Simply Good Foods Co (SMPL) 2020 Q3 法說會逐字稿

Greetings.

Welcome to Simply Good Foods Company's Fiscal Third Quarter 2020 Conference Call.

(Operator Instructions) Please note, this conference is being recorded.

I will now turn the conference over to Mark Pogharian, Vice President of Investor Relations.

Thank you.

You may begin.

Thank you.

Good morning.

I am pleased to welcome you to the Simply Good Foods earnings call for the third quarter ended May 30, 2020.

Joe Scalzo, President and Chief Executive Officer; and Todd Cunfer, Chief Financial Officer, will provide you with an overview of results which will then be followed by a Q&A session.

The company issued its earnings press release this morning at approximately 7:00 a.m.

Eastern time.

A copy of the release and the accompanying presentation are available under the Investors section of the company's website at www.thesimplygoodfoodscompany.com.

This call is being webcast and an archive of today's remarks will also be available.

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.

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 non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP.

Additionally, note that management's reference to legacy Atkins in today's presentation and remarks encompasses the Simply Good Foods business excluding Quest.

With that, it is now my pleasure to turn the call over to Joe Scalzo, President and Chief Executive Officer.

Thank you, Mark.

Good morning.

And thank you for joining us.

Today, I'll recap Simply Good Foods' third quarter results and provide you with some details on the performance of our Atkins and Quest brands.

Then Todd will discuss our third quarter financial results in a bit more detail, and we'll wrap up the discussion with an outlook perspective and then open the call to questions.

Before we get into the details of our Q3 results, I'd like to discuss the impacts we're seeing with respect to COVID 19.

First, on behalf of the company's Board of Directors and leadership, I want to say thank you to our entire organization, especially our supply chain team and their related partners.

They operated flawlessly in the quarter with no major issues.

Our teams worked collaboratively to meet the increased demand in the first half of March and ensured raw materials, production and distribution of our products occurred seamlessly throughout the quarter.

During early March, in the early stages of COVID-19, U.S. consumers pantry-loaded in anticipation of stay-at-home restrictions.

Our category and brands experienced accelerated growth during this period.

As state restrictions were instituted in late March, pantry-loading behavior ended for our category as shopping trips declined significantly, and for the most part, remained that way until restrictions began to ease later in the quarter.

With the declines in shopping trips, the category and our business was pressured as store trips focused on staples.

Within retailers, smaller-format grocery appeared to do better than larger-format retail like mass merchants, likely driven by shoppers' desires to avoid people.

During the entire quarter, we saw a step-up improvement in e-commerce as well as brick and mortar, click and collect, pickup and delivery, again, as consumers sought to avoid nonessential social contact.

Beyond these changes in shopping behavior, there were 2 other factors impacting our business in the quarter.

First, there were lower on-the-go usage occasions, especially for our bar business, which is highly dependent on away-from-home consumption.

Second, our brand benefits of weight management and active nutrition were less relevant to consumers during the early stages of home confinement.

Of note, the more snack-oriented portion of our portfolio that is consumed mostly at home, like the Atkins Endulge confections and Quest protein chips and cookies, did very well and were up nicely during the quarter.

Importantly, as we exited April, marketplace trends for Simply Good Foods and the nutritional snacking category steadily improved.

We believe the improvement was due to easing of stay-at-home restrictions that resulted in increasing shopping trips, increased brand relevance and higher instances of on-the-go consumption.

Despite the unprecedented volatility of COVID-19, we remain focused on long-term growth and doing what's right for the long-term health of our employees, our brands and our business.

Atkins and Quest third quarter results were impacted by COVID-19 movement restrictions that were in place for most of the fiscal third quarter.

These restrictions resulted in unprecedented changes in consumer and shopper habits and practices as day-to-day lives were disrupted nearly overnight.

With the majority of the population sheltering in place, shopping trips were down and there were fewer on-the-go usage occasions for our brands.

As a result, our sales and consumption declined.

Gross and EBITDA margin expansion exceeded our expectations and were driven by lower trade promotion, solid cost control of our outsourced supply chain and lower SG&A expenses.

As we stated at the end of May, the Quest integration and the ERP implementation are on track and progressing as planned.

Looking to Simply Good Foods total company retail takeaway, we outpaced the category, driven by Atkins Endulge and Quest cookies and chips, offset by the declines in bars, our largest segment.

Our bar segment is about 55% of our business and was pressured due to lower on-the-go usage occasions and by lower merchandising as retailers focused on shelf replenishment and dialed back on promotion.

Turning to the third quarter.

Net sales increased 54.2%.

Legacy Atkins net sales declined 8.3% as accelerating e-commerce growth was offset by declines in measured channels.

The contribution from Quest was a 62.5% benefit to net sales growth.

On a comparable basis, Quest Q3 sales were modestly lower versus the year-ago period.

The increase in adjusted EBITDA is a direct result of higher gross profit driven by the inclusion of Quest and a decline in legacy Atkins SG&A expenses.

Legacy Atkins total gross profit was slightly down due to lower volumes, but encouragingly, gross margins were up due to lower trade promotion and improved supply chain costs.

