Conagra Brands, Inc. (CAG) Earnings Call Transcript & Summary

We're excited to welcome Conagra back to the CAGNY stage. But first, please join me in thanking Conagra for the generous sponsorship of last evening's wonderful opening reception. I'm sure like many of you in this room, I'm a bit embarrassed by the sheer magnitude of meat snacks sitting in my room at this very moment, but also oddly comforted by it. It's been quite interesting to watch the performance of many of Conagra's core brands in terms of how well volume, share and distribution have held up even in spite of the necessary pricing actions that have been implemented and to think back on how this may have played out differently before the company had renovated and contemporized its portfolio. This is a credit to much of the work done well before the events of the past few years and has set the company up to be much more on its front foot as it leans even further into innovation and supply chain productivity work. So with us from Conagra today are President and CEO, Sean Connolly; and CFO, David Marberger. Sean, over to you, and thanks for being here.

All right. Thanks, Andrew. By the way, we are okay with you being oddly comforted. That's all as long as you're buying it at full margin after this event, we're good. Okay. Well, good morning, everybody. It is great to be with you here in person. It feels like it's been a long time since we together in person at CAGNY. So this is fantastic. Thank you for attending our presentation. And for those of you online, thanks for tuning in. Hopefully, some of you in the room got to attend that reception last night. It was great. I want to give a shout out to our world-class stable of chefs, once again showing us how it's done when it comes to great food. So we've got a busy day today. So let's get into it. I wouldn't be CAGNY without some forward-looking statements, so please take a second to look at this legal disclosure. All right, let's get into it. These are the key messages we want you to take away from our presentation today. First, we have a strong, well-managed portfolio with leading brands in highly attractive categories; second, we have clear growth prospects led by our very attractive frozen and snacking businesses; third, we have promising margin expansion opportunities, as you saw in our quarter 2 call just about a month ago. And lastly, we have an array of attractive capital allocation options, all part of our balanced approach to allocating capital in the pursuit of shareholder value. This is our agenda for today. I'm going to take you through who Conagra Brands is today and what we've done to become that company. Then I want to take you through a deeper dive of our attractive frozen and snacks business. I will wrap up with a preview of some exciting innovation that we've got soon to hit the marketplace. At that point, I'll turn it over to our CFO, David Marberger, who will take you through our financials and growth algorithm. Together, Dave and I will show you the multitude of ways we are confident we can create value for our shareholders. So let's get into it. Let's start with a quick overview of who we are. Well, the precursor to profits is purpose. And for Conagra, that's all about nourishing our people, our planet and our communities. So it should not come as a surprise to any of you that one of the ways we create value is through our sustainability and ESG efforts. We think being a good corporate citizen is not only the right thing to do, we think it generates a good return, be it in the form of greater consumer loyalty or cost savings or a better job recruiting and retaining our employees or stronger communities in which we operate. We think it pays off. And in the next couple of weeks, we will be publishing our new citizenship report. It will be on our website. I encourage all of you to take a look. We're very proud of that work. All right. Let's get into the profile of the business. We are $12 billion at net sales, and we are a highly focused company. Over 90% of our sales is in the United States, and over 90% of our sales is in the retail channel of train -- of trade. We like to say that our U.S. centricity enables what we call simplicity at scale. And if you think about it, about 80% of our shipments is focused on just 18% -- 18 customers. And at our top customers, we service their shoppers' needs in virtually every aisle of the grocery store. So between the success we've had with our innovation and the sheer scope of our portfolio across the store, we have fostered tremendous relationships with our customers, and that's quite important. Another unique thing about our portfolio is we have many light touch brands that provide tremendous utility to consumers, but also tremendous cash flow to our company. Now make no mistake about it. Consumers love our iconic market-leading brands. You can see a smattering of them on the right here. Our brands are found in 96% of U.S. households. So they're basically everywhere. And these are brands with stature. 82% of our revenue comes from brands that are ranked #1 or #2 in their category. Now where we play has been an important part of the Conagra transformation story. Over the last 8 years, we have curated an enviable portfolio that today is anchored in frozen and snacks. As you can see here, about 70% of our retail sales today is in the highly attractive frozen and snack space. The third piece is our ingredient and enhancer business. This is also a growth business for us, has tremendous appeal to younger consumers who are finding their way in their kitchen for the first time. And then the last piece of our business is shelf-stable meals and side, more of a cash-oriented business. But our focus has been on sculpting more and more of our revenue base to be in these highly attractive domains of frozen and snacks. Why? Because they're high growth, and I don't see that ending anytime soon. Frozen's 3-year CAGR is 7%. Snacks' is 10%. And if you look back over the last 3 years, 3/4 of our portfolio growth in retail has come from these 2 domains. So obviously, our strategy here is working. Now these days, it's important to point out where private label stands in our categories. And the bottom line is it under indexes. If you look at the left-hand side of this chart, you can see that in our categories, private label is about 14%, quite a bit below the peer set. And we have sculpted some of that by way of divestiture, exiting