康尼格拉食品 (CAG) 2022 Q2 法說會逐字稿

Good day and welcome to the Conagra Brands Second Quarter Fiscal Year 2022 Earnings Conference Call. (Operator Instructions)

Please note today's event is being recorded.

I would now like to turn the conference over to Brian Kearney from Investor Relations. Please go ahead, sir.

Good morning, everyone. Thanks for joining us. I'll remind you that we will be making some forward-looking statements today. While we are making those statements in good faith, we do not have any guarantee about the results we will achieve. Descriptions of the risk factors are included in the documents we filed with the SEC.

Also, we will be discussing some non-GAAP financial measures. References to adjusted items, including organic net sales, refer to measures that exclude items management believes impact the comparability for the period referenced. Please see the earnings release for additional information on our comparability items. The GAAP to non-GAAP reconciliations can be found in either the earnings press release or the earnings slides, both of which can be found in the Investor Relations section of our website, conagrabrands.com.

With that, I'll turn it over to Sean.

Thanks, Brian. Good morning, everyone, and thank you for joining our second quarter fiscal 2022 earnings call. Today, Dave and I will discuss our results for the quarter, our updated outlook for the remainder of the year and why we believe that Conagra continues to be well positioned for the future.

I'd like to start by giving you some context for the quarter.

First, as you all know, the external environment has continued to be highly dynamic. But our team remained extremely agile in the quarter and executed the Conagra Way playbook. We navigated the ongoing complexity and delivered strong net sales growth anchored in elevated consumer demand that continued to exceed our ability to supply, inflation-driven pricing actions and lower-than-expected elasticities.

While our net sales exceeded our expectations, margin pressure in the second quarter was also higher than expected driven by 3 key factors. First, while we anticipated elevated inflation during the second quarter, it was higher than our forecast. Second, we experienced some additional transitory supply chain costs related to the current environment. And third, in the face of elevated consumer demand that continue to outpace our ability to supply, we elected to make investments to service orders and maximize product availability for our consumers.

We expect margins to improve in the second half of the fiscal year as a result of the levers we pulled and continue to pull to manage the impact of inflation. We'll always look to our cost savings programs to offset input cost inflation. However, given the magnitude of the cost increases, our actions also include additional inflation-driven pricing. We communicated pricing to customers again in December.

For the year, we're once again reaffirming our adjusted EPS outlook, but our path to achieve that guidance has evolved. We're increasing our organic net sales guidance based on stronger-than-expected consumer demand and lower-than-anticipated elasticities. We're also updating our margin guidance given the increase in our gross inflation expectations for the year and the timing of the related pricing actions. Taken together, we continue to believe that elevated consumer demand, coupled with additional pricing and cost savings actions, will enable us to deliver adjusted diluted EPS of about $2.50.

So with that as the backdrop, let's jump into the agenda for today's call. We'll start with an overview of the quarter before going into more detail on our outlook for the second half of the fiscal year. I'll also share some of our thoughts on the structural changes we're seeing in consumer behavior, particularly with younger consumers. We believe these changes are further evidenced in the long-term potential of Conagra Brands.

Let's dig into the quarter. As you can see on Slide 7, our team delivered solid Q2 results. On a 2-year CAGR basis, organic net sales for the second quarter increased by more than 5% and adjusted EPS grew by nearly 1%.

As I noted earlier, we delivered these results in the face of a highly dynamic and challenging operating environment. Input cost inflation came in higher than expected in the quarter. In addition, we made some strategic decisions to service the heightened consumer demand we continue to experience.

As the entire industry incurred transitory costs associated with labor shortages, supply issues on material and transportation costs and congestion challenges during our Q2, we chose to invest in our supply chain and service orders. This deliberate decision ensured we could deliver food to our customers and consumers especially during the holiday season.

Maintaining physical availability is an important part of building trust with customers and maintaining consumer loyalty. The bottom line is that amid the supply disruption seen across the industry, we remain focused on building for the long term. While the net result of these factors was a negative impact on our margins during the quarter, we're confident that our purposeful approach better positions our portfolio for the future.

I want to take this opportunity to thank our tremendous supply chain team. They've been resilient in navigating this environment, allowing us to remain agile and deliver for our customers and consumers. I continue to be impressed by our team's commitment, and I'm grateful for their ongoing dedication.

Looking at Slide 10. You can see that our strong performance in the second quarter was broad based. Total Conagra retail sales were up 14.8% on a 2-year basis in the quarter, with double-digit growth in each of our domestic retail domains: frozen, snacks and staples.

Household penetration was also up this quarter, building upon the significant number of new consumers we've acquired over the past 2 years. Total Conagra household penetration was up 59 basis points on a 2-year basis, and our category share increased 41 basis points.

In addition to increasing household penetration and acquiring new consumers, we are retaining our existing consumers, as demonstrated by our repeat rates. Shoppers continue to discover our incredible products and their tremendous value proposition. As the chart on the right of Slide 11 shows, our consumers keep coming back for more.

As we execute our Conagra Way playbook, innovation remained a key to our success across the portfolio in Q2. Slide 12 highlights the impact of our disciplined approach to delivering new product and modernizing our portfolio. During the second quarter, our innovation outperformed the strong results we delivered in the year ago period. We continue to invest in new product quality, and it's supporting our innovation launches with deeper, more meaningful consumer connections. Once again, our innovation rose to the top of the pack in several key categories, including snacks, sweet treats, sauces and marinades and frozen vegetables.

