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Simply Good Foods [SMPL] Conference call transcript for 2022 q3

2022-10-21 12:41:06

Fiscal: 2022 q4

Operator: Greetings and welcome to The Simply Good Foods Company Fiscal Fourth 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, Vice President, Investor Relations for Simply Good Foods Company. Thank you. You may begin.

Mark Pogharian: Thank you, operator. Good morning. I'm pleased to welcome you to The Simply Good Foods Company earnings call for the period ended August 27, 2022. Joe Scalzo, President and Chief Executive Officer; and Todd Cunfer, Chief Financial Officer, will provide you with an overview of results, which will then be followed by Q&A session. The company issued its earnings release this morning at approximately 7:00 a.m. A copy of the release and the accompanying presentation are available under the Investors section of the company's website at www.thesimplygoodfoodscompany.com. This call is being webcast and an archive of today's remarks will also be available. Turning to the disclaimer. During the course of today's call, management will make forward-looking statements that are subject to various risks and uncertainties that may cause actual results to differ materially. The company undertakes no obligation to update these statements based on subsequent events. A detailed listing of such risks and uncertainties can be found in today's press release and the company's SEC filings. Note that on today's call, we will refer to certain non-GAAP financial measures that we believe will provide useful information to 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: Thank you, Mark. Good morning and thank you for joining us. Today, I'll recap Simply Good Foods' fourth quarter and full fiscal year results and provide you with some perspective on the performance of our brands. Then Todd will discuss our financial results in a bit more detail before we wrap it up with a discussion of our outlook and take your questions. I was pleased with our full year marketplace performance and financial results. In a challenging operating environment, full year net sales growth of 16.2% was slightly greater than our expectations, while adjusted EBITDA increased 13% and was in line with our estimates. Combined measured and unmeasured channel U.S. retail takeaway growth for the full year of 15.5% exceeded our expectations, driven by solid Quest performance across all forms and channels. Atkins significant e-commerce growth resulted in mid-single-digit full year retail takeaway for the brand in the combined measured and unmeasured channels. Importantly, we continue to grow share in the sub-segments of active nutrition and weight management. Our supply chain team performed well during the year and overcame many challenges to ensure customer service levels approached our typical targets. I'm extremely proud of all of our employees who showed tremendous tenacity and adaptability to overcome these challenges. Due to their efforts, we were able to continue our winning ways with retail customers and consumers while growing market share. As expected full year fiscal 2022 supply chain cost deflation was up mid-teens, resulting in gross margin contraction of 260 basis points. Inflation was primarily related to ingredient and packaging costs. Importantly, cash flow from operations was solid and provided us with the financial flexibility to pay down debt and opportunistically buy back shares. We executed well against our priorities for the year and are well positioned to succeed in fiscal 2023. The current recessionary conditions and its impact on shopping behavior and consumer demand provide a challenging environment for our categories and brands, especially in light of our high retail prices. That said we're cautiously optimistic of our growth prospects. In the first quarter of fiscal 2023, we're off to a good start as retail takeaway has improved time with post Labor Day back to work trends. For the six weeks ended October 8, point-of-sale growth in the combined measured and unmeasured channels was up about 14%. In fiscal 2023, we expect supply chain costs to be greater than last year and anticipate cost of goods inflation of low double digits. Similar to last year, it's mostly driven by higher ingredient and packaging costs. We project that our late fourth quarter price increase last year along with cost savings initiatives will offset projected dollar cost inflation this year, assuming input costs stay at current levels. Therefore, in fiscal 2023, we expect adjusted EBITDA to increase in line with the net sales growth rate. Gross margin is expected to contract with most of the decline occurring in the first quarter. You may recall we had not yet experienced significant supply chain cost inflation in the first quarter of last year. In summary, we're confident in the strength of our business and the diversification of our portfolio across brands, products and channels. In the current recessionary environment, our business is well positioned. Our brands over-index in mid to upper income consumers have little private label competition and strong presence in the mass channel that typically does well with shoppers during recessionary periods. We believe this will enable us to deliver on our sales and earnings objectives. Turning to the fourth quarter. Net sales growth of 5.5% was slightly greater than our expectations due to better than anticipated retail takeaway. Q4 combined measured and unmeasured channel U.S. retail takeaway growth was about 12%, and as expected outpaced net sales growth. The expected retail inventory drawdown during Q4 resulted in more typical retail inventory levels as we exited the fiscal year. Fourth quarter gross margin was 37.1%. The 210 basis point decline versus the year