Earnings Call
Utz Brands, Inc. (UTZ)
Earnings Call Transcript - UTZ Q3 2022
Operator, Operator
Good morning, and welcome to Utz Brands Third Quarter 2022 Earnings Conference Call. All parties are in a listen-only mode. After the presentation, we will have a question-and-answer session. As a reminder, this conference call is being recorded. I would now like to turn the call over to Kevin Powers, Head of Investor Relations. Please go ahead, Mr. Powers.
Kevin Powers, Head of Investor Relations
Good morning, and thank you for joining us today. On the call today are Dylan Lissette, Chief Executive Officer; Ajay Kataria, Chief Financial Officer; and Cary Devore, Chief Operating Officer. Dylan and Ajay will make prepared comments this morning, and all three will be available to answer questions during a live Q&A session. Please note that some of our comments today will contain forward-looking statements based on our current view of our business, and actual future results may differ materially. Please see our recent SEC filings, which identify the principal risks and uncertainties that could affect future performance. Before I turn the call over to Dylan, I just have a few housekeeping items to review. Today, we will discuss certain adjusted or non-GAAP financial measures, which are described in more detail in this morning's earnings materials. Reconciliations of non-GAAP financial measures and other associated disclosures are contained in our earnings materials and posted on our website. Finally, the company has also prepared presentation slides and additional supplemental financial information, which are posted on our Investor Relations website. And now I'd like to turn the call over to Dylan.
Dylan Lissette, CEO
Thank you, Kevin, and good morning, everyone. I'm pleased to report that our momentum continued in the quarter, and we again delivered results that were ahead of our expectations. Consumer demand remains robust for our brands and our products, driving record third quarter net sales. We have found that during both times of recession and when times are good, consumers reach for fun and indulgent snacks that they feel come at a modest price point, and our products are well positioned for continued success in a perpetually growing category. Furthermore, in line with our seasonality, both adjusted gross margins and adjusted EBITDA margins improved sequentially. In addition, we are successfully managing inflation as the combination of our revenue management actions and our productivity initiatives are now fully offsetting high inflation. These actions are providing the fuel to ramp up continued investments in our people, our brands, our selling infrastructure and our planning capabilities. For example, we are increasing our working media spend compared to last year as well as elevated merchandising and point-of-purchase support and spend. Given the close to 250-plus DSD routes that we have added year-to-date, we are investing in growing our selling organization, which includes people and new distribution centers, for example, to support our growth long-term. And finally, we have been increasing strength behind our planning capabilities to include investments in our people and processes to support our integrated business management initiatives and revenue management programs to ultimately provide a strong foundation for continued future growth, efficiency and capabilities. We believe these collective efforts will drive value for our retail partners and best position us to capitalize on our white space opportunities and drive consistent organic growth. Bringing this all together and based on our performance year-to-date, our current business momentum and what we're seeing currently regarding limited price elasticities, we are, once again, raising our net sales and adjusted EBITDA outlook for the full-year. Our cost visibility and forecasting capabilities continue to improve, and I'm incredibly proud of our team's execution against the expectations we put in place at the beginning of the year. Briefly touching on our third quarter financial results, total net sales grew approximately 16%, which reflects our strong organic growth of 12.6% as well as the contribution benefit from our acquisitions of 4.7%. I'm impressed with these results as we continue to drive strong net sales growth even as we continue to simplify our portfolio. Turning to our retail consumption trends in the quarter. For the 13-week period, our positive sales results continued, with our third consecutive quarter of double-digit retail consumption growth and we increased retail sales 17.2%. And, as we expected, our retail sales growth in the 13-week period slightly lagged the overall salty snack category. As noted in our second quarter earnings call, certain subcategories were impacted by the lapping of strong promotional features in the mass channel in the prior year and as expected, some of these timing dynamics continued into the third quarter. That being said, even as we lapped very strong growth in the prior year, our Power Brands continued the strong momentum in the quarter with growth of 17.4%, six of our nine Power Brands delivered double-digit growth. And to just highlight a few, our flagship, Utz Brands, which is about 52% of sales, grew more than 22%, Zapp's grew 29%, and ON THE BORDER grew about 12%. In addition, our Foundation brands had a very strong 16-plus percent growth rate in the quarter. In short, a very strong showing across our brands. Turning to our growth drivers in the quarter by subcategory. We delivered double-digit growth in retail sales across our three major subcategories of potato chips, tortilla chips and pretzels, which represent about 75% of our retail sales. In addition, we once again drove share gains in our largest and most important subcategory, potato chips, with robust growth of nearly 30%, led by strength across the grocery, mass and C-store channels. Important to note, in tortillas, our ON THE BORDER brand delivered over 50% growth in the last quarter in the grocery channel. This is a channel that the OTB brand has historically been underweight in, and we are excited to see these strong results in this important channel as the brand benefits from our route-to-market into this channel prove out. Salsa in Queso, a subcategory for us that is currently approaching $100 million in annualized retail sales, also continued to significantly outperform, once again, with growth of 22% and 65%, respectively. And as I mentioned earlier, our overall sales were impacted by the lapping of very strong promotional features in the mass channel in the prior