Q3 2023 Conagra Brands Inc Earnings Call
Good day and welcome to the Conagra Brands' third quarter 2023 earnings conference call.
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Relations. Please go ahead. Good morning, and thank you for joining us for the Conagra Brands' third quarter and first nine months of fiscal 2023 earnings call.
I'm here with Sean Connolly, our CEO, and Dave Marburger, our CFO, who will discuss our business performance and take your questions when my prepared remarks conclude.
On today's call, we will be making some forward-looking statements, and while we are making these statements in good faith, we do not have any guarantee about the results we will achieve.
Descriptions of our risk factors are included in the documents we filed with the SEC.
We will also be discussing some non-GAAP financial measures. These non-GAAP and adjusted numbers refer to measures that exclude items management believes impact the comparability for the referenced period.
Please see the earnings release for additional information on our comparable items.
GAAP to non-GAAP reconciliation can be found in the earnings press release, and the slides that we will be reviewing on today's call can both be found in the Investor Relations section of our website. I'll now turn the call over to Sean. Thanks.
Thanks, Melissa. Good morning, everyone, and thank you for joining our third quarter fiscal 2023 earnings call.
Slide five outlines what we'd like you to take away from today's call. Our top priority coming into fiscal year 2023 was margin recovery. Following the unprecedented environment of the last two years with COVID and the inflation super cycle, to facilitate that margin recovery, our execution focus is crucial.
Has it been on inflation justified pricing, supply chain improvements, and the pruning of low-margin volume, a strategy we have successfully deployed before and referred to as value over volume and?
Three-quarters of the way into the year, our plan is working.
In Q3, we delivered our second consecutive quarter of strong gross margin recovery. Our pricing execution continued to be excellent, while elasticities remained muted and consistent.
Our volume performance again led our near end peers versus our pre pandemic baseline.
And our supply chain continue to improve but service service levels exceeding 90%.
This improvement allowed us to rebuild inventories to appropriate levels and support most of the strong demand from our customers. However, there were exceptions as we experienced temporary manufacturing disruptions in certain categories that prevented us from being in stock.
Fight. We had strong results in the quarter overall, and we are updating our guidance for the year, including increasing our expectations for adjusted EPS growth and tightening the ranges for net sales growth and operating margins.
With that overview, let's dive into the results on slide six.
We delivered organic net sales of approximately $3.1 billion, representing a 6.1% increase over the prior-year period.
Our adjusted gross margin of 28.1% represents a 409 basis point increase over the third quarter of last year, and our adjusted operating margin of 16.9% represents a 321 basis point increase over that same period.
Adjusted EPS rose, 31% from last year to 76 cents per share.
Year-to-date results underscore the strength of our performance, with growth across all four metrics, including an 8% organic net sales growth compared to the prior-year period, and the robust margin improvements we set out to achieve at the beginning of the year.
Slide seven shows the sustained recovery of our gross profit margin for a second consecutive quarter. This margin recovery was our top priority for the year because our gross margins fund our innovation program, and that innovation has been the centerpiece of our playbook.
And our success in driving sustained category growth in our two strategic focus areas: frozen and snacks.
This recovery, therefore, means you should continue to expect a relentless stream of provocative innovation and brand-building support as we go forward.
In fact, looking at slide eight, you can see that Conagra is one of the only companies in our peer set whose gross margins are essentially on par with pre-pandemic levels.
Importantly, our brand strength and innovation pipeline position us well to maintain solid growth and healthy gross margins going forward.
As I mentioned at the beginning of the call, our sales growth was primarily driven by inflation-justified price increases coupled with ongoing muted elasticities. Slide nine shows the relationship between elasticities and price increases.
As you can see, elasticities have remained remarkably consistent and benign over the last eight quarters, even as we increased the price per unit of our products to help offset ongoing COGS inflation.
Slide 10 shows that our elasticities are among the best in the industry. The modest elasticities, which are well below historic norms, have remained consistent in the face of our inflation-justified price increases. This is a testament to the strength of our brands, the execution of our pricing strategy, and the limited impact.
<unk> of private label competition.
Turning to slide 11, as you can see at the total Conagra level, retail sales grew by 5% compared to the third quarter of last year and by 24.7% compared to three years ago.
To put some context around the five 5% number three points first there was a fair amount of noise in the year over year comps for the peer set in Q3. Some companies had a very weak year ago period due to supply chain challenges, while we had pockets of real strength in the year ago period due to omicron.
<unk> and strong customer support for products that have recently come off allocation.
Second, we continued to prune low-margin volume, most notably resuming our opportunistic value over volume strategy on select brands. This included eliminating 10-for-10 promotions on both value-tier vegetables and canned products, such as Chef Boyardee and Hunt's Tomatoes.
Third, we experienced manufacturing disruptions in certain categories that led to out of stocks in the quarter, most notably impacted were our canned meals and sides businesses, specifically canned pasta, canned beans, canned chili, and canned meat, all part of our grocery portfolio.
In Frozen, we had one noteworthy disruption as our fish business was on allocation, leading to out-of-stocks during peak season. This was due to a fire on our fish frying line, as reported in our second quarter 10-Q.
While these discrete issues suppressed our volume in Q3, the root causes have been largely resolved, and we expect volumes to rebound sequentially from here.