ago period was slightly greater than forecast. Todd will have a bit more on this in a second. Importantly, during the quarter, our supply chain team continued to perform well in a challenging environment as our customer service performance approached target levels. Adjusted EBITDA in the fourth quarter was about $51 million, an increase of 5.2%, and in line with estimates. Sales growth and G&A cost control partially offset higher supply chain costs. For the full year fiscal 2022 Simply Good Foods retail takeaway in measured channels increased 15%. And both of our brands outperformed their respective sub segments of active nutrition and weight management. Total Quest full year fiscal 2022 retail takeaway in measured channels was up 32.3% and greater than active nutrition segment growth of 20.4%. In fiscal 2022, the weight management segment declined 2.4%. Atkins outperformed this segment with retail takeaway up 3.2% over the same timeframe. Importantly, Atkins performance at unmeasured channels continues to significantly outpace measured channels. More on this in a bit. Turning to Atkins fourth quarter performance, consistent with prior quarters, brand relevance remains strong, supported by a growing base of buyers. Total buyers increased 11% in the year, and the buy rate was consistent with the previous quarters. Atkins’ Q4 retail takeaway in the combined measured and unmeasured channels was up slightly as outstanding e-commerce growth continued from previous quarters and offset softness in the IRI MULO universe. Atkins, Q4 POS at Amazon increased 75%, driven by solid growth across all major forms. We estimate total unmeasured channel retail takeaway increased about 40% and is now approximately 12% of total Atkins retail sales. For prospective you may recall the three years ago e-commerce represented less than 5% of total Atkins sales. Core shakes and meal bars performance improved as consumers continued recent return-to-work trends. Specifically, Q4 shakes retail takeaway increased 5.5% driven by solid growth in the food and club channels and meal bars about two thirds of our bar business strengthened during the quarter and were flat versus last year. Cookies and chips growth are progressing and are still in early stages of driving awareness and trial. Brand consumption and by rate was most impacted by soft confections and snack bar performance due to distribution losses and lapping of last year’s dessert bar launch. As we entered the new year, Atkins has experienced improving POS growth. For the six weeks ended October 8 combined measured and unmeasured channel retail takeaway is up about 3.5%. Performance was driven by continued strong e-commerce growth and improving core shake and meal bars with the latter likely tied to post-Labor Day return-to-work trends. Let me now turn the Quest where Q4 retail takeaway increased 24.6% in the measured IRI MULO C-store universe, and outpace the active nutrition segment. Growth was driven by solid performance across all major forms and retail channels, as well as increases in household penetration, strong consumption and success in new products. Quest, Q4 unmeasured channel retail takeaway was in line with measured channels as Amazon growth more than offset declines in the specialty channel. In Q4 Quest core bar retail takeaway increased 11.1% and outpaced bar category segment growth of 7.8%. The snack year portion of Quest products, that's cookies, confections, and chips continue to do well with Q4 measured channel retail takeaway up 51%. Growth was strong across all forums. That was driven by increasing household penetration, distribution gains and marketing investments to drive trial. We have a solid pipeline of innovation expect that snacks today slightly greater than 40% of total Quest measured channel retail sales will continue to generate solid growth over the near and long term. In fiscal 2023, Quest innovation is solid and we have a good balance of new products across all forms. In summary, The Simply Good Foods Company competes in an attractive category with two scale lifestyle nutrition snacking brands that are well developed across multiple forms and snacking occasions. Our brands are aligned with the consumer mega trends of healthy snacking with a nutritional profile that is protein rich and low in carbs and sugar. The profile has broad appeal to consumers interested in health and wellness as a means to achieving their goals, whether they are at home, in the office or on-the-go. Low category penetration and the aforementioned megatrends of wellness snacking should continue to be tailwinds and long-term growth levers. With a steady improvement in return to work trends, we expect improving relevance related to convenience, portability and on-the-go meal replacement. As we look to fiscal 2023, we believe we're well-positioned to build on our momentum and deliver solid net sales and earnings growth. Pricing and cost savings initiatives are in place to offset projected supply chain dollar cost inflation. Broad spot market prices of ingredient and packaging have softened versus the peak, although we have not yet seen meaningful cost declines for our key inputs. Therefore, we expect gross margins to decline, although at a lower rate than the last fiscal year. Most of the decline will occur in the first quarter as gross margins in the year ago period and yet to experience significant supply chain cost inflation. Our advantaged business model with lean infrastructure enables strong cash flow generation and provides us with financial flexibility. We are executing against our strategies and positioned for long-term sustainable net sales and earnings growth that we expect will create value for our shareholders. Now I'll turn the call over to Todd, who'll provide you with some greater financial detail.

