Q2 2022 Conagra Brands Inc Earnings Call
Strong net sales growth anchored in elevated consumer demand that continued to exceed our ability to supply.
Inflation, driven pricing actions and lower than expected elasticities.
While our net sales exceeded our expectations margin pressure in the second quarter was also higher than expected driven by three key factors first.
While we anticipated elevated inflation during the second quarter it was higher than our forecast.
Second we experienced some additional transitory supply chain costs related to the current environment and third in the face of elevated consumer demand that continue to outpace our ability to supply we elected to make investments to service orders and maximize product availability for our consumers.
We expect margins to improve in the second half of the fiscal year as a result of the levers we pulled and continue to pull to manage the impact of inflation.
We will always look to our cost savings programs to offset input cost inflation. However, given the magnitude of the cost increases. Our actions also include additional inflation driven pricing.
We communicated pricing to customers again in December.
For the year were once again, reaffirming our adjusted EPS outlook, but our path to achieve that guidance has evolved.
We're increasing our organic net sales guidance based on stronger than expected consumer demand and lower than anticipated elasticities.
We're also updating our margin guidance given the increase in our gross inflation expectations for the year and the timing of the related pricing actions taken.
Taken together, we continue to believe that elevated consumer demand coupled with additional pricing and cost savings actions will enable us to deliver adjusted diluted EPS of about $2 50.
So with that as the backdrop, let's jump into the agenda for today's call we.
We will start with an overview of the quarter before going into more detail on our outlook for the second half of the fiscal year.
I'll also share some of our thoughts on the structural changes, we're seeing in consumer behavior, particularly with younger consumers. We believe these changes are further evidenced in the long term potential of Conagra brands.
Let's dig into the quarter.
As you can see on slide seven our team delivered solid Q2 results.
On a two year CAGR basis organic net sales for the second quarter increased by more than 5% and adjusted EPS grew by nearly 1%.
As I noted earlier, we delivered these results in the face of a highly dynamic and challenging operating environment.
Input cost inflation came in higher than expected in the quarter. In addition, we made some strategic decisions to service the heightened consumer demand we continued to experience.
As the entire industry incurred transitory costs associated with labor shortages supply issues on materials and transportation costs and congestion challenges during our Q2, we chose to invest in our supply chain and service orders.
This deliberate decision ensured we could deliver food to our customers and consumers, especially during the holiday season.
Maintaining physical availability is an important part of building trust with customers and maintaining consumer loyalty the.
The bottom line is that a mid the supply disruption seen across the industry. We remained focused on building for the long term.
While the net result of these factors was a negative impact on our margins during the quarter were confident that our purposeful approach better positions our portfolio for the future.
I want to take this opportunity to thank our tremendous supply chain team they've been resilience in navigating this environment, allowing us to remain agile and deliver for our customers and consumers.
Continue to be impressed by our team's commitment and I'm grateful for their ongoing dedication.
Looking at Slide 10, you can see that our strong performance in the second quarter was broad based total conagra retail sales were up 14, 8% on a two year basis in the quarter with double digit growth in each of our domestic retail domains frozen snacks and staples.
<unk> penetration was also up this quarter building upon the significant number of new consumers, we've acquired over the past two years.
Total Conagra household penetration was up 59 basis points on a two year basis, and our category share increased 41 basis points.
In addition to increasing household penetration and acquiring new consumers, we are retaining our existing consumers as demonstrated by our repeat rates.
Shoppers continue to discover our incredible products and their tremendous value proposition as.
As the chart on the right of Slide 11 shows our consumers keep coming back for more.
As we execute our Conagra way playbook innovation remained a key to our success across the portfolio in Q2 <unk>.
Slide 12 highlights the impact of our disciplined approach to delivering new products and modernizing our portfolio.
During the second quarter, our innovation outperformed the strong results, we delivered in the year ago period.
We continue to invest in new product quality, and it's supporting our innovation launches with deeper more meaningful consumer connections.
Once again, our innovation rose to the top of the pack in several key categories, including snacks, and sweet treats sauces, and marinades and frozen vegetables.
Slide 13 demonstrates how our ongoing investments in E Commerce continued to yield strong results.
We again delivered strong quarterly growth in our $1 billion E Commerce business and e-commerce accounted for a larger percentage of our overall retail sales than our peers.
We outpaced the entire total edible category in terms of e-commerce retail sales growth during the second quarter, just as we did in the first quarter of 2022 and throughout fiscal 2021.
As we mentioned earlier, our strong net sales growth was driven by elevated consumer demand favorable elasticities and inflation driven pricing actions.
On Slide 14, you can see the extent of our pricing actions in the first half of the fiscal year.
During this period, our on shelf prices rose across all three domestic retail domains.
And as Dave will discuss shortly the pricing flowed through the P&L.
As you can see on slide 15 price elasticity has been fairly low it's been favorable to our expectations.
<unk> continued to see the tremendous value of our products relative to other food options a concept I will elaborate on in a few minutes.
Now, let's turn to the path ahead.
You can see on slide 17, we currently expect gross inflation to be approximately 14% for fiscal 2022 compared to the approximately 11% we anticipated at the time of our first quarter call.
This is a large increase and we're taking actions to offset the increase while still investing in the long term health of our business.
