SMPL - NASDAQ

Greetings. Welcome to The Simply Foods Company's Fiscal and Second Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded. At this time, I'll now turn the conference over to Mark Pogharian, Vice President of Investor Relations. Mark, you may now begin.

Thank you, operator. Good morning. I am pleased to welcome you to The Simply Good Foods Company earnings call for the fiscal second quarter ended February 25, 2023. Joe Scalzo, Chief Executive Officer; Shaun Mara, CFO; and Geoff Tanner, President, COO, and CEO Elect are with me today. Joe and Shaun will provide you with an overview of results, which will then be followed by a Q&A session. The company issued its earnings release this morning at approximately 07:00 AM Eastern Time. A copy of the release and accompanying presentation are available under the Investors section of the company's website at www.thesimplygoodfoodscompany.com. This call is being webcast and an archive of today's remarks will be available. During the course of today's call, management will make forward-looking statements that are subject to various risks and uncertainties that may cause actual results to differ materially. The company undertakes no obligation to update these statements based on subsequent events. A detailed listing of such risks and uncertainties can be found in today's press release and the company's SEC filings. Note that on today's call, we will refer to certain non-GAAP financial measures that we believe will provide useful information for investors. Due to the company's asset light strong cash flow business model, we evaluate our performance on an adjusted basis as it relates to EBITDA and diluted EPS. We have included a detailed reconciliation from GAAP to adjusted items in today's press release. We believe these adjusted measures are a key indicator of the underlying performance of the business. The presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today's press release for a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. With that, I'll now turn the call over to Joe Scalzo, CEO.

Thank you, Mark. Good morning and thank you for joining us. Today, I'll recap Simply Good Foods second quarter and provide you with some perspective on the performance of our business. Then Shaun will discuss our financial results in a bit more detail. Before we wrap it up with a discussion of our outlook and take your questions. As most of you know, on January 30th we announced that Geoff Tanner will be joining us as President and CEO Elect. Throughout his career, Geoff has been primarily focused on marketing, sales, and innovation within the food sector. So he brings superior experience along with credentials as a terrific leader and as you'll learn incredible passion to everything he does. The Board and I are confident that under his leadership, the company will continue its track record of growth and profitability and I look forward to partnering with him to achieve a smooth transition. I'll now turn the call over to Geoff for some introductory remarks.

Thanks, Joe. I'm on it that on July 7, I will become the next CEO of The Simply Good Foods Company. As you know, Simply Good Foods is a special company with two great brands, fueled by passionate employees and loyal consumers. These attributes have delivered top tier sales and earnings growth and will continue to do so going forward. Although my official start date was two days ago, April 3, I was eager to get a running start to learn about the business and meet with many of the employees via

