Good day, and welcome to the Conagra Brands Third Quarter Fiscal Year 2021 Earnings Conference Call. After today's presentation, there will be an opportunity to ask questions. Please note today's event is being recorded. I would now like to turn the conference over to Brian Kearney with Investor Relations. Please go ahead.
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, 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,
connegravrands.com. With that, I'll turn it over to Sean. Thanks, Brian. Good morning, everyone, and thank you for joining our Q3 fiscal 2021 earnings call. Today, Dave and I will discuss our strong 3rd quarter results, our perspective on how Conagra is succeeding in the current environment and how we are well positioned to drive Future growth from behavioral tailwinds.
So let's get started. Our business continued to perform well, both in the absolute and relative during the Q3. Our ability to deliver for stakeholders during this pandemic is not only a testament to our team's ability to adapt to the current environment, but a reflection of the work we've done to transform our business over the past 5 plus years. Our ongoing execution of the Conagra Way playbook, perpetually reshaping our portfolio and capabilities for better growth business to excel in the future. During the Q3, we continued to build on our momentum and invested across the company to further strengthen the business.
This included ongoing investments in physical availability to ensure our products are accessible online COVID-nineteen pandemic has presented an incredible consumer trialing opportunity. Our innovation and marketing approach has enabled us to secure Not only strong trial, but also strong repeat rates and market share gains. Based on the evidence we are seeing, which I will Summarized today, we expect to emerge from the pandemic with structurally higher volumes and share driven by the stickiness of the COVID Driven demand. But to be clear, we are not relying on these benefits to achieve our fiscal 2022 Organic net sales guidance. Given our confidence in the longer term value creation opportunities of our business, we Opportunistically repurchased approximately 300,000,000 of shares in the quarter.
We remain committed to a balanced approach to capital Our decision to repurchase shares demonstrates our willingness to capitalize on occasions when we believe we're undervalued. As we navigate the current environment, we're seeing input cost inflation accelerate in many of our categories and across the industry. Dave will detail multiple levers we have to manage this inflation. And finally, we are again reaffirming our fiscal 2022 guidance. I'll unpack these items a bit further in a moment, but I want to start by acknowledging our frontline team.
Our supply chain is a vital component of our success and I want to commend our team once again for their extraordinary execution Amid the COVID-nineteen pandemic, I'm extremely proud of the thousands of hardworking ConAgra team members This dedication has enabled our industry leading performance. We remain focused on keeping employees safe, while meeting the needs of our communities, Customers and consumers, and I'd like to thank everyone at Conagra for making this possible. Let's get into the business update. As the table on Slide 8 shows, our organic net sales growth of 9.7% Exceeded our expectations in the quarter despite the winter storm in February causing a small temporary disruption in the Supply Chain. We also delivered adjusted operating margin of 16% and adjusted EPS of 0 point 5 $9 both in line with our quarterly guidance.
This strong performance was driven by our continued execution of the ConAgra Way playbook. Foundation of everything we do is building superior products with modern attributes, great taste and contemporary packaging. Our 3rd quarter results demonstrate the continued strong performance of our new innovation, which is being accepted by customers and sought after by consumers. Once we have the product right, we need to make sure that consumers and customers have access to it across all channels. As we will detail today, This is exemplified by our investments in transportation to ensure physical availability amid elevated demand.
And finally, We support the mental availability of our products to ensure we connect with consumers in the right place at the right time And with the right messages, in the Q3, we supported our brands with continued investments in e commerce and digital marketing. Playbook is not just a slogan. It's the framework we use to run the business and it continues to deliver great results. During the Q3, we grew retail sales 13.8% with each of our domains, frozen, staples and snacks, outpacing the industry. As a result, we grew share in each of our domains.
Our strong broad based growth and share gains We're fueled by both our superior penetration and repeat purchase rates in the quarter. Slide 11 shows that our household penetration rate In terms of repeat purchase rate, as I mentioned a minute ago, the Conagra Way playbook starts with building superior products. When we began this journey over 5 years ago, we recognized that we had a lot of latent potential in the portfolio, but it had to be modernized. So we set out to aggressively do just that. And you'll recall that we established a goal of having 15% of our annual retail sales come from products launched within the preceding 3 years.
As you can see on Slide 12, our innovation performance has consistently exceeded our 15% goal Over the last 2 fiscal years and through the last 52 weeks and our fiscal 2021 innovation is performing even better And prior year innovation. Compared to last year's launches, the products we introduced through the Q3 this fiscal 2021 Have achieved 66% more sales per UPC and 53% more distribution points Per UPC, then during the comparable time period last year. And as you can see on Slide 13, Many of our new innovations are leading their categories. Looking ahead, we're starting to see strong will begin shipping in fiscal 2022. Critical to our ability to sustain our growing relevancy with consumers is the physical availability of Products, whether through brick and mortar or online, and Slide 15 demonstrates how our ongoing investments in e commerce Have continued to yield results.