The retail takeaway trends of our business tracks well with the category pre COVID-19 and during post COVID-19 stay-at-home restrictions.

The 3 periods of this chart provide you with a good visual of how our business has performed by week in calendar 2020.

Remember, the track channel POS accounts for most of Atkins revenue but only about 55% of Quest, given its large business in the convenience store, specialty and e-commerce channels.

Pre COVID-19, we enjoyed strong growth.

Our performance was in line with plan and we were on track to deliver another year of above-category performance.

From early to mid-March, our brands in the category benefited from stock-up purchasing behavior by consumers, anticipating soon to be imposed movement restrictions.

This pantry-loading period was relatively short-lived at about 3 weeks.

As most of the country entered home confinement, we saw a marked decrease in shopping trips and fewer use occasions for our portable and convenient on-the-go products, especially our large bar business.

These 2 factors resulted in a steep decline in retail takeaway for our brands and the category starting in late March.

As home confinement restrictions began to ease in May, shopping trips steadily improved from their trough in April and consumer interest in weight management and active nutrition steadily increased.

With these increases in shopping trips and brand relevance, our brand retail takeaway trends also strengthened.

In Q3, Atkins confections momentum continued with retail takeaway up 12.4%.

This strength was offset by softness in bars, which performed slightly better than the category, and shakes.

We estimate that about 40% of the consumption of Atkins products occurs away from home.

Therefore, lower on-the-go usage occasions impacted our large, convenient and portable, nutritious bar business.

The bright spot in Q3 was our online business.

Specifically, Atkins e-commerce sales increased 125% in the third quarter, driven by a mix of existing and new to e-commerce shoppers.

We estimate that e-commerce contributed about 6 percentage points to Atkins net sales growth in the quarter.

Year-to-date, e-commerce is up about 85% and represents about 9% of Atkin's total gross sales.

For perspective on the growing importance of this channel, legacy Atkins has nearly tripled its e-commerce business over the last 2.5 years, and we anticipate continued growth over our strategic planning cycle as stay-at-home restrictions have accelerated shoppers' adoption of online grocery shopping.

We also made solid gains in retailer click and collect, pick up and delivery, and are working on initiatives to ensure we retain these consumers.

Changing shopping behavior also impacted offtake in Q3.

Trips at large-format retailers, our biggest channel, are improving, but they're still lower than year-ago.

Traditional grocery channel trips are better, as is Atkins performance there.

Our brands are responsive as trips improve, and we believe the weight management and healthy snacking benefits of Atkins will become increasingly more relevant as movement restrictions are relaxed.

From a consumer metric standpoint, the decline in shopping trips, lower on-the-go usage occasions and the lower relevance of weight management during confinement impacted 2 key buyer metrics during the quarter.

The brand experienced lower buy rate as well as a significant slowdown in new buyer growth, with the 2 contributing most of the declines in overall brand consumption.

Not surprising, as restrictions have eased, both of these buyers metrics have improved, which reinforces the clear correlation between retail takeaway and less stay-at-home behavior.

Let me now turn to Quest, where Q3 retail takeaway increased 5.2% in the measured IRI MULO universe.

As a reminder, Quest generates about 55% of its U.S. sales in the IRI MULO universe of traditional food, drug, mass and club channels.

The other 45% of Quest U.S. sales are generated in convenience store class of trade and the unmeasured e-commerce and specialty channels which are not tracked by IRI or Nielsen.

Chips and cookies performed extremely well, with retail takeaway up a combined 54% in Q3.

Retailer and consumer demand for these products is exciting and represented about 24% of the Quest business during the quarter.

Quest bars were pressured during the quarter, down 17.6% and relatively in line with the category, due to fewer shopper trips, decreased brand relevance and lower on-the-go consumption.

In Q3, the specialty and c-store channels underperformed the measured universe.

We expect these classes of trade to be a headwind over the near term given the significant slowdown in shopping occasions in these channels.

As movement restrictions have eased, Quest has outperformed the category in tracked channels.

And in June, Quest retail takeaway was up across all measured channels, giving us confidence that the brand will continue to be responsive as consumers return to more normal shopping and consumption patterns.

After pulling back on marketing and retail merchandising in April, as movement restrictions began to ease and retailers return to more normal promotion activities, we increased trade promotion and marketing in late May.

We expect these investments of greater on-air advertising and trade promotion to continue throughout Q4.

Our initiatives are focused on a combination of advertising, both TV and digital, strong in-store merchandising and display support and innovation timed to the upcoming fall shelf resets.

In summary, the Simply Good Foods Company competes in a highly attractive category and with 2 scale lifestyle brands that transcend forms and usage occasions.

As we stated in our May 27 press release, the Quest integration as well as the ERP implementation is on track.

We have tremendous confidence in the leadership team as we execute on our growth vision of being the leading company in nutritious snacking category.

We have preserved distinct brand-building teams dedicated to the unique characteristics of our brands while simultaneously establishing the right foundation to leverage the scale of our combined organization in the areas of sales, marketing, and product innovation.