Thanks, Geoff, and welcome to the team. We are pleased with our second quarter performance that was greater than our expectations. During the important New Year, New Year season, Simply Good Foods Q2 retail takeaway in the US combined measured and unmeasured channels increased about 16%. As expected, US retail takeaway growth outpaced the net sales change principally due to the significant prior year retail customer inventory build. Shaun will provide more details on the difference between net sales and POS growth in just a bit. POS growth was driven by both brands. Quest performance was solid across key forms, customers and channels. Atkins continues to show growth in both measured and unmeasured channels. Additionally, Atkins e-commerce growth continues to be additive to measured channels. North American net sales performance was better than our expectations due to solid retail takeaway, although net sales were affected by some customer inventory reductions in the quarter. Additionally, international net sales were softer than our estimates due to the impact of the second price increase initiated earlier this year. Second quarter gross margin was 34.6% versus 36.6% in the year ago period. The 200-basis point decline was greater than expectations due to lower ingredient costs flowing through at a slower rate than anticipated and marginally higher other costs within our supply chain. Importantly, our supply chain team performed well with customer service near target levels. Adjusted EBITDA in the quarter was $50.9 million versus $54.2 million in the year ago period. The $3.3 million decline was better than our estimates due to North American sales performance greater than our expectations and solid SG&A cost control that was partially offset by supply chain cost inflation. International softness was greater than our forecast. Simply Good Foods retail takeaway in measured channels increased 14.2% with a good contribution from pricing and volume. Specifically, we estimate that Q2 measured channel POS was driven by about 9 points of price and 5 points of volume. Similar to the last few quarters, total unmeasured channel growth was additive to total company point of sale, resulting in a combined measured and unmeasured channel growth of about 16%. In the second quarter, Atkins and Quest combined measured and unmeasured channel growth were about 6% and 26% respectively, with performance top tier within the measured channel segments of weight management and active nutrition. Turning to Atkins second quarter performance. Atkins second quarter retail takeaway in the combined measured and unmeasured channels sequentially improved versus the first quarter and increased about 6%. Atkins second quarter POS at Amazon increased 35%. We estimate total unmeasured channel retail takeaway increase more than 25% and is about 13% of total Atkins retail sales. The brand continues to benefit from shopper channel shifting to e-commerce, as well as improved digital marketing initiatives. Brand relevance and loyal remained strong, supported by a growing base of new and total buyers. Buy rate was down slightly in Q2, although it improved from the first quarter. Moving on to measured channels in the IRI MULO and C-Store universe, Atkins second quarter POS increased 3.3% and as expected sequentially improved from the first quarter. Consistent with recessionary shopper channel shifting, performance was driven by solid trends in the mass channel offset by softness in the food class of trade. By form, Q2 shapes retail to takeaway increase 13.5% driven by solid growth across all major channels. Total Atkins bars were off 3.9%, a 300-basis point improvement for the first quarter. Meal bars, about two-thirds of the bar business increased 2.5% and were offset by snack bar distribution losses that we discussed last quarter and some pricing sensitivity from our July price increase. As expected, confection POS improved from the first quarter and Q2 confections retail takeaway was off 1.5% as we lapped the strong year ago performance of our dessert bar innovation. Importantly, the commitment to our brands in nutritional snacking category by major retailers remain strong. Although in the third quarter, we expect POS to slow as we faced tougher e-commerce comps on Atkins and anniversary promotions in the club channel that will not repeat. Let me now turn to Quest second quarter retail takeaway with the combined measured and unmeasured channel growth was 26% and continues to outpace the nutritional snacking category. In the second quarter, we estimate total unmeasured channel retail takeaway increased 21% as e-commerce strength was partially offset by softness in specialty channels. But second quarter POS at Amazon increased about 30% driven by growth across all forms. For perspective, total unmeasured channels in the second quarter were about 24% of total Quest retail sales. In measured channels, Quest retail takeaway increased 27.2% in the IRI MULO and C-Store universe. Growth was driven by solid performance across all major forms and retail channels as well as increases across all major metrics, specifically household penetration, base velocity, distribution and continued new product success. In the second quarter, Quest core bar business retail takeaway increased 24.1%. Growth was solid across original bars as well as the new minis. Consumer response in the new recipe that provides a much softer original bar is positive and driving growth. Additionally, the Hero bar is beginning to gain momentum, driven by distribution gains and higher velocities. The snackier portion of Quest products that's cookies, confections and salty snacks continued to do well with second quarter measured retail channel takeaway of 30%. Growth was strong across all snack forms as distribution gains and marketing investments continue to drive awareness and trial. Consumer response to the price increase initiated in late July is tracking mostly as expected, although elasticity on chips so far has been slightly greater than our estimates. The snacks portion represents nearly 45% of total Quest measured channel retail sales. It is already roughly equal to Quest bars in household penetration. We expect Quest snacks to continue to be a driver of the brand's growth over the next few years, driven by household penetration, as well as a solid pipeline of innovation. However, given the meaningful size of this part of the business, we expect the rate of growth over the next few quarters to moderate from its current levels. In summary, the company is uniquely positioned as a US leader in the fast-growing nutritional snacking category. We have two scale lifestyle nutrition brands that are well developed across multiple forms and snacking occasions. Our brands are aligned with the consumer mega trends of healthy snacking with the nutritional profile that's protein rich and low in carbs and sugar. This profile has broad appeal to consumers interested in health and wellness as a means to achieving their goals whether they're at home, in the office or on the go. This category remains well under penetrated from a consumer standpoint indicating a long runway for growth. This is evident in our second quarter retail takeaway of 16% that exceeded our forecast. However, as I mentioned earlier, net sales were affected by some retail customer inventory reductions. This is a watch out as we make our way through the third quarter. Our positive business momentum continued into the third quarter as March retail takeaway increased about 12%. We remain cautiously optimistic about our prospects over the remainder of the year. That said, we expect retail takeaway will moderate from current levels as we mark -- as we lap large year-ago comps and continue in an uncertain economic environment. While we expect full year fiscal 2023 gross margins to be below last year, we anticipate an improving cost environment in the second half of the year with sequentially improving margin from the second quarter to the fourth quarter. We will continue to execute against our priorities and remain committed to doing the right thing over the near and long term for our brands, our customers, and our consumers. Now I will turn the call over to Shaun, who will provide you with some greater financial details. Shaun?