Slide 13 demonstrates how our ongoing investments in e-commerce continued to yield strong results. We again delivered strong quarterly growth in our $1 billion e-commerce business, and e-commerce accounted for a larger percentage of our overall retail sales than our peers. We outpaced the entire total edible category in terms of e-commerce retail sales growth during the second quarter, just as we did in the first quarter of 2022 and throughout fiscal 2021. As we mentioned earlier, our strong net sales growth was driven by elevated consumer demand, favorable elasticities and inflation-driven pricing actions.

On Slide 14, you can see the extent of our pricing actions in the first half of the fiscal year. During this period, our on-shelf prices rose across all 3 domestic retail domains. And, as Dave will discuss shortly, the pricing flowed through the P&L.

As you can see on Slide 15, price elasticity has been fairly low. It's been favorable to our expectations. Consumers continued to see the tremendous value of our products relative to other food options, a concept I will elaborate on in a few minutes.

Now let's turn to the path ahead. You can see on Slide 17 we currently expect gross inflation to be approximately 14% for fiscal 2022 compared to the approximately 11% we anticipated at the time of our first quarter call. This is a large increase, and we're taking actions to offset the increase while still investing in the long-term health of our business.

To help manage our increasing inflation, we're taking incremental pricing actions, including list price increases and modified merchandising plans. Many of these actions have already been announced to our customers. As a reminder, there is a lag in timing between the impact of inflation and our ability to execute pricing adjustments based on that inflation. As a result, the incremental price increases will go into effect in the second half of the year with the most significant impact during the fourth quarter.

While it's easy to get caught up in the quarter-to-quarter impact of inflation and pricing, it's important to keep focused on the big picture. The long-term success of our business is driven by how consumers, particularly younger consumers, respond to our products. And when you take a step back to evaluate the broader environment and how our portfolio delivers against the needs of the modern consumer, we believe that Conagra is uniquely positioned for the future.

As we've detailed many times before, Conagra's on-trend portfolio filled with modern food attributes is winning with younger consumers. And our confidence is underpinned by the many changes we're seeing in consumer behavior that are proving to be structural, especially given that these changes are driven by younger consumers that represent the most significant opportunity for long-term value creation.

Younger consumers represent a large and growing part of the U.S. population, and they want to optimize the value that they get for the money they spend on food. A large part of optimizing their food spending includes shifting more dollars from eating away from home to eating at home. As they make that trade, they're choosing national brands. And we believe Conagra is ideally positioned to experience an outsized benefit from these behaviors given the relationship our brands are forming with younger consumers. Overall, Conagra is delivering superior relative value to consumers compared to both away-from-home options and store brands.

Let's take a closer look at these trends, starting with the population changes.

Slide 20 highlights the demographic shift underway in the U.S. Millennial and Gen Z consumers are a large and growing cohort. These consumers are starting to settle down, buy homes and start families. As we presented in the past, when people enter the family formation phase, they increase the amount of food they eat at home with an outsized increase in the consumption of frozen foods. And what we find particularly important about reaching Millennial and Gen Z consumers is that we believe they will remain more value focused than their predecessors.

First, let's talk about the near term. As you can see in the chart on the left, Millennial and Gen Z consumers are earlier in their careers and earning less than the older generations of working-age people. This is natural, but it bodes well for food-at-home trends in the shorter term. We believe that even as foodservice bounces back, younger consumers will be value conscious in their food choices.

Fewer younger consumers are expected to achieve the financial success of the generations before them. The data on the right suggests that Millennials are more likely to earn less than their parents. We believe this means that these savvy consumers will look to stretch their food dollars further even as they age.

The data also shows that younger consumers are already eating more at home. Compared to the population as a whole, Gen Z and Millennials have decreased restaurant visits more and sourced a larger percentage of their meals at home.

As these younger consumers have made the shift to at-home eating, the data shows that they're finding comfort in the quality, reliability and familiarity that national brands provide. We believe this makes a lot of sense. National brands provide value while replicating many of the on-trend flavors and modern food attributes that consumers are used to experiencing in away-from-home dining. When consumers make trades like away-from-home to in-home eating, trust is paramount. In short, national brands, particularly modernized brands like those in our portfolio, deliver on this trust imperative, and that's because they offer superior relative value versus other food options.

As consumers seek to stretch their household balance sheets in the face of broad-based inflation, one of the single largest levers available to them is the reduction in spending on food away from home as food-away-from-home prices are typically over 3.5x more expensive than food-at-home prices. This trade will likely become even more important for consumers as food-away-from-home prices have already increased faster than at-home prices in calendar 2021, and they are expected to increase at nearly twice the rate as at-home prices in calendar year 2022.

Our aggressive modernization of the Conagra portfolio over the past several years has put us in a strong position to capitalize on these structural shifts. Our portfolio has shown its competitive advantage with excellent trial, depth of repeat and share gain performance. Overall, we believe Conagra is well positioned to leverage these shifts to create meaningful value for shareholders.

And Slide 25 shows you the data to support our claim. Conagra is attracting more younger consumers than our peers and getting them to repeat at more attractive rates. By appealing to younger consumers now, we're building superior consumer lifetime value.

Importantly, the data shows that these new, younger buyers are stickier across our portfolio. We believe this comes back to the investments we've made and continue to make in our products and our brands. The Conagra Way has positioned us to win.