Todd Cunfer: Thank you, Joe, and good morning, everyone. I will begin with a review of our net sales. Total Simply Good Foods fourth quarter net sales increased 5.5% to $274.2 million, slightly greater than our estimate due to better-than-expected retail takeaway. Net price realization was a 9.5 percentage point contribution to net sales growth and volume was off about four percentage points. As Joe stated earlier, Q4 total retail takeaway was 12%, and as expected, resulted in a drawdown of the higher customer inventory we discussed last quarter. As a result, we exited the year with more typical retail inventory levels. North America net sales increased 6.4%. The March agreement to license the Quest frozen pizza business was a 0.9 percentage point headwind to North America net sales growth. The international business declined 16.6% due to the Europe business exit. Core international net sales was about the same as the year ago period. The combined Europe business exit and Quest Frozen pizza business licensing transaction was a 1.6 percentage point impact on total company net sales growth. Moving on to other P&L items for Q4. Gross profit was $101.8 million, a decline of $2.6 million versus the year ago period. Gross margin was 37.1%, a decrease of 310 basis points versus last year. Input cost inflation was in line with expectations, while unfavorable onetime co-manufacturer start-up costs and inbound freight due to higher diesel costs were greater than estimates. Adjusted EBITDA was $51 million versus $48.5 million, an increase of 5.2% versus the year ago period. Selling and marketing expenses were $26.9 million versus $30.8 million. The 12.6% decline versus the year ago period was due to a step-up in brand investments in the year ago period. G&A expense, excluding integration and restructuring expenses as well as stock-based compensation declined 4.4% to $24.1 million. The decrease versus last year was primarily due to lower compensation and corporate expenses. Moving to other items in the P&L. Interest expense declined $1.9 million to $5.4 million due to the repricing in the second quarter and pay down of the term loan. Our tax rate in Q4 was 19.4% versus 27.2% last year. The tax rate in the year ago period excludes the impact of the charge related to the noncash, nontax deductible warrant liability. The lower tax rate in the fourth quarter of fiscal 2022 is primarily driven by favorable international and state impacts. Full year results are as follows. Net sales increased 16.2% to $1.169 billion. Gross profit was $445.6 million, an increase of 8.7% versus the year ago period. Gross margin was 38.1% for the full fiscal year, relatively in line with expectations and a decrease of 260 basis points versus last year. The decline is primarily due to supply chain cost inflation partially offset by the previously discussed price increase. Adjusted EBITDA increased 12.9% to $234 million due to higher gross profit and G&A leverage. Selling and marketing expenses increased 7.8% to $121.7 million. The increase was driven by higher marketing investments. G&A expenses increased 1% or $0.9 million. This excludes charges related to integration costs, restructuring expenses and stock-based compensation. Moving to other items in the P&L. Interest expense declined $9.7 million to $21.9 million due to the repricing and pay down of the term loan. The full year noncash charge related to the remeasurement of our private warrant liabilities was $30.1 million versus $66.2 million in the year ago period. The full year effective tax rate, excluding the charge related to the warrant liability was 23.2% versus 27.2% in the year-ago period due to favorable international and state impacts. We anticipate the full year fiscal 2023 tax rate to be around 25%. Net income was $108.6 million versus $40.9 million in the year ago period. The increase of $67.6 million is largely due to the remeasurement of the private warrant liabilities. Turning to EPS. Fourth quarter reported EPS was $0.30 per share diluted compared to $0.19 per share diluted for the comparable period of 2021. In fiscal Q4 2022, depreciation and amortization expense was $4.9 million and similar to the year ago period. And stock-based compensation of $3 million increased $0.5 million versus last year. Adjusted diluted EPS, which excludes these items, was $0.36, an increase of $0.07 versus the year ago period. Note that we calculate adjusted diluted EPS as adjusted EBITDA less interest income, interest expense and income taxes. Full year reported EPS was $1.08 and adjusted diluted EPS was $1.59. 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 fiscal 2022, the company repaid $50 million of its term loan. And at the end of the year, the outstanding principal balance was $406.5 million. For the fourth quarter and full year, cash provided by operating activities was $43.3 million and $110.6 million respectively. As of August 27, 2022, the company has cash of $67.5 million and a trailing 12-month net debt to adjusted EBITDA ratio was 1.4 times. In the fourth quarter, the company repurchased shares were $31 million at an average cost of $33.69, bringing the full year repurchase amount to $60 million at an average cost of $34.79 per share. Additionally, in the fiscal first quarter of 2023, we repurchased $16.4 million of our common stock at an average price of $30.11. On October 19, 2022, the Board of Directors approved a $50 million increase in the existing stock repurchase program and $71.5 million remains available under the updated authorization. Capital expenditures in Q4 and the full year fiscal 2022 was $0.5 million and $5.2 million, respectively. In fiscal 2023, CapEx is expected to be about $5 million to $6 million. In fiscal 2023, we anticipate net interest expense to be around $25 million to $26 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: Thanks, Todd. We’re cautiously optimistic about our growth prospects over the next 12 months. In a challenging external economic environment, we believe we are well-positioned to generate solid net sales and adjusted EBITDA growth in the year. We continue to expect supply chain costs will be higher in fiscal 2023. However, the list price increase effective late in the fourth quarter of last year and cost savings initiatives are in place to offset dollar cost inflation. Additionally, we have made significant marketing and organizational investments in the business over the past few years that we believe will contribute to the growth of our consumer base, shelf presence and market share gains. Therefore, the company anticipates the following fiscal 2023. Net sales increased slightly greater than our 4% to 6% long-term algorithm, including a headwind of approximately 1 percentage point related to the previously discussed pizza licensing agreement. Gross margin is expected to decline, although at a lower rate than the last year. As previously discussed, most of the decline will occur in the first quarter. Higher costs over the remaining three quarters of the year should only slightly impact gross margin. Full year fiscal 2023 adjusted EBITDA is expected to increase in line with the net sales growth rate and adjusted diluted EPS is expected to increase similar to the adjusted EBITDA growth rate. Note that in fiscal 2023, adjusted diluted EPS growth is affected by higher interest expense due to an increase in the term loan variable interest rate partially mitigated by fewer shares outstanding. We appreciate everyone’s interest in our company, and we’re now available to take your questions. Operator?