Thank you, Joe. Good morning, everyone. I will begin with an overview of our net sales. Total Simply Good Foods second quarter net sales of $296.6 million was about the same as the year-ago period. This resulted in year-to-date net sales of $597.5 million, an increase of 3.4% versus last year. Looking at the Q2 drivers of growth, net price realization was about 8.2 percentage points and volume was off about 6.9 percentage points. The March 2022 agreement to license the Quest frozen pizza business was a headwind of 1.3 percentage points. As Joe stated earlier, retail takeaway growth outpaced the net sales change. On the bottom of this slide, we attempt to reconcile Q2 POS growth of 16% to Q2 North American net sales growth of 0.3%. The biggest driver of this difference is the impact of the year-ago period retail inventory build. As a reminder, in a typical year, we see retailers build inventory by one to two weeks in the first half of the year to support the New Year New You season. This bill typically comes out in Q3. Last year was atypical as most retail customers elected to build significantly higher inventory levels in the first half of fiscal 2022 and did not depleted until the fourth quarter of 2022 due to their supply chain concerns last year. We estimate the impact of this change in retail inventory compared to last year to be about an 11% -- percentage point headwind or about $30 million for the second quarter of fiscal 2023. Additionally, as Joe mentioned, the current period inventory reduction by some retailers was about a 3 percentage point impact or approximately $10 million. Lastly, the licensing of pizza was about a 1 percentage point drag. Moving on to other P&L items for Q2, gross profit was $102.7 million, a decline of $5.8 million from the year ago period, resulting in gross margin of 34.6%. The 200 basis points decline versus the year ago period was primarily due to higher ingredient and packaging costs. Versus our forecast, gross margin was off by about 50 basis points or $1.5 million due to lower ingredient costs flowing through at a slower rate than anticipated and marginally higher other cost within our supply chain. Net income was $25.6 million versus $18.5 million last year. The year ago period was impacted by the fair value change of private warrant liabilities of $12.7 million. Adjusted EBITDA was $50.9 million, a decline of $3.3 million from the year ago period. Selling and marketing expenses were $29.9 million versus $32 million last year, a decline of 6.3% largely due to the timing of spend within the year. GAAP G&A expense was $25.9 million and declined 1.3% versus last year. Excluding stock-based compensation, executive transition costs, restructuring and integration expenses, G&A declined 1.8% to $22.5 million. The $400,000 decline versus last year was primarily due to lower employee related costs. For the full fiscal year 2023, we expect selling, marketing, and G&A expense to be slightly down versus the year ago period. Moving to other items in the P&L, net interest income and interest expense increased $3 million to $8.3 million due to higher variable interest rates related to the term loan and our tax rate in Q2 was above 24.7%, about the same as last year. The tax rate in the year ago period excludes the impact of the change related to the warrant liability. Year-to-date results are as follows. Gross profit was $213.7 million, a decline of 5%. Gross margin of 35.8%, declined 310 basis points versus the year ago period. The decline was primarily due to higher ingredient and packaging costs. Net income was $61.5 million versus $39.6 million in the year ago period. The year-ago period was impacted by the fair value change of private warrant liabilities of $30.1 million. Adjusted EBITDA declined 6.8% to $111.7 million, primarily due to lower gross profit. Selling and marketing expenses were $58.5 million versus $62.5 million, a decline of 6.4% due to timing of spend within the year. G&A expenses increased 2.1% or $0.9 million. This excludes charges of $6.8 million related to stock-based compensation, executive transition costs, integration and restructuring expenses. Moving to other items in the P&L. Net interest income and interest expense increased $3.7 million to $15.3 million due to higher variable interest rates related to the term loan. Our year-to-date tax rate was about 22.7% versus 24.9% in the year ago period. The tax rate in the year ago period excludes the impact of a charge related to the warrant liability. We anticipate full year fiscal 2023 tax rate to be about 25%. Turning to EPS. Second quarter reported EPS was $0.25 per share diluted compared to $0.18 per share diluted for the comparable period of 2022. In fiscal Q2 2023, depreciation and amortization expense was $5 million and similar to the year-ago period and stock-based compensation of $3 million was about the same as last year. Adjusted diluted EPS, which excludes these items, was $0.32 compared to $0.36 for the year-ago period. Note that, we calculated adjusted diluted EPS as adjusted EBITDA, less interest income, interest expense and income taxes. Year-to-date second quarter reported EPS was $0.61 and adjusted diluted EPS was $0.73. Please refer to today's press release for an explanation and reconciliation of non-GAAP financial measures. Moving to the balance sheet and cash flow, as of February 25, 2023, the company had cash of $63.2 million. Year-to-date cash flow from operations was $53.3 million. In Q2, the company paid down $35 million of its term loan debt. And at the end of the second quarter, the outstanding principal balance was $365 million, resulting in a trailing 12-month net debt to adjusted EBITDA ratio of 1.3 times. Note, subsequent to the end of the quarter, we paid down an additional $15 million, so the current outstanding balance was $350 million. We anticipate net interest expense for the year to be about $28 million to $30 million, including noncash amortization expense related to the deferred financing fees. Year-to-date capital expenditures were $1.7 million. I would now like to turn the call back to Joe for closing remarks.