As I discussed earlier, we're reaffirming our adjusted EPS guidance of approximately $2.50 for the full year with a few updates on how we expect to get there. We're increasing our organic net sales guidance to be approximately plus 3%, up from approximately 1%. We're slightly adjusting our adjusted operating margin guidance to approximately 15.5%, down from approximately 16%. And we're updating our gross inflation guidance to about 14%, up from approximately 11%.

Now that I've highlighted our performance for the quarter and strong positioning for the future, I'll turn it over to Dave to provide more detail on our financial performance.

Thank you, Sean, and good morning, everybody. I'll start by going over some highlights from the quarter shown on Slide 28.

As Sean mentioned earlier, there were a number of factors that influenced our results this quarter. First, we were encouraged to see that consumer demand for our products remain strong. And second, elasticities were better than anticipated.

However, we also continued to see inflation rise across a number of key inputs, and the dynamic macro environment created challenging conditions for the supply chain. The team remained agile in response to these dynamics, including the decision to make additional investments during the quarter to meet the elevated demand and maximize the food supply to our consumers. Overall, our actions favorably impacted our top line during the quarter with organic net sales up 2.6% compared to the year ago period.

An important part of the top line success we've realized throughout the pandemic is our ongoing commitment to the Conagra Way. We've remained focused on building and maintaining strong brands across the portfolio. We continued these efforts in the second quarter with continued product innovation and by further increasing our spending on advertising and promotion, primarily focusing on e-commerce investments.

We show a breakdown of our net sales on Slide 29. The 4.2% decline in volume was primarily due to the lapping of the prior year surge in demand during an earlier stage in the COVID-19 pandemic as volume increased approximately 1% on a 2-year CAGR. The second quarter volume decline was more than offset by the very favorable impact of brand mix and inflation-driven pricing actions we realized this quarter, driving an overall organic net sales growth of 2.6%.

On last quarter's call, we noted that the domestic retail pricing actions were just starting to be reflected on shelves at the end of the first quarter. Those increases were reflected in our P&L this quarter, driving the 6.8% increase in price/mix. The divestitures of our H.K. Anderson business, the Peter Pan peanut butter business and the Egg Beaters business resulted in a 70 basis point decline, and foreign exchange drove a 20 basis point benefit. Together, all these factors contributed to a 2.1% increase in total Conagra net sales for the quarter compared to a year ago.

Slide 30 shows our net sales summary by segment both on a year-over-year and on a 2-year compounded basis. As you can see, we continue to deliver strong 2-year compounded net sales growth in each of our 3 retail segments, which resulted in a 2-year compounded organic net sales growth of 5.3% for the total company.

You can see the puts and takes of our operating margin on Slide 31. We drove a 6.2 percentage point benefit from improved price/mix, supply chain-realized productivity, cost synergies associated with the Pinnacle Foods acquisition and lower pandemic-related expenses.

Netted within the 6.2% are the additional investments we made to service orders and maximize product availability. These investments reflect the dynamic environment and actions we've taken to respond to it. This includes decisions to utilize more third-party transportation and warehousing vendors for some of our frozen products, incurring incremental cost to move product around our distribution network to better align with customer order patterns and delaying a plant consolidation productivity program to maximize current production. The 6.2% also includes transitory supply chain costs such as higher inventory write-offs and increased overtime to support operations.

The 6.2 percentage point benefit was more than offset by an inflation headwind of 11 percentage points. The second quarter gross inflation rate of 16.4% of cost of goods sold was approximately 100 basis points or $20 million higher than expected, driven by higher-than-anticipated increases in proteins and transportation, which are both difficult to hedge.

The combination of the favorable margin levers, our choiceful supply chain investments and inflation headwinds resulted in adjusted gross margin declining by 483 basis points. Our operating margin was further impacted by 20 basis points due to our increased A&P investment during the quarter, as I mentioned earlier.

You can see how these elevated costs impacted each of our reporting segments on Slide 32. While each segment was impacted, our Refrigerated & Frozen segment was impacted the most with adjusted operating margin down 707 basis points primarily due to outsized materials inflation and the additional investment incurred to service orders and get food delivered to consumers. We are confident that we will improve overall operating margins in the second half as we execute our additional pricing actions to offset the higher inflation rates.

As you can see on Slide 33, our second quarter adjusted EPS of $0.64 was heavily impacted by the input cost inflation across our portfolio. Even though the benefits of our first quarter pricing flowed through the P&L this quarter, the incremental inflation we incurred in the second quarter created an additional headwind. In response, we announced additional pricing to customers in early Q3 during December. Although we have yet another lag before this pricing benefits the P&L, we expect to realize benefits from these pricing actions in late Q3 with most of the impact in Q4.

Also, our Ardent Mills joint venture had another good quarter and delivered EPS benefit versus the prior year. We realized lower net interest expense and a slightly lower average diluted share count due to our share repurchases in prior quarters.

Turning to Slide 34. I want to unpack how Q2 adjusted EPS landed versus our expectations.

Our second quarter adjusted EPS came in lower than we originally had anticipated due to 2 main factors. First, as previously mentioned, inflation came in higher by approximately 100 basis points of cost of goods sold or approximately $0.02 to $0.03 of EPS. While we have announced additional pricing actions for the second half to offset the incremental inflation, the timing of these benefits is naturally lagging behind the higher inflation. Second, the cost we elected to incur to service orders, coupled with the additional transitory supply chain costs I described earlier, led to another $0.02 to $0.03 impact on our adjusted EPS. We are forecasting these service and transitory cost dynamics to improve as the second half progresses.