Help manage our increasing inflation, we're taking incremental pricing actions, including list price increases and modified merchandising plans. Many of these actions have already been announced to our customers. As a reminder, there is a lag in timing between the impact of inflation and our ability.
To execute pricing adjustments based on that inflation as a result, the incremental price increases will go into effect in the second half of the year with the most significant impact during the fourth quarter.
While it's easy to get caught up in the quarter to quarter impact of inflation in pricing, it's important to keep focused on the big picture.
The long term success of our business is driven by how consumers, particularly younger consumers respond to our products and.
And when you take a step back to evaluate the broader environment and how our portfolio delivers against the needs of the modern consumer we believe that conagra is uniquely positioned for the future.
As we detailed many times before.
<unk> on trend portfolio filled with modern food attributes is winning with younger consumers and our confidence is underpinned by the many changes we're seeing in consumer behavior that are proving to be structural especially given that these changes are driven by younger consumers that represent the most significant opportunity.
For long term value creation.
Younger consumers represent a large and growing part of the U S population and they want to optimize the value that they get for the money they spend on food.
A large part of optimizing their food spending includes shifting more dollars from eating away from home eating at home.
They make that trade theyre choosing national brands, and we believe Conagra is ideally positioned to experience an outsized benefit from these behaviors given the relationship our brands are forming with younger consumers.
Overall, conagra is delivering superior relative value to consumers compared to both away from home options and store brands.
Let's take a closer look at these trends starting with the population changes.
Slide 20 highlights the demographic shift underway in the U S millennial and Gen Z consumers are large and growing cohort. These consumers are starting to settle down by homes and start families.
We've presented in the past when people enter the family formation phase they increase the amount of food to eat at home with an outsized increase in the consumption of frozen foods.
And what we find particularly important about reaching millennial and Gen. Z consumers is that we believe they will remain more value focused than their predecessors.
First let's talk about the near term as you can see in the chart on the left millennial and Gen Z consumers are earlier in their careers and earning less than the older generations of working age people. This is natural but it bodes well for food at home trends in the shorter term, we believe that even as foodservice bounces back younger consumers will be value conscious.
And their food choices fewer.
Fewer younger consumers are expected to achieve the financial success of the generations before them. The data on the right suggests that millennials are more likely to earn less than their parents. We believe this means that these savvy consumers will look to stretch their food dollars further even as they age.
The data also shows that young younger consumers are already eating more at home compared to the population as a whole Gen Z and millennials have decreased restaurant visits more and sourced a larger percentage of their meals at home.
As these younger consumers have made the shift to at home eating the data shows that they are finding comfort in the quality reliability and familiarity that national brands provide we believe this makes a lot of sense national brands provide value while replicating many of the on trend flavors and modern food attributes that consumers.
They are used to experiencing in away from home dining.
When consumers make trades like away from home to in home eating Trust is Paramount.
In short National brands, particularly modernized brands like those in our portfolio to deliver on this trust imperative and that's because they offer superior relative value versus other food options.
As consumers seek to stretch their household balance sheets in the face of broad based inflation one of the single largest levers available to them is the reduction in spending on food away from home as food away from home prices are typically over three five times more expensive than food at home prices.
This trade will likely become even more important for consumers as food away from home prices have already increased faster than at home prices in calendar 2021, and they are expected to increase at nearly twice the rate as at home prices in calendar year 2022.
Our aggressive modernization of the conagra portfolio over the past several years has put us in a strong position to capitalize on these structural shifts our portfolio has shown its competitive advantage with excellent trial depth of repeat and share gain performance.
Overall, we believe conagra is well positioned to leverage these shifts to create meaningful value for shareholders.
In slide 25 shows you the data to support our claim on.
Conagra is attracting more younger consumers than our peers and getting them to repeat at more attractive rates.
By appealing to younger consumers now we're building superior consumer lifetime value importantly, the data shows that these new younger buyers are stickier across our portfolio. We believe this comes back to the investments we've made and continue to make in our products and our brands.
<unk> has positioned us to win.
As I discussed earlier, we are reaffirming our adjusted EPS guidance of approximately $2 50 for the full year with a few updates on how we expect to get there we're.
We're increasing our organic net sales guidance to be approximately plus 3% up from approximately 1%.
We are slightly adjusting our adjusted operating margin guidance to approximately 15, 5% down from approximately 16% and we're updating our gross inflation guidance to about 14% up from approximately 11%.
Now that I've highlighted our performance for the quarter and strong positioning for the future I will turn it over to Dave to provide more detail on our financial performance.
Thank you, Sean and good morning, everybody.
I'll start by going over some highlights from the quarter shown on slide 28.
As Sean mentioned earlier, there were a number of factors that influenced our results this quarter.
We were encouraged to see that consumer demand for our products remains strong and second elasticities were better than anticipated. However, we also continue to see inflation rise across a number of key inputs and the dynamic macro environment created challenging conditions for the supply chain.
The team remained agile in response to these dynamics, including the decision to make additional investments during the quarter to meet the elevated demand and maximize the food supply to our consumers.
Overall, our actions favorably impacted our top line during the quarter with organic net sales up two 6% compared to the year ago period.
An important part of the top line success, we've realized throughout the pandemic as our ongoing commitment to the Conagra way we.