Conagra has outpaced total edible retail sales and e commerce growth Each quarter throughout the pandemic and we've grown share in e commerce across 76% of our brands over the past year. As we've discussed 4, we believe that e commerce investment is a high ROI opportunity to deliver our message to consumers. Slide 16 details
Some of
the specific benefits to expanding our e commerce platform. E commerce shoppers over index to younger millennial consumers. When higher brand loyalty than those shopping in store. All of this demonstrates the opportunity for superior lifetime value that's being generated by our e commerce investment and growth. Now let's turn briefly to each of our retail domains and start with frozen on Slide 17.
Total Conagra frozen retail sales grew an impressive 12% on both a one- and 2 year basis in the quarter, which is an acceleration from the Q2. And as Slide 18 demonstrates, our growth in frozen accelerated on a sequential basis across many of our leading brands and categories. Our Snacks business also continued to deliver strong growth throughout the quarter Q3. As you can see on Slide 19, we generated double digit retail sales growth on a year over year and 2 year basis in snacking, We capitalized with strong Q3 velocity growth across our leading brands. Our Staples portfolio also delivered solid results in Q3, Including 15% retail sales growth led by double digit quarterly growth across key staples categories.
And As Slide 22 shows, the broad based growth we delivered in the 3rd quarter exceeded the already strong growth we delivered in the 2nd quarter. People are returning to their kitchens during the pandemic and new younger consumers are discovering the joy of cooking. As we've discussed before, The current environment has resulted in consumers trying or reengaging with our Staples products and coming back again and again. Overall, I'm very pleased With our in market performance across the portfolio this quarter and it's even more impressive given the fact that we delivered these results despite continued supply constraints resulting from sustained elevated demand outpacing our ability to supply. That takes us to what we see looking ahead.
As we try to understand where consumer trends are going, it's always helpful to look back at lessons from recent history. During the 'eight, 'nine recession, we saw consumers Shift from primarily consuming meals sourced away from home to meals sourced in home. While this shift is not surprising during the Part of a recession, it's important to recognize that the change in behavior, although event driven, lasted well past We are nearly 400 days into the COVID-nineteen pandemic. Consumers have adapted to at home eating and formed new habits that we to sustain well beyond the current conditions. And early data supports our hypothesis.
If you take a sampling of data From states that have been the most open based on the mobility of their residents throughout the pandemic, what you'll find The 2 year growth rates in retail sales are materially higher than pre pandemic and Barely consistent as states reopen and stay open. So while people are starting to leave their homes more frequently, They are still choosing to eat at home. Consumers are largely maintaining the habits they've acquired over the past 400 days, just like Psychology predicts. And while we're poised to benefit from sustained elevated at home eating, we are not resting on our We're taking our consumers for granted. We're continuing to invest behind our brands to create connections with consumers.
Slide 27 shows just One fun example of our innovative approach to brand building. We listen to our communities and identify the trends that resonate with them. As an example, the Slim Jim community online was built on memes. Given that fact, Doge and Doge We're a natural fit for our brand. Since joining the online conversation about the do good everyday sentiment of Dogecoin, we've tapped into Another channel for Slim Jim to engage with its community.
We've seen a market uptick in audience And including direct engagement and advocacy from the person that created Dogecoin as you can see on this slide. Not only is this community hungry for our product and new innovation, but they've also been quick to rally behind the brand Playing a large part in Slim Jim being crowned the champion of Adweek's March Adness bracket of the Top 64 brands. On its way to the title, Slim Jim defeated Doritos, Pepsi, Amazon, Wendy's, M and M And OREO in head to head matchups. We're excited about this and you should be on the lookout for additional crypto themed activations in the future. And Slim Jim is just one example of how we're connecting with the consumer.
Since the onset of COVID-nineteen last March, we've gained the equivalent of more than 4 years' worth of incremental new buyers. COVID has effectively supercharged new trial at a level rarely seen in our industry. Importantly, we're winning with younger consumers, nearly half of our new buyers are millennials and Gen Z. The steady trends shown on Slide 29 demonstrate that these new buyers are even more likely to repeat purchases Across many of our key brands, they are discovering our modernized portfolio and developing new habits that include our Products. And as you can see on Slide 30, we're outpacing our peers in terms of repeat rate as consumers are flocking to our brand More than to those of our top competitors across all of our domains.
