Utz Brands, Inc. (UTZ) Q3 2021 Earnings Report, Transcript and Summary

Thank you for standing by. My name is Brent and I will be your conference operator today. At this time, I would like to welcome everyone to the Utz Brands Incorporated Third Quarter 2021 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] It is now my pleasure to turn today's call over to Mr. Kevin Powers, Head of Investor Relations. Please, go ahead.

Good morning and thank you for joining us today. On the call today are Dylan Lissette, Chief Executive Officer; Ajay Kataria, Chief Financial Officer; and Cary Devore, Chief Operating Officer. Dylan and Ajay will make prepared comments this morning and all three will be available to answer questions during a live Q&A session. During this call, management may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management's current expectations and involve risks and uncertainties that could differ materially from actual events and those described in these forward-looking statements. Please refer to the Risk Factors in Utz Brands' most recent quarterly report filed with the Securities and Exchange Commission, as well as the risks highlighted in the company's press release issued yesterday for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Please note, management's remarks today will highlight certain non-GAAP financial measures. Our earnings release also presents the comparable GAAP numbers to the non-GAAP numbers provided and reconciliations of the non-GAAP results to the GAAP financial measures. Finally, the company has also prepared presentation slides and additional supplemental financial information, which are posted on Utz's Investor Relations website. You may want to refer to these slides during today's call. This call is being webcast and an archive of the call will also be available on the website. And now, I'd like to turn the call over to Dylan. Dylan?

