lot of brand momentum recently, as well. Since you're in so many categories, it's a little difficult for us from the outside to get a good sense on where the share trends look. I would anticipate they're up nicely. But if you could give any more context or color on where you sit in terms of share in the context of how you look at your brands?

Joe Scalzo, CEO

Yes, so we may be it would be helpful, sounds like you may be sub-segmenting the brands by form. It will be our strong recommendation that you look at sub-segments of weight management for Atkins, regardless of form. And on Quest, regardless of form active nutrition, which would include brands like Premier Protein, to name a few. Right? So in both of those segments, Atkins has outperformed the weight management segment, and Quest has outperformed the active nutrition segment, and that's what we track. There's so much interaction within our brands within the forms. It is more accurate to take a brand view, therefore a brand consumer benefit view than it is trying to sub-segment chips, and cookies, and shakes, and bars; because the brand will interact so much within those, you get a false read of what's really going on.

Kaumil Gajrawala, Analyst

Useful. Thank you.

Operator, Operator

Thank you. Our next question comes from the line of Alexia Howard with Bernstein. Please proceed with your question.

Alexia Howard, Analyst

Good morning, everyone.

Joe Scalzo, CEO

Good morning.

Todd Cunfer, CFO

Hi, Alexia.

Alexia Howard, Analyst

Hi, so this going into this year, I know we're entering the second quarter for you guys now, but the level of uncertainty is unprecedented, just given the pandemic, given the input cost inflation and all the other moving pieces, supply chain disruption and so on. If you had to rank order from here, what the key sort of uncertainties are in terms of risks and opportunities, given the changing guidance that we've just seen from you, how would you rank order the things that you don't know or that you don't have visibility into from here? Thank you, and I have a follow up.

Joe Scalzo, CEO

That's a great question, Alexia. What concerns me most? Well, first, any changes in consumer mobility and shopping behavior are a big concern. At the beginning of the pandemic, we saw significant volatility in consumption. Initially, spending surged, followed by a decline, and shopper traffic decreased, altering the mix of channels. When considering risks to the business, the impact of the Omicron variant on shopping behaviors and mobility is crucial—are people out shopping, or is life somewhat back to normal in this post-COVID landscape? Second, we implemented a price increase on September 15, but it won't really affect shelves until early November since retailers don’t adjust prices immediately. Therefore, we lack data on how this price change impacts volume, which is a risk for the second half of the year. Third, we are continuously addressing supply chain challenges. Our team has managed these well, but they face new issues daily, disrupting a usually steady flow of operations. Customer service has improved significantly, but behind the scenes, a lot of effort goes into maintaining this smooth appearance. Regarding costs, prices have remained fairly stable, but the question now is how long this situation will persist and how we plan to respond. I'm less worried about the price itself since it seems to have leveled off; the fundamental issue is how long it will last and our strategy for moving forward.

Alexia Howard, Analyst

Makes perfect sense, thanks, and thank you so much. Just a real quick follow up. You mentioned favorable mix in the press release this morning. What is that attributable to and how long is it likely to continue?

Todd Cunfer, CFO

During the peak of COVID, both brands experienced significant challenges in the bar business. However, as consumer behavior is returning to a more normal state, the bar business, especially for Quest, has shown a strong recovery. Customers are now enjoying a better balance between physical stores and online shopping. The convenience store sector for Quest has performed exceptionally well in recent months, which is a positive development for our overall product mix.

Alexia Howard, Analyst

Perfect, thank you so much. I'll pass it on.

Operator, Operator

Thank you. Our next question comes from the line of Rob Dickerson with Jefferies. Please proceed with your question.

Rob Dickerson, Analyst

Great, thanks so much. First, quick question, just the top line guide obviously implies deceleration year-over-year relative to Q1, and then realize that second half would likely grow more slowly than the first half, just in terms of Q2. Joe, I guess, and Todd too just given your comments, it sounds like you have hedged a bit, so to speak in terms of some elasticity risk for Q2, and then also there's the implied kind of roll off of the inventory build benefits. So I'm just curious, as we say, Q2 year-over-year top line relative to Q1, is there any kind of expectation for an increase in pricing given the timing and the pricing you've already implemented? And then two, on the volume side is there anything in there that could decelerate a bit outside of just the inventory built benefits you got in Q1? Thanks. I have a quick follow-up.