And we continue to believe that we are very well provides a structural increase in the demand for frozen food compared to pre COVID levels. Importantly, some aspects of the remote workforce adoption are expected to be permanent and this shift to remote work has the biggest impact on lunch and dinner occasions, the meals Our frozen portfolio over indexes in these occasions by offering hyper convenient meals and sides perfect for a quick lunch or family dinner. In addition to enjoying more food cooked together at home and including frozen as a key part of those meals, consumers are making what in 2020. Recent studies and our understanding of habit formation tell us that this shift toward at home entertainment is likely to continue post Pandemic. When consumers, particularly the younger generations, move their entertainment to the home, they increase the number of At home snacking occasions.
And during those occasions, consumers are choosing our brands time and time again. And as I've already touched on, younger groups are engaging more and more with our Staples segment as they learn how to cook at home. As the chart on the left demonstrates, young adults are increasingly moving from urban areas to smaller cities and suburbs where there are Fewer options for eating away from home. And as the chart on the right demonstrates, these young consumers, Gen Z and millennials, Are increasingly engaging with Conagra's staples portfolio as they discover their kitchens. Today, We are reaffirming our fiscal 2022 guidance.
As I said earlier, we're not incorporating expectations about the stickiness Of COVID driven demand in our reaffirmation of the organic net sales guidance. However, as we have detailed today, We are increasingly confident that we will benefit from the stickiness of the pandemic driven demand. And as Dave will discuss, while the Current inflationary environment provides us more of a challenge on margin than we were originally expecting. We will be pulling on all of our margin levers We continued to deliver solid execution during the Q3 and our business remains strong In the absolute and relative to peers, while inflation is accelerating, we have multiple levers to manage inflation and drive margin I'll start my remarks by calling out a few 3rd quarter performance highlights, which are captured on Slide 37. As we have detailed this morning, The business continued to perform very well throughout the Q3.
Strong execution from the supply chain and outstanding performance by our teams across The company enabled us to exceed expectations for net sales during the Q3, while meeting margin and earnings targets as we continue to strategically invest the business while managing inflation. Overall, reported and organic net sales for the quarter increased 8.5% 9.7 adjusted operating margin increased 31 basis points to 16% in the quarter. Adjusted EBITDA increased 9 point 9 percent to $566,000,000 in the quarter, while adjusted diluted EPS grew to $0.59 up 25.5 percent. Slide 38 illustrates the drivers of our 8.5% net sales growth versus the same period a year ago. The 9.7% increase in organic net sales was driven by a 6.1% increase in volume connected to the continued increase in at home food consumption as a result of the COVID-nineteen pandemic, a favorable price mix impact contributed a 3 point percent increase to organic sales growth.
As Sean mentioned, our organic sales growth was impacted a bit from the February winter storms impacted our ability to deliver product for a short time during the quarter. Our strong organic net sales growth was partially offset By the impact of a 1.2% decrease associated with the divestitures of the lenders, H. K. Anderson And Peter Pan Businesses, as well as the exit of the private label peanut butter business. As a reminder, we completed the divestiture of our Peter Pan Business on January 25, which was approximately 2 months into our fiscal Q3.
Turning to Slide 39, You will find a summary of our net sales by segment. In the Q3, we saw continued growth in each of our 3 retail segments On both a reported and organic basis as the continuation of elevated demand for at home food consumption benefited these segments. Our Foodservice segment was negatively impacted by reduced demand away from home. Importantly, innovation momentum in our retail segments continued throughout the quarter. Slide 40 outlines the adjusted operating margin bridge for the Q3 versus the prior year.
As you can see, our adjusted operating margin increased 30 basis points to 16%, in line with our guidance range for the quarter. Our adjusted gross margin increased by 12 basis points in the quarter versus the same period a year ago as our margin levers of mix, cost management, fixed that we made during the quarter. I'll discuss those in more detail in a moment. A and P increased 11.8% in the quarter, primarily driven by higher e commerce marketing investments, particularly for the Refrigerated and Frozen segment. And finally, our adjusted Was favorable to our operating margin by 30 basis points versus a year ago, as net sales grew at a faster pace than SG and A.
I'd now like to touch on certain transportation investments we made in the quarter. These are incremental transportation costs incurred On top of the core transportation inflation we experienced, so we've included these in our COVID-nineteen related costs In the margin bridge, these investments had a negative impact on our margins, but they helped us deliver more profit dollars. You can see by Q3 organic net sales exceeding guidance, demand was higher than we expected during the quarter. To adequately service We made the decision to invest approximately $15,000,000 in the quarter. This meant aggressively seeking out every available truck and adjusting how we ship to customers.
To best service demand for certain brands, we had to bypass our normal distribution network and Ship directly to customers. While we incurred additional cost to implement these actions, which impacted our operating margin, This enabled us to minimize out of stocks, maximize on shelf availability and maximize profit COVID has provided a period of significant elevated consumer trial of our brands and our innovation has outperformed expectations, allowing us to gain share with existing and new consumers, investing to keep product on shelves to support this momentum and to our retail customers, while they manage tighter inventory levels, was an easy business decision for us. While we expect demand to remain elevated for the foreseeable future, we believe we will be in a position to start rebuilding inventory over the next two quarters, which we believe will start removing the need for these incremental investments. I want to take a moment to comment on the input cost inflation we're seeing in the market And provide an overview of what we're doing to navigate it. As you can see on Slide 42, inflation increased 3.9% in the 3rd quarter.