Importantly, when you take the noise out of the short-term view and compare our growth with the stable baseline of three years ago, you see that our performance has been strong on both the top and bottom lines.
Examining the results against this time period normalizes the volatility across demand inflation and supply chain throughout the pandemic and demonstrates that Conagra is a top performer among our peer set.
Slide 12 details our top-line performance on a three-year basis, as measured over the prior 52 weeks and compared to our near-end peer group, which is footnoted in alphabetical order at the bottom of the slide.
Among this group.
<unk> continued to rank second in dollar sales growth and first in unit sales performance, just as we did in Q2.
This remains true when you look at the same chart, isolating the third quarter.
After Q3, the syndicated scanner data has shown that our unit sales trends have improved. In fact, in the four-week period ending on 325, our units ranked in the middle of our near-end peer group on a two-year CAGR basis.
Our continued top-tier pricing execution and volume performance are made possible by the strength of our brands and the superior relative value that our products provide to consumers.
Let's take a look at our top-line performance during the third quarter by retail domain, starting with frozen on slide 14.
We maintained our momentum, delivering strong retail sales growth on both a one- and three-year basis, improving by 4% and 23% respectively.
This growth was driven by a number of our key categories, including breakfast sausages and single serve meals.
It's worth noting that this performance comes on top of the very strong performance for our frozen domain in the year-ago period when the Omicron outbreak influenced consumers' in-home eating behavior. For example, single-serve meals grew 12% last year, creating a two-year stack of 18% in that category.
Turning to snacks on slide 15, you can see a similar story, we drove a 7% increase in retail sales compared to the third quarter of fiscal 'twenty, two and a 39% increase over the third quarter of fiscal 'twenty.
The continued momentum in this domain is broad-based across a number of categories.
Compared to last year, <unk> was up over 22%, and baking mixes and microwave popcorn both rose more than 10%.
Meat snacks grew 6% year over year, building on top of the 22% growth in the year-ago quarter, a period when meat snacks were coming off allocation and our customers were eager to fulfill demand for our leading products in this category.
We also continued to drive growth in our highly relevant staples portfolio. Despite the discrete supply chain challenges some of our can meals and sides businesses that I noted earlier.
This growth was led by whipped toppings, which grew more than 18% on a year-over-year basis.
Turning to slide 17, while we experienced transitory supply chain friction, we also continued to make progress on our supply chain initiatives during the third quarter. This progress benefited from the ongoing success of our productivity initiatives, which remain on track to achieve the targets we outlined at our most recent investor day.
And more moderate increases in COGs as anticipated.
These improvements in our supply chain lead to improvements in the service we provide our customers.
While we're making good progress in the supply chain, it's not back to normal, and industry-wide challenges persist. However, we're recovering as expected, and we see more room for improvement as we advance our productivity initiatives and the macro environment continues to normalize.
Overall, we're confident that we will deliver on our top-line and margin guidance for the year, and we're raising our bottom-line estimates.
With that in mind, we are updating our guidance to reflect that we now expect organic net sales growth of 7% to 7.5%.
We expect an adjusted operating margin of 15.5 to 15.6% and we're increasing our expectations for adjusted EPS growth to range from $2.72.
To $2.75.
Before I hand the call over to Dave, I want to reiterate our confidence in the path ahead.
We have successfully executed pricing actions in response to inflation.
Inflation is moderating, and elasticities remain remarkably consistent and benign.
We're moving past discrete supply chain disruptions and continuing to make progress on our margin expansion initiatives, such as productivity and value over volume, all within an environment that is normalizing.
And as we look at more recent scanner data, we are already seeing improvements in sales trends, and we expect that momentum to accelerate through the end of the fiscal year.
Overall, Conagra continues to benefit from strong brands, strong processes, and strong people, all of which are working together to drive sustainable growth and margin expansion.
With that, I'll pass the call over to Dave to cover the financials from the quarter in more detail.
Thanks, Sean, and good morning, everyone.
I'll begin by discussing a few highlights as shown on slide 20.
We delivered another quarter of strong results, reflecting the ongoing strength of our brands and successful execution of the Conagra Way playbook. In the quarter, organic net sales increased by 61% due to inflation-justified pricing and continued muted elasticities, as Sean discussed.
Adjusted gross margin increased by 409 basis points to 28.1%, and adjusted gross profit dollar growth was up 23.9% for Q3 and 17.8% year-to-date, benefiting from higher organic net sales and productivity initiatives. This reflects our focus on.
Margin Recovery.
This increase in adjusted gross profit contributed to strong adjusted EBITDA growth of 21.1% in the quarter.
Let me break down the drivers of our 6% organic net sales growth here on slide 21.
We delivered a 15.1% improvement in price mix from our inflation-justified pricing actions.
This price improvement was partially offset by a 9% decrease in volume.
If you simply apply conagra's current and historically favorable $5 four elasticity factor two to 15 <unk>.
1% price mix, you will see that elasticity explains approximately eight of the nine percentage points of the volume decline.
The remaining one percentage point of volume decline is mostly due to the supply chain disruptions we've discussed.
And given our elasticities have been running at these favorable levels for some time now, this level of volume decline has been planned in our fiscal 2023 sales and gross margin projections.