year. This is most pronounced in our tortilla chips and cheese subcategories, whose sales are more heavily weighted towards the mass channel. I will also note that pork rinds, which only represent about 5% of our retail sales, is something that our team is actively working to address the supply chain opportunities to unlock their full potential. And as we ramp pork production capabilities in our Kings Mountain facility, you will see that this new and modern facility should significantly help to address these supply chain opportunities. In the quarter, we also continue to make great progress driving geographic expansion, while also continuing to improve our execution in our core markets. We delivered double-digit retail sales growth across all of those geographies. In our core, which represents over 60% of our retail sales, retail sales increased over 18%, with our flagship, Utz Brands up 20%; ON THE BORDER tortilla chips up nearly 30%; and Zapp's up 22%. Beyond the core, we continued our momentum with double-digit sales increases in both emerging and expansion. In our emerging geography, which is our second largest geographic area, sales increased a robust 20.6%, with our Utz Brands growing over 34% even as we lap significant above-market growth of 23% in the prior year. And consistent with the earlier context, we shared related to our tortilla chips sales performance against the overall category, and given the weighting of ON THE BORDER brand in our expansion geographies and lapping strong promotional features in the mass channel in the prior year, this impacted sales growth in the quarter in expansion. Importantly, our flagship, Utz Brands, continues to show that its brand strength travels across the United States and was again, up nearly 30% in the expansion geography, and similar to the emerging geography, was building on the prior year's growth of 21%. Also, in the developing Better-For-You segment of salty snacks, we thought it was important to share that our retail sales in the natural channel increased by over 19% in the third quarter, significantly outpacing category growth of approximately 10%. Our main BFY, or Better-For-You brands in the natural channel are Boulder Canyon and Good Health, and we now have the #3 ranking in the salty snack category in terms of retail sales in the natural channel as measured by Spins. The Boulder Canyon brand also continues to deliver record sales in the traditional MULO-C IRI reporting as well. Finally, I wanted to take a few minutes to reflect on the momentum we've been building over the past few years as we mature as a public company. We have been on an impressive growth journey, marked by rapid expansion in our scale, geographic reach and our portfolio of brands and products. Since going public in August of 2020, our team has worked incredibly hard in the midst of challenging times, COVID-19 lockdown, supply chain disruptions, historically high inflation with a laser focus on doing what's right for our customers and doing what's right for our business for both the short term and also, most importantly, the long term. Over two years ago, we entered the public markets so that we could create an even stronger national platform of snacking brands that would be able to delight customers across the United States. I believe we've been executing very well across these strategies since going public, with strong progress across several areas. Just to name a few, since 2019, we have increased annual retail sales from about $970 million to over $1.55 billion, our market share has gone from 3.8% to 4.6%, and we've improved our salty snack category ranking from the fourth largest brand platform in the U.S. to now the third largest. In addition, we have improved our share in major channels that we had set out to focus on, moving from #4 to #3 in mass and from #3 to #2 in pub. We've also expanded into key subcategories, like tortilla chips, where we essentially had no share in 2019, and now we're up to almost 4% of share, driven by the acquisition of the ON THE BORDER brand, which is approaching $300 million in annual retail sales over the last 52 weeks. Finally, we've grown our Utz Buyers or households from $48 million to $63 million, and we have continued to expand our DSD network from about 1,650 routes to over 2,100 routes today, all the while converting from RSP to IO, moving from about 77% independent operator or IO in 2019 to about 91% independent operator today. All of these results are a true testament to our brand strength and to the incredible talents of our collective team of over 3,000 Utz associates that are dedicated to delivering on so many fronts to our continued success. Bringing it all together, I'm incredibly confident that the foundation we've built over the past few years has Utz uniquely positioned to continue to succeed for generations to come. So looking ahead, I've never been more excited about our growth opportunities as our business turns the corner after a challenging period. Utz has never been stronger, our growth opportunities continue to be multifaceted, and our management team is succeeding across so many fronts. To that end, we have strong growth momentum in the resilient and growing salty snack category, we are continuing to make investments to support our significant white space growth opportunities, our margins are recovering as revenue management and productivity are now fully offsetting inflation, and our recent acquisitions are enabling increased scale of manufacturing capabilities to efficiently support our strong demand. And finally, before I turn the call over to Ajay, I just want to make a few additional comments about our CEO transition that is currently underway. As we announced in early October, I am incredibly excited to pass the baton to Howard Friedman as our new CEO in mid-December. Having led some of our country's most iconic brands, and with his established track record of profitable growth, I believe Howard is the ideal leader to leverage our momentum and take Utz to the next level. For me, personally, I'm looking forward to my transition to Executive Chairman and then eventually Chairman of the Board as I will remain very actively involved in the company, helping to guide the company in various areas of importance from corporate governance to business strategy. Over the coming months, I will continue to work closely with Howard, our management team, and our Board to help ensure a smooth transition and to maintain the continuity of Utz's heritage and forward growth momentum. With that, I'd now like to turn the call over to Ajay Kataria, our CFO. Ajay?