Looking at Slide 35, we ended the quarter with a net debt-to-EBITDA ratio of 4.3x, which is in line with the seasonal increase in leverage expected for the second quarter. We expect to generate strong free cash flow in the second half of the fiscal year and expect to end the year with a net leverage ratio of approximately 3.7 to 3.8x. We remain committed to a longer-term net leverage target of approximately 3.5x and to maintaining an investment-grade credit rating.

I want to close today by reviewing the factors driving the updated guidance we issued this morning, which is shown here on Slide 36.

I'll start by saying that we remain confident in our ability to achieve approximately $2.50 in adjusted EPS for the full fiscal year. As the macro environment continues to be very dynamic, our expectations for the path to achieve that target have shifted. We are increasing our organic net sales growth guidance to approximately 3% to reflect our stronger-than-expected performance year-to-date as well as our incremental pricing actions in the second half.

We are lowering our adjusted operating margin guidance to approximately 15.5%. We expect the incremental sales and pricing actions in the second half to offset the dollar impact of the incremental net inflation and other supply chain costs.

We have increased our gross inflation expectations to approximately 14%, largely driven by higher estimated costs versus the previous estimate for proteins, transportation, dairy and resin. We will continue to monitor these input costs closely and will be quick to respond using all available margin levers. As Sean detailed, price elasticity has been favorable to our expectations so far.

As we have explained previously, there is a lag in timing between when we experience inflation, take actions, including pricing, to offset the dollar impact of the inflation and when we see those actions flow through our financial results. With respect to the additional pricing actions we have announced for the second half of fiscal '22, we expect to realize a small amount late in the third quarter and the full benefits from these price increases in the fourth quarter.

We, therefore, expect our third quarter margins to be roughly in line with second quarter margins with an increase in operating margins in Q4 as the pricing catches up with inflation and the impact of the lag is reduced. Our guidance also assumes that the end-to-end supply chain will continue to operate effectively as the COVID-19 pandemic continues to evolve.

Before turning it over to the operator for Q&A, I would like to reiterate that confidence in our ability to reach our earnings goal is based on the strength of our business at its core to manufacture and deliver foods that people enjoy.

That concludes my prepared remarks today. Thank you for listening. I'll now hand it back to the operator for questions.

(Operator Instructions) Today's first question comes from Andrew Lazar with Barclays.

Two questions for me, if I could. First, maybe Sean, you mentioned several times that elasticities remain sort of below expectations than maybe what you've seen historically. I realize there are a lot of dynamics at play that lead to that. I'm trying to get a sense of what you're building into sort of back half guidance along these lines in terms of elasticity just given more pricing is obviously set to keep rolling in, as you've talked about.

And does some of your expectation take into account the potential fading of some government stimulus? And how does that play a role again? And how you think about elasticity? And then I've just got a follow-up for Dave.

All right. Sure, Andrew. Let me hit that elasticities and stimulus.

I'd say our year-to-go outlook takes into consideration everything that we've seen in the marketplace to date and as well as our planned pricing and merchandising actions in the year-to-go period.

I will tell you that I see, with respect to elasticities, a major difference in the marketplace today in terms of how consumers are assessing value versus what I've historically seen in the past. Previously, a consumer's comparison of choices was between close proximity items inside the grocery store. Today, due to the demographic dynamics I talked about around young consumers home nesting as well as the huge move to working from home. The biggest comparison taking place from a value standpoint is between away-from-home choices and at-home choices. And as I said in my prepared remarks, the consumer is showing us that modernized national brands like ours are offering superior relative value, and that's having a positive impact on elasticities that we expect to continue. But we have factored in our year-to-go actions.

In terms of reduced stimulus payments, particularly SNAP, the short answer is we don't believe that the eventual end to the emergency allotments in the SNAP program is going to create a material headwind to our business. And fundamentally, it comes back to that superior relative value of our portfolio versus alternatives, but let me unpack this one a bit because I know it's been kind of a hot topic.

Since the start of the pandemic, consumers were actually able to reduce their overall food spending significantly. And that reduction was driven by the mix shift from higher-priced food away from home to lower-priced food at home. And at the same time that consumers have been able to save money on food because of that shift to food at home, many have also been receiving these COVID-related stimulus payments on multiple fronts, including for some higher SNAP benefits.

Now as this one component of consumer cash flow changes, that is as the emergency allotments in the SNAP program, sunset, we're not seeing and we don't expect to see a meaningful shift away from the newly created behaviors we talked about around eating national brands at home.

There are a few things that I think you need to keep in mind here. First, the reduction in SNAP dollars in the total ecosystem is already happening as a slow peeling back. It's not a cliff. Now to that point, the number of individuals receiving any SNAP benefits today has been declining versus pandemic highs already, and individual states are ending waivers and emergency allotments on their own schedules. It's not a onetime event.

Second, I'd say recent permanent changes to the SNAP program have actually raised core continuing SNAP benefits to a level that is higher than pre-pandemic. So the core SNAP consumer who has also benefited from other stimulus is going to have higher SNAP budget coming out of the pandemic than he did prepandemic.

And then third, the USDA forecasts that food-away-from-home prices are going to rise faster than food-at-home prices, and that maintains the value proposition of food at home for consumers.