Slide 22 shows the top-line performance for each segment in Q3.
We are pleased with the continued net sales growth across all four reporting segments.
Our domestic retail portfolio continues to perform well, with net sales in our grocery, snacks, and refrigerated and frozen segments up a combined 47%.
Our international segment saw solid growth in the quarter with organic net sales up 9.5%.
International reported net sales were up seven 7%, reflecting the unfavorable impact of foreign exchange.
Finally, we continued to see strong recovery in our foodservice segment, which grew 17.3% in the quarter.
I would now like to discuss our Q3 adjusted margin bridge, found on slide 23, as.
As Sean discussed, we are pleased to have delivered our second consecutive quarter of strong margin recovery.
We achieved a 10.9% margin benefit from improved price mix during the quarter and realized a 1.8% benefit from continued progress on our supply chain productivity initiatives.
These pricing and productivity benefits were partially offset by continued inflationary pressure, with 8% market inflation impacting our operating margins by 5.9% and a negative impact of 2.8% for market-based sourcing.
Finally, higher investment in A&P in adjusted SG&A during the quarter reduced margins by <unk>, 4%, and <unk>, 5%, respectively.
Slide 24 breaks down our adjusted operating profit and margin by segment.
While some supply chain challenges continued during the quarter, execution of pricing and improvements in our productivity and service levels allowed us to deliver adjusted operating margin expansion in each segment.
Total adjusted operating profit increased by 38% to $522 million during the quarter. Despite an increase in adjusted corporate expenses, primarily due to increased incentive compensation.
It is worth noting that we delivered a 321-basis-point improvement in adjusted operating margin in Q3 compared to a year ago while incurring incremental transitory costs in our grocery and snacks segment due to the supply chain challenges we've discussed.
Turning to slide 25, our Q3 adjusted EPS increased by 31% or $0.18 per share compared to a year ago, primarily driven by higher sales and gross profit, as well as from a small benefit in taxes.
Our Ardent Mills joint venture performance continued to be strong and is compared to strong results from a year ago.
These positives were partially offset by higher adjusted A&P and SG&A, as well as lower pension and post-retirement income and higher interest expenses compared to a year ago.
You can see on slide 26, we are continuing to strengthen our balance sheet metrics at the end of the third quarter. Our net leverage ratio was 3.65 times, down from 4.2 times at the prior year period.
Our net cash flow from operating activities reflects investments to rebuild our inventory levels.
Improvement in our inventories as enabled has enabled us to improve service levels above 90% and we are well positioned going forward in most categories to support sustained demand.
Year-to-date Capex was $267 million at the end of the quarter, down from $364 million in the prior-year period, while year-to-date free cash flow increased to $436 million.
We remain committed to returning capital to shareholders, as evidenced by the year-to-date increase in our dividend payments and share repurchases.
For the remainder of fiscal year 2023, we will continue to evaluate the highest and best use of capital to strengthen our balance sheet and optimize shareholder value.
As Sean mentioned in response to our continued business momentum and ongoing operating dynamics, we are raising our fiscal 'twenty three EPS guidance and narrowing our ranges for organic net sales growth and adjusted operating margin with only one quarter remaining in fiscal 'twenty three.
Turning to slide 28, I'd like to briefly discuss the considerations and assumptions behind our guidance. We continue to expect total gross inflation of approximately 10% for fiscal 2023 and expect gross inflation to continue for the full calendar year 2023.
We will update you on our Q4 earnings call in July with our inflation expectations for the full fiscal year 'twenty-four.
We expect our net leverage ratio at year end to remain approximately 365 times and anticipate capex spend of approximately 370 million for fiscal 'twenty three.
This number is below our original expectations due to the timing of certain projects. However, we remain committed to making capital investments to support our growth and productivity priorities, with a focus on capacity expansion and automation.
Lastly, we expect interest expense to be approximately $410 million and pension and post-retirement income to be approximately $25 million for the year, driven by the higher interest rate environment.
Our full-year tax rate estimate remains at approximately 24%.
To sum things up we are proud that we delivered another strong quarter in fiscal 'twenty, three, especially considering our supply chain environment that continued to present some challenges are.
Our service levels have improved, and our margins continue to recover to pre-COVID-19 levels.
And we remain committed to executing our strategic priorities to generate value for our shareholders.
That concludes our prepared remarks for today's call. Thank you for listening. I will now pass it back to the operator to open the line for questions.
Thank you well now begin the question and answer session.
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Today's first question comes from Andrew Lazar with Barclays. Please go ahead.
Great, thanks so much! Good morning, everybody.
Good morning.
Good morning, Sean.
Sean, maybe just start off with something a little bit broader.
I think we're all aware of.
What what the more sort of a negative narrative on the overall food group is at this stage.
As food companies lap the pricing and organic sales will slow, companies always have promotions to drive volume, and that will somehow compete away the margin recovery. I guess I was hoping that, in light of the kind of average results today and the sort of implicit fourth quarter EPS that appear to be a bit below the current street view, I guess I'm curious how.
Or would you characterize your results sort of in the context of the group wide narrative that I sort of just laid out.
Sure Andrew Happy to give you a perspective on the big picture and also tackle the Q4 implied guidance a little bit.