Ajay Kataria, CFO
Thank you, Dylan, and good morning, everyone. I would like to begin by congratulating Dylan for successfully leading the company over the last decade as CEO to our current position of strength and beginning the transition to Chairman of the Board. I am looking forward to welcoming Howard to Utz in December. And along with the rest of the management team and associates, I am excited to build upon this year's strong growth momentum. I would also like to congratulate all of our associates across the company for delivering another record quarter of net sales performance, along with continued sequential improvement to margins and year-over-year profit growth. Thank you, team. Now I will review a high-level summary of our third quarter financial performance, and then we will discuss our net sales and margin drivers. Our third quarter 2022 net sales were ahead of our expectations and increased 16% to $362.8 million. Adjusted gross margins expanded 79 basis points to 36.5%, and this includes an approximate 130 basis points of negative impact from our IO conversions. Our adjusted EBITDA increased by 6.5% to $47.7 million or 13.1% of sales, which was a sequential improvement of 100 basis points relative to our second quarter 2022 results. Adjusted net income was $22.5 million compared to $26.1 million last year. Our adjusted net income reflects good operating performance, offset by higher net interest expense due to higher interest rates and incremental debt and also higher core depreciation expense, as we have added new manufacturing assets through several acquisitions in the last 12 months. Moving to the P&L for some additional detail, starting with net sales. Our net sales growth in the quarter was 16%, driven by organic growth of 12.6%, acquisitions-related growth of 4.7% and an impact from conversion of RSP routes to IOs, which reduced the net sales growth by 1.3%. Our organic net sales growth of 12.6% was driven by price/mix of 14.7% and lower volumes by 2.1%. Both pricing and volume performance were better than our expectations as we continue to execute our planned pricing actions to offset inflation and experienced lower-than-anticipated price elasticities. As we had anticipated, volume was proactively impacted by approximately 300 to 400 basis points due to our strategic SKU rationalization activities that are meant to simplify our portfolio, optimize mix, and increase focus on our Power Brands. In addition, as we expected and referenced in our second quarter earnings discussion, we are also lapping strong promotional features in the mass channel in the prior year that temporarily impacted volume growth. In the third quarter, adjusted EBITDA increased 6.5% and margins were 13.1% of sales. Decomposing the change in the adjusted EBITDA margin for the quarter, positive drivers include price/mix benefit of 14.7% as we continue to take pricing actions to offset inflation and productivity improvement of 200 basis points. Offsetting these drivers were unfavorable margin impact of 14.3%, driven by higher inflation, including transportation costs and selling and administrative expense of 350 basis points. Our inflation impact versus last year was comprised primarily of elevated labor and transportation costs as well as higher commodity input costs. Selling and administrative expense, which excludes distribution expense, increased primarily due to higher accruals for incentive compensation, commensurate with fiscal 2022 performance lapping softer performance last year. In addition, as Dylan described earlier, we continue to increase our investments in our people, brands, selling infrastructure and planning capabilities to support our growth. Importantly, our third quarter margin performance was consistent with our value creation strategies and reflects the execution of our playbook. Just to highlight a few, we are proactively optimizing our revenue mix and rationalizing less productive and lower-margin SKUs and we have eliminated more than 350 SKUs, with a primary focus on private label and certain partner brands. These actions free up capacity in our plants and distribution network, which will help us to service higher-margin Power Brand business over time. We are further developing our price pack architecture programs and optimizing our trade spend, leveraging improved technology, talent and analytical capabilities. We are delivering our expected M&A cost synergies from our recent acquisitions since going public. And importantly, all of these acquisitions are now fully integrated into our new ERP systems. This is an important building block for our ability to operate our business using a common platform, which gives us better visibility to drive future portfolio synergies and scale. We are ramping up production at our new Kings Mountain facility, with our first pork production occurring in the third quarter of 2022 and kettle chip production planned for the second half of next year. Importantly, Kings Mountain will increase capacity for certain key subcategories that have been more recently affected by certain supply constraints. Finally, we are executing our productivity programs focused on manufacturing efficiencies, including logistics and network optimization, packaging design work and product formulations. We are on track to deliver productivity of approximately 3% of this year as a percent of COGS, which is helping to offset gross inflation. More importantly, our talent and capabilities have improved significantly in this area. I am incredibly proud of our execution this year during a challenging environment, and we expect these programs will continue to build momentum into fiscal 2023 and beyond. Now turning to cash flow and balance sheet. Beginning with cash flow, we generated stronger cash flow from operations in the third quarter of $34.4 million, which brings our year-to-date cash flow up to $8.1 million. Of note, as we had previously discussed, our cash flow this year has been impacted by the $23 million of buyouts of multiple third-party DSD distribution rights in the first quarter of the year that were treated as contract terminations and booked as an expense in adherence to GAAP. In addition, our working capital performance improved in the third quarter, consistent with normal seasonality, and we expect this to continue and to be a