Todd Cunfer, CFO

Yes, we saw point of sale growth in the first quarter, with total consumption in the range of 18% to 19%, which we are very pleased about. We believe this will be similar in Q2. We shipped a bit more than what was consumed since we were replenishing inventory affected by the summer period. Our outlook is for point of sale consumption to remain consistent. There is always some uncertainty about inventory levels at the end of the quarter, but we feel comfortable with a consumption rate in the high teens to around 20%. The exact net sales figures will depend on shipment levels, which can fluctuate by a couple of points, but we expect the point of sale to remain very stable. Looking ahead to the second half, we faced a 1% to 2% growth in the first half of last year, while we grew 25% in the second half, making the comparatives more challenging. Additionally, as noted in the previous question, there are factors affecting pricing flexibility and consumer movement. Therefore, we may be taking a more cautious approach in our assumptions for the second half, given the tougher comparisons.

Joe Scalzo, CEO

Yes, the thing is, I think it's a little deceptive is, second half growth rate starts to step down relative to the first half. We're really confident in our ability to grow the top line; the absolute dollar sales are a manifestation of the year-ago comparison to the second half year, not our ability to grow the business. We're very confident in that, and we feel like we've got the products, the marketing, the programming at retail to continue to drive strong dollar sales. So we're very confident in that.

Rob Dickerson, Analyst

Fair enough. And then just quickly on the incremental pricing commentary, it would seem as if just kind of given the timing of your fiscal year, if you were to implement incremental pricing at retail and just given kind of the lag of announcement relative to when it hits the shelf, it would seem like that could be maybe kind of a late fiscal 2022 event if needed, but probably higher probability that kind of rolls into 2023, is that fair?

Joe Scalzo, CEO

When you, maybe this will be helpful, Rob. When you make the decision, the price takes you three or four months to execute it with customers. So the minute you pull the trigger, it's three to four months before you can execute, and then from a retailer standpoint, another few months for them to reflect it at shelf, so there's a delay to that. And again, as I mentioned in one of the previous questions, our view of the lingering cost is a recent one, so we're just starting to evaluate our options right now.

Rob Dickerson, Analyst

Got it. All right, great. Thanks a lot.

Joe Scalzo, CEO

Thanks, Rob.

Operator, Operator

Thank you. Our next question comes from line of Ben Bienvenu with Stephens Inc. Please proceed with your question.

Ben Bienvenu, Analyst

Hi, thanks. Good morning. I want to follow up on the revenue side of the equation. You talked about among the potential risks outside of your control, one of which being consumer ability. When you think about your ability to mitigate those risks, thinking about innovation as a growth driver and your ability to price, how comfortable do you feel in terms of the elements that are within your control to help mitigate any risk associated with external factors that are out of your control?

Todd Cunfer, CFO

Yes, great question. I think two, there are two risks that people lock up at home or don't want to go into stores. Right? Those are the two risks, I think. So when they lock up at home, their snacking occasions change, right? So for us, probably the single biggest mitigator has been the growth in all other forms. What I mean by that is on both brands we have a bar business and a shake business, which I think is the center of the fairway core business for us. Right? And as we've noted in our commentary with Atkins, bars especially for Atkins highly correlate to being at work and being in transit. The nice thing that we've learned as we've launched into cookies, chips, and confections is they don't correlate to location at all. So our ability to grow those is a nice hedge against the risks that we see in consumption on bars if people would kind of go back to staying at home and not going out. The second factor is shopping behavior. If you remember the earliest, I mean, it's been two years but if you remember the earliest behaviors, people stopped shopping and limited the number of retail outlets they were going to. Best hedge there has been ecommerce business; the major brick and mortar retailers have accelerated their ecommerce business, both ordering online and having it delivered as well as pickup and delivery. So they combined with Amazon is a natural hedge to people shopping behavior and retail doors changing. So we feel like, yes, there's a risk out there. Probably going to be transient, but we've had some natural hedges to offset those challenges, still keeps me up at night though.

Ben Bienvenu, Analyst

Okay, that's great, thanks. My second question is a follow up on cost. You talked about, I think 75% of your exposure is covered. Could you discuss is that uniform across the year or would it be that the nature of that be that you're fully covered for the next several quarters and more exposed for maybe the fourth quarter? And then within that coverage, where are the buckets of leases versus most coverage?

Joe Scalzo, CEO

Yes, we'd rather not get into that level of specificity. There are, to answer your question broadly, there are some commodities where we are covered for the entire year. There are some commodities, and some more minor ingredients where we might be only covered for 50% to 60% of the year, so it's not uniform. But again, I don't want to get, for competitive reasons I don’t want to get into specifics. But 75% of the year, there's not a huge difference between the commodities, but there are some commodities that we are fully covered on.