commodity-oriented categories like cooking oil, peanut butter, liquid eggs. Look at the right-hand side of this chart, private label over the last year has actually shrunk in our categories. Why is that? Well, we think it's because our portfolio tends to be center of plate, snacking or categories that have relentless innovation. And those are the attributes of categories that tend not to perform as well with respect to private label. Now not everybody in this room is familiar with what we've done in the last 8 years, so let me hit the highlights quickly. I joined the company about 8 years ago. It's hard to believe. And when I got to Conagra, I saw the opportunity was clear. The company had become too complex, had outdated capabilities, had some challenges in terms of capital allocation and frankly, the performance was disappointing. So I believe the company needed a fresh start. That's what we decided to do a wholesale transformation. Now as you might imagine, transforming a nearly 100-year-old company is a heavy lift. But we had a clear vision and we had a tremendous amount of confidence in our playbook, so we went for it. This is our journey since we implemented our playbook back in 2016. First, the transform phase that was literally about unwinding 95 years of norms of structure, all the things that were baked in place, including culturally. Then came the build phase. It was all about modernizing our brands, bringing new people onto the team, implementing new processes, new capabilities and refreshing the culture. And then the accelerate phase where we sit today, which is all about winning in the marketplace and winning in the workplace. And as you'll see, we've been accelerating and don't see that stopping anytime soon. Our playbook is called the Conagra Way. It's built on these 5 differentiated capabilities that we have implemented over the last several years, starts with demand science, which is all about mining the data to understand what is growing within food and beyond. And then asking ourselves, what are the attributes that are driving that growth? And would it make sense to those attributes into our categories and our brands. If the answer is yes, we bring in our design team, and they design everything from the culinary to the packaging, everything we need to go to market. Then we hand it off to our world-class sales team, who focuses on what we call progressive selling. This is about helping our retailers understand the deep insights behind our innovation so that they can have confidence that our innovation will outperform that of our competitors, but more importantly, drive overall category sales, which it has. Then we hand it off to the marketing team and focus on modern marketing. I'll talk about this in a couple of minutes. And all of this is underpinned on a winning culture. We're a big company, but it's a very entrepreneurial, very flat, very agile team. As many of you know, the Conagra Way playbook has been very successful with respect to innovation. On the left-hand side of this chart, you can see the compounding effect of multiple years' worth of successful innovation. Each color represents a different year. So you can see our innovation is sticky, and it is working. On the right, several other data points showing you how successful our innovation has been in the marketplace. I'll point to the one in the middle which is just a good reminder that our innovation isn't only working for consumers. It's working for our retail partners, where we have built tremendous credibility. And today, they are giving us 1.4x the number of total points of distribution they gave us just a few years ago. And through that innovation, we have premiumized our portfolio. What I'm showing you here is total Conagra average price per unit indexed back to fiscal '14, the year before I started with the company. If you look at the bar on the right, past 52 weeks, it's up 44%. So we've dramatically premiumized this portfolio over the last 8 years and these products still represent an excellent value to our shoppers, which you can see in our sales line, this is our sales line since fiscal '16. It has built consistently. In fact, it's accelerated. And importantly, our market share is improving as well. It's grown virtually every year since we implemented our playbook. Now I should point out, it's not just about revenue and share. How about profit. Take a look at this. This is our EPS CAGR since fiscal '16. So this is a sustained period of time. And we have averaged over 10%. Look at how that compares to our 5 near-in peer and the broader peer set, which includes some of the confection and snacking folks. It's been outstanding EPS performance. Despite this, we remain a great value today. Here's total shareholder return since fiscal '15, the year I joined. You could see it's been fully competitive versus the broader peer set and quite a bit ahead of near-in peers. And I should point out, this does not include the incredible value we created with the successful spinout from Lamb Weston, which has been a home run. Yet we still remain a great value. And our momentum is building. These are the numbers we had put up 1 month ago at our 2Q earnings call. You can see organic net sales, up nearly 9%. Importantly, adjusted gross margin, up over 300 basis points and nearly back on par with pre-pandemic. Strong operating margin performance and EPS up nearly 27%. But we're not done. We've navigated the pandemic. We've proven that we can pass through inflation justified pricing. Our brands have proven resilient in the face of that pricing, and we have what we believe is the best team in the business. And when you put it all together, we remain highly confident that we are a compelling investment opportunity. All right. Let's take a closer look at our highly attractive frozen and snacks businesses. I'm going to start with frozen. This is a business where we've not only driven the success of our brands, but as you'll see in a minute, we have driven the massive cat frozen category overall. But first, I have to take you back to 2015. Not that long ago, frozen was an undermanaged and underappreciated space to say the least. There was virtually no innovation. The food quality was terrible. Retailers were focused on ultra-Low price's points, and we believed this was an enormous missed opportunity. In part, because we saw frozen is nothing more than a temperature state and the perfect temperature state for today's consumers. You