It also provides improved efficiency in our supply chain and customer service functions and facilitates enhanced go-to-market strategies.

We believe this structure will help us drive meaningful net sales and earnings growth into the future.

The Atkins and Quest brands are tightly aligned with consumer megatrends for healthy snacking with a nutritional profile that's protein-rich and low in carbs and sugar.

This profile has brought appeal to consumers interested in better for you as well as weight management and active nutrition shoppers looking to achieve their goals.

Assuming home confinement restrictions continue to ease, we anticipate that our brands will become increasingly more relevant to our target consumers.

As such, over the remainder of the fourth quarter and into fiscal 2021, we'll invest in our brands and position our business for long-term growth.

We're operating our business for the long term and committed to doing the right thing for our employees, our customers, consumers and investors during these unprecedented times.

Now I'll turn the call over to Todd, who'll provide you with some greater financial details.

Thank you, Joe, and good morning, everyone.

Let me start with 2 points as they relate to the numbers you see on the slides that follow.

First, for comparative purposes, we will review financial statements for the 13 and 39 weeks ended May 30, 2020.

Second, given our asset-light strong cash flow business model, we will evaluate our performance on an adjusted basis as it relates to EBITDA and diluted earnings per share.

We have included a detailed reconciliation from GAAP to adjusted historical items in today's press release.

We believe these adjusted measures are a key indicator of the true underlying performance of the business.

I will begin with a review of our net sales.

Third quarter legacy Atkins volume declined 9.4%.

The legacy Atkins e-commerce business increased 125% in the quarter and contributed about 6 percentage points of growth.

Brick-and-mortar volume was off 15.4% and net price realization was a 1.1% benefit.

Note that the return to our normal inventory build in Q2 we discussed last quarter represents the variance between Q3 net sales and the retail takeaway that Joe discussed.

The Q3 Quest contribution was a 62.5% benefit resulting in total Q3 net sales increase of 54.2%.

The volume decline I mentioned on the previous slide was primarily driven by bars.

As this slide depicts, bars is more than 50% of our business and very profitable.

Despite these pressures, we were able to expand gross margin.

Also note that confections, chips and cookies are about 20% of our sales and up nicely versus last year.

We believe the at-home snacking usage occasion is a white space opportunity for us.

Now for a review of third quarter results across other major metrics.

Gross profit was $88.6 million, an increase of $31.9 million or 56.4%, driven by the inclusion of Quest.

Gross margin improved 60 basis points to 41.2% in the quarter, driven by reduced trade promotions and lower supply chain costs, partially offset by mix as bar growth lagged the overall business.

Adjusted EBITDA increased 74.2% to $43.4 million, driven by the increase in gross profit and legacy Atkins SG&A expenses which declined versus the year-ago period.

Looking at it by line item.

Total company selling and marketing expenses increased by 40% or $7 million to $24.5 million.

The increase was due to Quest as legacy Atkins declined about 10%.

G&A expenses, excluding Quest-related integration and restructuring costs as well as stock-based compensation, increased about 50% in Q3, attributable to the addition of Quest as legacy Atkins cost declined about 21% primarily due to lower incentive compensation.

Please note that Q3 adjusted EBITDA benefited from lower costs in 2 areas.

First, the COVID impact on retailers pushed in-store displays and merchandising from Q3 to Q4.

This lowered our trade rate versus prior year in Q3 and will increase trade versus prior year in Q4.

Second, based on our revised outlook for the full year, we trued up our incentive compensation accrual in Q3 with a much less favorable impact to EBITDA in Q4.

Additionally, compared to a more modest expense in Q3, the majority of ERP-related expenses will hit the P&L in Q4.

Moving to other items in the P&L.

Interest expense increased $4.9 million to $8.3 million due to the higher term loan balance.

Our effective tax rate in the third quarter was 26.9%, slightly higher than the year-ago period of 25.4% due to timing of select items.

For the full year, we anticipate an effective tax rate of around 26%.

As a result, reported net income in Q3 was $16.4 million versus $13.5 million in the year-ago period.

Year-to-date results are as follows.

Net sales increased 54.7% to $594.1 million, driven primarily by the Quest acquisition and a 4.6% increase in the legacy Atkins brand.

Gross profit was $236.2 million, an increase of $78 million or 49.3% driven by legacy Atkins sales growth and Quest.

This was partially offset by the previously discussed noncash $7.5 million inventory purchase accounting step-up adjustment related to the Quest acquisition.

As a result, reported gross margin was 39.7%, a 150 basis point decline versus last year.

The noncash inventory step-up adversely impacted year-to-date gross margin by 130 basis points.

Adjusted EBITDA increased 56.8% to $116.9 million, driven by the increase in gross profit, partially offset by selling and marketing expenses which increased 47% or $22.4 to $70 million.

The majority of the increase, about 85%, was due to the addition of Quest.

G&A expenses, excluding Quest-related integration and restructuring costs as well as stock-based compensation, increased about $20 million to $58 million due to the inclusion of Quest.