Thanks, Shaun. In a challenging economic environment, we are well positioned to maintain our marketplace momentum. Over the remainder of the year, there are solid plans in place for both of our brands that we believe will drive sales and earnings growth, particularly in the fourth quarter of the fiscal year. Therefore, we anticipate the following for fiscal 2023. We reaffirm net sales increased slightly greater than our 4% to 6% long-term algorithm. We continue to expect fiscal 2023 gross margins to be lower than last year, however, the overall cost environment is improving, including ingredients in the second half of the year and, in particular, in the fourth quarter. However, full year fiscal 2023 gross margins will decline greater than our previous estimate due to the year-to-date gross margin performance and slightly higher costs within our supply chain over the remainder of the year with most of this headwind in the third quarter. We have made significant marketing and organizational investments in the business over the past three years and believe it will result in the growth of our consumer base, distribution and market share. As such, we believe total SG&A expense will be slightly lower than last year. Full year fiscal 2023 adjusted EBITDA will increase, but slightly less than the net sales growth rate. And adjusted diluted EPS will increase less than the adjusted EBITDA growth rate due to the company's expectation of higher interest expense from an increase in the variable interest rate related to its term loan debt. As we look to the third quarter of the fiscal year, retail takeaway is off to a good start with March POS up about 12%. We have customer programming in place that should enable us to maintain marketplace moment. We expect Q3 net sales to increase slightly versus last year due to the typical retail inventory drawdown related to the first half of the year inventory build and year-ago promotions in the club channel that will not be repeated. Q3 gross margin is anticipated to decline around 100 basis points and adjusted EBITDA is expected to be about the same as the year-ago period due to lower ingredient costs flowing through slower than anticipated and slightly higher cost in other areas of our supply chain. Importantly, the retail takeaway growth in our category and our brands remain compelling. As such, we are excited about the near and long-term growth prospects and we'll continue to execute against our strategies as a path to increasing value for our shareholders. We appreciate everyone's interest in our company and are now available to take your questions. Operator?

Thank you. We'll now be conducting the question-and-answer session. [Operator Instructions] Thank you. First question is from the line of Cody Ross with UBS. Please proceed with your question.

Good morning. Thank you for taking our question. First question is just around your sales cadence for the rest of the year. We have a couple of moving pieces here. You previously noted that shipments should exceed takeaway in the back half given the unusual cadence last year. Can you remind us specifically how much you expect to ship above consumption in 3Q and 4Q? And can you also take into account the retailer inventory reductions? I think you said it was a 3% headwind or $10 million this quarter. How should we think about the retailer inventory reductions going forward?

Yes, good morning, Cody, this is Joe. I just step back because I think you summarized it well, but for those who may not as be familiar with kind of the cadence from last year. So I want to start with -- just for perspective, I want to start with the overall health of our business from a demand standpoint can be best seen in point of sale. So not nearly the noise that we're experiencing this year in net sales. So our POS on our business, we finished the quarter plus 16%. We're one month into the quarter that we're in at plus 12%. Our business -- overall health of our business from a demand standpoint is very healthy. We're cautiously optimistic as we move through the second half of the year. We've been exceeding our own expectations on POS and we feel pretty good about the momentum that we've got as we move through the second half of the year. Now, as it pertains to net sales, lot of noise in the numbers and it has -- much of it has to do with last year. So just to remind folks of what last year was like, customers having difficulty given customer service across basically the food space, they took positions in inventory that were very atypical. And in our case, big inventory build, as you saw in Shaun's comments, about 11 point differential relative POS to shipments from the inventory build last year. A typical year we would see far or less and that inventory would come up pretty quickly, normally in the third quarter. Last year that inventory didn't pull down until the fourth quarter. So we have very unusual pattern to our business, big inventory, 3 times what would have been normal, in some cases 4 times what would have been normal, none of it coming out in the third quarter, a good portion of it coming out in the fourth quarter. So the headwind that we're going to -- the headwind that we faced in the second quarter becomes a tailwind for us in the fourth quarter. And we would expect the 11 points that Shaun mentioned, a good portion of that will reverse out in the fourth quarter from a comparison standpoint. But inventory, there are many things that we as a management team control, trade inventory flows is not one of them. So we just keep our eye on it, have conversations with customers about it, but it's not something that we control. But I would expect a good portion of that reverse out that we -- the 11 point reverse out that we experienced last year that would be our tailwind. As it pertains to the year that we're in, there was -- we saw in the second quarter retailers running and not top retailers, so kind of second tier retailers. There was a 3 point drag to shipments and it's from retailers running less inventory in their systems tends to be Tier 2 customers, tends to be small regional grocery, some distributors that service our small format business, but we saw drawdowns below what was typical. So we're just going to keep our lag continue, hard to say, we're going to keep our eye on it. And obviously it's one of the reasons that we're a little bit cautious about our business as we move through the second half of the year.