We've remained focused on building and maintaining strong brands across the portfolio.
We continued these efforts in the second quarter with continued product innovation and by further increasing our spending on advertising and promotion primarily focusing on e-commerce investments.
We show a breakdown of our net sales on slide 29.
The four 2% decline in volume was primarily due to the lapping of the prior years year surge in demand during an earlier stage in the COVID-19 pandemic as.
As volume increased approximately 1% on a two year CAGR.
The second quarter volume decline was more than offset by the very favorable impact of brand mix and inflation driven pricing actions, we realized this quarter.
Driving an overall organic net sales growth of two 6%.
On last quarter's call. We noted that the domestic retail pricing actions, we're just starting to be reflected on shelves at the end of the first quarter.
Those increases were reflected in our P&L this quarter driving the six 8% increase in price mix.
The divestitures of our HK Anderson business, the Peter Pan Peanut butter business and the egg beaters business resulted in a 70 basis point decline in.
And foreign exchange drove a 20 basis point benefit.
Together all of these factors contributed to a two 1% increase in total Conagra net sales for the for the quarter compared to a year ago.
Slide 30 shows our net sales summary by segment, both on a year over year and on a two year compounded basis as.
As you can see we continued to deliver strong two year compounded net sales growth in each of our three retail segments, which resulted in a two year compounded organic net sales growth of five 3% for the total company.
You can see the puts and takes of our operating margin on slide 31.
We drove a six two percentage point benefit from improved price mix supply chain realized productivity.
Cost synergies associated with the Pinnacle foods acquisition and lower pandemic related expenses.
Netted within the six 2% are the additional investments we made to service orders and maximize product availability.
These investments reflect the dynamic environment and actions, we've taken to respond to it.
This includes decisions to utilize more third party transportation and warehousing vendors for some of our frozen products and.
Incurring incremental cost to move product around our distribution network to better align with customer order patterns and.
And delaying our plant consolidation productivity program to maximize current production.
The six 2% also includes transitory supply chain costs.
Such as higher inventory write offs and increased over time to support operations.
The six two percentage point benefit was more than offset by an inflation headwind of 11% 11 percentage points.
The second quarter gross inflation rate of 16, 4% of cost of goods sold was approximately 100 basis points or $20 million higher than expected.
Driven by higher than anticipated increases in proteins, and transportation, which are both difficult to hedge.
The combination of the favorable margin levers are choice full supply chain investments and inflation headwinds resulted in adjusted gross margin declining by 483 basis points.
Our operating margin was further impacted by 20 basis points due to our increased A&P investment during the quarter as I mentioned earlier.
You can see how these elevated costs impacted each of our reporting segments on slide 32.
While each segment was impacted our refrigerated and frozen segment was impacted the most with adjusted operating margin down 707 basis points.
Primarily due to outsized materials inflation and the additional investment incurred to service orders and get food delivered to consumers.
We are confident that we will improve overall operating margins in the second half as we execute our additional pricing actions to offset the higher inflation rates.
As you can see on slide 33.
Our second quarter adjusted EPS of <unk> 64.
Was heavily impacted by the input cost inflation across our portfolio.
Even though the benefits of our first quarter pricing flowed through the P&L this quarter the incremental.
Inflation, we incurred in the second quarter created an additional headwind.
In response, we announced additional pricing to customers in early Q3 during December.
Although we have yet another lag before this pricing benefit the P&L we.
We expect to realize benefits from these pricing actions in late Q3 with most of the impact in Q4.
Also our ardent mills joint venture had another good quarter and delivered EPS benefit versus the prior year.
We realized lower net interest expense and a slightly lower average diluted share count due to our share repurchases in prior quarters.
Turning to slide 34, I want to unpack House Q2, adjusted EPS landed versus our expectations.
Our second quarter adjusted EPS came in lower than we originally had anticipated due to two main factors.
As previously mentioned inflation came in higher by approximately 100 basis points of cost of goods sold for approximately two to three of EPS.
While we have announced additional pricing actions for the second half to offset the incremental inflation. The timing of these benefits is naturally lagging behind the higher inflation.
Second the cost we elected to incur to service orders coupled with the additional transitory supply chain costs. I described earlier led to another 2% to <unk> impact on our adjusted EPS.
We are forecasting the service and transitory cost dynamics to improve as the second half progresses.
Looking at Slide 35, we ended the quarter with a net debt to EBITDA ratio of four three times, which is in line with the seasonal increase in leverage expected for the second quarter.
We expect to generate strong free cash flow in the second half of the fiscal year and expect to end the year with a net leverage ratio of approximately $3 seven to three eight times, we remain committed to our longer term net leverage target of approximately three five times and to maintaining an investment grade credit rating.
I want to close today by reviewing the factors driving the updated guidance. We issued this morning, which is shown here on slide 36.
I'll start by saying that we remain confident in our ability to achieve approximately $2 50.
And adjusted EPS for the full fiscal year.
As the macro environment continues to be very dynamic our expectations for the path to achieve that target have shifted.
We are increasing our organic net sales growth guidance to approximately 3% to reflect our stronger than expected performance year to date as well as our incremental pricing actions in the second half.
We are lowering our adjusted operating margin guidance to approximately 15, 5%.