And then finally, I'd just say, and perhaps most importantly, the early data does not show that as SNAP benefits end, consumer behavior changes relative to food at home. We are, as you can imagine, closely watching the states where emergency allotments have already ended, and we have not yet seen a significant change in consumers' purchases of packaged foods. And that, we believe, is because, as I said, our brands are offering superior relative value versus both away-from-home alternatives and store brands, especially given the huge move to working from home.

Great. That was very helpful perspective. And then just a quick one for Dave. And my sense is you'll get a lot questions along these lines, Dave. But obviously, given your expectations that you just talked about in terms of margins for 3Q, I think they're some 150, 200 basis points sort of below maybe where consensus was looking for. And I get it's timing lag around pricing coming through and impacting 4Q more significantly and then some of these incremental costs starting to sort of fade a little as the year goes on.

So I guess my question is, it puts, obviously, a lot more pressure on 4Q to kind of deliver the year. I guess are you -- would it be your sense that you're building in some level of flexibility to that based on what it requires in 4Q? And I guess what's your level of visibility to that at this stage given it does seem like it's more 4Q loaded? So it's a broader question, but you sort of get where I'm coming from.

Yes, no. And you summarized it well, Andrew. Let me try to walk through it so I can kind of hit the kind of the big puts and takes.

So as I mentioned in my remarks, we expect Q3 operating margins to be roughly in line with Q2 margins and then Q4 margins up. If you look at the puts and takes from Q2 to Q3, we've increased our total inflation estimate for the year from 11% to 14%. So now we expect second half inflation to approximate 11.5%, and that's off of a prior year inflation that was about 6.5%.

We also expect that some of the additional costs we incurred in the second quarter to support shipments and getting product to consumers will continue into the third quarter given the continued challenges in supply chain. We're forecasting that this complexity will gradually improve as we approach Q4 and the March time frame.

The additional pricing actions, which are critical, we announced in December and they were accepted, and we have a small impact in Q3 given the timing, but we'll have a much bigger impact on Q4 from the pricing. So the pricing has been announced, it's been accepted, and we have very good visibility to that for forecasting purposes. So Q4 will benefit meaningfully from these pricing actions. We expect price/mix to approximate 10% in the fourth quarter as we'll start to catch up with the inflation and the reduced pricing lag that impacted us through the first half and will impact Q3.

Q4, as you mentioned, will also benefit from the decline in incremental costs to support shipments that I just referenced as well as a decline in some of the transitory costs that hit us in Q2 as well. So it's important to note that although we expect meaningful improvement in Q4, we're still forecasting higher inflation, as I mentioned. So if you look at our cost per unit of volume, we expect that to continue to increase in H2 before being offset by the pricing in Q4.

And the next question today comes from Ken Goldman at JPMorgan.

Dave, I just wanted to clarify. When you said to expect 3Q's margin to be roughly in line with 2Q's margin, is this comment solely about the operating margin? Or should that roughly apply to the gross margin as well?

Well, I was commenting on the operating margin, but that's driven by the gross margin.

Okay. Perfect. And then I wanted to clarify. You mentioned inventory write-offs, I think I heard, and higher overtime expenses as maybe some of the examples of 2Q's nonrecurring challenges. I guess, number one, can you elaborate a bit, if I did hear that right, on what the write-offs were? And can you also talk a little bit about labor availability over the last couple of weeks maybe as Omicron has started to affect more people? And how much of that risk is baked into your guidance as well?

All right, Ken, it's Sean. Let me start with the back piece because I know that's also a hot topic. And you wrote about it the other day, which is absenteeism.

And what I'd say there is, I told my team back in July the word of the year this year is perseverance, and that has certainly proven to be true. We faced a number of factors that have converged to create a persistently challenging operating environment, things like sustained elevated demand alongside a protracted pandemic and a strained supply chain and acute inflation. But against that backdrop, I'd say our team has done a remarkable job persevering and doing everything possible to keep our food in consumers' hands, particularly in Q2, which is our largest volume quarter.

But to your point, clearly, it's not perfect yet, and I think it's entirely reasonable for all of us to project that the next month or so could remain strained within the supply chain as Omicron runs its course. But I'd say we'll persevere through that, too. But as you saw in Q2, and you referenced some of the things, not at normal efficiency, which is a factor as to why margins in Q3 are expected to be similar to what we put up in Q2.

But we will persevere because keep in mind that Q3 is a smaller quarter volumetrically than Q2, call it, 5% to 10% less volume on average. We also have a geographically diversified manufacturing footprint across our plants and those of our co-packers'. We don't have like one big mega plant. And as we saw early in COVID, there are steps we can take to maximize line efficiencies and throughput, things like SKU simplification, et cetera. And as I mentioned earlier, we're -- we've already tightened up our merchandising activity in the year-to-go period.

So collectively, these things should help ease the impact of Omicron-driven absenteeism. And importantly, as you highlighted in your note from Tuesday, there's good reason to believe that, that challenge will be short lived.

So I'd say to sum up, the team is staying agile. And as we move beyond Q3 and into Q4, clearly we see opportunity. We'll begin to wrap the onset of input cost inflation. Our most recent pricing actions will be rolling into market and Omicron-driven absenteeism should be diminished. And all of that positions us to deliver meaningful improvement in multiple metrics as we go into the final quarter.

Dave?