Quick clarification and then a follow-up. Is that retailer inventory reduction embedded in your guidance going forward, meaning it does not come back?

Yes.

Okay. And then just secondly on the gross margin, I believe on the last earnings call, you talked about gross margin being down more than 100 basis points in the second quarter. It came down roughly 200 basis points this quarter. Can you help us understand the changes that you're making, so that the cost surprises in gross margin don't happen as frequently? And can you just help us understand what your expectations were for gross margin going into the quarter? Thank you and I'll pass it on.

Okay, Cody, I'll take that one. Thanks for the question. So let me take a step back for a second, couple of context, things for you. One, yes, the margin came in about 50 basis points or say, worse than we thought it was going to be for the quarter. Just for context, that's about $1.5 million on about a $200 million COGS number. So, I wouldn't say it's a huge thing. Really two major themes as it relates to our, say, supply chain or cost of goods sold. The first is the commodity environment and the evolution of this. If you go back to last year, we were seeing significant commodity increases, double-digit inflation, obviously, led to our pricing actions. That said, we hit an inflection point on this and we're seeing a general easing of the inflationary cost environment, specifically the softening of the spot markets in most commodities over the last six months and in particularly dairy protein. That said, our [indiscernible] inventory valued at higher price points and burning through that slower than we anticipated. Savings are there, flowing through the P&L at slower rate. That's the biggest change of our gross margin for the year. Second macro trend is really a shift in focus or prioritization of our supply chain. Last year, we were focused on improving fill rate, increasing capacity, inventory levels was priority one to make sure we can maximum -- to get to a point where we filled our customer needs. Now we're trying to maximize working capital inventory levels, improving the efficiency of the supply chain, and getting back to basics in my words. So bumps and bruises along the way, working with the co-man to get to the right finished good inventory levels and settling into this environment. So we've estimated unanticipated charges related to production runs, purchases in the overall operating environment. So all this is a transition issue and we're settling into where it want to be. We're carrying about six weeks finished goods inventory on average, servicing our customers in the mid-90s, so not totally there yet, but really close. Costs are coming down, savings are there, just a slower pace than we originally thought. As it relates to the processes we put in place, reminder, we don't own the ingredients at our co-mans, we just help them procure it overall. So we don't have the -- that on our balance sheet overall. So we're working with them now to get a better feel for what's out there. And we put place -- processes in place in the second quarter to improve that going forward. So we think we have that in place right now.

Thank you very much. I'll pass it on.

Our next question is from the line of Steve Powers with Deutsche Bank. Please proceed with your question.

Yes. Great, thanks. Maybe to follow up on that point. Can you just -- Shaun, can you clarify if sales are coming in slightly ahead of your expectations, can you just talk a little bit more about why the ingredient costs are flowing through slower than expected, this is the disconnect there or maybe I am missing something.

Well, a couple of things, Steve, I would say first of all as we've worked through, again, the commodities that we have out there, the commodities are at different price point. I'll give you an example, one of the biggest pieces of our commodity favorability we're seeing is whey. And whey protein is actually fairly down overall. The burn through that from our co-man is just coming at a slower rate than we originally had thought going forward. So even though we're selling product as we go through it, how we actually reduced the inventories to get to the point where we're actually recognizing that savings in our P&L, they just come at a slower rate. I think the second piece is, yes, we're doing better from a POS standpoint. Obviously, volume is not increasing as much POS as obviously Joe talked you through. So we're not seeing the volume and we are basically adjusting that in a co-man environment as well, getting to lower volumes. That's what they're making obviously as volume, not necessarily the price piece of that. Does that help?

Yeah. That does help. Okay.

And Steve, just say -- just so you understand, right, so you're -- we've come out -- we've come from an environment where you wanted as much inventory as you could have in your system backlog, right. So there is -- when you produce to a supply plan, not to a demand plan. So as you're bringing inventory levels down to more normal levels, your actual production levels come down. So units are running slower as we bring our inventory levels down against the same demand, right. The other context here is, we're talking about really small changes. Shaun said this. In the quarter, we're talking about a $1.5 million or nearly $200 million of cost. And as you dig into the [due to] (ph) of it, none of it is really big things. It's a smattering of small inflationary things, slightly worse than what we have anticipated. And if you just step back from all of this, we own contracts for lower ingredients. We can see the cost environment in our business changing fundamentally. It's just happening a little slower than what we anticipated.