We expect the incremental sales and pricing actions in the second half to offset the dollar impact of the incremental net inflation and other supply chain costs.
We have increased our gross inflation expectations to approximately 14%.
Largely driven by higher estimated costs versus the previous estimate or proteins transportation.
<unk> and resin.
We will continue to monitor these input costs closely and we'll be quick to respond using all available margin levers as Sean detailed price elasticity has been favorable to our expectations. So far.
As we have explained previously there was a lag in timing between when we experienced inflation take actions, including pricing to offset the dollar impact of the inflation.
And when we see those actions flow through our financial results.
With respect to the additional pricing actions, we have announced for the second half of fiscal 'twenty. Two we expect to realize a small amount late in the third quarter and the full benefits from these price increases in the fourth quarter.
We therefore expect our third quarter margins to be roughly in line with second quarter margins with an increase in operating margins in Q4, as the pricing catches up with inflation and the impact of the lag is reduced.
Our guidance also assumes that the end to end supply chain will continue to operate effectively as the COVID-19 pandemic continues to evolve.
Before turning it over to the operator for Q&A I would like to reiterate that our results this quarter and throughout the pandemic have reflected our ability to consistently deliver superior relative value to our consumers are.
Our confidence in our ability to reach our earnings goal is based on the strength of our business at its core to manufacture and deliver foods that people enjoy.
That concludes my prepared remarks today. Thank you for listening I'll now hand, it back to the operator for questions.
Thank you we will now begin the question and answer session.
To ask a question with Star then one on this have some phone.
And so it isn't a speaker phone please pickup your handset before pressing leukemias.
Your question. Please press Star then two.
So the first question cultural and through Lazaro with VR.
Please go ahead.
Good morning, and happy new year everybody.
Good morning.
Two questions for me.
If I could first maybe Sean you mentioned several times that elasticities remain.
Below expectations, and maybe what you've seen historically.
And I realize there are a lot of dynamics at play that lead to that.
I'm trying to get a sense of what youre building into sort of back half guidance along these lines in terms of elasticity just given more pricing is obviously set to keep rolling in as you've talked about.
And.
Some of your expectation takes into account the potential fading of some government stimulus and how does that play a role again and how you think about elasticity and then I've just got a follow up for Dave Alright.
Alright, sure Andrew let me hit that elasticity isn't stimulus.
I would say our year to go outlook takes into consideration everything that we've seen in the marketplace to date as well as our planned pricing and merchandising actions in the year ago period.
I will tell you that I see with respect to elasticities, a major difference in the marketplace today in terms of how consumers are assessing value versus what <unk> historically seen in the past previously.
<unk> comparison of choices.
Between close proximity items inside the grocery store today due to the demographic dynamics I talked about around young consumers home nursing as well as the huge moved to working from home. The biggest comparison, taking place from a value standpoint is between away from home choices and <unk>.
Home choices and as I said in my prepared remarks, the consumer is showing us that modernized national brands like ours are offering superior relative value and thats, having a positive impact on elasticities that we expect to continue but we have factored in our year to go actions in terms of.
Reduced stimulus payments, particularly snap the short answer is we don't believe that the eventual end to the emergency allotments and the snap program is going to create a material headwind to our business and fundamentally it comes back to that superior relative value of our portfolio versus alternatives, but let me unpack. This one a bit because I know, it's been kind of a hot topic.
Since the start of the pandemic consumers were actually able to reduce their overall food spending significantly and that reduction was driven by the mix shift from higher priced food away from home to lower priced food at home and at the same time that consumers.
Consumers have been able to save money on food because of that shift to food at home. Many have also been receiving these COVID-19 related stimulus.
Payments on multiple fronts, including for some higher snap benefits.
Now as this one component of consumer cash flow changes that is as the emergency allotments in the snap program Sunset, we're not seeing and we don't expect to see a meaningful shift away from the newly created behaviors, we talked about around eating national brands at home and there are a few things that I think.
Need to keep in mind here first the reduction in snap dollars and the total ecosystem is already happening as a slow peeling back it's not a cliff.
That point the number of individuals receiving any snap benefits today has been declining versus pandemic highs already and individual states are ending waivers and emergency allotments on their own schedules, it's not a onetime event.
I would say recent permanent changes to the snap program have actually raised core continuing snap benefits to a level that is higher than pre pandemic. So the core snap consumer who has also benefited from other stimulus is going to have higher snap budget coming out of the pandemic than they did pre pandemic and a third.
The USDA forecast that food away from home prices are going to rise faster than food at home prices and that maintains the value proposition of food at home for consumers and then finally I would just say and perhaps most importantly, the early data does not show that as snap benefits and consumer behavior.
<unk> relative to food at home, we are as you can imagine closely watching the states where emergency allotments have already ended and we have not yet seen a significant change in consumers purchases of packaged foods and that we believe is because as I said, our brands are offering superior relative value versus both away from home alternatives and store.
And especially given the huge move to working from home.
Great. Thank you for that that was very helpful perspective.
And then just a quick one for David and my sense is you'll get a lot of questions along these lines, Dave, but obviously given your expectations that you just talked about in terms of margins for <unk>.
150, 200 basis points sort of below maybe where consensus was looking for it I get it it's timing lag around pricing coming through and impacting <unk> more significantly.