Let me start by saying, as I've mentioned on these calls many times before, navigating these inflation cycles is pretty mechanical: you get hit with inflation, you take the price, you don't reflect it right away, and therefore, you experience a lag which compresses margins. But then, pricing catches up and margins recover, as you saw us begin to do.
Do really materially in Q2.
And when you wrap these actions, dollar growth comes down and unit performance improves, both because elasticities wane and because you wrap the unit impact. So that stuff is all mechanical and it's all predictable. I think what you're getting at is the big question, which then becomes what comes next, and the goal is.
Obviously, sustained growth in the debate that you're poking at here is what the tactic will be.
And to me that answer is crystal clear, especially for us simply by looking at how we have pursued growth since I have been with Conagra the answer.
Word is, innovation just look at our frozen performance over the past eight years. It was 100% about premium innovation, but ironically also value over volume philosophy around actually eliminating low quality promotion. So the question then becomes, why would Conagra suddenly?
<unk> or anybody else, for that matter, suddenly believes that the opposite approach is now a smart growth strategy. That doesn't make a lot of sense to me, as far as Q4 goes.
Listen, as I said in my opening remarks, I feel very good about where we are. Our plan is working, our margin recovery is in place, our elasticities remain benign and consistent, supply chain is improving, innovation is hitting the market, and top-line trends are improving. So, in terms of the implied Q4 guide, we think it's prudent.
Supply chain is improving but it's not all the way back in our position all year has been to plan conservatively in this regard and as far as unit volume goes I think we gave you a lot of color on that already but for those that are more inclined to focus on short term trends are two year unit.
In the most recent four-week period scanner data, which is ending $3.25, it was right smack in the middle of our peer set and at levels that are entirely predictable, as our muted elasticities kind of show you. So, to be above that, either elasticities would have to be nonexistent or...
You would have to ship ahead of consumption, and the former is unrealistic, while the latter is not part of our playbook.
Alright, great. Thanks. Thanks, so much and then just I didnt here just a quick one I didn't hear any mention of the canned meat recall is impacting the quarter and I am pretty sure. There was supposed to be some impact, but maybe I got that wrong and then I'll pass it on thanks, so much.
Yes, Andrew.
Said in Cagny, we expected a 50 basis-point impact on Q3, and that's exactly what it did – it impacted US by 50 basis points on sales. We also had an additional impact of around $8 million in fees and other costs.
One thing that has changed is we're really ramping up the replenishment on the shelves. So we're not going to see that full replenishment of the 50 basis points we lost in Q3 come back in Q4. Instead, it's going to drift into the beginning of fiscal 2024, which is great.
Great. Thanks, so much.
Thank you, and our next question today comes from Ken Goldman of J.P. Morgan. Please go ahead.
Hi, thank you.
I just wanted to ask a little bit about the guidance for the top line just trimmed at the top end very slightly not a huge deal, but just trying to get a little bit deeper into the reasons behind that is it mainly just the manufacturing issues that you had or are there. Other factors that we should think about as we as we look at that.
And I'll make a quick comment and then I'll turn it over to Dave in manufacturing.
Friction that we've run into is part of the reason why we've had a conservative outlook for so long, as these things keep popping up. For the US, it happens to be solely isolated around Canton, whether it's Vienna sausage or other things.
A quality issue that we've had to deal with regarding cans, where we needed to be, and frankly, you've seen those kinds of issues pop up across the industry. This is largely tied to labor, where you're dealing with a lot of inexperienced labor in companies and their suppliers. These issues lead to quality problems that sometimes you find before you produce the product, and sometimes you find them after production.
So that impacted Q3, and it will.
Drift a little bit into Q4. The good news is we've gotten to the root cause of those things and we've got them contained, so now we just have to get the remnants out of our system, so to speak. But again, that means the setup going forward as we do that, I think, is a positive and should become a tailwind. Dave, do you want to add anything?
John hit it just to give you a little more specifics, as I just mentioned in the previous question. We do not expect now to see the bounce back from the ARMA recall in Q4; that is going to drift into next year. That was a 50 basis point impact on Q3, and then also in that category, as Sean talked about Chili's beans, and then the impact of the [unk].
Frozen fish.
These dynamics were working through that it's improving but we're still on allocation and some of those specific categories and actually skews and so that is impacting Q4 as well on the top line. If you just think about it. This way if you look at that the previous guidance, which was 7% to 8% for the full year that implies a midpoint for Q4 of about five.
8% with the revised guidance for the year, which implies a midpoint of about 48%. So that's about a 100 basis point decline in the armor, and then these other allocation issues with the brands I just mentioned are pretty much that.
Okay. Thank you for that.
Then, for my follow-up, you trimmed your CAPEX outlook. You're hardly the only company to be doing that these days. I understand, and I think I know the reasons why. I'm just curious, Dave, you mentioned that it's more of a timing issue. I'm curious how delayed are those projects in general, and is it fair to say that nothing really affects your supply chain optimization?
Playing off course, or is there anything in there that's delayed as well? Thank you.
No Ken, we're still on track with the commitments we made at our Investor Day on the $1 billion over three years. A lot of it is just normal timing in this environment, where we're still working through things as they just take longer.
Ordering certain materials and things that you need to execute.
Capex projects Theyre, just theyre, just taking a little bit more time, so, but it's not it's not at all changing kind of the opportunities we see in the projects that we that we're going to target.