can basically take whatever food you can imagine in the frozen section and flash freeze it from the peak of freshness, it's convenient, ready when consumers are. There's limited food waste and spoilage. And basically, you can get restaurant quality at home when it's done right at a great value. So our attitude when it came to frozen was, if you can dream it, we can freeze it. So in 2015, we set out to build what would prove to be a relentless stream of innovation in the frozen space. Innovation that would ultimately change the way consumers and our customers thought about frozen. It all started with data to understand the attributes that drive growth in CPG more broadly and then our great design team bringing it to life. So you know what? It worked. Frozen today is a vibrant area driving total retail store sales. Look at the left-hand side of this chart, these are all the departments that you see in the IRI data. The #1 department in terms of growth in the past 3 years is frozen, over 10%. Look, on the right, you can see that frozen appeals to people of all ages. But most importantly, it has excellent appeal as always has to the younger generation, a generation where we will have structural headwinds going forward. And I want to point out that the success in frozen is not a pandemic-only phenomenon. On the left-hand side of this chart, you'll see frozen was outpacing food more broadly, pre-pandemic. And since the pandemic, it has accelerated and the gap has widened. So it shouldn't surprise you that today, we are the largest player in frozen food in the United States at $6.5 billion. But look at the size of the entire market. We are just getting warmed up. Not surprisingly, you can see the effective innovation in our categories. Our categories are outpacing frozen more broadly. But look at this data point on the right, if you really want to appreciate the impact of innovation in frozen. Our categories have contributed 71% of all the growth in that massive frozen space. So when you get after it, it comes. Again, private label underdeveloped in frozen, you can see in this chart, I will also point out that our largest frozen subcategory frozen single-serve meals is much, much lower than this even. Now to win in frozen, you have to have scale and you have to have scope, and we've got both. These are the 5 frozen categories where we compete, meals, vegetables insides, breakfast, desserts and plant-based protein. All of these areas are big and all of these areas are growing. And when we start our work in frozen, it always starts with these 4 brands. Why? Because they are juggernauts. These 4 brands have driven 87% of our growth in frozen. Marie Callender's and Birds Eye are $1.5 billion scanned at retail. Banquet is now $1.1 billion and Healthy Choice is rapidly approaching $1 billion. So absolute powerhouse brands. But our success in frozen has been more broad-based than those 4 brands. In fact, if you look at our cumulative market shares overall, you can see outstanding performance here now over 41%. Our innovation, again, robust and sticky. Here are a couple of metrics we look at. On the left, we call this renewal rate. It's the percentage of our annual sales in frozen that came from items we've launched in the past 3 years. We put up a number over 14%. You can see our peer set is quite a bit behind that. On the right, you can see the sheer magnitude of this innovation, and again, how sticky it's proven. Now to really get an appreciation for how differently these brands show up today versus the past, I'm going to show you in these next few slides, a bit of a side-by-side. What it looked like in the old days on the left, what it looks like now on the right. Here's Healthy Choice. This is a brand that was invented in the 80s. It was all about heart health for the elderly. We completely remade the brand. You see our Power Bowls line on the right, which has been a home run because health appeals to people of all ages and it means many different things. and notice the average scan price change here as we've done this premiumization. Here's Marie Callender's. Look how old fashioned it was on the left, not that long ago. Look at it now on the right, premium, modern and working, $1.5 billion brand. Now here's one that many of you probably wrote off about a decade ago, maybe more, Banquet. It was stuck at a $1 forever and nobody believed that would ever change. Well, we liberated the brand from a $1. We completely remade the quality. We launched the Mega line. This is a brand that about 5 years ago was scanning a little over $500 million. Today, it's scanning nearly $1.1 billion. It is a juggernaut. Look at the average scans here as we've liberated this brand from its historical form. And guess what? Consumers love it. They think it's a better value. Birds Eye. We got a lot going on at Birds Eye, but our strategy on Birds Eye is premiumization. That's where the action is. That's where the profit pool is. Not playing veg. So you can see how we premiumize this portfolio over time. This is our vegetable and sides business with Oven Roaster, Skillets et cetera. Again, look at the scan. But Birds Eye is not just about vegetables and sides. These days, it's about meals. And you can see how our Voila line has changed with skillet meals, sheet pan meals and oven baked meals. And again, look at the scans, premiumization in action, still a superb value. P.F. Chang's has been modernized and extended into attractive areas like multi-serve meals, protein-only and appetizers. Our plant-based meat alternative business is Gardein. And here, when everybody was chasing food service in the meat counter, we stuck to our wheelhouse in frozen. And we ultimatized Gardein, you can see the new Ultimate line on the right, which is premium and has been a home run, look at the change in average scan. We've been gaining dollars, we've been gaining share. Now how do we market these brands and all this innovation? Well, in a word, effectively. The way we market these days is very modern, progressive and it gives consumers what they want. We operate in the digital and social realm. We have an entire team of people who focus on nothing other than building relationships with influencers and thought leaders in the digital and social realm, and let them help them tell their personal stories of how our brands fit into their lives. It's very real, it's very authentic. It's very effective. Take a look. Let's go to the tape. [Presentation]