And then some of these incremental costs starting to sort of fade a little as the year goes on.
I guess my question is.
It puts obviously a lot more pressure on <unk> to kind of deliver the year I guess.
Or you would be your sense that youre building in some level of flex.
Flexibility.
But based on what it requires in the <unk> and I guess, what's your level of visibility to that at this stage given it does seem like it's more <unk> loaded. So it's a broader question, but can you sort of get where I'm coming from thanks. So much.
<unk> summarized it well Andrew let me, let me try to walk through it. So I can kind of hit that kind of the big puts and takes so as I mentioned in my remarks, we expect Q3 operating margins to be roughly in line with Q2 margins and then Q4 margins up if you look at the puts and takes from Q2 to Q3, we have increased our total inflation Este.
For the year from 11% to 14%. So now we expect second half inflation to approximate 11, 5% and that's off of a prior year.
Inflation that was about six 5%. We also expect that some of the additional costs, we incurred in the second quarter to support shipments and getting product that consumers will continue into the third quarter. Given the continued challenges in supply chain. We're forecasting that this complexity will gradually improve as we approach Q4 and the <unk>.
<unk> timeframe.
The additional pricing actions, which are critical we announced in December and they were accepted.
And we have a small impact in Q3, given the timing, but we'll have a much bigger impact on Q4 from the pricing. So the pricing has been announced its been accepted and we have very good visibility to that for forecasting purposes. So Q4 will benefit meaning meaningfully from these pricing actions we expect.
Price mix to approximate 10% in the fourth quarter as we'll start to catch up.
With the inflation and the reduced pricing lag that impacted us through the first half and will impact Q3 Q4. As you mentioned mentioned will also benefit from the decline in incremental cost to support shipments that I just referenced as well as.
A decline in some of the transitory costs that hit us in Q2 as well so.
It is important to note that although we expect meaningful improvement in Q4, we're still forecasting higher inflation as I mentioned, so if you look at our cost per unit of volume, we expect that to continue to increase in H, two before being offset by the pricing in Q4.
Thanks, so much.
And our next question today comes from Ken Goldman with Jpmorgan. Please go ahead.
Hi, Thanks, so much.
Dave I just wanted to clarify when you said to expect <unk> margin to be roughly in line with <unk> margin is this comments solely about the operating margin should that roughly apply to the gross margin as well.
Well I was commenting on the operating margin, but thats driven by the gross margin.
Okay perfect. Thank you.
And then I wanted to clarify.
You mentioned inventory write offs, I think I heard and higher overtime expenses as maybe some of the examples of Syracuse nonrecurring challenges I guess number one can you elaborate a bit if I did hear that right on what the write offs were.
And can you also talk a little bit.
About labor availability over the last couple of weeks, maybe as <unk> started to affect more people and how much of that risk is baked into your guidance as well.
Alright, Sean let me, let me start with the back.
Because I know Thats also a hot topic and you wrote about it the other day, which is absenteeism.
And what I would say there is I told my team back in July the word of the year. This year as perseverance and that has certainly proven to be true. We faced a number of factors that have converged to create a persistently challenging operating environment things like sustained elevated demand alongside a protracted pandemic.
And a strained supply chain and acute inflation, but against that backdrop I'd say our team has done a remarkable job persevering and doing everything possible to keep our food in consumers' hands, particularly in Q2, which is our largest volume quarter, but.
To your point clearly, it's not perfect yet and I think it's entirely reasonable.
For all of US to project that the next month or so could remain strained within the supply chain is omicron runs its course, but I would say, we will persevere through that too, but as you saw in Q2 and you referenced some of the things not at normal efficiency, which is a factor as to why margins in Q3 are expected to be similar to what we put up in Q2, but we will persevere.
<unk>.
Keep in mind that Q3 is a smaller quarter volumetric Lee then Q2 call it 5% to 10% less volume on average we also add a geographically diversified manufacturing footprint across our plants and those of our co Packers, we don't have like one big Mega plant.
And as we saw early in Covid. There are steps, we can take to maximize line efficiencies and throughput things like SKU simplification et cetera, and as I mentioned earlier.
We've already tightened up our merchandising activity in the year ago period. So collectively these things should help ease the impact.
Omicron, driven absenteeism and importantly, as you highlighted your note from Tuesday, There's good reason to believe that that challenge will be short lived so I'd say to sum up the team is staying agile and as we move beyond Q3 and into Q4, clearly we see opportunity we will begin to ramp the onset of input cost inflation in our most recent.
Pricing actions will be rolling in the market and omicron, driven absenteeism should be diminished and all of that positions us to deliver meaningful improvement in multiple metrics as we go into the final quarter, Dave Yes. So let me get the first part of your question Ken. So yes, we were impacted two to three in the quarter.
From incremental transitory costs and that included higher overtime across all of our supply chain operations giver, given the labor challenges and higher inventory write offs regarding the inventory.
In this environment.
We're at the end to end supply chain has been strained we're moving fast to meet demand as our suppliers. So our food safety and quality standards are the highest priority for this company and include product from suppliers that we use as well.
We have thorough processes for ensuring that the raw materials and finished goods meet our standards before they're utilized and if not we write them off and that's what happened in Q2.