Great. Thank you.
Thank you, and our next question today comes from Pamela Kaufman with Morgan Stanley. Please go ahead.
Hi, good morning.
Thanks, Tim.
Just a question on the Q4 guidance.
At the midpoint of our updated full-year guidance for operating margin, it implies that Q4 operating margin will decline year-over-year. However, we have seen about a 180 basis point operating margin expansion year-to-date. So, what is driving that more cautious Q4 margin outlook?
Yes, Pam, let me get to a good question. So, Sean mentioned that our approach to guidance this entire fiscal year has been about being prudent, and it's because of the volatile environment we're in with supply chain challenges and then the historic inflation in pricing. We're continuing that approach for Q4, so we still.
Expect an inflection in our gross margins, but we are building in what I'll call a healthy level of contingency for supply chain friction costs in our cost of goods sold. Also, just a more specific item regarding SG&A: we will be up in Q4 versus the prior year and up versus Q3 absolute dollar levels.
SG&A will be more in line with what we saw in Q2 in terms of SG&A dollars. So, we expect to finish the year near that 9% of net sales level, and that's just timing.
And then, for EPS, we always forecast a sort of more moderate.
Estimate for Ardent Mills.
So that would be down versus what we delivered for Q3. So they are really the key drivers I think it's just.
We're taking a prudent approach to our guidance.
Got it, thanks. And then, just on gross margins.
<unk> had very strong gross margin expansion year to date.
How should we think about gross margins in Q4, and then into next year?
Can gross margins continue to maintain a positive 28% level, and how are you thinking about the contribution coming from productivity and mix?
Yes, Pam it's Sean.
First, I'd say we were deliberate in stating right off the bat that our top priority this year was on gross margin recovery. It kind of comes back to Andrew's point: why is that so important? Because gross margins fund our innovation program, and our innovation program is how we drive high quality.
Stained growth that can be margin accretive over time. This all hangs together, it's a simple concept so.
If you think about what we tried to do around here as a company and our playbook, it's all about perpetually improving our growth rates and improving our margins. We do that in a variety of ways, from the mix of our portfolio to our value-over-volume strategy to our relentless approach to innovation. That's what it's all about, so we're not giving long-term gross margin guidance from here, but I will.
Would you say, what we've always said, which is topically.
Our game plan is to drive a northward trajectory in sales and gross margins.
The future.
Okay. Thank you.
Thank you. Our next question today comes from David Palmer of Evercore ISI. Please go ahead.
Oh, thank you. Good morning! I wanted to ask you about your multi-year sales trends, or how you're maybe thinking about that this quarter.
Sales trends were stable over a four-year basis, and your guidance implies roughly stable organic sales trends, with that 5% or so organic growth in fiscal [unk].
I wonder if you see reasons for re-acceleration in the multi-year trend into the first half of this upcoming year.
You mentioned the supply chain; perhaps a point or so, and the reason I'm asking this is because, you know, stable quarterly trends will get you to maybe flat to up 2% organic revenue by the first quarter, which I'm sure is not great news. So I'm wondering about reasons for reacceleration beyond that.
And maybe that supply chain hiccup you mentioned.
Well Hey, David.
We are not obviously going to discuss next year's guidance today, but I will come back to the mechanical point.
Made it at the beginning of the Q&A section here, we're going to go into this phase here, where we start getting into Q1, and then Q2 and then Q3 next year, where you really start to ramp up the pricing and you're going to see dollars come down, but you'll see the unit declines that were tied to multiple waves and pricing tied to the elasticity start to rebound.
So that that's going to be a shift that's going to be in everybody's next fiscal year and it's going to be different for every company. Because every company started pricing so youre going to see that shift and I think everybody has got to start to model for that and prepare for that because.
Then when you get through that Youre going to be back to pretty much everybody's long term algorithm and for us the sales that's low single digits and so that's what we expect and then we pursue that a variety of ways the bulk of which is.
Is through innovation, Dave, anything else you'd add to that? Yes, but David, what you're poking at is true, right? So, if you think about armor, for example, where we had a recall - we pulled everything, and now we're replenishing, and some of that will drift into the beginning of fiscal 2004. So.
When you have that, it's obviously going to be a tailwind, right, for the quarter. However, that's what made these last couple of years so difficult because, every quarter, there are different dynamics in terms of when various companies are on allocation, and then when they get off allocation, and what that does to shipments versus consumption. It's hard to put a really fine point on it, and we're not going to get into detail.
On guidance until July, but conceptually that's correct. When you're on allocation or you're out of stock and then you replenish, you are going to see a bounce back from that.
Yeah. Thanks. So I wanted to ask maybe one more on the leap. I see if you could comment a bit more on the inflation you said you're expecting, quote, inflation for all of calendar 'twenty-three if that were up low single digits.
Then you you would be talking about a flat.
Second half of calendar 'twenty, three meaning you for first half of fiscal 'twenty-four so I'm wondering what.
What type of inflation are you thinking about for as you as you enter into fiscal 'twenty four.
Yeah, David we're going to we're going to give more detailed guidance on fiscal year 'twenty for inflation on our July call I think to do it now I think is a bit premature what I can tell you is as you have seen every quarter our market inflation has been decelerating. Okay. So the rate of inflation has come down and we expect that.