All right. Let's keep moving. We're not done. Looking ahead, several frozen tailwinds exist starting with family formation, yes, millennials and Gen Zs are settling down. They're beginning to have kids. When that happens, their frozen consumption per category goes up, when they have more kids and more kids, it goes up and up again. That's a tailwind. Additionally, we believe that the shift to at-home eating and the shift to remote working will remain elevated versus pre-pandemic, and that's good for business. And then finally, it's impossible to argue with the notion that frozen offers superior relative value compared to perishable or away from home, which is also good for business. So that's frozen. Let's talk snacks. You obviously know people love snacks. But look at the per capita consumption increase. They're eating more and more every year since 2016, it's remarkable. Well, in 2018, after we got our frozen business up and rolling, we turned our attention and our playbook to snacks. And you can see here that it has worked. The results have been stellar. It really was all about running it like a snack business, which is all about relentless innovation and an intense focus on price-pack architecture. And again, it's been quite effective. So not surprisingly, we have become a top 10 player in the overall snack space at over $3 billion. And look at our growth rate. We're outpacing the larger snack players and snacks overall at 10%. It's been a fantastic thought -- role we've been on. Now I should point out, we are not a direct-store delivery snacking company. We enjoy the benefits of being a warehouse delivered snacking company, whether it's supply chain efficiency on the balance sheet or through enhanced margins, which this is certainly a good margin business for us. When you look at our snack business, big picture, there are 2 parts to it. On the left, it's our permissible snack business, which has grown at about 11%. This is a protein-forward business. It's all about being on-the-go, being in distribution and all points of purchase and having an intense focus on price-pack architecture. Then there's our sweet treat business on the right. You can see that's all about at-home indulgence and over-the-top experience. These are some of our permissible snack brands. Meat snacks, led by Slim Jim. We have several great brands that combined to lead the way in popcorn and then our great Seeds business with Davids and Bigs, super strong relative market share again. These are some of our sweet treat brands, puddings and gels with Snack Pack, our baking business with Duncan Hines and our Hot Cocoa business with Swiss Miss, very high share brands, very successful in the marketplace. I'll point out once again private label underdeveloped in our snacking category. It's underdeveloped in snacks overall, but look at our snacking categories, permissible and sweet treats relative to snacks overall, very low private label development. Our 2 big platforms, meat snacks and popcorn, incredible momentum. On the left, you can see our meat snacks platform is now over $1 billion with a 12% compound annual growth rate, and our popcorn platform rapidly approaching $1 billion, 10% CAGR. So clear momentum on our biggest -- the vast majority of our snack business. But we have additional growth opportunities elsewhere. Look at Snack Pack, David and Bigs and Swiss Miss and look at these growth trends versus 3 years ago. Just stellar growth-oriented businesses for us. Now looking ahead, what are we going to stay focused on, well, it's about distribution expansion and engaging consumers. With respect to distribution expansion, it's about showing up everywhere snacks are sold, and standing out through provocative innovation. And with respect to engaging our consumers, again, it's about engaging these consumers we call irrefutable advocates, real people to tell real stories about our brands in their own words. And I'm going to show you what it looks like in snacks, one of the brands I'm going to show you here is Slim Jim. And I should point out that about a year ago, Slim Jim debut on TikTok, and in 1 year's time, Slim Jim has amassed over 4 million followers, making Slim Jim the fastest-growing brand in TikTok history. Let's look at the tape. [Presentation]