Year-to-date legacy Atkins G&A is 8.6% lower versus last year, driven primarily by lower incentive expense.

Business transaction, integration, restructuring costs and stock-based compensation were a combined $43.7 million and primarily associated with the Quest acquisition.

Moving to other items in the P&L.

The net impact of interest income and interest expense was an increase of $15.1 million due to the higher term loan balance.

Year-to-date income tax expense was $8.2 million versus $13.2 million in the prior year.

As a result, Q3 year-to-date reported net income was $22.2 million versus $41.4 million last year.

Turning to EPS.

In the third quarter of 2020, the company reported $0.17 per share diluted compared with $0.16 per share diluted for the comparable period of 2019.

Q3 was impacted by integration costs of $4.1 million and restructuring expenses of $1.4 million.

Adjusted diluted EPS was $0.26, an increase of $0.06 versus the year-ago period.

Note that we calculate adjusted diluted EPS as adjusted EBITDA less interest income, interest expense and income taxes.

Year-to-date reported EPS was $0.23 a share versus $0.49 per share diluted in the prior year, impacted by the noncash inventory step-up of $7.5 million, integration costs of $9.4 million, business combination costs of $26.9 million and restructuring expenses of $1.4 million.

Year-to-date adjusted diluted EPS was $0.71, an increase of $0.11 versus the year-ago period.

Please refer to today's press release for an explanation and reconciliation of non-GAAP financial measures.

Moving on to the balance sheet and cash flows.

Year-to-date, we paid down $21 million of term loan.

And at the end of Q3, the outstanding term loan balance was $635.5 million.

As of May 30, 2020, the company had cash of $111 million.

Subsequent to the end of the third quarter, the company paid down the $25 million that it borrowed under its revolving credit facility in March.

At the end of June, the company's estimated cash balance was about $80 million.

Despite the negative volume impact due to COVID in the third quarter, the company generated free cash flow of nearly $40 million, and we are well on track to achieving the targeted trailing 12-month net debt to adjusted EBITDA ratio of less than 3.7x by fiscal year-end 2020.

We anticipate net interest expense to be $31 million to $32 million.

Year-to-date, depreciation and amortization was $11.6 million and capital expenditures was about $800,000.

Capital expenditures for fiscal 2020 are expected to be about $2 million lower versus our previous forecast as the estimate for ERP implementation has been reduced.

I would now like to turn the call back to Joe for closing remarks.

Thanks, Todd.

The marketplace trends of our brands have improved sequentially as home confinement restrictions eased during our fiscal third quarter and into the first month or so of the fourth quarter.

We believe the increase in consumption is due to increasing brand relevance, more shopping trips and more on-the-go consumption.

Rapid growth in e-commerce and pickup and delivery has contributed to these positive trends.

However, in the near term, we expect channel-shifting away from large format to continue and the trips in the convenience store and specialty classes of trade will remain pressured.

As we have previously stated, there are many long-term growth opportunities that exist in this category and our business.

Consumers continue to tell us that health and wellness snacking is important to them and low household penetration will be a tailwind for our business and category for years to come.

Given our visibility well into our fiscal fourth quarter, we feel reasonably confident in providing total year guidance.

Assuming no major changes in U.S. movement restrictions in the final weeks of our fiscal year, for the full fiscal 2020, the company anticipates net sales of $790 million to $800 million and adjusted EBITDA of $145 million to $150 million.

Legacy Atkins net sales and adjusted EBITDA is expected to be about the same as the year-ago period, including the headwind of a 53rd week in fiscal 2019.

The company estimates that the extra week included in the fiscal year 2019 is a headwind to year-over-year comparisons of reported legacy net sales growth in fiscal 2020 of about 200 basis points of growth.

Our outlook for full year 2020 adjusted diluted earnings per share is $0.86 to $0.90 compared to $0.77 in 2019.

Please refer to today's press release for an explanation of the company's definition of adjusted diluted earnings per share.

We appreciate everyone's interest in the Simply Good Foods company, and we are now available to take your questions.

(Operator Instructions) Our first question is from Chris Growe with Stifel.

I just want to ask, as I look at your guidance for the year and the implied level for the fourth quarter, it seems like you're -- as I'm just kind of backing into it, your legacy Atkins outlook is pretty similar to what happened in Q3, and we have seen an improvement in -- obviously, in -- a slow improvement in sort of reopening of some of these states.

So I want to get a sense of that legacy Atkins outlook for the business.

And then to also understand around that, are there any unique like inventory movements, consumer pantry levels?

And then you also noted like a trade promotional shift from Q3 to Q4.

Just to understand how those play into your outlook for Q4 legacy Atkins sales.

Yes.

So Legacy Atkins Q4 will be slightly better than Q3 on an apples-to-apples basis.

Hoverer, the 53rd week, which is an 8-point headwind for the quarter, 2 points for the year, is obviously significant.

With retailers pushing out trade promotions and merchandising activity, that's a 2- or 3-point hit to Q4.

So we got a benefit in Q3, that shifts to Q4.

So we'll do a little bit better apples to apples on a volume basis, but the 53rd week is the biggest impact.