To continue into Q4, we have guided to approximately 10%, which implies about a 5% market inflation rate in Q4.
In terms of the 8% that we saw in Q3.
Still, roughly about 10% is materials, which is two-thirds of our costs, including the right ingredients and packaging. So we are still seeing market inflation at a high level there. Although it is coming down, as I mentioned, and then when you get into the manufacturing side with labor, that's more in the higher mid to upper single digits there.
Transportation and warehousing has actually been kind of lower single digits. So that has that has been.
Coming down.
Stronger, so that's where we are now, but we're not going to give all of that detail until we do it in the context of our full guidance for fiscal 2024. I think that's the way we want to do it.
Okay. Thank you.
Thank you, and our next question today comes from Nik Modi with RBC Capital Markets. Please go ahead.
Yeah. Thanks, good morning, everyone.
Just a quick question, Shaun, on how you're thinking about the rolling off of the SNAP benefits and the impact, obviously.
It has on just the overall packaged food space just curious do you have any thoughts on.
State that rolled off last year, and if you have any observations there.
And then, just tied to that, given how dynamic the promotional environment is and how savvy Conagra has been with digital, I'm just curious as to how you think about measuring the ROI of some of that spend. Would you expect that kind of digital promotion side of the business to really start ramping up in the back half of the year?
Sure Nick Let's talk snap first so you know out of the 50 States, we've got 18 rolled off.
These.
They've sunset these emergency allotments previously, and then you've got 32 that just rolled off recently; so, what do we know so far?
Now, is that what we saw in terms of impact to our portfolio from the 18 with no material impact? We've been tracking that for some time. I've mentioned this on calls before, and we just have not seen any material impact there. I will give you, as I did last quarter, one perspective on why I think that's the case.
For our portfolio, we already have really great value offerings within the Conagra portfolio. So, if you have a more limited SNAP allotment.
It seems logical to me that you would use them on things that are inherently harder to afford, and our products are inherently easier to afford. That may explain why we've seen such a modest impact, but you have 32.
<unk> that have just recently come off - it's just brand new data. We monitor this over an eight-week period. So, we can see if there's any movement there and we will do just that. But based on what we've seen in the ATM thus far.
I just don't have good rationale for staying that that would be any different on the result.
With respect to digital.
I would say use the word promotion. I think what we do is digital marketing. I mean, we literally do some digital promotion with our customers, where they shop online and things like that.
We invest in search to make sure people find our products, but a lot of what we do to drive buzz on our brands is what I talked about at Cagny, which is really finding real people who use our brands to tell their story.
Our brands fit into their lives in their own words, very authentically; we call those people irrefutable advocates.
Live on TikTok, and things like that, we build relationships with them and they tell our story, and it's incredibly efficient, which is why you see our A&P line looking lighter than you see in companies that use traditional tools because it's far more efficient than traditional methods.
<unk> media, which is not only expensive but it's.
Heavily effective, so we've done that. I just saw some new stuff for my team yesterday that's coming on a couple of our brands, and I'm very excited about it. We're just going to continue.
This is an evolution in terms of digital marketing with these irrefutable advocates we love. We think it works for us, and we're going to continue to drive it hard.
Great and just one one just quick question.
How long do you think it will take to get back to fill rates that were in line with pre-pandemic levels? I mean, do you guys have any visibility?
Timeline on that.
Frankly, we're there on some categories right now, so we gave you the north of 90% number. But, this is a pretty vast portfolio, as you know, and so the way you should interpret that is the 90-ish number at the portfolio level has embedded within it some categories and brands that are already back to 98%, which is <unk>.
Best in class, where we've already been equal, we have had manufacturing disruptions that we talked about quite a bit today.
We're still on allocation, or we're still replenishing stock on the shelf, and we have to do that before it's even going to scan. So, when you put those all together, you get that low 90 service level.
Transitory stopped manufacturing disruptions; we've got it contained. We're ramping it up, and so that average that we quoted today should improve from here, Dave. Yes, just one thing to add.
Our inventory levels, in terms of days on hand and safety stocks, are finally back to pre-COVID-19 levels, where we want them. So, we are in really good shape with our inventory levels and are well-positioned. We have a couple of categories, which we have talked about, where we are still working through; but overall, I feel really good about where we are now.
Our inventory levels.
Excellent, thanks, guys. I appreciate it.
Thank you, and our next question today comes from Peter Galbo with Bank of America. Please go ahead.
Hey, guys. Good morning. Thank you for taking the question.
Okay.
Sean, I just wanted to clarify one of your comments, I think, in your prepared remarks.
Talking about more of the recent Nielsen data you said you expected an acceleration kind of going forward in that data, but then if we just look at the <unk> guidance, obviously theres a detail on the sales growth rate. So maybe you can just.
Clarify that for us quickly.
Well, what I'm really getting at there is relative to Q3. I mean, we, as I pointed out in my prepared remarks, had a lot of noise in the year-on-year quarterly data in Q3, both for us and our peers.
And.
And we had some of the supply chain issues hit us in Q3, so as we ramp up and get past some of the unusual comparisons, we had some strong comps on big businesses. In Q3, we move into Q4, the profile of the comps change on some of our big businesses, plus you'll see we'll get back in stock on some of these items.