All right. Yes, those are real people. Overall, it's undeniable. Conagra is winning in these highly attractive areas of frozen and snacks. Look on the left here, 84% of our growth over the last 5 years has come from these 2 domains. So it's clearly working. It's driving the overall company performance. And on the right, you can see our market share improvements. This is the last piece of my presentation before I turn it over to Dave. This is where I give you a blitz, sneak peek of the innovation to come. I will move quickly. So buckle up. Everybody loves pizza. But these days, not everybody loves carbs. Well, we can give you a great pizza without the carbs. These are our new Banquet Mega Crustless pizza offerings, they're fantastic. Healthy Choice Power Bowls, we're going to continue to keep the pedal to the metal here. These are 2 new great seafood varieties that are totally incremental to what we already do. All right. Let's -- here we go. Marie Callender's. Additional focus on sides. It's been successful in the marketplace. These are indulgent sides if you're on a diet, you might want to go back to Healthy Choice. But these are iconic favorites like green bean casserole, great at the holidays, great year round. We have a big Marie Callender pie business. But when we talk to our pie users, some of them too are cutting back on sugar. So we ask them, what can we give you? It's obvious, less sugar, we're giving it to them. Our P.F. Chang's franchise continues to extend. This time in vegetables. These are great easy to prep sides that are preseasoned and sauced . Teriyaki Broccoli is a good example. But P.F. Chang's is a premium product. In these days, sometimes consumers are looking for more value-oriented innovation. So what we're doing is taking the iconic La Choy business out of center store and introducing it to the freezer section, fantastic products, filling more of a value void in that high-growth Asian space. A ton of stuff happening on Birds Eye. This is one of my favorites. These are dips. Who doesn't like dips because it's kind of an extension of snacking, right? These are spinach artichoke dip and Buffalo Cauliflower dip as an example. I encourage you to get these for all your game day events. In these days, you can't be in the vegetable business without having a spectacular Brussels Sprout, right? So these are flame-grilled, fire-roasted Brussell Sprouts, you just heat them up and they're ready to go. You don't need any culinary skill just by Birds Eye. These are Fusions, this is a combination of things. It's all about elevated vegetables and sauces. And we have a kids business, Kid Cuisine. It was one of the last businesses that we got to in terms of our modernization efforts, and it's been growing robustly this year in the marketplace since we did that. So we're going to build on that momentum with this level up line extension. It's all about a fun interactive experience built around our Dino nuggets platform. Our Gardein ultimate line will continue to expand. We know a lot about bowls. So why not bring the great Gardein ultimate lineup into bowls, as you can see here. We also have the Purple Carrot brand, which you may know as a vegan meal kit that's home delivered. We sell this product in the grocery store. This is an example, our new vegetable fried rice line. Here's a fun one. Everybody loves Wendy's Chili. But you've never been able to buy Wendy's Chili before at the grocery store until now. We are launching Wendy's Chili nationally. We have a sizable chili business with a lot of regional stars around the country. Now we've got a national brand, and it's one of the most well-known chili brands you can find. You saw the success in popcorn, particularly in microwave popcorn, now that people are getting their entertainment a home. But a lot of our consumers these days are all about robust flavor and they want to control their amount of flavor. So we're launching this new line of Orville Redenbacher popcorn seasonings spanning savory to sweet. Slim Jim, back in the game on innovation because we had some capacity constraints over the last year during COVID. This is an example of our Monster line, Chile Limon. This business is just a phenomenal, phenomenal brand. Our Duncan Hine's Epic kits have been a success for us. Now we're partnering with Cinnabon in the area of muffins, which is incremental to our portfolio, really great product, easy to make, give it a try. And of course, our Dolly Parton partnership has been a home run, who doesn't love Dolly. Everybody loved Dolly. Last year, we did cakes. This year, we're doing biscuits, cornbread and brownies. You can't beat it. And much like in pies, where our pie users said, "Hey, some of us are on a low sugar diet now". Same insight applies to Swiss Miss. So what are we doing? We're giving you a keto-friendly alternative. Another fun one, Mrs. Butterworth's, you're looking at pancake mix and syrup. This is going to make you feel old. It's celebrating the 20th anniversary of Elf the movie because we know that Will Farrell's elf loved pancakes and syrup. And I'll wrap up with Vlasic, the best snap in the pickle business, but sometimes you like some heat. We're going to give you that in a partnership with Frank's RedHot. So that's just a sneak peek of some of the things we've got coming our way. I'll turn it over to Dave by wrapping up with the messages we want you to take away from our presentation today. We have a strong, well-managed portfolio with leading brands in highly attractive categories. We have clear growth prospects, as you can see, especially in frozen and in snacks. We have promising margin expansion opportunities. We're already putting those points on the board. You saw that a month ago. And in array of attractive capital allocation options. So that's it for me. I'm going to turn it over to our CFO, Dave Marberger, to walk you through our financials and growth algorithm Dave, over to you.