source of cash in the fourth quarter. Year-to-date, capital expenditures were $68.7 million. As a reminder, in April, we announced and closed the transaction of our Kings Mountain facility. In accordance with GAAP, the $38.4 million purchase cost of this facility was recorded on our statement of cash flows as a capital expenditure and not as an acquisition. Excluding the purchase of the Kings Mountain facility, capital expenditures would be $30.3 million. Moving to the balance sheet. Net debt at quarter end was $870.2 million or 5x normalized adjusted EBITDA of $175.6 million. In addition, after the end of the third quarter and as we previously announced, we entered into a new real estate senior secured term loan of $88 million, maturing in 2032. Importantly, this loan has an effective fixed rate of 6% via an interest rate swap. Amid a rising interest rate environment, this real estate term loan puts in place a low fixed rate instrument that increases our financial flexibility as we continue to expand distribution and generate strong organic growth. Proceeds from this strategic financing were used to pay down in full the outstanding amount under our revolving credit facility, with excess cash going to the balance sheet. Pro forma for this transaction, as of October 12, our liquidity significantly increased to approximately $215 million as compared to $138 million as of fiscal third quarter ending October 2. And now about 70% of our long-term debt is fixed at approximately 4.6%. Also, just as a reminder, we have no significant maturities on our debt until 2028. And our credit structure is comprised of covenant-light debt instruments. We have no maintenance covenants on our term loan B, which provides significant EBITDA headroom, while we work on reducing leverage. Now turning to our full-year outlook for fiscal 2022. Given our stronger-than-expected year-to-date performance, continued strong consumer demand and better-than-expected price elasticity, we are again raising our net sales and adjusted EBITDA outlook. We now expect total net sales growth of 17% to 19% and organic net sales growth of 13% to 15%. As we have better visibility into price elasticity impact, given our third quarter results, our net sales growth outlook now assumes fourth quarter volume performance to be similar to our third quarter results, and fourth quarter price to deliver more than 12% in price/mix benefit. Our volume outlook assumes continued incremental and strategic SKU rationalization in the fourth quarter, as we optimize our portfolio with an enhanced focus on prioritizing production and distribution of branded products to unlock additional capacity for our growing Power Brands. Given our stronger net sales outlook, unchanged assumption for gross input cost inflation and the building benefits from pricing and productivity, we are again raising our adjusted EBITDA growth outlook from a growth of 2% to 5% to a range of $166 million to $170 million. This raised outlook translates to a year-over-year growth of approximately 6% to 9%. As a reminder, in line with typical seasonality, we expect fourth quarter margins to be lower than third quarter margins. We continue to expect gross input cost inflation, inclusive of raw materials, labor, fuel and freight, to be a mid- to high-teens percent increase versus the prior year. In response to these rising costs, we have been implementing inflation-justified pricing actions, and you have been seeing these build in our sales results as we implemented new actions in February and May of this year and more selective actions were executed in October. Given better-than-expected revenue management actions to date, we now expect to deliver low double-digit price/mix this year to help cover our inflation expectations. In addition, we now estimate capital expenditures of approximately $40 million versus our previous expectation of $50 million. The lower spend this year is largely due to the timing of certain projects, which we now expect to occur in fiscal 2023. As a reminder, our CapEx guidance excludes the purchase price of the Kings Mountain facility. In addition, we continue to expect an effective tax rate of approximately 20% and net leverage at year-end to be consistent with year-end 2021. Before I turn the call back over to Dylan, I would like to thank our entire Utz team, once again for setting us up for a successful exit to fiscal 2022, and a strong position stepping into 2023. In addition, I want to personally thank Dylan for being an incredible partner, coach and operator, and I look forward to his continued counsel from the Board's Chair. Thank you, Dylan. Over to you.
Dylan Lissette, CEO
Thanks, Ajay. Before we open up the call for questions, I'd just like to reiterate how well positioned I believe we are in the current environment. Our enhanced planning capabilities are helping to improve throughput and unlock bottlenecks. The salty snack category remains strong with minimal price elasticity and minimal private label penetration. We now have proven and developing capabilities to offset continued inflation with both price and productivity. And we have mitigated our interest expense risk and a potential rising rate environment. And as a further note, we don't have any material foreign exchange exposure nor do we have any pension liability exposure. In closing, I believe that we have turned the corner, our visibility has greatly improved, and I'm confident in our ability to continue to drive organic net sales and adjusted EBITDA growth next year. Importantly, we will continue to invest in key areas to support our growth while we manage high inflation. With that, operator, you may open up the call to questions.
Operator, Operator
Thank you. Our first question comes from Andrew Lazar from Barclays. Please go ahead. Your line is open.
Andrew Lazar, Analyst
Great, thanks. Good morning, everybody.
Dylan Lissette, CEO
Good morning.
Andrew Lazar, Analyst
Maybe to start off. Obviously, I realized you're not providing sort of detailed '23 guidance at this stage. But I just wanted to get a sense of, if there was anything that you can sort of see today that you do have visibility to that might sort of take us off course from kind of an algorithm year, which is essentially, I guess it's 3% to 4% net sales growth and 6% to 8% adjusted EBITDA growth?