Yes. So let me get the first part of your question, Ken.

So yes, we were impacted $0.02 to $0.03 in the quarter from incremental transitory costs, and that included higher overtime across all of our supply chain operations given the labor challenges and higher inventory write-offs.

Regarding the inventory, in this environment, it's no secret the end-to-end supply chain has been strained. We're moving fast to meet demand, as are our suppliers. So our food safety and quality standards are the highest priority for this company and include product from suppliers that we use as well. We have thorough processes for ensuring that the raw materials and finished goods meet our standards before they're utilized. And if not, we write them off. And that's what happened in Q2. We do believe that this impact is transitory in nature as we move into the third quarter. So we always have some level of inventory write-offs, but this was higher than we expected for those reasons.

And the messaging, just to wrap it up, is not a demand-driven write-off. It's a supply chain-driven issue, meaning demand is still there?

Yes, I'll get that. That is...

Yes.

Supply chain is a complex thing and there are like multiple facets. And when each of them run into challenges, it tends to have a bit of a compound effect, and this is the kind of friction that you see during those kind of transitory windows.

And our next question today comes from Bryan Spillane at BofA.

Just two quick ones for me. Maybe the first, Dave, can you give us a little bit of help with some color on some of the below-the-operating profit line items for the balance of the year or for the full year? I think interest expense consensus is around $380 million. Equity income, I guess, with Ardent Mills, it's -- there are some tailwinds there. So maybe that will be up. The -- and also the tax rate. If you could just kind of help us a little bit in terms of how we should be thinking about the below-the-operating profit line for the full year.

Sure. I think on the interest expense, I think that number is in line, the one -- the number that you quoted, the $380 million. Ardent, we had benefit in the quarter, which you saw, and we expect to continue to have benefit. So we see upside in Ardent, and that contributes to our EPS, call it, $2.50. So we have upside in Ardent year-to-go. And the tax rate should be in line with the 23% guide that we have. We're a little favorable this quarter slightly, but that's the right rate to use.

Okay. And then, Sean, just as we're -- as you're in this inflationary period, and I think you mentioned maybe in response to one of the questions just adjusting merchandising, pre-COVID, there was a -- more of an emphasis to spend, I guess, above the sales line because that was kind of where the bang for the buck was. And now it seems like if that -- there's not a real incentive to do that here. Are you shifting more of that spend into A&P? And is that sort of going to be an ongoing thing, especially as we're kind of in this inflationary environment?

Yes. I would not think of it that way, Bryan. The money that is spent in brand building above the line, there's all kinds of investments in there. Traditional merchandising is one of them. My comments in the prepared remarks today were basically about not being as aggressive as we typically would on normal in-store merchandising. And so that piece of it, we've been very consistent on since the part -- start of the pandemic because it just doesn't make sense to stimulate excess demand when you're already having trouble servicing the demand you've got.

The other investments that we make above the line have been robust for several years now, and that won't change because that's where we get the best -- some of the best ROI we get in brand building. It's everything from investing in COGS through all the product innovation and packaging innovation we do, to investing with our customers to get the right merchandise, to get the right physical placement on the shelf in terms of getting our new items in the store, getting the right kind of support in store, investing with our customers on things like sampling and in-store theater. So those investments are really brand-building investments, and those have continued strong. The piece of the above the line that I was referring to was exclusively that merchandising piece.

And then with respect to the A&P being up in the quarter, that, as I've said before, can change any given quarter depending upon what our innovation agenda is. If we have a new item hitting the marketplace that we want to spotlight and A&P is the right way to go, particularly in e-commerce, which we continue to drive, we'll put that money there. So that will move around quarter-to-quarter, but no philosophical changes in the way we spend.

And our next question today comes from David Palmer at Evercore ISI.

Question on Slide 31, that 620 basis point benefit from productivity, hedging price, mix and other. I just would love to dig into that a little bit. You have pricing of 680 basis points. And I would imagine you might have a few hundred basis points of productivity and some hedging benefits. So that number could be seen as low, but obviously, there are some headwinds in there. Could you dig into that and maybe give a sense of the headwinds offsetting what might be significant benefits of pricing and productivity?

Sure, David. Let me give you a kind of a high-level bridge.

So we clearly had the benefit of pricing. We always combine price/mix, right? So we did have unfavorable mix in the quarter. A primary driver of that is because our away-from-home segment was up 15%, and that's a lower-margin segment. So you get the unfavorable segment mix there. And there is some unfavorable brand mix embedded in the business. But the away from home is the big driver there.

But You're right, we have productivity and sourcing. Combined, we had over 500 basis points of favorability there or improvement. But then the additional supply chain costs that we incurred that I went through plus absorption hit us because volumes were down. We had forecasted that, but that's in those numbers. So that's a headwind for the additional supply chain costs outside of inflation, which we show separately. So that's a high-level bridge to get you to the 620.

And then as you're looking through the rest of the year, can you give a sense even directionally about some of those line items, how you're thinking about -- I mean, it sounds like we're going to get some more pricing benefit. Perhaps how you're thinking about the cadence and directions of those items on gross margins.

Yes. So from a price/mix perspective, we're estimating price/mix now will be approximately 6% for the year. So Q3 should be in line with Q2. And as I mentioned, Q4 price/mix, we expect to be at about 10%. So clearly, there's a benefit there.