This was higher than our 3.5 percent estimate and reflects the broad based impact on the cost of materials, And Transportation and Logistics. We expect the rate of inflation to continue to accelerate over the next few quarters. Fortunately, have a variety of levers that can be used to offset this pressure, including pricing. We have already mobilized our inflation justified pricing plans, With some actions already in market, others communicated to customers and some yet to come. History shows us that price Adjustments are more likely to be accepted in the market when industry wide and broad based input cost inflation occurs and that's the environment we see today.
We will also leverage our capabilities beyond just pricing to offset margin pressure, including overall mix management, Cost savings measures such as our ongoing supply chain realized productivity programs and the optimization of our fixed cost leverage. In short, we will continue to closely evaluate the impact of inflation on our business and are confident in our ability to line of our adjusted operating profit and margin by segment for the quarter. We are very happy with the continued profit growth in the quarter, which more than offsets the decline in Foodservice. Slide 44 summarizes the drivers of our 3rd quarter adjusted diluted EPS From continuing operations. In the quarter, our adjusted diluted EPS of 0 point 5 compared to the same period a year ago.
The growth in the quarter was primarily driven by the increase in adjusted operating profit associated with the Slide 45 summarizes Conagra's net debt and cash flow information. We ended the 3rd quarter with our net debt to adjusted EBITDA leverage ratio our balance sheet in a stronger position and given our strong operating cash flow, we have increased our investments in the business. Our year to date CapEx increased over $130,000,000 compared to last year to fund important capacity and productivity projects. By our recently increased dividend as well as by executing our 1st share repurchases since the close of the Pinnacle acquisition. During the We opportunistically repurchased 8,800,000 shares for $298,000,000 demonstrating our willingness To capitalize on occasions when we believe we are undervalued.
Looking forward, we will continue to be focused on Slide 46 summarizes our current outlook. As we've said throughout our comments today, Conagra's business is performing well and we remain optimistic Regarding our ability to generate continued strong performance in the quarters ahead. For the 4th quarter, we expect organic net Sales to decline approximately 10% to 12% as we lap the 21.5% growth in Q4 a year Our Q4 guidance represents a strong 2 year growth rate of approximately 7% to 9.5%. As a reminder, reported net sales will also be impacted by last year's 53rd week. We expect 4th quarter operating margin be in the range of 14% to 15%.
This estimate includes the combination of continued transportation investments to support Product availability at similar levels to Q3, the lag in timing between our pricing actions And the expected acceleration of inflation as well as a continuation of the A and P investment increase that started in Q2. As a reminder, our fiscal 4th quarter is historically our lowest operating margin quarter given seasonality, as just mentioned, does not include a 53rd week. Given these sales and margin factors, we expect to deliver 4th quarter adjusted EPS in the range of $0.49 to $0.55 Our 4th quarter guidance also continues to assume that the end to end supply chain operates effectively during this period of heightened demand. And finally, we are reaffirming all of our fiscal 2022 guidance metrics. As Sean mentioned, While the current inflationary environment provides us more of a challenge on margin than we were originally expecting, We remain focused on utilizing our entire toolkit to deliver our profitability targets, which we are reaffirming today.
When we report Q4 results in early July, we plan to provide more detail on our fiscal 2022 expectations. That concludes my remarks this morning. Thanks for listening. I'll now pass it to the operator to open it up for questions.
Thank you. We will now begin the question and answer session. And today's first question comes from Andrew Lazar with Barclays, please go ahead.
Great. Thanks very much for the question. Sean, in conversations with investors more recently, There appears to be this sort of lingering concern that ConAgra will take whatever actions necessary to deal with inflation in fiscal 2022, even if such actions might have sort of negative implications beyond 2022. So in other words, Conagra can hit its fiscal 2022 goals, but do so in a way that is somehow deemed less sustainable or lower quality. And I guess in light of rising inflation seen in Today's results on margins and sort of the margin commentary for next quarter, I'd expect these concerns to only grow from here.
So I guess I'd love your take on this and maybe to address this sort of very specific investor concern if you could.
Sure. Thanks, Andrew. Good to hear from you. Hope all is well. Well, the short answer is that that concern is totally unwarranted.
But let's Copter up for a second, just look at the big picture here. Over the past 6 years, we have totally transformed our company and our culture And the magnitude of the portfolio modernization we've delivered is arguably best in class. And that incredible work by our ConAgra team Put us in a position to capitalize on the unique and unprecedented trialing opportunity that COVID presented. We knew that our modernized products would perform and that our repeat purchases would be excellent. So what did we do?