Ajay Kataria, CFO
Andrew, this is Ajay. Thank you for your question. You're correct that we are not providing guidance for 2023 at this time as it's still early for specific numbers. However, I want to emphasize that our visibility into the business has significantly improved, and we are experiencing considerable momentum as we approach 2023. Based on our current outlook, there is nothing that should impede our progress next year, and we are confident in our ability to achieve the algorithm you mentioned. I also want to highlight some areas of progress that we previously discussed. Our capabilities in planning, supply chain, revenue management, and productivity are solid, and we are still in the early stages in several of these areas, with momentum continuing to build. The category remains strong, and price elasticities are minimal. We are investing in the business and plan to continue doing so. We also anticipate high single-digit inflation regarding the percentage of COGS next year. Despite this, our capabilities will enable us to offset those challenges, and we should be able to meet our algorithm goals next year.
Andrew Lazar, Analyst
Thank you for that. And then Dylan, I was hoping maybe we could explore a little bit more in sort of what ways you see the new CEO being additive to Utz in terms of unique skill sets and such. I guess what are the areas where Howard can perhaps enhance capabilities? And essentially, what does he bring to the table? Thanks so much.
Dylan Lissette, CEO
Yes, thank you, Andrew, for the question. I'm really excited about Howard joining the team. We announced his arrival in early October, and over the past five weeks, he has interacted with many employees and associates, visited some of our plants, and focused on understanding our business better. He is also beginning to identify opportunities, challenges, and areas where we can improve. We have a few more weeks until his official transition in mid-December, but he has been doing great so far. His expertise in innovation, marketing, and operations is impressive, and he has a solid background in building brands. While we have historically excelled in branding over the last century, I believe we have underinvested in innovation and expanding our product line as well as in marketing and branding. Moving forward, part of our strategy is to increase our investments in these areas. I truly believe that with Howard onboard, we will see a synergistic effect that benefits investors, shareholders, the company, and the brand. I'm encouraged by the interactions we've had so far and am confident in what the future holds.
Andrew Lazar, Analyst
Thanks so much.
Operator, Operator
Our next question comes from Jason English from Goldman Sachs. Please go ahead. Your line is open.
Jason English, Analyst
Good morning everyone. Congratulations on the ongoing progress. I have a couple of quick questions. First, can you provide an update on your free cash flow outlook? Also, regarding cash management, how do you prioritize reducing your leverage compared to pursuing mergers and acquisitions given the current interest rate situation?
Ajay Kataria, CFO
Hey, Jason, thank you. Yes, we are very pleased with the Q3 results. We experienced strong cash flow during Q3, consistent with our seasonal trends. As we move into Q4 and conclude 2022, we expect to maintain our solid performance in terms of cash. Our goal by the end of fiscal 2022 is to reach a level close to where we finished in 2021, and we are on track to achieve that. Regarding leverage, our strategy remains unchanged. We aim to reach the upper end of our leverage range of 3x to 4x in fiscal 2023, and we continue to work towards that goal. We have taken positive steps to improve our margins, enhance earnings, drive growth, and generate free cash flow. We are actively managing both our revenue and expenses to achieve our leverage objectives.
Jason English, Analyst
Based on kind of the P&L math, it looks like to get there, you're going to have to put M&A on the back burner for a while, at least through next year. Is that fair? And also in terms of the routes that you bought, the distributorships that you bought back, is that just a restructuring, should we expect you to resell those and raise more cash going forward? Thank you.
Ajay Kataria, CFO
We appreciate your comments. Regarding M&A, we're still pursuing opportunities. We're focusing on strengthening our master distributor buyouts and the DSD route infrastructure. Since the end of 2021, we've successfully added about 250 routes to our portfolio, which is driving our growth. This effort will continue as we remain opportunistic with M&A. As we consider M&A and expanding the business, we are being careful with our investments and mindful of our leverage, and this approach will continue.
Dylan Lissette, CEO
Yes. And Jason, this is Dylan. Say hi to your dogs for us, if you don't mind. In terms of spend on M&A, I think what we did in 2022 and 2021, was invest a lot into our capacity. So we saw M&A that we did Festida in 2021, R.W. Garcia in late 2021. We didn't have a lot of that in 2022. We don't think we'll have a lot of that in 2023 as we look forward. But if you add up sort of the cash that left the system for those acquisitions, they were really building blocks for the foundation of supporting the growth of the OTB brand, the growth of our overall capacity and demand cycle. So as we look into 2023, while to Ajay's point, we are not taking M&A off the table. I mean we have our balance sheet. We have other ways of our equity and ways to look at how to think about M&A, especially if it's very strategic, very accretive expansion to our platform that adds value to our scale and relevance in the industry. So it's not off the table, but we obviously are understanding that we're trying to drive down our leverage. We're going to generate more cash. We're not going to have as much capacity building cash going out the door in 2023, like we did in 2021 and early 2022. So I think we're in a really good spot as we look 2023.