We continue to expect our productivity to click along, as it's done, both our core productivity and our sourcing benefit. So that will continue to track. We laid out the inflation and kind of what that looks like. So they're really the key drivers.

And then as I mentioned, David, the cost we got hit with in Q2, the transitory costs, we really expect those to start to go down in Q3 and into Q4. And then some of the incremental costs to support selling and getting product on shelves, that will continue through Q3 and then we expect that to decline in Q4. So that's a high-level kind of bridge.

And I'll stop here, but the supply chain friction costs, whether those -- you're really calling them transitory or another, but you can see that during COVID, there's a lot of these costs. How much of that would you estimate is in the fiscal '22 gross margins that you're anticipating overall? How much of the supply chain, you call it, COVID-era friction costs do you think are weighing on that 15.5% overall margin?

David, let me get back to you on that because there are so many different components of cost. I want to go through that to make sure that I classify it right.

Yes, Okay.

Yes, things are on the move clearly, David, and we can see it. Some things had begun to improve more recently and then you got -- Omicron comes in. So things are still moving in terms of multiple things going in different directions.

But we do see some of these friction points improving based on our best available information right now as we kind of move out of Q3 and into Q4, and that's part of what helps the gross margin piece improve in Q4. But there's more to it than that in terms of gross margin recovery in the fourth quarter and frankly beyond the fourth quarter.

And I come back to the big picture, which is the key to navigating these acute inflationary cycles, is 2 things: a, brands that resonate with consumers; and b, perseverance. Because the former enables implementation of inflation-driven pricing and a benign consumer response to that pricing, we have both of those things in place, and that's critically important for this company. The latter, perseverance, is an important reminder that once you wrap acute inflation with pricing in place and strong demand, material improvements, they can come pretty quickly. And so sharp inflections are fairly common when these 2 things are in place, pricing and benign consumer response.

And all the data we have suggest that consumers, particularly our younger ones, are seeing our products as being in that value sweet spot between away from home and store brands, and it's driven by demographic dynamics and the huge move to working from home. So all of that says we're coming to kind of the end of this really challenging period as we kind of get into Q4, and that's a good setup on the other side.

And our next question today comes from Jonathan Feeney at Consumer Edge.

A couple of questions. First, a detailed one. If I look at the bridge between measured pricing, what appears to be, you could weigh things across the months differently, that looks like about 9% and your realized price/mix was about 6.8%. Like I realize scanner doesn't cover everything, but if you could comment, Dave, particularly on any of the big buckets of things that affect that lag. I'm particularly concerned about whether it is the case that retailers maybe are margining up on some of -- on this pricing environment.

And maybe a related question would be, broadly -- Sean, you mentioned several times, elasticities are low. That's clearly the case. Utilization is high. You can't even make enough things for the consumers' demand you know is there. What -- big picture, like what is preventing -- maybe as an industry or an ever detail you're comfortable getting into, what is preventing pricing from getting through because it's been a while now. So any comments you have on that?

Well, I would just say that I think the pricing is getting through. We've certainly been very upfront with our customers about the true cost inflation we are experiencing and what we believe is the justified action or, in this case, actions -- consecutive actions to take price. And different -- we don't control what customers do with the price they put on shelf. But I'd say on average, they tend to pass it through pretty close to the way we pass it through to them. There may be some that take a small margin grab. Equally, there may be some that compress because they want to gain market share. So it tends to come out in a wash, and it tends to be pretty much in lockstep.

But what I would say is keep following the scanner data because we anticipate that the pricing actions that we take are going to show up in that scanner data. It's unfolded thus far, Jon, pretty consistently with what we expected.

Yes. And Jon, I would just say, to my previous point, mix does impact that 6.8% number. So we had some negative mix in the quarter. .

I got you. And Sean, yes, that's clear, clear you're exiting the quarter with much stronger pricing at scanner.

Our next question today comes from Robert Moskow with Crédit Suisse.

A couple of questions. I think your forecast says that you expect these transitory costs to dissipate in the second half of your fiscal year. But did you experience them in December and in January in your fiscal third quarter? Because I would imagine absenteeism and these issues would have continued. Are you experiencing it now in the third quarter?

And then the second question I had is, ,I looked at what's changed in your -- in my model anyway, is it looks like you raised your pricing guidance for the year, but you didn't really change your volume guidance for the year. And I know you've talked through your confidence in the elasticity and all that. But when pricing gets up to 10% in the May quarter, I mean, that's a significant change for what consumers are going to see. And you're also going to have an Omicron wave that's going to be fast and dissipate quickly. So you might have consumers relieved that it was mild and quick and may go back to restaurant eating faster than you think. So am I correct that you didn't change any volume estimates for the year in relation to price?

Let me comment on the first piece because in terms of Q3, as I mentioned in my response to Ken a little bit ago, we don't expect Q3 to operate at what I'll call normal efficiency. And Dave talked about some of the transitory expenses in Q2 that we were willing to incur because we were determined to get as many boxes of product as we could into consumers' hands. And so that's an inefficiency. And that -- there are a variety of things that created that in Q2. We think some of that dynamic will persist in Q3, although it might look differently. It might be more Omicron-driven absenteeism for the first, whatever it's going to be, 6, 7 weeks of Q3 and less of something else where we've seen improvements already taking place. So that's what I was referring to earlier when I said some things are already improving, then there's other things a bit of whack-a-mole that start to create a bit of a headwind like the Omicron absenteeism.