Okay. I mean that -- because that -- that's going to -- I mean, that was sort of that's the crux of my question, because there had been these slow kind of slices that it impacts your forecast and have come cost -- results come in slightly below external forecast as this has been progressive. So the question I guess as you look forward, maybe you just answered it, but do you have the visibility and is there anything else you need to do? I mean, we've been talking about sort of a climb back to that 40% objective over time. And in this quarter we're a long -- we're a long way from it. So I'm just trying to get your [Multiple Speakers]

We're not that far from it, right. So the fundamental question you got to ask yourself, is the cost environment coming down, is it going up, coming down or is it neutral? It's coming down. I own contracts for lower cost ingredients, substantially own them. We got to get to them, right. So as units are a little bit slower, it takes a little bit longer to get to them. And then the cost environment in general in the first half of the year, little bit through the third quarter has been inflationary right. So every surprise is a cost surprise in the opposite direction, right. We're seeing that environment start to ease, right. So the question of, can you see everything, we're much better than we were at the beginning of the year in what we're seeing. But in general, the cost environment is coming down. So as we move through the second half of the year, if there are surprises, they are all in likelihood going to be going the other direction. Is that a helpful perspective. [Multiple Speakers] We're zooming in on a really small difference, right. And as Shaun said, no one thing. So we can't put our finger on is this or is that. What we're putting our finger on is, prices have been -- just costs have been a little stickier higher than what we've anticipated and it just kind of pops up in a few places and you see them, right. That environment is changing. We can see it changing. It's just happening a little slower than what we thought.

Okay. And my last question real quick just to round it out. Is -- talk -- it sounds -- just relative to what you said 3Q versus 4Q on the topline cadence, it feels like more is weighted to 4Q versus how at least our forecast their structure, I think the Streets as well and a lot of that's on the inventory catch up and rebuild lapping last year. But I'm just -- I'm listening to that against the context of the smaller -- small retailers already drawing down inventory, is there -- is there a risk that as consumption slows, inventory exits -- inventory rates and the trade exit the year just at a structurally lower level and some of this margin benefit therefore slips into the subsequent year. Is that ring fenced in your outlook or is that risk something that we should be thinking about?

Yes. Look, I think the most of our major customers, the top five customers, 70%, 75% of our shipments are operating at normal inventory levels. So eye -- we're keeping our eye on that factor. I don't -- we bake that into our estimates. I don't think it's a big issue. It's obviously was a three-point issue in the quarter. It was a little bit of a surprise. I don't expect it to be an overhang [Multiple Speakers] little bit cautious. And again just so for the quarters, the big driver of the difference in net sales performance third quarter to fourth quarter was last year's inventory drawdown. So it's -- I know, if you look at our shipments, it looks like a hockey stick in Q4, but the reality of it is, the inventory came out in the fourth quarter last year, we will ship greater than consumption from a rate standpoint just because last year's shipments were depressed in the fourth quarter.

Yes, understood. Okay, thanks so much.

Our next question is from the line of Alexia Howard with Bernstein. Please proceed with your question.

Good morning, everyone.

Good morning.

Good morning, Alexia.

So two questions. Firstly honing in on Quest, obviously, the pace of growth the consumer takeaway is still very strong and has been for quite some time. I'm just wondering what innings are you in on the distribution gains? Is it new outlets or is it more of the expansion of SKUs in certain channels? Presumably velocity is improving over time as well. But I'm just trying to figure out, you mentioned a slowdown is expected as the business gets bigger, but at what point does that happen and what are the levers can you pull? And then I have a follow-up.

I had the benefit of having watched Atkins for 10 years and watch the progress of distribution gains on average. I think Atkins MULO + C has 45 items in distribution, top retailers 60 to 65. So Quest is in very early innings. And you have to remember, we bought a business that was principally a singles business. The team -- the Quest team prior to the acquisition started looking at multi-packs. So there is opportunity in the bar business alone for us to build out distribution in larger pack sizes. You then have -- you then have the opportunity for us as we've been innovating in other snacks to build out that platform over time. So very early innings in distribution gain. More importantly on this business, lots of opportunity to drive brand awareness and trial. So relative to Atkins, everybody knows Atkins, high, high brand awareness. Quest is still relatively unknown as a brand. So the money that we've added and invested in this brand, I think when we took the brand over, we were -- the team was spending about 4% of net sales and marketing, we're now up to close to 8%. We got to keep the pressure on there to keep the brand awareness and trial growing because it's still not particularly well known as a brand. And you can see the brand promise is big. This is a big business still with relatively low brand awareness and still growing with a lot of opportunity and trial. So that's the game and I'm really excited, Geoff is exactly the guy to make that happen.

Great. And as a quick follow-up, now that you can sort of see light at the end of the tunnel on the supply chain and input cost pressures, are you beginning to see expectations that promotional activity will step up in retail or is that still on the back burner for now? Thank you. And I’ll pass it on.