Operator: Thank you. At this time, we’ll be conducting a question-and-answer session. Thank you. Our first question comes from the line of Chris Growe with Stifel. Please proceed with your question.

Chris Growe: Hi, good morning.

Joe Scalzo: Hey Chris.

Todd Cunfer: Hi, Chris.

Chris Growe: Hi, I just want to ask a question if I could first. And I think what we heard from in your prepared remarks around the brands, a pretty robust suite of new products for both brands, Atkins and Quest. And so I just want to get a sense of to what degree that – how that compares against the prior year you seeing – are you seeing more activity? And then kind of rope that into shelf resets and kind of what to expect in sort of these fall shelf resets for the brands?

Joe Scalzo: Yes. Chris, I’d say pipeline remains robust. I wouldn’t say it’s any better or any worse than prior years, but a pretty good pipeline both in core products where you’re replacing weaker items with new innovations on flavors as well as innovation in new forms. So it feels more of the same, which has been a pretty good pipeline over the last few years. And from a reset standpoint, I think we’re going to continue to see movement from retailers towards bigger brands and away from shiny objects. I think retailers continue to be concerned about foot traffic. They understand bigger brands in the category drive foot traffic into their stores. So they’re very focused on getting the bigger brands right from a distribution standpoint and filling in around them. I would expect that to continue to be the case. So we just saw Walmart reset in August and the bigger brands benefited from that reset. We saw a significant uptick in our business with both brands from that reset. And I think that’s going to play out as the year plays out as the full reset plan.

Chris Growe: Okay. Thank you for that. And I had just a follow-up question on just the Atkins brand in general. And there’s been a little bit of an improvement there in the underlying growth rate. I think you cited shakes and obviously meal bars. I just want to get a sense of – from the – like is there still a continued call it, diet weight management category sort of drag here from mobility, you were talking about kind of post Labor Day getting back to work. Do we start to lap that to where we see more normalized trends in the Atkins brand. And then underneath that, are you seeing – it seems like we’ve seen a little bit more momentum here in shakes and confectionery, which could hopefully help drive a little better growth in the coming year?

Joe Scalzo: Yes. Thanks for that question. Good question. I think first and foremost, I don’t think we ever had a just broadly a weight management issue, i.e., people not looking to lose weight the brand relevance, as indicated by household penetration has continued to be strong. So interest in the brand remains really well. Our challenges have been a buy rate challenge tied around pandemic snacking and meal replacement behaviors. As we have seen people go back to work. We’ve seen a steady improvement in the brand over the fourth quarter and into the first quarter. A little bit of what investors haven’t seen is there’s been a significant uptick in Atkins in e-commerce, which has been adding, call it, 3, in some cases, 4 points of growth to the MULO growth that you can see. So there’s been that shifting that I think investors have not seen the business has been a little bit stronger than what you would pick up in measured channels. As people have gone back to work, we’ve seen the core kind of meal replacement that kind of portable meal replacement, snacking occasion that is kind of – that tends to be work driven. We’ve seen improvement in that business. So our core shake business is strong. We’re seeing our meal bar business performed really well. So that’s been really encouraging from a brand standpoint. I would say, there’s – you pointed at it in our – in your question. There are two like tactical issues on Atkins that we’re addressing as we speak. The first is we saw a slowdown in our snack bar business. It was driven around distribution losses in the spring. And items went out as we put in cookies and chips, we got to fix that, and that’s well underway. And then second, we’ve been lapping some new products from last year. So there’s a pipeline of confection items that’s going to be coming into the marketplace. So I would expect as the first half plays out, we would see improving trends in both of those forms.

Chris Growe: Okay. That was great color, Joe. Thanks for all your time.

Joe Scalzo: Have a good day, Chris.

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

Steve Powers: Great. Hey, guys. Thanks and good morning. Maybe first a question for Todd. Just to dig into the inflation and gross margin outlook. The low double-digit inflation that you called out. I just – I guess, I’m curious just how much of that is locked in through hedging and is sort of definitive in your planning versus is more subject to variability, number one. And then relatedly, you talked about most of the gross margin degradation happening in the first quarter. But I’m just trying to – just trying to figure out what the curve looks like. And do you expect any margin recovery as the year progresses? Or is gross margin expected to be down kind of throughout the year, but obviously weighted to the first quarter?

Todd Cunfer: Yes. So we are – to your first question, we’re about 50% covered right now. If you – regarding Q1, last year, our gross margin – excuse me, was up about 70 basis points. So we still had not seen much of the inflation hit in Q1 of last year. We still had a fair amount of coverage on. So this will be the time where we experienced a lot of year-over-year inflation for the first quarter of this year. Just to give you a perspective, commodities and packaging last year are up about 20%, and we anticipate something close to that again this year. Now obviously, freight is going to be less for us from a growth rate, co-man inflation costs will be less. So the overall total inflation will be more in the teens, but the actual input costs are extremely significant over kind of this 15 to 18-month period. We are – we’re – right now, the way we’ve done our budget, we will have some gross margin declines in the back part of the year, but not big. And as we’ve mentioned, we have not assumed that the cost structure gets better. We’ve kind of assumed it stays where it is. We are hopeful that trend line will continue as the year goes on. We’ve already started to see a little bit of light at the end of the tunnel here where some of our input costs are starting to soften up as we potentially go into a recession there’s a decent chance that may continue. So we may be in a better position on our next quarter call that gross margin for the second half of the year looks a little bit better. But right now, the big hit will be in Q1 because we’re lapping strong gross margin expansion last year, and then we’re expecting some slight margin contraction for the remainder of the year.

Steve Powers: Okay. Perfect. That all makes sense. Thank you. And then, I guess, the second question for either one of you or both is just as I think about where the business is today versus where it was a year plus ago, and obviously, the macroeconomic back up, as you just alluded to, is also different and more challenging. I guess, my question is, is how that changes your approach to demand building inclusive of the shift to e-commerce that we’ve seen. Just as you think about advertising and promotional plans, how has it changed? How does the current environment and the trends of the business shift, both your thinking in terms of how much you spend, and I guess, where and how you spend it.