Thanks, Sean. Good morning, everybody. It was great to see some of you last night at our dinner. So let me start with our framework for driving strong total shareholder return at Conagra. It starts with our Conagra Way playbook for driving growth, which Sean just went through. It also includes a focus on driving operational efficiency and productivity to improve our margins, which we reviewed in detail at our Investor Day earlier this fiscal year. That results in strong operating cash flow that we allocate to investments in the business, reducing our debt and providing strong returns to shareholders. Now this framework continued to pay off as demonstrated by our strong Q2 and first half financial performance. For the first half, we grew organic net sales 9.1%. And that was driven by our inflation-justified pricing and moderate elasticities of demand on our unit volumes sold. Our adjusted gross margin for the second quarter was up 310 basis points to 28.2% and was up 140 basis points for the first half, driven by the strong net sales and productivity. Our operating profit and operating margins for the first half were up significantly. And this is why we were increasing our investments in both A&P and SG&A to drive growth in the business. And that strong operating profit combined with really strong performance from our Ardent Mills joint venture resulted in a first half EPS growth of 22% versus a year ago. Now this strong first half performance resulted in us increasing our fiscal year '23 guidance on all metrics at our recent Q2 earnings call. Today, we are reaffirming this guidance. We expect organic net sales growth of plus 7% to plus 8%. We expect adjusted operating margin in the range of 15.3% to 15.6%. And we expect adjusted EPS of $2.60 to $2.70, which is an increase of 10% to 14%. And we expect our net leverage to approximate 3.7x by the end of fiscal '23. Also in the quarter, a product recall was announced on our Armour can meat business. And this was due to issues we were having with damaged cans. We don't expect this to have an impact on the full year financials, but it will have a timing impact on net sales between Q3 and Q4. Okay. So I just talked about significant gross margin inflection in the second quarter. And this chart, a bit busy lays this dynamic out. So it's no secret that all of the food companies -- every company is dealing with record inflation. We estimate that our gross market inflation through the end of fiscal '23 will be up over 30% on a 3-year stack. We also talked about we were one of the earliest food companies to get hit with inflation. It hit us starting in the fourth quarter of fiscal '21 with gross market inflation of 9%, which you can see on this chart, on the blue bar. And you can see inflation accelerated significantly from there. As a result, we took aggressive pricing actions, which you can see by the green bars on this chart. But we've talked about often, and we were one of the first companies to talk about it because inflation hit us early, the lag. The lag between when that inflation hits your P&L and when you can communicate a price increase, get that price increase into market and benefit -- you get the benefit in your P&L. So you can see looking at this chart, it wasn't until the first quarter of this fiscal year that pricing actually caught up with inflation. And you can see in the second quarter that accelerated -- that's what drove our significant gross margin improvement in the second quarter. We expect this dynamic to continue in the second half of our fiscal '23. Now importantly, the line below this is our elasticities of demand. And our elasticities have remained completely consistent over the last 8 quarters, as you can see here, coming in about 0.5 of a coefficient. And that's favorable to pre-COVID historic trends on elasticity. Now given the dynamics of COVID and then the record inflation that we all had to deal with and then the pricing that we had to take to deal with that, there's a lot of complexity in the short term. So we like to look at our recent consumption data versus 3 years ago versus pre-COVID, and that's what this chart does. So this is our retail consumption on a 52-week basis ended January versus 3 years ago, and we're showing it on a dollar basis and on a unit volume basis. And it's for us and for our near-in competitors. Now we have tremendous respect for our competitors because we've all been dealing with this in a crazy environment for the last 3 years. But what you see here is when you look at dollar sales on a 3-year CAGR basis, we rank second versus the near-in peer set and an annual growth of 7.8%. When you look to the right side, you see unit volume sales on a 3-year CAGR. We are #1 in the peer set, and we're slightly below the flat. If you look at the same chart on a 13-week and 4-week basis end of January, the rankings would be the same. No change. We could not deliver this pricing execution and this volume performance, if it wasn't for the strength of our brands, and the superior relative value that the Conagra brands bring to the consumer. We follow a balanced approach to capital allocation. Since fiscal '16, we've made significant operational and capital investments in the business. We've executed acquisitions and divestitures to reshape our portfolio for growth, and we continue to look for opportunities to reshape our portfolio. We've prioritized debt reduction, and we remain laser-focused on our long-term leverage target of 3x while providing attractive returns to our shareholders and maintaining our commitment to a solid investment grade credit rating. So today, we're also reaffirming our long-term financial algorithm, which as a reminder, is after fiscal '23. So for fiscal '24 and beyond, we expect organic net sales growth of low single digits. We expect operating margin in the mid- to high teens, and we expect adjusted EPS growth of mid- to high single digits based on our expectations of sales and margin performance. We expect continued strong cash flow from the business, exceeding $1.2 billion annually. And we expect our CapEx as a percentage of net sales to accelerate to 4% to 5% through fiscal '25 as we fund our supply chain investments in capacity and automation. And then we expect that CapEx to come back down to 3.5% to 4% after fiscal '25. We target a dividend payout ratio of 50% to 55% of EPS. And again, we're focused on our long-term leverage ratio of 3x. So in conclusion, hopefully, it's clear why Conagra is well positioned to drive shareholder value. We have made significant investments in innovation which has strengthened this portfolio for growth. The strengthening of the brands has enabled us to price to offset the record inflation and recover our margins. And while not fully where we want to be, our supply chain is normalizing as evidenced by our improved service levels. We've also fully integrated the Pinnacle acquisition and delivered over $300 million of cost synergies, which is 10% of Pinnacle's revenues. And we finished all that while dealing with COVID, which is a testament to the executional excellence of all our awesome Conagra people. And finally, we remain committed to strengthening our balance sheet and retaining our solid investment grade credit rating. That includes our prepared remarks. We're now going to take some questions.