Jason English, Analyst
I completely agree, the acquisitions are solid and make a lot of sense. My team was also very impressed by them, as you pointed out.
Dylan Lissette, CEO
Thank you.
Operator, Operator
Our next question comes from Rob Moskow from Credit Suisse. Please go ahead. Your line is open.
Robert Moskow, Analyst
Hi, I was just hoping you can give us a little more color on whether or not there are more incremental pricing actions that you still need to take to cover the high single-digit inflation you're talking about for '23. Or is this inflation really just kind of a wraparound of inflation that's accumulated during the course of '22 and will be mostly in the first few quarters of the year?
Ajay Kataria, CFO
Yes, there is an impact from inflation as well as from pricing and productivity. We benefit from price and productivity simply by maintaining our current practices. That said, we have discussed our enhanced capabilities extensively. As market conditions necessitate, we are ready to act on both pricing and productivity to counter any challenges we encounter. I want to emphasize that we are working on price pack architecture and improving our portfolio mix. We've mentioned SKU rationalization, and a key aspect of that is replacing sales from lower-performing items with sales from power brands, which yield higher margins. We're already starting to see the advantages of this approach, as reflected in our price/mix performance in Q3. All our efforts position us to manage high single-digit inflation into 2023 organically before needing to consider further actions.
Dylan Lissette, CEO
I think Ajay is expressing the right points. Our technology and talent in specific areas have significantly improved. Considering the complexity of our business with direct store delivery, direct-to-wholesaler operations, and third-party master distributors, we have a lot going on. We manage multiple brands and product groups. Since the beginning of 2021, when we implemented these changes, our capabilities have grown notably over the past 18 months. We've brought in not only skilled talent but additional resources as well. This development will be crucial as we seek to identify the next opportunities for sales growth. Our improved capabilities may lead to a price increase, but it could also be more about analyzing our data and working closely with our customers and sales channels to uncover potential opportunities, focusing on our pricing strategy and product presentation consistently.
Robert Moskow, Analyst
To summarize, it seems there were no list price increases in the fourth quarter, and it appears there won't be a need for any. Additionally, is your inflation guidance for this year the same as it was three months ago, or have there been any changes?
Ajay Kataria, CFO
The inflation guidance remains unchanged. We have maintained good visibility, so there has been no need to adjust it over the past three to four months. Regarding new pricing in October, we are being very selective. We implemented a few rounds of price adjustments in February and May, which have been beneficial. In Q4, we are focusing on addressing parts of the portfolio that we previously overlooked and reaching out to customers and channels that we have not addressed yet. We are actively working on that. There is no overall list price increase that was implemented in October.
Robert Moskow, Analyst
Got it. All right. Dylan, congratulations. Thanks a lot.
Dylan Lissette, CEO
Great. Thank you.
Operator, Operator
Our next question comes from Michael Lavery from Piper Sandler. Please go ahead. Your line is open.
Michael Lavery, Analyst
Thank you. Good morning.
Dylan Lissette, CEO
Good morning.
Michael Lavery, Analyst
In the second quarter, you mentioned that the sales distribution was leaning towards the first half of the year. However, it now seems to be more balanced or slightly favoring the second half. You referenced the improved outlook for the price mix increase for the year. Could you elaborate on that a bit? How much of it is due to promotional adjustments or mix? Did you end up implementing more list pricing than you initially expected?
Ajay Kataria, CFO
Thank you, Matt. Yes, the sales are now more balanced between the first and second halves of the year. The improved outlook is due to two main factors. One significant factor is that the volume decline we expected because of consumer pullback in elasticities for the second half did not materialize in Q3, and we anticipate Q4 will be similar to Q3. This leads to an improved volume assumption. That's a key driver. Additionally, we saw a greater price benefit in Q3, which will carry into Q4, influencing higher sales for the second half. When we spoke three months ago, we projected more than a 10% price increase for the year, but now we are looking at a low double-digit price increase for the year.
Michael Lavery, Analyst
And from the 3Q run rate, should 4Q hold that? Or is there any reason for deceleration holding it would certainly put it closer to like, I think, a 12.5 or even 13 on the year? Is that the right way to think about it?
Ajay Kataria, CFO
Yes. Q4 should hold the Q3 numbers with one edit that we have to consider last year's lap. So the fact that last year stepped up in Q4, so we are backing that out. So your calculation of around 12% for Q4 in terms of price mix is spot on.
Michael Lavery, Analyst
Okay. Great. And could you just touch on the price gaps competitively? With all of the pricing in the market, have you seen those change in any categories or for certain brands that have been meaningful? Or has the pricing being pretty broad across the segments and categories?
Ajay Kataria, CFO
So I think the short answer is the category has been pretty rational. So for the most part, it's been moving in lockstep. So I don't think that gaps versus competition or anywhere in the category in the subcategories anything has gone high. Dylan, any?