Joe Scalzo: Good question. I would say, first of all, as we go into the year, look, there’s a reason for us to be cautious, right? You’re heading into what is, if not, by strict definition in a recessionary environment. So you would expect consumers to be tight with their pens. We’re starting to see it in slowing demand overall in food, growth in private label, shift in shopping behavior, these consumers moving away from grocery, moving to value retailers and they’re being a little bit more cautious, focused on value being cautious around purchasing. So it warrants us being a little bit cautious about our outlook going forward. And it’s reflected in the guidance that we provided in FY2023. That said, we’ve got reasons to be optimistic. First of all, we’re carrying good momentum into the first quarter. We’re seeing an uptick in our POS stronger performance on both brands. We like our – as Chris – as I answered in Chris’ question, we like our pipeline going into the year. We like retailers focus on bigger brands. So I think from our perspective, we’re optimistic about the year but cautious about the external environment as we head into it. So our view is we’re going to read POS, and we’ll make adjustments from an investment standpoint based upon how we see it. I think Todd’s characterized the cost environment, the way we see it, like we’ve planned for inflation not to improve. So first, second half sort of like first half. There are some lead indicators that would suggest some of that’s going to come back to us. We’ll read that situation, and we’ll make decisions based upon investments from a marketing standpoint based on how that plays out during the year. Did I answer your question? The only other thing I would say is your focus on value in times where consumers are starting to pinch pennies. So fortunately for us, we tend to have value sizes, you focus on temporary price reduction and your merchandising activities, you try to get more displays out to center of store because foot traffic is down. So your tactics shift to shopper and consumer behaviors. But overall macro, we’re going into the year pretty optimistic with the side of caution given the external environment.

Steve Powers: Yes. Thank you very much. That last piece really got to the point. Thank you very much, Joe and thanks Todd as well.

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

Alexia Howard: Good morning, everyone.

Joe Scalzo: Hi, Alexia.

Alexia Howard: Hi, there. So two questions. The first one is on price elasticity because I know that we’re only getting a more picture or a partial picture in the measured channels. And we’re seeing pretty high levels of price elasticity in there. Now I know that you’ve got stronger growth in e-commerce, I know we’ve got the data points of 9.5% pricing with volumes of 4%, but presumably, that was also impacted by the retailer inventory reductions this quarter. So if we were to include the non-measured channels. Could you give us any insight into overall levels of pricing and sort of run rate levels of volume declines? And then I have a follow-up.

Joe Scalzo: So Alexia, we’re in kind of a turbulent time right now because we actually have two overlapping price increases. So we took a price increase that was sort of started being effective this time last year. We just took one in August and September. So there’s net somewhere around 15, 16 points of pricing in the marketplace a short period of time. So we’re watching that very closely. Obviously, as one burns off, we’ll be interested in seeing what the elasticities are. I would characterize last year’s price increases about what we expected for the total part. I would say, elasticities around one, they lapped a little longer than you would expect. Typically, you’ll see pricing elasticity start burning off after a number of purchase occasions for three, four, five, we start seeing people get used to the new pricing. I would say last year, it was a little later in coming consumers’ reaction to it and lasted longer. So we’re heading into a more difficult recessionary environment, the absolute prices are as high as we’ve historic highs for our brand in the category. That’s one of the areas why we’re being cautious about our guidance where we want to see how consumers respond in a more challenging economic environment with their decisions and the reaction to the prices.

Todd Cunfer: Yes. And to your earlier point, Alexia, you’re right that we were down 4 points in volume for the quarter, but we pulled about 5 points of inventory out in the quarter. As you know, we shipped ahead of consumption in the first part of the year. So true like-for-like kind of consumption volume was up about 1% and 2%. And as Joe said, we’ve been seeing about one for one across the board. And I think our anticipation is that elasticity will kind of stay for a while.

Alexia Howard: Great. Thank you very much for those comments. And then just as a quick follow-up. You mentioned co-manufacturer costs being up, which I think they have been for a while. But that was one of the things that was worse than expected this quarter. How much visibility do you have into those co-manufacturing costs as we look out into fiscal 2023? Is it locked in now? Or could there be some uptick? Thank you and I’ll pass it on.

Joe Scalzo: Yes. So the fourth quarter issue was an issue around start-up of a new product and a new co-man. So the business, so not an inflationary increase of contract manufacturing costs. So the way the industry works is typically, when you’re doing start-up runs and the contract manufacturer is not getting production, you pay for the line time. So we had a number of products with a new co-man and/or a new product that took longer than what we anticipated. So we had to run multiple days, multiple shifts. That’s a fixed cost to us. That was higher than typically what we would have forecasted, we would view that as a onetime cost.

Todd Cunfer: Yes. We have so – to Joe’s point, we have very good visibility on the annual inflation rates on co-mans. Those are negotiated typically every year. There’s absolutely inflation, but kind of single-digit inflation. And again, very good visibility to what those costs are for the foreseeable future.

Alexia Howard: Great. Thank you so much. I’ll pass it on. Appreciate that.

Operator: Thank you. Our next question comes from the line of John Baumgartner with Mizuho. Please proceed with your question.

John Baumgartner: Good morning. Thanks for the question.

Joe Scalzo: Hey John.

John Baumgartner: Maybe, Joe, first off, I’d like to ask about Quest and specifically the bars business. I mean I think since you made the acquisition, distribution growth has really outperformed the bars category by quite a large margin across all your measured channels. I’m curious at this point, how we should think about the next phase of growth there? I mean are there specific channels where you think distribution and availability can increase further, should we think about new formats, whether it’s wafers or anything like that? Just specific to Quest bars, just your thoughts on future growth.