We do believe that this impact is transitory in nature as we move into the third quarter. So we always have some level of inventory write ups, but this was higher than we expected for those reasons.
And the messaging just to wrap it up there is not a demand driven write off it's a supply chain driven issue.
Demand is still there, yes, yes correct.
Supply chain is a complex thing and there are.
Multiple facets and when each of them running.
Run into challenges it tends to have a bit of a compound effect and this is the kind of friction that you see during those kind of transitory windows.
Very clear thanks, so much.
Our next question today comes from Bryan Spillane of BLA. Please go ahead hey.
Thanks, operator, good morning, everyone.
Just just to two quick ones from me, maybe the first game.
Can you give us a little bit of help with some color on some of the below the operating more operating profit line items for the balance of the year or for the full year.
I think interest expense consensus is around $3 80.
Equity income I guess with ardent mills.
There is some tailwind there so maybe that'll be up and.
And also the tax rate if you could just kind of help us a little bit in terms of how we should be thinking about the below the operating profit line for.
For the full year.
Sure I think on the.
On the interest expense I think that numbers in line that the number that you quoted the $3 80.
Ardent we had benefit in the quarter, which you saw and we expect to continue to have benefits. So we see upside in art and that contributes to our EPS call. It $2 50, So we have upside in our year to go and the tax rate should be in line with the two.
23% guide that we have we are a little favorable this quarter slightly but.
That's the right rate to use okay. Thanks for that and then Sean just.
Sure.
In this inflationary period and I think you mentioned maybe in response to one of the questions.
Adjusting merchandising.
Pre COVID-19 there was more of an emphasis the spend.
Yes above the sales line because that was kind of where the bang for the Buck was and now it seems like.
That there is not a real incentive to do that here or are you shifting more of that spend into A&P.
And is that sort of going to be an ongoing thing, especially as we're kind of in this inflationary environment yes.
I would not think of it that way Brian.
The money that is spent in brand building above the line there there's all kinds of investments in their traditional merchandising is one of them my comments in the prepared remarks today, we are basically about not being as aggressive as we typically would on normal in store merchandising and so that piece of it we've been very consistent on since the part.
Start of the pandemic because it just doesn't make sense to stimulate excess demand when you're already having trouble servicing servicing demand you've got the other investments that we make above the line have been robust for several years now and that won't change because that's where we get the best some.
Some of the best ROI, we get in brand building, it's everything from investing in Cogs for all the new product innovation and packaging innovation, we do to investing with our customers to get the right merchandising to get the right physical placement on the shelf in terms of getting our new items in the store getting the right kind of support in store investing with our.
<unk> on.
On things like sampling and in store.
So those investments are really brand building investments and those have continued strong the piece of the above the line that I was referring to was exclusively that that merchandising piece and then with respect to the A&P being up in the quarter that as I've said before.
Change any given quarter, depending upon what our innovation agenda is we have a new item hitting in the marketplace that we want to spotlight.
<unk> is the right way to go, particularly in E Commerce, which we continue to drive.
We'll put that money there so that will move around quarter to quarter, but no philosophical changes in the way we spend okay. Thanks for that John happy New year guys. Thank.
Thank you.
And our next question today comes from David Palmer of Evercore ISI. Please go ahead.
Thanks.
On Slide 31, you have that's 620 basis point benefit.
From productivity hedging price mix and other.
Just would love to dig into that a little bit you have pricing of 680 basis points and I would imagine you might have a few hundred basis points or productivity and some hedging benefit so that number could be.
<unk> is low, but obviously, there's some headwinds in there could you dig into that and maybe give a sense of the headwinds offsetting.
What about what might be significant benefits of pricing and productivity.
Sure David Let me, let me give you a kind of a high level bridge. So we clearly had the benefit of pricing, we always combined price mix right. So we did have unfavorable mix in the quarter. A primary driver of that is because our away from home segment was up 15% and Thats a lower margin segments. So you get the unfavorable segment.
Mix, there and there is some unfavorable brand mix embedded in the business, but the away from home is the big driver there.
Youre right, we have productivity and sourcing combined.
Had over 500 basis points of favorability there are improvement, but then the additional supply chain costs that we incurred that I went through plus absorption hit us because volumes were down we had forecasted that but that's in those numbers. So that's a headwind for the additional supply chain costs outside of inflation.
We show separately, so that's a high level bridge to get you to the 620.
And then as Youre looking through the rest of the year can.
Can you give a sense even directionally about some of those line items, how youre thinking about.
It sounds like we're going to get some more pricing benefit, perhaps how youre thinking about.
The cadence and the directions of of those.
Items on gross margins.
Yes, so from a from a price mix perspective, we're estimating price mix now will be approximately 6% for the year. So Q3 should be in line with Q2 and as I mentioned in Q4 price mix, we expect to be at about 10%.
So clearly there's a benefit there.
Continue to expect our productivity to click along as it has done both our core productivity and our sourcing benefit so.
And that will continue to track.
We laid out the inflation and kind of what that looks like.
So they are really the key drivers and then as I mentioned, David the cost we got hit with in Q2, the transitory costs, we really expect those to start to go down in Q3 and into Q4, and then some of the incremental cost to support selling and getting product on shelves that will continue through Q3 and then we.