Okay.

And do you believe consumer pantry levels are now at a level that does not incorporate a higher rate of inventory overall?

We do.

We're in an apple -- we're in a good position from inventory.

No big shifts on a year-to-date basis.

So we think it's very level at this point.

Okay.

And then just one other question, which is around the fall shelf resets as we kind of move through the quarter and get closer to that period.

Is that occurring at retail?

Have you had some retailers that are not resetting shelves?

And I'm just curious, from a high level, is that a net benefit to you?

Do you have a lot of new products prepared for those shelf resets?

Yes.

So Chris, so far, it appears everybody is on track that would normally be resetting in the fall to reset in the fall.

So we're in the midst of those decisions right now.

It's hard always to predict.

We've got, I think, the best pipeline in our business in quite a while.

So we're cautiously optimistic.

But again, in the middle of those decisions, those things will start in -- we'll start hearing about them in August, for resets, call it September, October, November.

Our next question is from Faiza Alwy with Deutsche Bank.

Yes.

So a couple of questions for me.

First, I just wanted to talk about the gross margin because I think the expansion was pretty impressive and really proved out of your variable cost structure.

So I just wanted to understand a little bit more the quantification of how much did lower promotions help?

And you also mentioned favorable supply chain cost.

So I'm wondering if those -- as we look ahead to next year, do those continue, or were those more onetime-oriented?

And I think you'd also mentioned mix as a positive impact.

So just more color around gross margins.

And if possible, if you could break it out between legacy versus Quest, that would be helpful.

Yes.

So a couple of thoughts.

So the trade shift obviously helped us in the quarter.

That was a tailwind, will be a headwind in Q4 as retailers pushed promotions from Q3 to Q4.

As we talked about in the prepared remarks, it was a little bit over 100 basis points positive price realization in the quarter due to that trade shift.

Supply chain just had an absolutely spectacular quarter.

They couldn't have performed any better.

We had some really just favorable cost trends and no hiccups whatsoever, even given the COVID situation.

So the legacy Atkins business had some really nice margin expansion in the quarter.

As you know, the Quest business, their gross margins are a few points lower than legacy Atkins.

So that puts a little bit of a drag on the overall business.

But spectacular performance by Atkins.

Good performance like Quest as well.

They were hurt by the bars being down.

That is their most profitable business.

So with bars being down, that was a bit of a drag, but their supply chain performed equally well.

Yes.

I'd make a few points as it pertains to next year.

Given just downturn in demand in general, it looks like a relatively benign input cost year coming up.

I would have said 6 months ago, that would not be the case, we're seeing a fair amount of inflation.

So as we look to input costs next year, I think we're in the -- we're in a favorable position just from an input cost standpoint.

And then obviously, we start benefiting from a supply chain standpoint starting in FY '21 as some of the cost synergies of the integration of the 2 businesses, which is on track.

And part of that is our ability to benefit from our combined volumes with our key suppliers as well as ultimately getting into a single distribution network and benefiting from a freight and distribution warehousing standpoint.

Yes.

We'll talk about those more at Q4, but as Joe points out, benign input cost structure, and we will have some gross margin favorability because of the synergies.

You also made one of the point which I think is really important.

If we were a vertically integrated business right now, the volume loss, we would be absorbing some significant fixed cost leverage, right?

One of the strengths of our business model is it's a pretty variable model.

So as our volume has declined, our variable cost is -- we're not sitting on a bunch of fixed costs that then have to flow through to the P&L.

So a real benefit to our business.

I also want to highlight that our contract manufacturers done a phenomenal job.

They've got whipsawed in the quarter, at the beginning of the quarter.

We had them making as much product as they could make because it was hard to see, in the early stages of pantry-loading, how long that would sustain itself.

And then the business significantly stepped down, and we had to actually go back to them and change our forecast going forward.

They did a phenomenal job.

They've been terrific partners, and we really appreciate their flexibility and responsiveness.

Great.

That's really helpful.

If I could just ask one more.

It seems like on Slide 10, you highlighted Atkins Shakes that support immune health.

And that seems like a very sort of relevant message currently.

And it seems new to me, but I could be wrong.

But I'm just wondering, like, how are you thinking about that as a marketing message going forward?

Are there changes that you're making on the shelf?

Have you improved the product?

Have made any changes to, I guess, product ingredients?

Anything else?

Just more color around that message...

Yes.

So we've been tracking consumer attitudes all along in the process.

We saw, from an attitude standpoint, the increased concerns around immunity.

We saw a pickup in supplement consumption.

And we know from -- we have vitamin packs in our shakes.

So they're vitamin-fortified.

With those vitamin fortifications, you can make certain claims around boosting immunity, which, given the changing consumer attitudes around us, we thought that was a good tactical decision.

So -- and we're executing it 360, so television spots talking about it, actually stickering shakes right now in the marketplace, shelf tags around it, promotion support around it.

So I think it's a short-term tactic.

I think people will evolve over time.

But as long as we see the -- our trackers talking about that's a high consumer interest claim or benefit and we can make those claims, we'll do that tactically.