Really early innings, right. So no, we're not seeing, you're asking the question as costs get better, so I appreciate that question. How do you see investing, how will you invest back? For us, we would be -- we would be looking to get marketing investment back to where we feel like is a healthy level. So as gross margins approach 40%, we want to get the marketing spend up in the 9% to 10% range, right. We will be spending that with customers on a tactical basis. Especially, we've seen some issues with pricing elasticity on some of our products. So you might start using temporary price reduction or base price reduction to get those more in line with what our consumers see the value. But those are decisions that Geoff and the team will start wrapping their mind around as we start thinking about the next fiscal year and where cost are going to come in and how we want to deploy those funds.

Great, thank you very much. I'll pass it on.

Have a good day, Alexia.

Next question comes from the line of John Baumgartner with Mizuho Securities. Please proceed with your questions.

Good morning. Thanks for the question.

Hey, John.

Joe, I wanted to ask about elasticity. You noted the downside to sales from international that was tied to the price increases, but I think elasticity isn't something we're really seeing in the US up to this point in the category at least. And I think we're also even seeing better lifts on promo relative to pre-COVID. So are there any would you say discrete factors impacting non-US markets that are driving the volume pressure or is it just general headwinds that could hit the US later in [indiscernible] 2023? And I guess I'm also thinking about [Multiple Speakers]

You're talking about what are we seeing in New

Exactly. International markets, exactly. I guess I'm looking at it in terms of the inventory reductions too, because it feels like based on sell-through, the environment in the US would be better than retailers are hunkering down.

Yes, let's start with -- let's start with our Australia and New

Okay. Okay. And just to build on that, from the category level at retail, just given the limited elasticity, the lifts on promo, are you seeing anything or do you expect to see any benefits for the category in terms of higher visibility, display in the store, maybe more momentum to out of the [HPCIL] (ph), anything coming out of COVID as retailers sort of reset these aisle and categories that you think had sustained growth for your areas going forward? Thank you.

Yes, Look, it's a great question. So, if you just step back and think about this from a category management story from a customer standpoint, so we're in the part of the store where most of the other categories think cough, cold, oral care are infrequently -- less frequently purchased categories. So, things that are store food, weekly shopping. The aisle that we're in, more like monthly shopping, right. And so one of the roles this category -- the reason each HPC loves this category, it is a foot traffic driver to the aisle. So we actually bring people to the aisle at a greater rate than their normal shopping patterns. So we serve a purpose for them and helping them build basket in a part of the store that's a higher-margin part of the store, better -- just part of the store they want to build the business in. So as you think about out of aisle display, we're a really good category for those things because it then drives people down the aisle, get shoppers in there, builds their market basket. So that behavior was true through all COVID and we're seeing that behavior continue. In fact, it's part of our category management story. This is an important -- this is important category for you in this aisle and we have two of the premier lifestyle brands that bring people to the aisle.

Thank you, Joe. Appreciate it.

You're welcome. Have a good day.

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

Hi, good morning.

Good morning.

Good morning.

Just a question on Atkins. You mentioned that the buy rates are down year-on-year. Given that mobility is improving and has continued to improve and you are now comparing against periods of lower Atkins buy rates, why are they continuing to move down? And how are you thinking about stimulating Atkins purchasing going forward among [Multiple Speakers]

That’s a good question. Thank you. Right in my wheelhouse. I love these questions. So, first and foremost, the overall health of the brand is strong. Our ability to grow buyers has continues to be simply outstanding. So we feel very comfortable household penetration, total number of buyers, total of new buyers. People are coming to the brand and that's really important. So during COVID, buy rate was driven by snacking behavior changes. And we've seen a rebound kind of from the worst part of those snacking behavior changes effect on buy rates and now our buy rate is almost flat. The driver of the buy rate -- and we've seen a rebound on bars. So it's -- we're not facing any of the not working bar decline issues. We're seeing self-inflicted issues around the mix of our business. So if you look at what's growing on the brand right now, it's strong shape growth, strong chip growth. Relative to bars, those are all from a unit purchase standpoint trade down in service. So bars are five pack or in eight pack, the chip is a single, the shake is a four pack. So we're end -- we have a mix issue with the business and it's around the pipeline of innovation that we've got. We got to get back in the bar innovation business. We got to fill out our pipeline there. That work is underway. As we move through the spring and the summer, we would expect those trends to improve as products hit the marketplace. But it's -- we don't have a COVID work issue anymore. We don't have a COVID issue. We don't have a bar issue driven by snacking behavior. We have an innovation pipeline mix issue in the business that we need to fix. And it's a good quality problem to have because we're bringing in a lot of people to the brand right now. So we just got to get our mix better.