Dylan Lissette, CEO
Yes. I'd say, Michael, that everyone in the industry is facing real inflation pressures. There are significant increases in the costs of cooking oils, such as cottonseed and soybean oil, as well as pressures on freight and labor. Many different commodities are feeling these pressures. As we all work to adjust prices to manage inflation and continue our investments in technology, personnel, and infrastructure, I believe the industry will face similar challenges and innovations to navigate these issues. Therefore, I don't anticipate any drastic changes in pricing trends across the industry.
Michael Lavery, Analyst
No that's helpful. I was partly thinking about subcategories, particularly regarding Slide 7. You highlighted some promotional changes that affected our view on share momentum. I'm trying to understand if we should anticipate a rebound in share momentum or if there are any competitive price shifts that could be persistent and should be considered.
Dylan Lissette, CEO
Yes, pricing isn't significantly impacting our results. It's quite impressive to report 17% to 18% growth in retail sales. On a year-over-year basis, we've experienced strong growth in mass and OTP, as well as certain subcategories from the previous year. We're comparing against a very strong third and fourth quarter from last year. However, when we analyze the channels and brands, we see exceptional double-digit growth across many of our brands, which isn't driven by pricing but rather by year-over-year comparisons. We have some insights into how recent weeks have performed. Our DSD business, which constitutes about half of our operations, is doing very well. We are pleased with our ongoing results. Ultimately, this isn't a pricing issue; it's more about comparing year-over-year performance, which is just a snapshot of the moment.
Michael Lavery, Analyst
Okay, great. That's helpful. Thank you.
Operator, Operator
Our next question comes from Bill Chappell from Truist Securities. Please go ahead. Your line is open.
Bill Chappell, Analyst
Thanks. Good morning.
Dylan Lissette, CEO
Good morning.
Bill Chappell, Analyst
I just want clarification. Your 17% to 18% growth is certainly strong, but it was slightly below the salty snack category. Is that due to pricing, comparable sales, product mix, or anything else I should consider? How do you expect this trend to continue as we approach the fourth quarter?
Dylan Lissette, CEO
Yes, I believe my response is quite similar to what I said earlier. The category is impressive, showing growth rates of 17%, 18%, and 19%. This is notable considering it has traditionally only grown at 3% to 4%. Our performance was slightly below expectations, primarily due to the mass channel. Last year in the third and fourth quarters, that channel and brand had an outstanding performance. We are comparing our results against that. If you examine the underlying brands like Utz, Zapp's, and OTB, they are all experiencing double-digit growth. For instance, OTB is growing by 50% in the grocery channel, which is excellent. One of the reasons we acquired that brand was to expand into areas like grocery and food, and we are witnessing the positive outcomes of that strategy. I would view this as a minor, temporary fluctuation.
Bill Chappell, Analyst
Okay. Would you say there was any advantage for the category or your business from another phase of reopening? I'm thinking about how schools are back to normal compared to last year and how the return to the office is happening more. Perhaps this has positively affected single serve or higher price points, but you might have better insight into whether this had an impact.
Dylan Lissette, CEO
Yes. When work-from-home arrangements started, people wondered if that contributed to our sales increase, as many were working remotely. Then we transitioned to a hybrid model with some back in the office a few days each week, but our sales remained strong, not only for us but across the entire category. It’s a robust category. Now, as we see a slight shift toward more people returning to the office and fewer working from home, we're noticing some changes in purchasing channels. This change is likely more influenced by economic factors than solely by work-from-home trends, as consumers are looking for discounted products and altering their buying habits. Nevertheless, our sales momentum remains strong, and the category itself is performing well. Pricing plays a role in this, alongside low price sensitivity and limited private label competition, as well as our unique distribution strategy. Over 50% of our business utilizes a direct store delivery model, supported by more than 2,100 independent operators who sell our products in stores daily. This gives us a significant competitive edge in the market, which many of our competitors also leverage. This distribution approach is crucial for our ongoing success in this category.
Bill Chappell, Analyst
Got it. And last one for me. Just any update on the publics rollout? I'm hearing Atlanta, and certainly start to see the product, but I didn't know if you saw the most of the impact in 3Q? Or we would see mostly impacted by 4Q? Any thoughts would be great.
Dylan Lissette, CEO
Yes, we began setting up stores around April and May, which marked the start of our second quarter. The third quarter has seen further development. While I prefer not to discuss specific customers, we have mentioned Publix as a significant partner due to their large presence. We are still in the very early stages. I have nearly 28 years of experience, and I've learned that building long-lasting relationships with customers is key. I remember when Walmart was a $50 million business for us, and now it’s grown to five, six, or seven times that size. Strong customer relationships and excellent service are crucial. In Florida, we had less than 3% market share in the $2.2 billion snacking category, and we are steadily increasing that as we strengthen our relationship with Publix. We aim to be discussing Publix as a major customer for us ten years from now. Successfully partnering with Publix will also open doors to other customers in that market. There’s no reason we shouldn’t achieve 8%, 9%, or 10% market share there, similar to our performance in the Mid-Atlantic region in the next five to seven years. This is a sizable and growing market, and we view this as just the beginning. We anticipate that Publix could easily become a $50 million customer, and in the upcoming years, it could be two to three times that, as is typical with most of our customer relationships.