Our next question is from Brian Holland with D.A. Davidson.

If I could ask first about -- just a follow-up on the guidance and how it pertains to Atkins.

The [standard] data out yesterday would imply that Atkins was down about 5% year-on-year in June.

So can I infer from -- obviously, guidance flat.

I know e-commerce, a bit of an offset here.

But given the increased merchandising and marketing investment that's being made, and I don't know if there's any anticipated sell-in benefit around the distribution or anything, but is the expectation, I guess most specifically, that Atkins consumption should turn positive by the end of August?

Is that kind of embedded in the expectations set here?

No.

That is not embedded in the expectations.

I mean, we're -- as we said, we're assuming very hard to -- it's hard to figure out how this -- how COVID is going to play out in the next several weeks and several months.

We have assumed it's status quo.

So we're assuming we're going to be similar, slightly better, to kind of where we are tracking right now.

E-comm, just seasonally, is not as big in Q4 because -- just because of the summer months, some of our products get shut off.

So it will be a nice positive impact, don't get me wrong, but it won't be as positive as it was in Q3.

So we anticipate we'll continue to track a little bit higher, but we do not anticipate right now that we will -- on the Atkins business that we will go positive.

Yes, it's really important as you're weighing all the factors, you talked about a few of them, increased merchandising support at retail, increased advertising support.

The big factor is what's the trend in stay-at-home confinement?

That has been a significant factor, high correlation to our business.

That will be the driver.

We've assumed in the balance of -- in the last weeks, it stays about where it is.

And with that, our performance will be about where it's been.

And again, there's 3 drivers of this we mentioned in our prepared comments.

The first one is, when you're staying at home, the relevance of our brand benefits just isn't as high, right?

Weight management, active nutrition.

When you're hanging around the house most of the time, not as important.

Second, we have -- a significant portion of our consumption is on the go.

There's just not as many of those occasions going on when I'm confined.

And then lastly, there is a high correlation in shopping behavior and confinement, both in the quantity of shopping as well as where I shop.

So those 3 factors really have a significant impact and have been highly correlated to our business and is the key driver as we look at our business in the fourth quarter and we think about our business in 2021.

Perfect.

Really appreciate the color there.

And then I guess, as you talk about consumer mobility, obviously, you can get pretty granular with the data and track based on some of the earlier reopening states and now maybe more recently as there have been a resurgence in COVID-19 cases.

What -- do you see a divergence in trends in markets that have reopened?

Or maybe in some markets where we're seeing now more recently increases, is there -- is it moving in line with that?

Or are the trends broadly kind of consistent across the U.S.?

Yes.

Unfortunately, we don't -- given the presence of national retailers, it's really difficult to look at your business on a local basis, right, and be able to correlate locally.

I suspect that where states have opened, our business is better because the national correlation is pretty high.

So I suspect where places have opened up and people are more mobile, our business is better.

And the reverse is true.

Where there is more confinement, shopping is down, brand relevance would be down and on-the-go use occasions would be down.

So I don't have visibility into kind of county by county, state by state, but I suspect that's going to be true.

(Operator Instructions) Our next question is from Jason English with Goldman Sachs.

And bummer because I have like 7 questions, but I'll keep it tight.

I'm not going to run through 7. I guess, to stay focused, advertising and marketing pressure on the consumer.

I think last quarter, Joe, you talked about in anticipation of perhaps some lower ROI in the current environment and plans to perhaps pull back a bit, and we saw in trade spend this quarter.

Could you give us where -- could you go over you -- kind of where the cadence of your advertising investment is as well as your trade spend throughout the course of the year?

And as we look into 4Q, we're hearing more trade come back.

Is the advertising coming back, too?

Effectively what I'm asking is, what is that pressure on the consumer look like throughout the year?

And should we, if at all, be expecting any sort of response from that investment?

First of all, Jason, it was a complete coincidence that the comment was made on limiting questions right in front of you.

That was a complete coincidence.

I'm sure.

I'm sure.

So first thing is the merchandising cadence was really driven by customers, right?

So in the third quarter, as they really struggled to keep up with their supply chain, store operations folks really were focused on cleaning the stores overnight, getting products on the shelf.

So for us, we were just responding to the fact that they just stopped promoting and really refocused operational resources in stores.

So as their operations have returned to more normal states, they put promotion back in place.

I suspect in the -- all other things being equal, the level of activity that we're going to have in the fourth quarter, probably a little bit stronger than what we had last year.

Hard to know until it actually gets executed and we can see the impact of it, right?

So -- but based on just planning, we have a strong fourth quarter relative to prior year.

As it pertained to advertising, we were -- we started tracking immediately consumer attitudes, and we saw a significant falloff in the relevance of our brand benefits.

So we dialed back -- we just did a value judgment and said, "Hey, people are confined at home.

Are they really going to be concerned about active nutrition and weight management?" We felt like there were other things, based on the data we're seeing, that they were focused on.

And we just -- we pulled back advertising.

We didn't shut it off, but we pulled it back, and we did that pretty significantly.