First from Andrew Lazar.

Sean, Dave touched on this a little bit, but the last couple of periods of scanner data from a consumption standpoint, both from Conagra in the industry as a whole have decelerated already quite a bit, particularly on volume. I was hoping you could put a little context to that in the context of your other comments on elasticity. And maybe more importantly, what that may mean or is that incorporated meaning the recent data points in sort of the full year guidance that you provided?

Yes, let me take the back end first because it's probably most important to you. We had our call -- earnings call about a month ago, we updated our guidance there. What you're seeing is absolutely incorporated into that guidance. Now let me give you a little perspective on what you're seeing. What you should not do is look at changes in trend versus year ago and short-term windows and draw a conclusion that something is changing with respect to elasticities. That is a faulty analysis. It's going to give you the wrong answer. In our case, you can see a bit of a trend shift in January, and it's not due to elasticities. Our elasticities remain benign. They remain well below historical norms, and they remain among the best in the food space. What you're seeing instead has to contemplate other factors. In our case, a particularly strong year ago period where a lot of companies were on allocation. We were coming off allocation in some very big categories. Our customers were eager to get our products and put them on the floor. In addition, there's some timing of events. There's also supply chain disruptions. I told you all in January that while we're making good progress in supply chain, it's not back to normal. We expected in the year-to-go outlook that things would pop up. You just heard about the latest thing, which is a recall in our canned Vienna Sausage business. So those are the things that can affect that -- those comps versus a year ago. But importantly, what we're seeing is contemplated. I'll give you a better way to try to understand volumes, look at volumes, be it the past 4 weeks, 13 weeks or 52 weeks versus a stable base period, which is pre-pandemic. And when you look at that across 52 weeks last quarter, 13 weeks or the last 4 weeks, you will see that Conagra unit performance ranks #1 amongst our near-in peer set, which we look at, which is 6 companies.

We'll go to Ken Goldman.

Clearly, a lot of your brands and categories are doing great. You talked about frozen in general doing very well. I was just curious if you could elaborate a little bit more on what we're seeing in scanner data about the frozen and veggies category. And maybe some of the share losses that you're experiencing in measured channels there? And how do you expect to kind of get that back a little bit?