We invested during the pandemic to maximize trial and try to capture the lifetime value of these new mostly younger consumers. Look no further than our aggressive stance on transportation solutions and e commerce in Q3. So if you flash forward to fiscal 2022, our conviction around getting our products, Our modernized products into consumers' mouths won't change. We play the long game and we do not burn the furniture to create better margin percent Optics, short term. This is my I think it's my 9th year as a public company CEO and I've never taken that route.
So I don't think that concern is warranted.
Great. Thanks for that. And then a quick follow-up. I didn't hear and I may have missed it, The synergy capture in the quarter, I don't think it was in the slide deck and it's been in there the last couple of quarters. So maybe, Dave, if you could just comment on how that came in, in the quarter?
Yes, Andrew. We're right on target with synergy. There was $24,000,000 of incremental synergy in the quarter. That brings us to 2 $70,000,000 cumulative and we're still on track to hit our target of $305,000,000 by the end of next year.
Great. Thanks very much.
And our next question today comes from Ken Goldman at JPMorgan. Please go ahead.
I apologize if not.
We can hear you now, Ken. We missed the beginning. We missed the beginning.
Okay. We'll try anyway and just cut me off if you can't hear me. But Sean, as you know, Just to kind of piggyback a little bit on what Andrew was saying. One of the bigger investor questions is whether you can hit that 18% Minimum margin number next year, right? I'm sure you hear that more than we do.
You obviously maintain that range today, but the 3Q margin came in lighter than you expected, 4Qs will as well. And then you have an acceleration of inflation into next year. So despite your reiteration and even though pricing and savings are going to accelerate, There's an argument to be made that your current numbers are saying these tailwinds won't be quite enough to offset costs. So I guess my question is this, Just how confident are you in that 18% to 19% range? And why isn't it somewhat at risk, at least more than it was 3 months ago, Given net cost inflation that we're seeing?
Well, we've reiterated 2022 and we feel good About the 2022 algorithm overall, Ken. And the precise permutation of how things unfold is not yet clear because things Moving around still quite a bit, but here's how I think about 2022 in general. Is what we were originally envisioning. The top line clearly looks stronger. Margins look more challenged short term Due to inflation and the lags that usually follow price increases.
And so given we're still in the midst of finalizing our annual operating plan and our pricing plans, it is premature to communicate the precise permutation of how things will unfold. But in our eyes, we
And our next question today comes from Chris Growe with Stifel. Please go ahead.
Hi, good morning.
Good morning.
Hi. Just had a couple of questions here. For the first one just would be that as we think about the levers you have to That inflation going forward, there's multiple levers, obviously pricing and promotional spending, those sorts of things. I'm curious in terms of like your cost And you have a little bit of residual synergies, but
should we think of that
as the first line of defense? And how much in the way of, say, like productivity savings do you have To help offset inflation before you have to jump into actual pricing and other levers you have to pull, that makes sense.
Yes. All right. So let me start, Chris, with the big picture here and then we'll go over to Dave with the more granular detail. Here's how I think about this whole inflation slash Leverpricing kind of concept. Principally, when we're experiencing inflation as we are currently, we will be very aggressive offset it using multiple levers like our cost programs, which you cited pricing, trade and mix.
Now with regard to inflation justified pricing, it's really there not a question of if we will move, it's a question of is typically shorter as you know in Foodservice and in those retail categories with simpler is to fully offset inflation over time and through all of these levers and we're working very aggressively to do that. And as I pointed out before, something else to keep in mind too is that the priority for both Conagra and our customers is to sustain growth. Now doing that means we got to keep our proven innovation machine running and doing that means we have to offset inflation. So in other words, our Customers understand this more often than not because they've seen and they count now count on the tremendous vitality that our innovation Programs have driven into important categories like frozen and snacks. And last thing before I turn it over to Dave is, by the way, I am very happy that we've been so aggressive in modernizing our portfolio for the past 6 years because you can see it in the numbers.
The dedication that these consumers now have to our products will be another factor that helps us navigate this inflationary period. Dave, do you want to talk any more about the other the cost savings levers or anything? Yes, sure. So Sean hit the pricing. As it relates to realized productivity, First of all, we have a very experienced supply chain organization with really strong processes across the entire network.
So if you look historically, we've approximated 3% of cost of goods sold realized productivity savings if you go back historically. Efficiency in the plants, network opportunities, sourcing, there's just a series of different areas and we continue to execute projects to drive cost savings opportunity. So obviously, this isn't changing as we look forward. There's other levers though. As Andrew had asked previously, we're track with our Pinnacle synergies to go from our $270,000,000 where we are year to date this year to $305,000,000 by the end of next fiscal year, Less COVID related costs in fiscal 2022.