As we continued to track, and I think we did trackers every 3 or 4 weeks, the longer -- the more people -- the longer people were in confinement, the more confinement started to ease, the more their attitude started returning to more pre-COVID level.

Not back to where they were originally, but hey, I'm a little bit more concerned about my weight.

I'm a little bit concerned about what kind of shape I'm in.

And then we had some data that suggested, where we spent the money, people who saw our messages and marketing, that we had a lift in sales relative to folks that didn't see it.

So we started layering back in the marketing investment towards the end of the third quarter, and we're going to invest in the fourth quarter pretty much steady state.

And you may remember, on our Atkins business, we had a pretty significant investment year ago.

We're going to get pretty close to matching that on Atkins.

And Quest, it continues to invest at levels in fourth quarter will be very much in line with where they were in the first and second quarter.

Our next question is from Alexia Howard with Bernstein.

So can I ask about how this curve ball that you've just been thrown in the form of COVID is going to affect your innovation plans from here?

I think in the prepared remarks, you mentioned the at-home snacking opportunity being some sort of white space for you.

But does this materially change where you're going to be investing resources in the types of behaviors that you're going to be going after?

Yes.

So I think at the highest level, as a result, the pipeline is what we expected our pipeline to be pre COVID.

So that is a testament to our R&D organization, our operations organization.

They've done a phenomenal job, as you can imagine, mostly working remotely with finishing their tabletop work and then working with our contract manufacturers to get products tested in their manufacturing facilities.

And so they've done a phenomenal job to keep on track.

It has not been easy, it's been pretty challenging, but the team has done a phenomenal job of executing in very difficult circumstances.

The pipeline is as rich as I've seen since I've been CEO here.

So we've got a fair amount of innovation coming in the fall and as we move into the spring.

I think the comment around -- the comment Todd made around innovation is about 25% of -- is around the kind of the noncore bar and shake portion of our portfolio.

So we are now -- 25% of our business really isn't in bars and shakes.

So we have a -- Quest has a healthy chip and cookie business, Atkins has a very healthy confections business, and those businesses have a fair amount of innovation coming because we -- 2 things: The need state's different, the use occasions are different and complementary to our bar and shake business overall.

So not surprising, as we look at different forms, we're seeing a lot of incrementality.

You should expect that going forward.

Our next question is from Rob Dickerson with Jefferies.

So I just have a question around kind of go-forward flex in the model, right?

What we see -- or what we saw in Q3 was quite impressive, right, on the cost side.

Now you move into Q4, right?

It sounds like trade promo goes up a bit, marketing or brand-building is going up, there's been -- and there's been innovation on the way.

We're sitting here 6 months from now, and let's just say the trajectory maybe that's been a little bit positive kind of reverses out, right?

Just stay-at-home orders are extended or what have you, right?

We don't really know.

I'm assuming that flex is still there, right?

It's not as if you now have to plan and commit to these marketing and promotional plans into back-to-school in the fall.

If you're sitting here in your fiscal Q2 next year and something happens, it sounds like you can kind of revert, so to speak, as you did in Q3.

And that's all.

Yes.

Rob, I think a great question.

First, just want to reinforce, there's a high correlation between sheltering and our growth in our business.

So we expect FY '21 to be highly dependent upon what happens from a sheltering in place standpoint.

We have the flexibility to flex investment up or down based upon that.

We are using consumer trackers.

We're talking to customers every day, right?

If customers get concerned about in-store operations and dial back promotions, we will do that with them.

If we're seeing interest in our brand benefits wane, we will pull back marketing investment.

We have the ability also in -- we have the ability to read the effectiveness of our marketing investment.

If we see those lifts starting to fall, we will dial back and adjust accordingly.

So yes, it's a good business model, right?

We're relatively sophisticated in the front end from a marketing standpoint and we got a variable cost model, so we don't get punished when volume gets softer.

So it's a good model from an investment standpoint.

I think you can expect us to continue to behave similarly as we watch sheltering change as we move into fiscal '21.

Our next question is from Jon Anderson with William Blair.

So my question is on Quest.

I guess it's a 2-parter, I apologize for that.

Could you just talk a little bit about the current gross margin profile of Quest, why it's lower than Atkins?

I think it's only a few points lower, but is it a scale issue?

Is it kind of a product mix issue or cost of ingredient issue?

And what you expect there, can you kind of get that up to kind of a legacy Atkins level over time?

And then also on Quest, if you could just talk about what you see as the biggest kind of white space opportunities, whether it be ACV in measured channels or product line expansions going forward?

So I'll take the gross margin question first.

So yes, their gross margins are about 3 points lower.

Part of it is -- actually, it's almost all product mix.

Their bars have a very similar margin to the Atkins bar business.

Some of their other products, pizza, cookies, are lower-margin.

I think those margins will get a bit better as they scale up over time, but that product mix, it will probably not get all the way to the legacy Atkins business.

So the second question is where the white space is on Quest.

Do you want to take that, Joe?

Yes, I'll take it.

First, I just want to acknowledge, the Quest team has done a phenomenal job over the last 24 months in radically overhauling their supply chain to get their cost in line.