Well, first, overall in frozen, the same story with elasticities. We really haven't seen some change. There's some dynamics within frozen in terms of where we were a year ago. where we are now. In vegetables, in particular, I would direct you back to the comments we made today. Our strategy on Birds Eye is all about value added. We look at the total category and about 90% -- 85%, 90% of the category has now moved to more of a value-added play. There is the bottom 10% to 15%, which is a more of a commodity play. I think everybody here, many of you know about our company, we are focused on value over volume. So one of our strategies on Birds Eye has been to move more of the portfolio into the value-oriented set. That's where the growth is, that's where the profit pool is. So you will not see us chase low-value, non-investment grade volume at the very low end of the tier. That's been part of our strategy all along. And they see that at different customers from time to time depending upon what their strategy is at the very low end, we don't chase that volume. We chase value through the innovation we showed you today. And if you think back to when we got started with Birds Eye just a few years ago, this brand has never in better shape. These are premium quality products that are generating high dollar ranks, so it's a very good mix and it's accretive to where we've been.

We will come back up front, Bryan Spillane.

Dave talked a little bit about CapEx being elevated in the next couple of years. Can you just drill into that a little bit with regards to how much of that is supporting just truly incremental capacity, so more volume? How much of it is modernization? And also, how much of it supports, I guess, expansion into some of the more value-added products. So I'm just trying to understand how much of it is maintenance versus growth, I guess, and also if there's an efficiency kind of margin implications for that CapEx.

Roughly, we're 60-ish, 40% in terms of growth versus maintenance. That's a rough number in the aggregate. In terms of our investments, I would say a majority of it is actually to drive automation, which we talked about a lot in our supply chain presentation at Investor Day, which is drive part of what's driving our $1 billion cost savings target over 3 years. So I would say the majority of the incremental spend is on the automation with some capacity opportunities. You can see our strategic brands in frozen and snacking, there's high demand. And so you always go through an evaluation when you use a co-manufacturer, the economics to be very attractive of bringing that back in. So we look at that on a case-by-case basis, but it's to support the growth in the frozen and snacking businesses.

Yes, I'll just add because this is a very important part of our margin program going forward is supply chain modernization. If you did not get a chance to see our Investor Day presentation back in July, our Chief Supply Chain Officer, Ale Eboli laid out this $1 billion program in supply chain. It's got all the detail you want to know about how we are modernizing our supply chain over the coming years and investing CapEx behind it. So if you want that detail, go to our website, you'll find that presentation.

Alexia Howard.

Great. Can I ask about putting numbers around innovation and marketing? It seems to me pre-pandemic percentage of sales from innovation over the last 3 years was the number that people gave out. I suspect things got pulled back a bit on innovation during the pandemic. You've obviously got a lot coming out now. Where are you and where do you hope to get over time?

Yes. Great question, Alexia. I shared a metric we use today to assess our innovation program. We call it renewal rate. It's a percent of our annual sales that comes from stuff we've launched in the past 3 years. Pre-pandemic, we had gotten to about 15%. Back when we started, our company was about 8.5%. So you can see the improvement. When the pandemic hit, I thought that number would fall below 10% again, and surprisingly, it did not. We're one of the few companies that kept -- at our retailers request the pedal to the metal on innovation, and we keep a lot of innovation flowing into the marketplace. Not all of it. In some places, we ran out of capacity, Birds Eye, Slim Jim, things like that. So you saw it come down a little. In frozen today, we're about tracking about 14%. I'm comfortable with that number. 14% to 15%, we think is about the right number for us. When the market is hungry for innovation if you're too far below that, you're probably going to be outpaced by your competition. If you're too far above that, you run the risk of SKU proliferation and then pulling products out in the marketplace. So for us, Alexia, that's about the sweet spot.

And then I think we'll take our last question, Cody Ross.

You put up an interesting chart up there, your 3-year sales CAGR versus your competitors and also showed your unit volume. Can you just talk about the actions you took prior to COVID that enabled you to take this robust price over the last 3 years, while still seeing volumes hold in there pretty stable.

Yes, I think it's a great question, Cody. I think you have to look at frozen as the area where it's most vivid. And frankly, the conclusion you can all draw is that pricing was just too low in frozen pre-pandemic. It Was too low. When you're selling products at $1 and $2, there are severe limitations to what you can deliver in the form of quality. So what we've been able to illustrate for the retailer is that consumers will welcome a $4.50 unit because if you think about it, it's still ridiculously cheap compared to what they're going to buy away from home at fast casual, it's a phenomenal value, but now it's far better quality. So that's really been the unlock and that premiumization chart I showed is that the consumer is not looking at our added quality and the increased price as a more expensive product that they're struggling to buy. They're far more eager to buy it because it's still a great price, and it's a far better eating experience.

I think that's all the time we have questions for in the room. So thank you for attending the presentation, and we'll see you in our breakout.

Thanks, everybody.