As people become vaccinated, the entire end to end supply chain is going to benefit from less supply disruption and that will enable us to reduce excess cost being incurred in fiscal 2021 to support demand. The Q3 incremental transportation investment that discussed in my remarks, that's one example. That was $15,000,000 of investment just in this quarter. Another area is supplementing volume with co mans, Both the incremental cost of the co man and the incremental distribution cost to get it from the co man to the customer. And so That's another important lever.
We're over $100,000,000 year to date in those COVID related costs that as we look to 'twenty two It should really be an opportunity for us to get that out of the base. We will have some headwinds with fixed overhead absorption And overall segment mix, but we think product mix is an opportunity for us. And then as we always talk about margin accretive innovation, our innovation continues to be Strong and we're really bullish on making sure that it's margin accretive. So yes, there's a lot of things, a lot of dynamics that's Driving this right now, but based on the analysis we've done in the different scenarios, we think we have various ways that we can reach our
Okay, great. That was helpful. I have just one quick follow on. In relation to those transportation investments Is there another $15,000,000 in the 4th quarter that the way to think about it? And is that basically helping you rebuild inventories more quickly?
Is that way to think about that investment?
Yes. So I'm not going to give you the specific. We do expect additional investment in Q4. I'm not going to say that it's exactly 15%. It's a little fluid.
The overall objective is to optimize getting product to customers as quickly and efficiently as Possible. So for certain categories in Staples and Snacking where inventory has been tight, we made the decision to bypass our normal DC distribution system network and shipped directly from plant or directly from one selected DC. So that gives us Better inventory, and it allows us to meet customer demand more efficiently, and it improves product availability, but it comes at an incremental cost Inefficient shipping lanes and sporadic frequency of distribution routes. So, there's a lot of dynamics there that's going to continue into Q4, And we'll manage that number the best we can.
Okay. Thank you very much for all that color.
Our next question today comes from David Bomer in Evercore ISI. Please go ahead.
Thanks. Just to follow-up on some of those Questions with regard to fiscal 2022. You mentioned pricing actions and you mentioned increasing inflation over the next few quarters. Do you anticipate That the gross margin trends and perhaps earnings growth will be more of a back weighted will make fiscal 2022 more of a back weighted year Given the timing of inflation versus pricing? And I have a quick follow-up.
Yes, David. We're not going to get into specifics So on fiscal 2022 right now, as we said in my comments, we expect the inflation rate to accelerate into Q4 and into early Fiscal 2022, but we'll give more color in July when we give our Q4 earnings. David, it's Sean. We've talked about How these acute inflationary periods work with respect to pricing many times over the years. And this lag Concept is an important one, right?
When you see broad based inflation across an industry across the basket the way we're seeing now, you tend to See the whole industry kind of acknowledge that they're they've got to contend with these things. They've got to deal with it. And not I said a few minutes ago, not all businesses are created equal in terms of when the positive impact of pricing shows up in the P and L Versus the negative impact of the inflation, there can be a lag. So over the course of a full year, that's kind of how you tend to see it go as you see more About a headwind in the short term and then you see recovery as pricing goes into the marketplace. And then oftentimes there's a benefit following year as you begin to wrap.
So we'll see how it plays out this year. We can say at this point is we're Flat out on all of these integrated margin management levers that we go after in times like this.
And just to follow-up on the topic of setting up fiscal 2023 after you hopefully achieve your targets in fiscal 2022. If you're achieving if the stickiness is above what your guidance implies And you mentioned that you're not anticipating with this guidance that the COVID related trial will relate will End up with stickiness in that demand. But if you do have that, you do have strong multiyear sales trends and you have room to reinvest. What where do you anticipate those investments going from here? Where do you see the most opportunity?
Thanks.
David, it entirely depends upon what is the barrier to maximizing trial in any given window. So Q3 is a very instructive example in this regard. You could look at our top line in Q3 and say, wow, we beat our guidance on the top line. Was that because of the A and P increase? The answer to that is no.
We planned for a double digit increase in A and P and we still over delivered on our top line. So what was it exactly that drove the incremental Lift on the top line. It was a deliberate and spontaneous choice by our management team to invest in Transportation solutions that are atypical for us, they come at a higher cost and we chose to do that and make that investment. Why did we do that? Because we've got Phenomenal repeat and depth of repeat data.
And so we're very confident in the ROI of that investment because we're very serious about investing in the business In the short term, during this trial period, in order to capture this lifetime value. So we've been doing it. Also the decision to continue to lean hard on e Commerce where we tend to get the best ROIs, we tend to over index most with the younger consumers who are going to be the ones that deliver that lifetime value. This is very purposeful in our regard and we are absolutely we don't want any comments today on beyond 2022, but what we can say is we're playing the game Hard to optimize what Beyond 'twenty two looks like in terms of our consumer base because we're having such good fortune generating loyalty.