Got it, that makes sense. That's helpful. And then my second question is just on e-commerce and just generally growth and unmeasured channels. You continued to see strong performance in e-commerce and Amazon, in particular. What's driving that? And how are you thinking about e-commerce growth in the second half given you have tougher comparisons in that channel?

Yeah, so first of all, just a little bit of the history, we -- Quest was an e-commerce startup brand, so -- it wasn't -- it was part of how the brand grew up. So when we bought the business, we bought a lot of institutional knowledge around e-commerce in a big seat at the table with Amazon. We've now -- and if you look at the -- if you look at the Quest business, our e-commerce plus specialty is around 24% of the business today. So big portion of the business. Atkins has come a long way in a short period of time. It's about 13% of the Atkins business. So what we've learned from our Quest experience is you got to get to catalog, right? You got to get the right items, the right fewer items, so that you bring consumers on the catalog to fewer items, more eyeballs enable you to promote. And getting the right items also is important to Amazon's profit mix. So we're running that playbook. So last year, you saw Atkins spike. We started that catalog rollout with shakes or shake business, had a significant step up. We're now running that playbook through the rest of the Atkins lineup. And just to give you a little bit of a sense that Atkins average price point on Amazon was somewhere around $10, $11, more like $22, $23, $24 on the Quest. So we got room to go, right. There is -- and we need to continue to improve. It pertains to the second half of the year, wrap against much bigger numbers, right. So growth is still good. We still feel really confident about the growth what you start to come at you -- going to come up against that 75%, 80% growth that we saw last year. And so the rates going to come down a little bit. We would expect over the next few years e-commerce Amazon is going to outstrip brick and mortar growth and could become a larger -- a larger portion of the business. 20%, that should be a nice target for Atkins to get it there over time.

Thank you.

You're welcome.

Thank you. Our last question comes from Rob Dickerson with Jefferies. Please proceed with your question.

Great. Joe, I just wanted to circle back to the comment you made I guess from Pam's question on kind of shakes, bars and what's going on Atkins. So on the bar side, right, I mean clearly you see it, we see it in tracked channels, volumes are still somewhat pressured. And you're basically just saying, it's just a bit of the absolute price points to the consumer given pack size is just kind of too high and too big. So like with all hands on deck is like we should be assuming, I guess that we would see maybe some smaller pack size and kind of smaller absolute price point such that velocity would have a higher probability of improving. Is that -- just trying to [Multiple Speakers]

No, actually even -- it's even simpler than that. When we -- your bid -- when you bid -- you have to step back on Atkins, right. Atkins is a high consumption brand. So -- and there are very few brands in the store like this, right. So if you're a first year buyer, you're buying about 35 servings. If you're second, third year buyer, you're buying close to 100 on average. So if you're a heavy buyer, you're at daily eater and then so. So how you innovate gives consumers the variety that they need given the buy-rate that they have, which are big buy rates in multiple years, heavier buyers, right. So how you innovate determines how people purchase. Last spring, we innovated on chips and cookies and shakes and our pipeline, in particular, on snack bars was not strong enough. So, we saw significant distribution losses on snack bars, double digit distribution losses, we got to fix that. And the reason that affects buy rate is just think, I'll do this simple -- I'll do the simple example. If I swap out a weak snack bar for a chip and the consumer comes to the shelf to buy a unit, I just traded them from a five-unit purchase or five items serving purchased to a one. That affects your buy rate, right. So it was -- for us we -- in allowing snack bars to lose distribution in favor of chips was a trade down and at buy rate issue. Something we completely control and something that we're going to fix. Is that makes sense?

Yes, that makes complete sense. And I mean also just asking the question because I feel like it does kind of all flow-through, right, just in terms of kind of the inventory, the inventory kind of de-load on bars from last year, kind of -- what kind of reverses inflows this year. But then, in terms of, if you're a retailer, you're saying I am getting higher velocity on these products innovation, maybe I'll take a little bit more inventory, like we're not bringing as much on bars, maybe I'm not as quick to get that inventory than the buyer is not as good and therefore the costs don't flow through as much, right, blah, blah, blah. So kind of was fully loaded question, is that -- does that make sense?

Well, I think clearly, if you don't have bar innovation, you're not going to have bar inventory and you're going to be in that situation. Absolutely. But I mean, to be really clear, the fixed here on buy rate, again it's small numbers of decline. So we're not talking about big declines in buy rate. It is small. It's mix driven. It's innovation-driven and we will fix it.

Perfect. That's all I had. Thanks, guys.

All right. Have a good day.

Thank you. We've reached the end of the question-and-answer session and I will turn the call over to Joe Scalzo for closing remarks.

Thank you for your participation on the call. We look forward to talking to you at the end of our third quarter. We hope you all have a good day. Thank you.