But when you put it all together on that piece of it, I'd say we'll persevere. That's why we expect volumes -- we're still focused on getting as much volume as we can out in Q3 even if it comes at less efficiency than what we normally expect.

And then as we exit Q3 and go into Q4, we expect some of those friction points will diminish. I think it's reasonable to expect them to diminish. And then as we wrap pricing, that's when you start to see the meaningful margin expansion.

In terms of sales, Dave, I know you got some comments here for Rob. But I -- Rob, one thing I want to keep coming back to here is the calculus on how the consumer determines value. Historically, it might be widget A versus widget B side by side on the shelf. And if you see a $0.20 increase, it translates to meaningful elasticity. That's not the comparator today. The comparator today is we are selling a product that might have been $2.69 and it might go up to $2.89 or something like that versus the alternative is to go away from home where prices have increased even faster and is $14.50.

We are clearly a superior value proposition versus that, and that is what the consumer is seeing. And part of that is being aided by the fact that they're working at home. They're -- a lot of these consumers are working at home now. They're not working in the office. So there's more structural stuff at play here than you would typically see, and that's why we believe we've seen very little elasticity. We've seen some but much lower than historical to date, and we don't see a whole lot of reasons that's going to change materially going forward. Dave, did you want to...

Yes. Just on the transitory costs, the piece that's inventory related, Rob, that I discussed earlier, we do see that as transitory as we get into the third quarter. So that'll come down.

And then volume, our internal forecast. Our volume declines are -- volume has declined a little bit in our internal forecast. It's not significant, but it is down. And as Sean said, the way we do this is we go brand by brand, category by category, and we look at our demand science models and determine the elasticity. So it's a bottoms-up forecast of impact on volume based on the brand and category where we're pricing. So that's how we get to it. But volume is a little bit down versus where it was in the previous forecast.

Okay. So a little bit down. All right.

And our next question today comes from Alexia Howard with Bernstein.

So I just want to dig into the e-commerce slide on Page 13. You basically said that 80% over 2 years in fiscal '21, 50% over 2 years in Q2. I assume that means that year-on-year, things have slowed materially. Is the 9.4% that you're at, at the moment, is that mostly click and collect? What are the e-commerce investments that you're making at the moment? And does that mean that the profitability of the e-commerce channel is now different from the regular brick-and-mortar approach that you're taking? And I have a quick follow-up.

Yes. Alexia, the -- we have made, if you -- even if you look within our A&P line, a lot of the investments that we -- if you look at our total A&P pot, it's changed dramatically in the last 7 years in terms of what we spend it on, much less in-line TV and things like that, that you've heard me talk about before that are inefficient. So instead today, we put those investments into social and digital platforms but also importantly into e-commerce.

So I would say we made the decision a few years back to treat e-commerce as a bit of a start-up business, and we said we're going to invest in it. So we've been, I would say, overinvesting relative to other areas in e-commerce because it's far more elastic. We've seen the business. We get the purchases started in consumers' basket. And it's both pure blood e-tailers and brick-and-mortar retailers who are -- have built out their e-commerce platforms. Both of them have been very high-growth areas for us and very strong investment areas for us.

And what we found is that there is a good ROI on these investments in e-commerce because once we invest to kind of getting into the consumer repertoire and are part of their shopping algorithm online, it translates to a repeat purchase. So we get them when they come back whatever the purchase cycle is for that product.

So that's been -- one of our key marketing shift there is, is to go hard after e-commerce the last few years, and we're very happy with the returns, and that's why we continue to invest there. We'll move around from quarter-to-quarter. And when you look at the percent comps, it also can be a bit misleading because it's a function of whatever we did in the base period. We might have -- we might be wrapping a huge base year in any given quarter when you see a relative dip, but you see large absolute growth.

So overall, it's a big priority for us. It's working really well. And you'd be amazed at the kinds of products that are working well in e-commerce. Frozen, for example, is one that you may not think of intuitively as being very successful in e-commerce, but it is. And these are profitable sales for us.

Very helpful. And just a quick follow-up. Pace of innovation. You highlighted that innovation is an important driver for you at the moment. I remember over the last few years you've meaningfully increased the percentage of sales from new products. Are you at a level -- what level are you at now? And are you comfortable with where you're at? Or are you expecting increases -- further increases over time? .

Yes, we call this the renewal rate, the percentage of our annual sales that comes from stuff we've launched in the past 3 years. And we've gotten to about 15% from -- back in the day we started, we were about 9%. And that's -- I like that level, and -- because what it reflects is that -- and it's a persistent amount of innovation because consumers have new benefit areas that they become interested in every single year. For example, last year, in Healthy Choice, we -- we're already wrapping huge numbers on Power Bowls, but we went with the grain-free trend, which was a big thing, and it's been a big success for us innovation-wise.

So we try to be out ahead of our competition using our demand science team in terms of emerging trends. And it's interesting because many times when we're bringing out a new trend, our competitors are just catching up and they're launching a knockoff of last year's stuff. And so that -- keeping out in front of these trends, I would say, will continue to be an important part of our innovation repertoire.

And ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Brian Kearney for any closing remarks.

Great. Thank you. So as a reminder, this call has been recorded and will be archived on the web, as detailed in our press release. The IR team is available for any follow-up calls that anyone may have. So feel free to reach out. Thank you for your interest in Conagra Brands.

Thank you, sir. This concludes today's conference call. We thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.