Thank you.
And our next question today comes from Alexia Howard with Bernstein. Please go ahead.
Good morning, everyone.
Hi, Alexia. Good morning.
Hi. I hope you can hear me okay. So my first question is, You've obviously made a number of divestments over the last several months and maybe longer than that. Now that we're coming up to the expiration of the deferred tax assets, are we done with that? Or is it possible that there might be more about to come?
Well, obviously, we have been active over the years And our philosophy on that has really not changed. It's been that if there's a business that It doesn't fit strategically, if it's a chronic drag on our sales or chronic drag on our margins or somebody else just really puts a tremendous value on it, we're And to divestitures, should a legitimate offer come along that we see clearing the hurdle of the intrinsic value of the business. And that's kind of always been our case. And that's we're fully aware of the timing of the capital loss carry forward. And we have divested assets leveraging that along the way.
And frankly, we have been open to other things as well. But we're just it's not strategic for us, let me put it this way, To pursue utilizing the capital loss carry forward for the sake of utilizing the capital loss carry forward, it would be strategic for us to divest An asset that didn't fit or was something that wasn't a priority for us as long as the valuation that was inbound clear the intrinsic value of that. And if that to happen, at any point in time, we would be open to it. That's when that's in place, we've done deals.
Great. And then as a follow-up, Your price mix is obviously in the Q3 at least nicely positive. I guess that's partly because of the pandemic and The I guess maybe lower promotional activity or maybe it's different. But I'm curious about the mix component there and what exactly is Driving, if it is positive, the mix piece and how you expect that to develop going forward? Thank you, and I'll pass it on.
Alexia, just roughly of the price mix benefit we saw in the quarter, it's roughly fifty-fifty mix and kind of price and promotion. I'll kind of put it into those 2 buckets. As it it comes to the mix part of it, a lot of that is really segment mix. So we are growing our domestic retail Segments significantly, which are strong in terms of sales mix relative to our Foodservice business, which is down. But we're also seeing favorable mix within the business.
So it's really a combination of segment and kind of brand product mix, if you will. And Alexia, Sean here. Just one other thing that I would encourage the investor to think about as they think about our top line long term. If you think about our You've got 3 consumer domains. You've got frozen, you've got snacks and you've got staples.
And so what does A long term investor have to believe to feel good about our top line going forward. I think they've got to believe that there's continued growth opportunity in frozen. I certainly do. They got to believe there's continued growth opportunity with this awesome Snacks business we have. I certainly do.
But what's really interesting post pandemic is the Staples business. And that's a very Strong margin business for us and it's been performing phenomenally well. And this whole dynamic with younger consumers learning how to cook, Realizing the tremendous value proposition of Cooking Simple Meals at Home, beginning to form families and this kind of at home Nesting. It's a real phenomenon and that's a good thing because it would lead a reasonable person to believe that that business is at least going to be stable. So if you think about the total mix of the portfolio, you've got a big profitable stable business and 2 growing domains.
I like the way that shapes
Our next question today comes from Bryan Spillane with Bank of America. Please go ahead. Hey, good morning, everyone.
So just quick ones for me and maybe I might have missed it, but Dave, the guidance of the 'twenty two reaffirmation, is that net of Peter Pan divestiture? Sure. Or is that I guess that's the question. Is it net of the divestiture or not?
Yes. It's net of the divestiture. It's out of there.
And then Second question, I guess, Sean, is we're thinking about the possibility or the potential that some of the Demand behavior sticks going forward. How does that affect or does it have an impact at all on manufacturing capacity and as you assess this, I guess, over the next year or so, I guess, what I'm asking is, is there potential that you might have to Elevate capital spending for a while or make some acquisitions to expand capacity, enough manufacturing capacity to Sort of support and at the base that would be elevated versus where it was in 2019?
Yes. Brian, we've already been doing that across a number of our businesses and top line remains We'll continue to do that because if you look over time at the IRRs we get on numerous broad based capital investments, the best IRRs Typically those associated with increasing capacity on our growing businesses like Slim Jim and others. So That's a great return on all time and we'll continue to look for opportunities to do that. And we spread it out based on how we need it. But we've already been making those investments in added capacity both internally and with co packers.
Interestingly, the way it, as you all know, works with some of these co packer investments is Those can be a headwind to margins in the short term. But if you believe that the demand on the other end of the consumer there is sustainable, Typically, when you repatriate that capacity back in house, that's expansive to margin at that point in time. So that concept remains And
our next question today comes from Jason English at Goldman Sachs. Please go ahead.