Bill Chappell, Analyst
Great. Thanks so much.
Dylan Lissette, CEO
You're welcome.
Operator, Operator
Our next question comes from Ben Bienvenu from Stephens. Please go ahead. Your line is open.
Jim Salera, Analyst
Hi guys. Its Jim Salera on for Ben. I wanted to ask on the volume side of things. I think you guys saw a negative volume for the first time this year. Is that also just a function of lapping the higher promotions last year or maybe we started to see kind of the upper point of consumer tolerance for these price increases?
Ajay Kataria, CFO
The main reason for the 2% decline in volume this quarter was a 300 to 400 basis points decrease due to our own SKU rationalization efforts. Overall, the underlying business remains quite strong. If we exclude that effect, our volume would have increased by a couple of points. Retail data does not fully reflect consumption, and we are actually growing in areas not captured by retail data. While our unit sales are performing well, the pound volume has been affected by some weight reductions and changes in our mix. There are various factors at play here, but ultimately, we reported a 2% decline in volume, which would have been a 2% increase if we excluded the impact of SKU rationalization.
Jim Salera, Analyst
Okay. Great. And I guess just to build off that. When you guys do the SKU rationalization, especially if you're pulling out some of the partner brands on the private label. Is the hope that you then replace that shelf spot with either a power brand or one of maybe like a newer products? Or are you just giving up that spot and letting somebody else kind of take the lower-margin business on the private label side?
Dylan Lissette, CEO
Yes, Jim, this is me. And as an example on like Partner Brands, we took a partner brand that was running around $5 million in 2021. At the end of 2021, we terminated that partner brand relationship. We replaced that space with Utz Brands. The conversion process creates a couple months of sort of murkiness right, where one does not necessarily equal one, one may equal 0.6. But then two months later, it equals 0.8. Three months later, it equals one. Eight months later, it equals 1.2, 1.3. And to maybe Ajay's comments earlier about mix and the more that we replace that partner brand with a power brand of Utz, we're going to have a larger margin attributable to it. So we're thinking very long-term. This goes against private label and partner brand as well. We're thinking very long-term. We have our partners that make sense for us strategically, and we're going to maintain those. They're good for our system, for our efficiency. And then we have ones that I think we can rationalize, and we'll continue to sort of drive that. So when we think about our net sales growth in the quarter, and we think about volume, some of that we are literally proactively going out, like the example I gave. We're eliminating a customer relationship, and then we're replacing that with our either production, if we're perhaps removing a private label customer that we're making product for, or our brands if we're replacing like a partner brand that we had the opportunity to do that. Long-term strategic and, in our opinion, the right thing to do.
Jim Salera, Analyst
Excellent. Thanks guys. I pass it on.
Dylan Lissette, CEO
Thank you.
Operator, Operator
And our last question comes from Peter Galbo from Bank of America. Please go ahead. Your line is open.
Peter Galbo, Analyst
Hey guys, good morning. Thanks for fitting me in. Just two really quick clarifications, I think, on my end. The first, Ajay, on your margin comment on fourth quarter being down versus the third quarter, I'm assuming that's an EBITDA margin comment, but does that also apply to gross margin?
Ajay Kataria, CFO
Yes, it's both.
Peter Galbo, Analyst
Okay. And then maybe just, secondly, going back to Andrew's first question. Obviously, trying to understand some of the qualitative moving pieces on 2023 revenues or the revenue build. I guess it would just be helpful, the SKU rationalization, the 300 to 400 basis points, it was in the quarter, is that a good carryforward to use on a 4Q basis? And then when does that kind of finalize out in '23? And maybe the same on the IO discounts, should you be mostly through that at some point through '23? Thanks very much.
Ajay Kataria, CFO
I believe that around the middle of the year, we will start to see the effects of what we experienced this year. As we move past this period, the impact will be less pronounced compared to what we are currently observing. We will maintain the SKU program, although perhaps not to the same extent as this year. We anticipate wrapping up the impact of this year's adjustments in the second quarter of next year. Regarding the IO conversion, we expect to be largely completed by the end of the fourth quarter, with about 100 routes remaining to be converted in the first half of the year. It's normal to have ongoing routes being introduced and presold. Overall, once we fully convert in the first half of 2023, the effects of fresh conversions will diminish and eventually disappear by the end of 2023.
Peter Galbo, Analyst
Great. Thanks very much.
Dylan Lissette, CEO
Thank you.
Operator, Operator
We have no further questions. I would like to turn the call back over to Utz Brands' CEO, Dylan Lissette, for closing remarks.
Dylan Lissette, CEO
Thank you very much for joining us today for our third quarter financial results. We ended with a great year, and it's a testament to our team and to our brand and to our company. And we thank you all, very much for joining us today.
Operator, Operator
This concludes today's conference call. Thank you for your participation. You may now disconnect.