Joe Scalzo: Yes. I think one of the strengths of the acquisition as we combined to selling organizations with complementary skills. So in the case of food drug mass that was an at constraint, you’re seeing that start to play out now in distribution gains in Quest and in particular, we’re using an old Atkins playbook move from singles to multis. So that’s going to continue to play out as the years progress, trading people up from one to four packs on our classic bars. And I think that’s – you’re going to continue to see that happen. Second, the Quest team had just a terrific small-format team, right? So do a really good job, breadth and depth of penetration. You’re seeing the kind of classic original Quest bar build distribution over time as we further penetrate those distribution channels with better placement, so more items, better location in small format stores. I think you’re going to continue to see that play out. And then lastly, there’s a nice innovation pipeline going on our bars right now. So, we have many bars on Quest, and I’ll talk about those in a second, but you also have dipped to bar. So basically, the basic two key flavors of our original bars with a dip chocolate outer layer, both of those are moving in distribution as we speak. The minis are interesting because if you’ve eaten our classic bars, you know that they can be pretty – they can be pretty satisfying, right? And for some people, just too big. So minis are kind of a smaller snack fewer calories, a little less society from them. And so we think they’re pretty innovative from a bar – growth standpoint. And then lastly, we have a – if you haven’t tasted the new products, the product upgrade that we have on our classic bars, it’s pretty terrific. So the upgrade provides a softer, longer kind of better eating experience, and we expect that’s going to provide an uptick in our OG Bar business as we go forward. So, we’re pretty optimistic. The Quest bar business, we think, has a pretty long runway for growth. We’ll drive it through white space and through product innovation and upgrades, and we think it’s more than a few years of runway of opportunity for that business.

John Baumgartner: Great. Thank you for that. And just a follow-up, touching on the strength in e-commerce for Atkins. As you mentioned, the growth there maybe is stronger than expected. Is there anything unique to that brand you would highlight as a factor behind that? I mean is there a channel-specific pricing you’re doing? Are you increasing frequency of digital-specific advertising? How would you characterize the support for that accretive growth? And how long do you think it sort of persist here going forward? Thank you.

Joe Scalzo: Yes. So it’s been on a pretty good trajectory. We said in our prepared comments, it was under 5% of Atkins three years ago. I think if you go back four years, it was under 1%. So it’s been – this is where combining with Quest has been a huge advantage, e-commerce, the size of the e-commerce business on Quest. From a development standpoint was ahead of Atkins. And so as we put those two businesses together, in particular at Amazon, we got a bigger seat at the table, and we learned a little bit more about the opportunity on Atkins. So a lot of the growth we’re experiencing right now on Atkins is due to our improvement of our catalog of products offered. So, we did a refocusing of our shake business as a first phase, trying to get the average price point on Amazon over $20, which is a key for their profitability. And if they’re making more money, then they’re more likely to push you from a growth standpoint. So you can promote more, you can get a deal of the days and special promotion opportunities. So, we’re seeing that play out. Obviously, there’s a there’s an opportunity as we go further into the Atkins portfolio and get the catalog right on Atkins, we see an opportunity for continued growth on Atkins over the next few years. Just to give you a benchmark, Atkins is about 12% e-commerce. I think Quest is around 20%. So there’s eight points of opportunities we go forward. We’re going to chase that pretty hard over the next few years.

John Baumgartner: Thank you, Joe.

Joe Scalzo: Have a good day.

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

Jason English: Hey, good morning, folks.

Joe Scalzo: Hey, Jason.

Jason English: Couple quick questions. First, real quick, housekeeping. Can you remind us the order of magnitude of that price increase that you put in August, September? And secondly, this sort of one time co-man line time expense that you incur in the fourth quarter? Can you quantify that please?

Joe Scalzo: Yes. The average price increase at the end of the year is about 8% similar to the one that we took in September the previous year. Co-man was between $1 million and $2 million.

Jason English: Okay, thank you. And then bigger picture question. Joe, looking across the diet landscape, there’s a lot of turbulence, Medifast’s guidance, Weight Watchers is struggling. Slimfast is down. You’re seeing a lot of volume pressure on Atkins, albeit, I could see you’re certainly outperforming the market. Meanwhile, these new pharma solutions that have been approved by the FDA seem like they’re on fire and like Novartis can barely keep up. Well, they can’t keep up actually with Wegovy demand. Are we seeing a shift from traditional dieting into these new pharma solutions? It certainly looks like it is. If so, how do you think it’s impacting your business? And I know there’s been active, you’ve had active efforts over the years to try to transition Atkins away from active dieters to more lifestyle. Can you remind us like rough split, your best guess to rough split of consumers? How much are – what percentage are active dieters? What percent are just more living an active lifestyle?