Categories, where we've had fish, where we've had some limited ability to supply those, conspire to show improving consumption trends. So, I referenced the four weeks.
Nielsen's ending, 325.
Today, our units and our dollars have shown improvements, and that's a four-week number, right? So the fact that the staggering four-week numbers that come out every two weeks are improving kind of shows you that embedded in that is weekly data that is improving week after week after week, and that's really what I was referring to.
Got it. Okay. That's helpful. Thanks for that.
And Dave.
Going back to the question around Capex, and obviously understanding the timing.
Just also understanding.
Like cashless operations is actually running a little bit behind last year.
Maybe there's a timing mismatch on working capital, but how should we think about free cash flow, perhaps through the rest of this year and particularly as we get into next year?
With some of the debt maturities that you have upcoming.
Yes, absolutely.
All of the cash flow from operations impact that you are talking about is from US building back our inventory levels. So youll see on our cash flow statement the increase in working capital related to inventory and that gets back to the point I just made where we are back to healthy levels with our inventory great safety stock levels.
We feel really good moving forward, so as we get into...
Especially in Q1 of fiscal 'twenty-four, we should be in a position where you can start to see inventory is more of a tailwind versus a headwind, and it's just been an investment to build back our inventories to the safety stock levels that we want to be able to execute our plan.
Thank you. Our next question today comes from Alexia Howard with Bernstein. Please go ahead.
Hi, good morning.
Hi, there.
First of all, ask about the surge in the food service side of things; it's obviously been strong for a while.
Oh, there are particular channels in there that are doing very well. I'm just wondering about the overall recovery on that side of the business, and then I have a follow-up.
Okay, yes.
We're really pleased with foodservice our sales were up 18%. We had just over 1% volume decline we've seen strength in a couple of different areas. Our commercial business has been up we have a popcorn business, which was very healthy in terms of volumes in the quarter and then obviously the pricing we've been able to.
Pass on inflation-justified pricing, and we have not seen volume declines or significant volume declines from that in the area. We're still focused on our margin. So, we've seen nice improvement in margins in food service, but we still have some work to do to get back to the pre-COVID-19 margin level.
Another 200 to 300 basis points of improvement and I'll be I'll be happier with the margins, but overall, we're really pleased with kind of how our foodservice business has bounced back.
Got it, and then, as a follow-up, I'm just curious about the market share trends in frozen.
It looks as though.
Things are down a bit in that part of the business. I'm wondering if it's supply constraints.
How does that recover over time is that a faster pace of innovation as we roll into 2020 for a marketing or what pricing actions are being needed on our promotional activity. If you need it on that side of the business. Thank you and I'll pass it on Alexia It's Sean.
Yes that is a great example of what I mean by noise in the quarter and year on year I mean, if you want to.
Look at our sustained market share trends in frozen since 2016 and 2017 when the renovation program really ramped up; it's been extremely strong.
Consistently, and now we're wrapping up a quarter where there is a bunch of noise in there. Let me just give you some examples of that.
Omicron was last Q3, and we had businesses that performed especially single serve meals.
<unk> Well, during Omicron, because people are staying home, they were having lunch at home and so we had very big comps on some big businesses there. We also had competitors in frozen in the year ago period that had major supply chain challenges and lost merchandising events, where we picked it up, also impacting our comps in the year.
Period, and we did not repeat some of those this year.
And then you've got the fish fire issue. So there is a fair amount and I should mention, value over volume on a bird's eye view is one of the things that volumetrically, it's going to affect those numbers because.
10 for 10 promotions and our company as well.
We've weaned ourselves off of promotion big time since 2015. In the last quarter, we were just over 20%, but until we hit this most recent inflation cycle, there still have been surgical 10 for <unk> in our company's portfolio that were not very profitable. They existed in two places: one was in low-tier vegetables.
And the other was in some of our canned meals and sides businesses, like Chef Boyardee for example. We have eliminated that practice, and this was the right window for us to do so. We refer to this as value over volume. As you've seen us do in the past, when we take that action, we will purge some low-profit volume out of our base margin.
We will expand, and now have a much stronger base to build on with high quality, more premium innovation, and that is one of the things we're doing at the low tier vegetables: getting out of that 10 for 10 business. So, hopefully that gives you some color. We feel awesome about our frozen business and the innovation pipeline we've got going forward.
Super helpful. Thanks so much! I'll pass it on.
Thank you, and our next question today comes from Jason English with Goldman Sachs. Please go ahead.
Thanks Tommy.
Questions about Ardent Mills' JV banner year. This year, on top of a great year last year, I know you're not giving guidance for next year, but maybe you can help level set us as we look to a "normalized" year. What do you think is the right level for an existing model for that business?
Okay.
It's a difficult question to answer.
Ardent Mills is a great business; it's a newer business that has been growing and it really has two key components to its business. First, it's core milling and blending business, where it creates great flours that it sells to customers. Second, it has more of a trading-type business. That core business has continued to grow.
The margins have expanded; they have a great mix and great strategies to really drive the margins on that business in sales. They've also benefited from this environment and the volatility on their trading side of the business. So the question comes down to, what's that trading piece, I think.