Hey, good morning, folks. Thank you for slotting me in and congrats on another strong quarter. A couple of questions. First, recently tactical one and building off of Alexia Howard's The price mix contribution, I think you said around half from lower promotions. With the pricing actions you put in place, is it reasonable to expect a decent chunk of that be offset or mitigated by promotions coming back into the system?
Or do you think it's reasonable that we could actually continue to operate at a much more subdued promotional level?
Well, if you just go back over the years, Jason, you've seen us pretty dramatically ratchet down our promotion reliance over the last I think probably on average, we probably reduced our reliance on promotion more than most food companies. And Frankly, COVID, again, illuminated some of the inefficiency that has emerged over the years in some of the traditional promotions. It's just the lifts that the industry used to see on a lot of categories are a lot smaller today. So it's We're big believers in redeploying any inefficiency we can find in our total marketing spend and higher ROI ways that could be in trade. As you've seen before, we've found tremendous inefficiency in some of the A and P lines and we've actually managed and reinvest some of In store with retailers, but not against traditional kind of stack them high and watch them fly types of investments.
So that type of that priority is Always intact for us and we will continue to try to push our over time our reliance on Price based promotion downward. Obviously, last year was kind of an extreme base, and so they'll we'll see how that unfolds over time. But principally, that's we think about it. Dave, you want to add? Yes.
The only thing I would add to that is that, Jason, that's why I said price and promotion because we really look at them together. When you're looking at the impact of price, obviously, you have to look at not just the list price, but how you promote, what your strategy is to promote as well. So it all goes into the Net realized price calculus. So just wanted to clarify that.
No, for sure. That makes a lot of sense. Okay. And on that topic Of allocation to maximize return, you've talked a lot about your investment in ecom@aandp. I'm assuming that's you're referring to retail media.
It sounds like Walmart's making a pretty big push to try to drive more with Connect and integrating with its joint business planning, Kroger's Is it reasonable to expect that investment to continue to climb next year? It's part 1 of the question. And part 2 is, if so, Where can you fund it? Can this come out of trade or does it need to be incremental dollars into the P and L?
We're As I've mentioned many times, we're agnostic to where we put brand building dollars as long as we get good impact And a good ROI. And so your example on TV, I think it was a number of years ago, I said, look, a lot of people could have come to us and offer to Media is what we choose to run and it's a question of what's the effectiveness and what's the ROI on that. So we're open minded to different investment. But by the way, that's not all that we've invested in, in e commerce. As we've talked before, the importance of investments in search and other things so that we show up Well, in the digital shelf, so to speak, are very important.
But we have been pretty good at Keeping our overall level of total marketing investment rock solid over the years, we just tend to move it around from Pocket to pocket based on what specific opportunity in any given window gives us the greatest impact and the greatest return on investment.
So you can move it around it. It sounds like the answer is if it has to grow, you can sell from that
And by the way, if we just principally, if we were ever going to add incremental investment to what we would do, it would be because we see a return for that. And that's where what I mean by that is those incremental investments to me, when you see opportunities where they're not a tax on EBIT, But they're actually an accelerant to EBIT because of what they do to the top line. That's positive ROI. We've always been open to that kind of thing. I that's Not something we're forecasting, but it's just principally how we think about those kinds of investments.
For sure. That makes sense. Thanks a lot. I'll pass it on.
And our next question today comes from Robert Moskow with Credit Suisse. Please go ahead.
Hi. Thank you for the question. I was wondering in your forecast for the rest of the calendar year, have you baked in any assumptions for Government stimulus programs running out SNAP benefits, which are elevated now dissipating. I would imagine that would Your consumer base a little more than most packaged food companies.
You tell
me if you agree. And is it possible to disassociate that with the stickiness you expect from all the new trial you got from COVID? How have you made your macro overlay assumptions there?
Well, with respect to the stickiness, stimulus and other things aside, We obviously think it's real and that our conviction there is growing even stronger day by day. But we don't need that stickiness, as I said before, to get to our revenue algorithm. Hopefully, as the database case And I think that's obviously going to unfold based on how the data continues to unfold. In terms of things Regulatory changes, tax changes, stimulus changes, things like that, SNAP, we do our best to try to Prognosticate exactly how that's going to land and factoring it into our forecasting processes and you should assume that we do that. We've got I think you guys know we've got a really impressive demand science team and they look at macro factors like that, that could have an impact And we leverage them to get to the best forecast we can get to.
Okay. And then one quick follow-up. Are you Expecting to increase A and P double digit again in 4th quarter?
Yes. As part of the guidance, I did that was in my prepared remarks. That's correct.
Okay, great. All right, thanks.
And ladies and gentlemen, this concludes the question and answer session. Would like to turn the conference back over to the management team for any final remarks.
Great. Thank you. So as a reminder, this call has been recorded
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.