Joe Scalzo: Yes, look Jason, I don’t – I like your theory. The data in our business doesn’t support it. So we’re not seeing declines in interest in brand. So you would – if your pharma theory were true in our business, we would see fall off in buyer lack of loyalty. You would see inability to recruit new buyers. So I don’t think in snacking, we’re seeing that impact on our business. I’m not disagreeing with your macro trends, but we’re just not seeing in our business. The slowdown in Atkins is driven by changes in snacking and meal replacement behavior driven around the pandemic. And the evidence of that I think is pretty strong. And I think the improvement in the business has been driven by changes in that as we go forward. So I don’t think that’s the case in the case of our business. So I think part of it to your point is we’ve moved away from kind of fast weight loss, historical positioning of the brand to more lifestyle positioning. And I don’t have the most recent numbers. I do remember we were about a 40 share of dieters. There were about 8 million dieters. That’s probably four-year old data now. And lifestyle, when we started there were about 33 lifestyle – million lifestyle consumers. We started at about a 10 share of them. And my guess is we’ve grown that pretty significantly over the last few years. And – but even as we were doing that, we weren’t – until the pandemic, we weren’t seeing buy rate differences, right? I think snacking behavior is snacking behavior and lifestyle people didn’t show a change in buy rate from typically what annual behavior of a dieter would be. So like I get your concept, I think it’s an interesting theory. I don’t think it’s playing out in our business. If you look broader in the category too, I don’t think it’s playing out in Slimfast’s business either. I think Slimfast went all in on keto, it turned out to be a low carb bad. They rode it up and they’re riding it down now. And I think once that gets out of their business, their business should be fine.

Jason English: All right. Thank you. I appreciate it.

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

Pamela Kaufman: Hi, good morning.

Joe Scalzo: Good morning.

Todd Cunfer: Good morning, Pam.

Pamela Kaufman: How are you thinking about the growth in Quest versus Atkins for fiscal 2023? Do you expect Quest to continue to generate outsize growth relative to Atkins, or is it going to be more balanced given the comparisons that the brands are facing? And then just related to that, how do you think they’re each positioned in a more value-oriented consumer environment? Does Quest do better because it has a more affluent customer base? Does Atkins outperform because of lower price points? Thank you.

Joe Scalzo: Great questions. I would expect Quest continues to outperform from a growth standpoint. It’s earlier in its history. It’s got distribution gain, it has distribution opportunities that frankly, Atkins is further along in, it’s got a strong e-commerce business. So it’s going to ride e-commerce trends really well. Price points on – we’re a little cautious about – we tend not to do it. How does Quest compare to Atkins? But I would tell you we’re cautious about the price points in general. Quest are higher, right? Atkins are a little bit less. Atkins has some value sizes but Quest doesn’t have. So Atkins is probably better positioned from a value standpoint, but I think Quest has got a heck of a lot of momentum right now, right? Its core bar business is growing. It’s got innovation that’s doing well. It’s on a roll from a distribution standpoint. We would expect Quest to outperform. And I think Atkins is well positioned from a value standpoint to ride through kind of the recessionary period.

Pamela Kaufman: Great. Thank you. And then just on the P&L, so you expect EBITDA to grow in line with sales, but gross margin to decline. So can you talk about where you have opportunities for leverage in operating expenses and how you're thinking about marketing investment for next year?

Todd Cunfer: Yes. So we're going to try to keep all of SG&A relatively flat at least for now until we see a break in the commodity picture. So G&A will be very, very tight on. That'll be very flat for the year. Marketing right now will also be flattish. You got to recall the last three or four years we may have had significant increases in marketing well ahead of net sales growth, 9% of net sales right now. So we have over $100 million in marketing for our business. We have a really nice bucket of marketing funds to work from. We're going to be cautious just because of the environment out there right now. So we're going to hold that relatively flat from a dollar perspective. We're not going to decline it, but we'll hold it flat and if we see a break in commodities you can count on us to start to reinvest more marketing dollars in the second half of the year.

Pamela Kaufman: Great. Thank you.

Operator: Thank you. Our next question comes in line of Cody Ross with UBS. Please proceed with your question.

Cody Ross: Good morning everyone. Thank you for taking my questions. I just want to the pressure that Atkins came under this past summer. You called out distribution losses in your prepared remarks; can you just discuss what drove those distribution losses and discuss your plans to regain that loss distribution?

Joe Scalzo: Yes. Let's step back, Cody, because I think you're zooming in on a portion of the story. I think, again, if you look – take a look at what's been going on in Atkins is we've seen a change during the pandemic of snacking behavior. And when you're not at work you're not the advantage of portable meal replacement at work. Those snacking occasions were in fact lower levels than kind of pre-pandemic levels. That had a general – in a general impact on buy rate from a brand standpoint. So as we've seen those trends start to change, we're starting to see the buy rate of those products start to pick up. We saw it in our meal bar business; we saw – we're seeing in our shake business. I did mention that there are one or two issues that happened over the spring, which were amplifiers of the trends that the trends we're experiencing, and that was we lost distribution on snack bars as we put in some items in, in chips and cookies and obviously we're moving to fix that issue as we speak right now. So that's new product innovation on snack bars to fill in the losses that we experienced over the summer. And then we had talked about this before. We had a new product launch last September/October one in distribution October/November on confections, they were dessert bars and the repeat on those hasn't been great, so obviously the fix there is innovation on indulge the kind of confections in order to, to offset those declines.

Todd Cunfer: Just to be clear, Cody, I mean absolutely snack bar is down in distribution. Total distribution's been in good shape. It's been flat-to-up over the last year. And as Joe mentioned earlier, we did really well in the Walmart reset on both brands. So you'll start to see those TDP growths increased by already seeing it in the data and we're optimistic at the full resets to come in November we'll be positive as well. So distribution continues to be a strength for us.