Ben Bienvenu, Analyst

Okay, fair enough. Thanks so much, and best of luck with the rest of the year.

Todd Cunfer, CFO

Thank you.

Operator, Operator

Thank you. Our next question comes from line of Steve Powers with Deutsche Bank. Please proceed with your question.

Steve Powers, Analyst

Yes. Hey, thanks. Good morning, guys.

Joe Scalzo, CEO

Good morning.

Todd Cunfer, CFO

Hi, Steve.

Steve Powers, Analyst

I guess, as you think about the cadence of fiscal 2022 from a gross margin perspective, I guess I'm trying to get a better feel for your anticipated exit rate on gross margin into 2023. It seems like there's a sure hit to come versus prior expectations in the next couple of quarters. But I guess I'm less clear where your guidance and current forecasts have you exiting 2022 versus three months ago, and where you want to be because, as you said earlier, that 40% plus gross margin is a big part of your P&L advantage. So as we step away from that the next couple of quarters, I guess, how much progress can we expect to make back towards that ambition by year end?

Todd Cunfer, CFO

Yes, so as we mentioned earlier, we're going to obviously start to see the hit pretty significant here, hit here in Q2. Q3 will be the toughest comp for us, not only from a 2022 cost perspective, but if you remember Q3 last year, we just had a blowout gross margin expansion; just kind of everything was clicking 140 basis points of gross margin expansion even despite a pretty difficult environment. So that's going to be a tough lap. We saw costs start to rise in Q4 of last year a bit, still had gross margin expansion. So again, we are not completely covered for the year and obviously, a lot of things can change in the next six to nine months. But we should start to see gross margin degradation be a little bit less severe as we go into Q4. It really depends on where commodities are for the end of the year, it really depends on whether we take any very specific actions. But it should be better in Q4. And if it's, as we've said several times here on the call, if things are not where we want it to be, you can be rest assured we will take some action that will either start to impact Q4 or more importantly impact 2023.

Steve Powers, Analyst

Yes, okay. But I guess from a, just a, what's embedded in your outlook, I guess the year-over-year dynamics because of the comps, but sequentially are you going to take a big step down in 2Q and then kind of go sideways for the next three quarters, or do you expect to see sequential improvement in gross margin given the levers?

Todd Cunfer, CFO

Yes, it will depend on how everything unfolds. As we move into the third and fourth quarters, the gross margins will be relatively similar on an absolute basis year-over-year. There will be some changes, as mentioned, but the absolute gross margins are expected to remain fairly consistent in the third and fourth quarters.

Steve Powers, Analyst

Okay, fair enough. And I guess if I could just totally different topic, give us any comments on the M&A landscape in terms of opportunities crossing your desk, as well as any change in your appetite to entertain deals, just given the uncertainty you're facing, we've been talking about for the last, almost hour?

Joe Scalzo, CEO

It's a pretty busy environment with a lot of opportunity and as we've stated on a number of occasions, sellers have frothy expectations and buyers need to be aware. So we continue to evaluate complementary brands to our portfolio, and we like to think of ourselves as value buyers. So we're looking for assets of decent size, given the size of our portfolio, the number of brands and the size of those brands. We need to understand the consumer promise as part of that, have a pretty good understanding of who the consumer target is, and our ability to more effectively market that brand to that consumer target in order to grow it. We have supply chain synergies, and a strong selling organization that we could add a brand to the bag too and accelerate. But for the most part, you're looking for strong consumer brands that are complementary to our portfolio today. Those are out there, and you just continue to have to chase them to see if you can get a business at a decent value.

Steve Powers, Analyst

I appreciate it, Joe. Thanks a lot.

Joe Scalzo, CEO

All right. Have a good day.

Operator, Operator

Thank you. Our next question comes from line of Pamela Kaufman with Morgan Stanley. Please proceed with your question.

Pamela Kaufman, Analyst

Hi, good morning.

Todd Cunfer, CFO

Good morning.

Pamela Kaufman, Analyst

I know that it's a very dynamic environment, but I was curious if you're observing any changes in demand from the recent renewed rise in COVID cases? And would you expect any short-term headwinds from changes in consumer mobility? And what, if anything, have you factored into your outlook from Omicron?

Joe Scalzo, CEO

Yes, we've not, first, in our prepared remarks, we've not factored any changes, either positive or negative, from a demand standpoint. So our view is, it remains where it is. Omicron has been a recent phenomenon. If you think about it last month, it was in South Africa; now it's 95% of the cases in the United States. So it's a little too early to call. We're not seeing dramatic foot traffic changes. We're not seeing dramatic changes in consumption behavior or apparently movement, but you have to keep your eyes open; this thing is pretty dynamic and pretty volatile.