That the decline in Q4, so that's a high level kind of.
And I'll stop here, but.
The supply chain friction costs what are those.
Really calling them transitory another but you can see that during COVID-19. There is a lot of these costs how much of that would you estimate within the fiscal 'twenty to gross margins that youre anticipating.
Overall, how much of the supply chain you can call.
Call. It Covid era friction costs do you think are weighing on that 15, 5% overall margin.
Yes, David Let me, let me get back to you on that because theres. So many different components of cost.
They go through that to make sure that I classify it right. Okay. Yes things are on the move clearly David and we can see it some things had begun to improve.
More recently and then you've got Omicron comes in so things are still moving in terms of multiple things going in different directions, but we do see some of these friction points improving based on our best available information right now as we kind of move out of Q3 and into Q4 and that's that's part of what.
Helps the gross margin piece improve in Q4, but there's more to it than that in terms of gross margin recovery in the fourth quarter and frankly beyond the fourth quarter and I'd come back to the Big picture, which is the key to navigating. These acute inflationary cycles is two things a brands that resonate with consumers and be perseverance because.
The former enables implementation inflation, driven pricing and a benign consumer response to that pricing.
We have both of those things in place and that's critically important for this company. The latter perseverance as an important reminder, that once you wrap acute inflation with pricing in place and strong demand material improvements that can come pretty quickly and so sharp inflections are fairly common when these two things are in place.
Pricing and benign consumer response, and all the data we have suggests that consumers, particularly our younger ones are seeing our products is being.
That value sweet spot between away from home and store brands.
And it's driven by.
Demographic dynamics and the huge moved to working from home. So all of that says we're coming to kind of the end of this.
It really challenging period, as we kind of get into Q4 and that that's a good setup on the other side.
Thank you.
And our next question today comes from Jonathan Feeney of consumer edge. Please go ahead.
Thanks, very much a couple questions first.
Detailed one.
I look at the bridge between measured pricing what appears to be it could wait things across the market differently, but it looks like about nine and your realized price mix was about to say.
I realize it doesn't cover everything, but if you could comment.
Particularly on any of the big buckets of things that affect that lag I'm, particularly concerned about.
Whether it is the case that retailers maybe are margining up on some of this pricing environment and maybe a related question would be.
Broadly.
John You mentioned several times here.
These are long, but thats clearly the case.
Utilization is high you can.
Even make enough things for that consumers demand you know is there.
What.
Big picture like what is preventing maybe as an industry are endeavor detail you are comfortable getting into what is preventing pricing from getting through it because it's been a while now.
Any comments you have on that thanks.
Well I would just say that I think the pricing is getting through we've certainly been very upfront with our customers about the true cost inflation, we are experiencing and what we believe is justified action or in this case actions consecutive actions too to take price and different we don't control what customer.
As do with price they put on shelf, but I'd say on average they tend to pass it through.
Close to the way we pass it through to them there may be some that that take a small margin grab equally there may be some that compressed because they want to gain market share. So it tends to come out in the wash and it tends to be pretty much in lockstep, but what I would say is.
Following the scanner data because we anticipate that the pricing actions that we take are going to show up in that scanner data.
It's unfolded, thus far John but pretty pretty consistently with what we expected.
Yes, John I would say to my previous point mix does impact that six to eight number. So we had some negative mix in the quarter.
Got you, Thank you and Sean Yes, that's clear.
Existing the quarter with much stronger pricing, it's got it. Thank you.
Thank you.
Yes.
Question comes from Robert Moskow with Credit Suisse. Please go ahead.
Hi, there guys happy new year.
Couple of questions.
I think your forecast says that you expect these transitory costs to dissipate in the second half of your fiscal year.
But did you experience then in December and in January in your fiscal third quarter, because I would imagine.
Absenteeism and these issues would have continued are you experiencing it now in the third quarter and then the second question I had is.
Looked at whats changed in Europe.
In my model anyway.
It looks like you raised your pricing guidance for the year, but you didn't really change your volume guidance for the year.
And I know you talk through your confidence in the elasticity and all of that but.
When pricing gets up to 10% in the May quarter, I mean, that's a that's a significant change for what consumers are going to see.
And Youre also going to have an omicron wave thats going to be fast and anticipate quickly so I might have consumers relieved.
That it was mild in quick and May go back to the restaurant eating faster than you think so.
Am I correct that you Didnt change any volume estimates for the year.
In relation to price.
Let me comment on the first piece.
In terms of Q3.
As I mentioned.
My response to Ken a little bit ago.
We don't expect Q3 to operated on what I'll call normal efficiency and Dave talked about some of the transitory expenses in Q2 that we were willing to incur because we were determined to get as many boxes of product as we could into consumers' hands and so that's an inefficiency in that.
There are a variety of things that created that in Q2, we think some of that dynamic will persist in Q3, although it might look differently it might be more Ami kron driven absenteeism for the first whatever it's going to be six seven weeks of Q3 and less of something else, where we've seen improvements already taking place. So that's what I was referring to earlier when I said some things are already improving.
Many of the other things have been a whack a mole that start to create a bit of a headwind like.
Omicron absenteeism, but when you put it all together on that piece of it I'd say, we'll persevere. That's why we expect volumes were still focused on getting as much volume as we can out in Q3, even if it comes.