So I think 24 months ago, they were in-house manufactured all bars.

They had some egregious ingredient contracts.

They've done -- Dave and his team have done a phenomenal job of improving gross margins on the business, giving them room to improve their margins but also to invest in marketing.

They've done a great job.

We're going to continue that work going forward.

We feel very comfortable in our ability to continue to get their margins up.

As it pertained to the white space, continuing the work that, that team started.

So white space.

So if you just think about the origins of Quest, it was a sports performance, active performance business that grew up in e-commerce, grew up at specialty sports stores and in your gym.

And then -- and was a protein bar business.

That's the history of the brand.

It has evolved from that to be more than just protein bars, more than just specialty and online.

So growing their white space into c-stores, into grocery, mass merchants, club.

That work has to continue.

And by the way, also from just a bar business into other forms.

And within the bar business, pretty much selling single bars to multi packs.

So that work is going to continue, right?

Continue to penetrate, drive points of distribution in food, drug, mass, move from just being a single bar business to a multi pack business and then expand in new forms.

So the success of their cookie business and the growth of the cookie business, the ability to expand into chips, really strong.

They've created some strong legs of growth in the business.

They have very -- a broad and deep innovation pipeline.

We're going to continue to push forward in those areas.

Our next question is from John Baumgartner with Wells Fargo.

I guess, Joe, when we think about the revenue and distribution opportunities, the club channel has been an area where the business hasn't really maximized its potential thus far.

So in a COVID world and now with Quest, seeing what you're seeing, does it change how you're thinking about the opportunities there, whether it's increased ability to expand the breadth of some of these new products you're talking about?

Or maybe some flexibility to offset lower margins within club with either product mix or distribution elsewhere?

Just how are you thinking about the options on distribution going forward?

Yes.

Our folks that run our Sam's and BJ's business would take exception to the comment that our club store business isn't good, right?

Could be better.

So first of all, we have a strong business in club, a growing business in club, broad distribution.

We do a really fine job there, right?

I think what you're alluding to is the opportunity at Costco.

And for anybody that does business at Costco that didn't start in Costco because you have a lot of brands that kind of got their legs at Costco and then expanded more broadly, the challenges with Costco is always finding the right product, price, value equation that doesn't disrupt your mainstream marketplace.

We continue to work with Costco to find those solutions that are acceptable from our standpoint and acceptable from Costco's standpoint, from a price/value standpoint, and we'll continue to work on that.

Yes.

Do I think, ultimately, that, that would be a nice growth driver for our business?

Yes, I would.

Am I not -- am I surprised that neither Quest nor we in the United States have a strong Costco business?

Given how the brands grew up, I'm not surprised that, that is the case.

So it's a difficult -- once you've grown up in other channels, it's a difficult channel, it's a difficult customer to go into and attempted to grow.

It's a much different proposition than if I grew up at Costco and expanded more broadly.

So look, we continue to work, we look for those solutions.

Eventually, I think we'll find one.

Didn't mean to short the efforts there.

Well, I do that all the time internally, and then I'm reminded that we do have a good club store business.

And our final question is from Ryan Bell with Consumer Edge.

You said that about 40% of the sales are coming from on-the-go consumption.

How do you think about the impact of working out, going to a gym versus just the broader mobility trend?

I know we've heard anecdotally about consumers building out their home gyms.

Is there any impact that you think that, that would have on your brands?

Yes, first of all, the data I gave you was Atkins data.

I think the away-from-home or on-the-go consumption at Quest is a little bit lower but dependent on the bar business.

So I think you bring up a question that we talk about a lot.

So the first, broadly, if I'm out and about, our business is going to perform better.

Part of the Quest equation is actually an active nutrition equation.

They're highly linked to people that work out.

Working out happens to be linked to gyms.

So I think as people start trying to figure out what those solutions are, I think our business will do better, right, because they're going to be working out.

And I do think this -- solving your own -- because your gym's closed, figuring out how to work out will be part of the equation going forward.

I think people will -- I don't know if you noticed, Amazon sold out of dumbbells and kettle bells, and you couldn't get a bench on Amazon for a while.

So people are clearly looking for at-home solutions to working out.

And I think as -- if gyms get stalled in opening, you're going to continue to be -- see people start searching for those solutions.

And I think the reason they are doing that is the -- in the back of their mind, they've gone from safety, immunity concerns, staying at home in the early stages of this, to, okay, I may have to live a little like this, so weight management becomes increasingly more important to me and working out becomes increasingly important to me.

How am I going to solve those things?

And then I think you'll see there, as we're experiencing, their eating patterns, their snacking patterns will change.

They become friendlier to us.

So I think great question.

And I do expect people to start solving that as they go forward.

We have reached the end of our question-and-answer session.

I would like to turn it back to management for closing remarks.

Yes.

Thanks again for your participation on the call today.

We hope you continue to remain safe, and we look forward to updating you on our fourth quarter results in October.

Have a good week.

Bye.

Thank you.

This concludes today's conference.

You may disconnect your lines at this time, and thank you for your participation.