The center line of performance for Ardent Mills will continue to go up; it's just quarter to quarter. There can be more volatility, given the nature of the business.
Yeah Okay.
First quarter 'twenty, one you told me it was.
About $70 million was a reasonable number on an annualized basis. The core business is growing, and it sounds like it's more of a 70.
But clearly.
Well south of the $1.80 a share or whatever you're going to deliver this year.
Somewhere in that range of care.
No, not at this point.
Okay and then.
The performance this quarter was solid. Obviously, volumes are soft, but no worse than expected, other than frozen. Frozen was a bit of an odd man out in terms of the relative underperformance of volume versus what we saw at Nielsen. You mentioned frozen fish; could you unpack a little bit more of that?
What drove the sharp sequential acceleration and the underperformance compared to what we're seeing in Nielsen, and you mentioned that you're pursuing value over volume, which makes sense. How are you rightsizing your manufacturing network?
To adjust for the lower volumes.
Yeah, Jason, I'll come back to the kind of thing that I just shared with Alexia. If you're looking at year on year, you have to consider what was in the last year. So you got to look at it at the brand level; you've got to pull out the Omicron stuff.
Even better, look at it on a two-year stack basis.
Because you had omicron strength in single serve meals weakness this year and fish and then the bigger one is.
At the right time to get off of the 10 for 10 promotions in birds eye is now because we're in a pricing cycle, and basically, the way to think about it is in an inflationary environment you don't want to stick to your promotion practices, especially in these high-velocity promotions that are not very profitable. You don't want to stick to what where you were before and inflation.
Super cycle, you have to move off that, and frankly, while these inflation cycles are painful for manufacturers to go through to a degree, sometimes they are actually quite good for you because they become a catalyst for getting your pricing right and moving away from legacy promotions that customers are very attached to or that are low margin.
Stability. So, the timing is just right for us to go further on that.
And on the business as I cited some of it in frozen and some of it in our can business.
Got it thank you.
Thank you, and our next question today comes from Rob Dickerson with Jefferies. Please go ahead.
Great. Thanks.
Just one question from me.
Just to kind of stick to the refrigerated and frozen.
Your line of questioning.
So Sean.
Profitability margin in that.
And that segment is clearly the highest, I think we've ever seen.
And clearly, a huge step up year over year as you step up relative to Q1.
Of this year.
Yes. It sounds like maybe there are some.
Need over time to kind.
Kind of increasingly invest in that side of the business, but at the same time, you were almost hitting a 21% op margin. So.
As we think forward whether its Q4 next year five years forward.
Would you say now you've kind of reached a kind of a.
A point of profitability in that business that maybe you would have expected, coming out of the Pinnacle acquisition.
Is that level of profitability?
Sustainable, or at least within some rational range.
Factor again, the volatility of the supply chain et cetera, that's it thanks.
Hey, Rob.
Yes.
You saw pretty pretty massive expansion.
And in that frozen, refrigerated segment, part of it was where things like the vegetable promotion decisions that we made contributed to that, and it's one of the reasons why I always remind our investors.
Before you get too focused on absolute gross margin numbers focus on gross margin trajectory because through an investor's lens. That's I think what people want is they want gross margins that can sustainably move north and so.
With our company, and where we were even ten years ago, due to the lack of innovation and because of the legacy prices that were stuck at certain levels or in some cases decades, you saw that the structural margins had drifted lower – well, by unwinding that under management premium, we were raising the portfolio we have.
The ability, over time and across all of our segments, to drive northward with progress in our gross margins, is central to our strategy. That's what we're doing in frozen, and it's one of the things that contributed to the growth in the quarter. The only other color I would give on frozen specifically, is something I mentioned at Cagny- which is.
To be very profitable in frozen, you have to have scale.
We have been very deliberate over the last several years and continuing to build our scale and frozen because when you've got scale you can drive that profit in that margin improvement and if you've got the innovation program that wins with consumers and then you've got you've got the trifecta.
That's really our game plan.
And just to clarify.
Obviously, realized you're not guiding for next fiscal year.
All of us have to put something in our model. So, I'm just curious.
I looked at that percent margin operating in Q3; it doesn't sound from what you're saying that there is anything necessarily in there that was one-off, which could have inflated that in a given quarter. That's basically what you're managing toward, and hopefully, it would be somewhat sustainable.
Yeah, Rob. This is Dave. I think that's fair. I think if you kind of step back and just look at the last two quarters, and this implies further advice.
The entire domestic retail business are the gross margins have been inflicted.
The volume has been down by 8.5% to 9%. So, we've been able to improve the margins with the volume decline because it goes back to the earlier point. We know there is elasticity in pricing. So, we knew there were going to be volume declines, and we planned for them, and it's all in the forecast for the margin.
We don't see that materially changing. We're not going to give you a specific number, but I think.
Those dynamics are right and Thats why this value over volume approach is really important that we look category by category and we understand the dynamics and we focus on managing our margin as we manage it as we manage the volume.
Thanks, guys.
Thank you.
Ladies and gentlemen, this concludes today's question-and-answer session. I would like to turn the conference back over to Melissa Napier for any closing remarks.
Thank you very much for joining us. This morning, Investor Relations is available for any additional follow-up questions that you might have, and we hope everyone has a wonderful day.
Thank you. 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.