Pamela Kaufman, Analyst

Okay. And then I have a broader question on Quest. Quest has seen very strong growth over the last several years. How are you thinking about the midterm growth rates for the brand, and what do you see as the key drivers? How much would you expect to come from increasing household penetration versus distribution expansion and innovation?

Joe Scalzo, CEO

Yes, well, let me define it. Let me tell you how we think about it, and then it might give you some insights, right? So for us, the key metric from a marketing standpoint is household penetration. All the other factors are derivative factors to help that. So share of voice of marketing, whitespace from a distribution standpoint, product innovation, all accelerate our ability to drive household penetration. So the Quest brand has benefited in the last year or so from two big factors. Factor number one has been the bar business has started to recover from COVID confinement and, in particular, channel has helped that sentiment; we have a big C-store business, small format business. That team has done a phenomenal job at kick-starting, as foot traffic has improved, they are kick-starting the bar business for Quest. You're seeing a rebound in bars, which is 60% of the Quest business. So that's been a big factor for us. The second is kind of all other forms, what we call the snackier portion of the Quest portfolio, have done extremely well, with the exception of our RTD business for Quest; all of the snackier portion of the portfolio has done extremely well. Cookies continue to grow; chips, we've been supply constrained; the demand has been so strong; confections have done extremely well. Those have driven oversized growth rates in the business. I think collectively in our prepared remarks up 100% year-on-year. You're not going to law of large numbers will eventually affect the growth rate. But we would expect Quest to continue to outperform the sub-segment of the category, the active nutrition category that they're in on a sustainable basis.

Pamela Kaufman, Analyst

Thank you. And then just a quick question on pricing. So pricing was a mid-single-digit benefit in the quarter, but you indicated that it should continue to build over the course of the year. So how should we think about the magnitude of contribution from pricing over the remainder of the year?

Todd Cunfer, CFO

Yes, we took a price increase that averaged about 7.5% to 8%, and because of the timing of the price increase, we didn't get the full benefit in Q1, only around 5%, 6%. So we'll get an extra two points from pricing now; that's the good news. The question is, what's the impact on volume and elasticity, but from a pure pricing perspective, we will get an extra two points for the remainder of the year.

Pamela Kaufman, Analyst

Thank you. That's helpful.

Operator, Operator

Thank you. Our next question comes from line of Eric Larson with Seaport Global Securities. Please proceed with your question.

Eric Larson, Analyst

Yes. Thanks, guys, and congrats on a good quarter. So Joe, I just want to dial back to the kind of the category growth. This whole nutrition category, you folks in your sub-segments are outperforming your peers, but in the first quarter, and maybe this is just a timing issue and what happened a year ago, and maybe these numbers really aren't all that important from one quarter perspective, but what segments of the nutritional snacking category are actually growing faster than you? And maybe it's not sub-segments, maybe it's what value proposition segments are growing faster and are they sustainable? How are you looking at the total category?

Joe Scalzo, CEO

Yes, you hit it right on the nose. We don't compete, and we see the category in three pieces: active nutrition with Quest, Premier protein, a number of brands, weight management with Atkins, and then we see nutritious bars like CLIF and KIND as the third segment. That category is experiencing right now, against very easy comparables, strong growth. So it is along with active nutrition, outperforming weight management on a year-over-year basis. That will moderate as the comparables get more challenging, right? So bars really got slammed in COVID. So the nutritious bar segment is comping some easy comps. They'll get difficult as you move through the year. We're comfortable overall; if you look at the total category, we're comfortable we can outperform the total category in any one quarter or half year given what's been going on in COVID. You may see some segments outperform some other segments. But over the long term, we're pretty comfortable in our ability to outperform the total category.

Eric Larson, Analyst

Yes, got it. So it's just a comp issue and it's just a lot of noise in the quarter, and that will kind of work its way out over the next two to three or four quarters. So thanks, Joe. I appreciate the comments.

Joe Scalzo, CEO

You're welcome. Looking into your stacks right now is a very useful exercise. You drive yourself crazy with your ego.

Operator, Operator

Thank you, ladies and gentlemen, this concludes our time allowed for questions. I'll now turn the floor back to Mr. Scalzo for any final comments.

Joe Scalzo, CEO

Yes, thanks for your participation on today's call and the terrific questions. We hope you continue to remain safe, and we look forward to updating you on our second quarter results in April. Have a good day.

Operator, Operator

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.