Cody Ross: Great. Thank you for that clarification. And then I just want to discuss your snacks platform, do you really launched into that really two years ago. Can you just give us a state of the union of your snack segment right now? How big is that platform? How is it doing relative to your expectations? And then where do you see it going over the next two to three years? Thank you.

Joe Scalzo: I'm assuming Cody you're talking about just in general non-bar and shakes innovation?

Cody Ross: Yes.

Joe Scalzo: So yes, just step back, look, we have a core business. Our core business is bars and shakes. Bars predominantly on Quest bars and shakes on Atkins, just from an innovation standpoint, given the buy rates of these businesses, I think it's easy to miss this point. But we have businesses that in just general snacking terms have really high buy rates. So if you're an Atkins buyer, you're a multi-year Atkins buyer, you're buying two snacks a week on average, right? So innovation, variety even in the core businesses become very important. So, then as you think about non-core we have our confection business strong on both brands, big business, growing fast on Quest as it entered it last year. You have cookies and chips. Quest, obviously multiple years into that; chips has been an salty snacks beyond that has been a growth engine for the business. It's been driving household penetration. It's a source of new buyers into the brand. We – it's doing really well. We intend to continue to build on that. And then obviously a baked platform with cookies has done. Very well we innovated with frosted cookies a year-ago that continues to be a strong platform. So as a company we view those forms as an opportunities to get into different snacking occasions in different day parts. So our core business tends to be more prior to lunch. So as you start innovating in those other forms, you tend to be more later in the day in different snacking occasions. Confections tend to be late in the afternoon, early in the evening; it’s kind of a sweet tooth thing. Chips and cookies tend to be for the most part, between lunch and dinner. So we’re trying to penetrate those occasions. And then what we look at is can we create a snack food product that kind of turns the macros of traditional snack foods upside down, right? Good in protein, low in the stuff that you don’t want carbs and sugar. If we can make a good tasting product and it’s a sizable kind of conventional snacking category. We like entering those because we can give people a better-for-you option that tastes great.

Todd Cunfer: Yes. And just to be clear, we are very, very cognizant of that core bar and shakes has to be healthy. It has to be growing. So we’re not relying on these new, newer snack platforms to drive the growth, we have to drive the growth of bars and shakes. So that core is about 55% on Quest. The snack pieces the rest. It’s growing very, very nicely the snack piece but the bar business, as you know, is growing in the teens as well. So that’s what we need to do going in the future. Right now, bars and shakes is about 75% of Atkins. And so we like the fact that meal bars and shakes are doing really, really well right now. We’re just starting to launch the cookies and the chips, keeping a close eye on that, but at the core platforms on both brands are not doing well. We’re not going to be successful.

Cody Ross: Thanks for the color. I’ll pass it on.

Operator: Thank you. Ladies and gentlemen, our final question this morning will come from the line of Ben Bienvenu with Stephens Inc. Please proceed with your question.

Jim Salera: Hi guys Jim Salera on for Ben. Thanks for taking our question. I wanted to ask the strategy as you’re expanding some of these new snacking SKUs. If you have a consumer that maybe isn’t a Quest buyer on the bar side, what’s the thought process about getting them to be an incremental buyer, whether it be the protein chips or the cookies. So you guys have a new like cheese cracker out, you just talk maybe about the strategy to get incremental buyers into the category that might not be in that core demographic?

Joe Scalzo: Yes, I think I – the answer is similar to the answer from the last question, right? We look to penetrate as many snacking occasions and need states as we can. So a cheese cracker and a salty snack is a different snacking occasion than a confection product. So you’re trying to penetrate less about, who are the consumers looking at that more about offering more snacking occasions and more need states than we can fill with our existing portfolio. Now the reality of it is you pointed to it really well. We’re able to in particular, with our chip business, salty snack business; we’re bringing in a lot of new buyers. In fact, I think I saw the data that our salty snack business already has the same household penetration as our bar business. So we’re bringing in consumers on that in that form into the franchise. Now it’s our job to strengthen the positioning of the brand to get them to see it as more than just the salty snack brand and get them to buy cross purchases and other forms. And obviously, part of our marketing is designed to do that both online and mainstream media. So you build the brand, you get people to use multiple forms. You bring them in one form, you get them to try the others, and that’s our strategy going forward. So it’s less about who are the consumers. We understand who the target is for Quest. It’s more about giving them the snacking occasions in the need states that they’re looking for. So they don’t have to go anywhere else for their snacking products. Did that answer your question?

Jim Salera: And maybe if I can – yes and actually if I could just have a follow-up. Do you guys know the composition, just to use like chips as an example, do you know the composition of buyers what percentage are existing Quest borrower shake consumers versus incremental to the category, they don’t chop Quest and they just started buying the chips.

Joe Scalzo: Yes, we know the people that we’re bringing in new to brand on Quest on chips, and we know those that are actually already bar buyers. Yes. So you can see that data – obviously, it’s big enough. I’m sorry.

Jim Salera: You’d be able to give a percentage breakdown?

Joe Scalzo: No, I don’t think we’ll share that data now.

Jim Salera: Okay. Great. That’s all for me. Thanks for the color guys.

Joe Scalzo: Thanks. Thank you for your participation today on today’s call. We hope that you continue to be safe, and we look forward to updating you on our first quarter results in January. Have a good day.

Operator: Thank you. This concludes today’s conference call. You may disconnect your lines at this time. Thank you for your participation.