At less efficiency than what we'd normally expect and then as we exit Q3 and go into Q4, we expect some of those friction points will diminish I think it's reasonable to expect them to diminish and then as we ramp pricing. That's when you start to see the meaningful margin expansion in terms of sales, Dave I know you've got some comments here for Robin.
Rob one thing I want to keep coming back to here is the calculus on how the consumer determines value historically it might be widget, a versus widget be side by side on the shelf and if you see 2000 and increase that translates to meaningful elasticity, that's not the comparator today the comparator today.
We're selling a product that might have been.
In Q2, 69, and it might go up to $2 89, or something like that versus the alternative is to go away from home where prices have increased even faster is $14 50.
We are clearly a superior value proposition versus that and that is what the consumer is seeing and part of that is being aided by the fact that they are working at home a lot of these consumers are working at home now they're not working in the office. So there's more structural stuff at play here than you would typically see and that's why we believe.
We've seen very little elasticity, we've seen some but much lower than historical to date and we don't see a whole lot of reasons, that's going to change materially going forward, Dave do you want to yes, just on the on the transitory costs.
<unk> inventory related Rob that I discussed earlier, we do see that as transitory as we get into the third quarter. So that so that will that will come down.
And then volume our internal forecasts are volume declines or volume has declined a little bit in our internal forecast, it's not significant but it is down and as Sean said the way. We do this as we go brand by brand category by category and we look at our demand science models and determine the elasticity. So it's a bottoms up forecast.
<unk> impact on volume based on the brand and category, where we're pricing. So that's that's how we get through it but volume is a little bit down versus where it was in the previous forecast.
Okay, so a little bit that alright, thank you for that clarity.
Our next question today comes from Alicia.
First name. Please go ahead.
Good morning, everyone and thank you for the question and happy New year.
So I.
I just want to dig into the E Commerce slide on page 13.
You basically said that.
Yes, 80% of it two years in fiscal 'twenty, 150% type of thing is in Q2, I assume that means that year on year slowed materially.
Is the nine 4% that you asked at the moment is that mostly click and collect.
One of the ecommerce investments that youll.
We're making at the moment and does that mean that the profitability of the E Commerce channel is.
Now different from the regular brick and mortar approach that you're taking thank you and I have a quick follow up.
Yes Alexia.
We have made.
Even if you look within our A&P line.
A lot of the investments that we've if you look at our total A&P part it's changed dramatically in the last seven years in terms of what we spend it on much less in.
In line TV and things like that that you've heard me talk about before that are inefficient. So instead today, we put those investments into social and digital platforms, but also importantly into E. Commerce. So I would say we made the decision a few years back to treat E. Commerce is a bit of a startup business and we said we're going to invest in it so we've been.
I would say over investing relative to other areas in e-commerce, because it's far more elastic we see the business we get the purchases started in consumer's basket and it's both pure blood E tailers and brick and mortar.
Retailers, who have built out their e-commerce platforms, both of them have been very high growth areas for us and very strong investment areas for us and what we found is that there is a good ROI on these investments in e-commerce, because once we invest to kind of getting into the consumer repertoire and are part of their shopping algorithm on.
Line it translates to a repeat purchase so we get them when they come back whenever the purchase cycle is for that product.
So that's been one of our key marketing shift there is to go hard after ecommerce last few years and we're very happy with the returns and that's why we continue to invest there will move around from quarter to quarter and when you look at the percent comps. It also can be a bit misleading because it's a function of whatever we did in the base period, we might have we might be wrapping a huge base.
This year in any given quarter when you see it.
Relative dip, but you see large absolute growth.
So overall.
It's a big priority for us, it's working really well and you'd be amazed at the kinds of products that are working well and ecommerce frozen. For example is one that you may not think of intuitively as being very successful in e-commerce, but it is and these are these are profitable sales for us.
Very helpful and just a quick follow up on pace of innovation you highlighted that innovation is an important driver for you at the moment I remember over the last few years meaningfully increase the percentage of sales from new product are you at a level what level are you at now and.
Are you comfortable with where you are or are you expecting increases further increases at the time.
We call. This the renewal rate the percentage of our annual sales that comes from stuff. We've launched in the past three years and we've gotten to about 15% from back in the day. We started we were about 9% and I like that level and because what it reflects is that and it's a persistent amount of innovation because consumers have new benefit.
Areas that they become interested in every single year for example last year at healthy choice, we were already wrapping huge numbers on power bowls, but we went with the grain free trend, which was a big thing and it's been a it's been a big success for us in innovation wise. So we try to be out ahead of our competition using our demand science team in terms of emerging trends and it is.
Interesting because many times when we're bringing out the new trend or competitors are just catching up and they're launching a knock off of last year's stuff and so that.
Keeping out in front of these trends I would say, we will continue to be an important part of our innovation.
<unk>.
Great. Thank you very much I'll pass it on.
Ladies and gentlemen, this concludes our question and answer session I would like to turn the conference back over to Bryan Garnier <unk> closing remarks.
Great. Thank you. So as a reminder, this call is been recorded and will be archived on the web as detailed in our press release.
IR team is available for any follow up calls that anyone may have so feel free to reach out. Thank you for your interest in Conagra brands.
Thank you Sir This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.