Thanks, Kevin. Good morning, everyone, and welcome to our third quarter earnings call. First off, I'd like to give a special welcome or recently promoted CFO, Ajay Kataria. Ajay joined us in 2017 with a strong public company financial background and a great amount of experience with several CPG companies. He worked directly for our Chief Operating Officer, Cary Devore over the last few years and I'm excited to have him fully into the CFO role now. Thank you to both Ajay and Cary for such a well-planned out transition. So let's get started this morning with a few key messages. Demand for our brands remain strong and our two-year sales growth is accelerating, as we continue to lap the elevated consumption impact from COVID-19 pantry loading in 2020, with improved strength in our core and significant growth in our emerging and expansion geographies. Our IRI retail sales outpaced the salty snack category on a two-year basis, with our Power Brands significantly outpacing the category, with strong performance across all retail channels. On a longer-term basis, I'm also happy to report that our national expansion continues both ACV growth of around 600 basis points over the last two years and total points of distribution gains of approximately 22% over that same time period. We expect that these trends will continue into the future, as our team consistently builds out our national presence. Like most of the industry, gross margins in the quarter were impacted by rising inflation, but our pricing actions and productivity initiatives are underway and on track and continue to build, as we exit the year with a carry forward benefit expected into fiscal 2022. s I'm sure you can imagine, after 26 years of being at Utz and as CEO for almost a decade, I'm very proud of our incredible Utz associates, as we celebrate both our 100-year anniversary, as well as our first year as a public company. We remain very focused on continuing to think long term and we continue to deploy the value creation strategies that have enabled us to succeed for so many decades. To that end, I'd like to take a minute to reflect on our progress this quarter against these strategies. We took this incredible company public with the goal of building a fast-growing profitable national snack food platform and we know that delivering on our long-term value creation strategies is the path to achieving that vision. If we are successful in this, we will deliver long-term results for all of our stakeholders, our Utz associates, our customers, our loyal consumers, and our shareholders. It will lead to better opportunities for our team as we continue to grow, better turns on the shelf and traffic for our retail customers as well as continuing to deliver the absolute best tasting snacks to our consumers. If we can do all of this, we will create significant long-term value for our shareholders. So on that note, let's check-in on how we are performing against our core objectives. As a reminder, our foundational core value creation strategies are, to reduce costs and expand margins, to reinvest some of these savings, to accelerate revenue growth and to continue to leverage our platform in core abilities to make strategic acquisitions that add value to our company. Let's start first with reducing costs and expanding margins. We made good strides in the quarter to help build the foundation for a more advantaged margin profile in the future. We are fishing hard on our productivity programs, which are focused this year on continuous improvement in automation across key manufacturing processes, and we remain on track to deliver about 2% productivity this year. Productivity will continue to increase as we ramp up investments in higher ROI projects. In addition to deploying capital for these initiatives, we have several continuous improvement and process-related projects, that will drive productivity, that don't require significant capital and we are hiring even more talent in engineering and productivity as we enhance and invest in our capabilities across our entire supply chain optimization efforts. In addition, moving from company-owned routes to independent operators is a continued strategic initiative for Utz as well. We want that entrepreneurial mindset to be pervasive across our entire DSD network, and we continue to make progress every single quarter. To that end, we converted approximately 42 routes in the quarter and we remain on track to convert approximately 200 routes this year with our continued long-term goals to be 100% converted to independent operators around the middle of 2022. I'm also happy to report that for the first time, we have grown our DSD route base to over 1800 routes, which includes approximately 60 new routes this year, which we continue to believe is a very important part of our competitive advantage in the industry. The path to higher margins is also underpinned by our price-back architecture initiatives, which includes better trade management and higher net price realization. Trade management will benefit from improvements we've made in people, process and technology, including standing up a new trade management system as part of our new ERP. On net price realization, we have been taking pricing actions throughout the year in response to the higher inflation across our entire supply base. And while there is a natural lag, the pricing benefits are starting to really build as we expected and price mix improved to a 4.2% contribution to year-over-year net sales growth in the quarter. That will continue to move even higher in the fourth quarter, but it's still lagging the continued cost increases that we are seeing. Next year, as the carry-forward benefits of pricing actions built, we would be better positioned to offset inflation increases. We have more pricing already lined up for Q1 of 2022. And if costs continue to rise, we will take even more price. Luckily, we believe in the strength and the quality of our brands, which allows us to continue to price accordingly into the future. Finally, as our sales mix shifts more to Power Brands, this will further help in improving our margins. Power Brands today improved to 87% of our retail sales, up approximately 200 basis points from this time two years ago. As per our plans, this will continue to build to an even higher percentage as we go forward. Our next strategy is reinvesting to accelerate revenue growth. The key objectives remain in place and are accelerating our Power Brands, expanding our distribution in underpenetrated channels, continuing our geographic expansion, and increasing our presence in key salty snack subcategories. We have made tremendous progress across each of these objectives in the quarter as our sales growth continues to accelerate and we delivered two-year gains across both the map and C-store channels as well as our expansion in emerging geographies and we increased our presence and share in certain subcategories, most notably tortilla chips. I'll expand on these areas a bit later in my remarks. Finally, we continue to execute on our goal of making and effectively integrating strategic acquisitions. Two weeks ago, we announced our latest acquisition of RW Garcia, a family-owned and operated artisan maker of high-quality organic tortilla chips crackers and corn chips. RW Garcia has significant production capacity to support the growth of our brands, which will position us better to serve more demand, and be more efficient in doing so. Further, RW Garcia products are non-GMO verified, certified gluten-free, low sodium and free of artificial additives, or preservatives, which we believe long term will bolster our better-for-you portfolio, and will upon closing bring our platform-wide sales in the better-for-you category, to around $100 million on an annual retail sales basis. From a financial standpoint, this is a highly accretive transaction where we will pay 5.7 times adjusted EBITDA, assuming run rate cost synergies that we have a clear line of sight into. We look forward to closing in December of 2021, and welcoming the RW Garcia team and their capabilities into the Utz family. Beyond the RW Garcia signing of definitive documents announcement, we completed four acquisitions since going public in late August of last year. Our team is incredible at this – and I'm happy to report that, all of the integrations are going smoothly, and we're on track to deliver against our top line and bottom line targets. Our team has a proven M&A playbook that's been actively deployed over the last decade, and I'm happy with our progress year-to-date and in the third quarter. Turning to the financial results in the third quarter. Net sales grew over 26%, which reflects the positive contribution from our acquisitions, as well as organic growth of 1%, or 2% when you adjust for the impact of our IO route conversions. I'll note that, this quarter we returned to year-over-year organic growth as we expected and this was on top of our 10% organic growth in the third quarter of 2020. Importantly, our net sales momentum is building, and our pro forma two-year CAGR of 6.4% is an improvement from 6.1% in Q2 and 4.3% in Q1. And we – based on what we are seeing in October, we expect this trend to continue in the fourth quarter. In addition, adjusted gross profit grew 13% and adjusted EBITDA grew 17%, as margins were impacted by the key input cost increases that I described earlier. Shifting to our IRI MULO-C retail sales results for the period ending October 3, we are happy to report the two-year CAGR share gains have happened for both our Power Brands and the entire Utz platform. Our two-year CAGR share and growth rates continue to accelerate driven by our Power Brands. This is part of our long-term strategy as described previously, as we move our portfolio into a tighter more responsive brand portfolio over time. Our Power Brands gains are outpacing the category, on almost all metrics and our Foundation Brands performance is getting better, but it still reflects our emphasis to focus on our Power Brands, as well as some of the negative impact on Foundation Brands when we execute our M&A strategy. Additionally, our ongoing SKU rationalization focus is mainly on our Foundation Brands, which is consistent with our long-term strategy, but has obviously heightened in this environment as we look to simplify our portfolio. We believe that these great retail sales results are proving that the Utz Brands can and will continue to grow off of a higher level of sales from the COVID-19-driven consumption trends of 2020. Turning to our growth drivers in the quarter. Our total Utz portfolio gained share across four of the five major subcategories that we track and we gained share in Salsa and Queso as well. We continue to increase our presence in key salty stuff, snack subcategories with share gains on a year-over-year basis in tortilla chips, pretzels cheese and selfikeso and on a two-year CAGR basis, we grew 8% in potato chips versus a subcategory of 5.1% and 17% growth in tortilla chips versus the subcategory of 7.6%. It is truly great to see our two largest subcategories in dollar sales are growing and are taking share. As a reminder, at this time last year our presence was nearly non-existent in tortillas and today we have a 4.3% share and we are the number three brand in tortilla, due to our acquisition of ON THE BORDER in December 2020, as well as the continued growth of our TORTIYAHS! brand. In the quarter, we continued to make great progress driving geographic expansion, while also executing to improve the performance in our core. We grew 13.3% in expansion and 14% in emerging geographies outpacing the category by about 400 bps and 500 bps respectively. There is no doubt that our brands travel very well beyond our core and it's exciting to see our continued successes, as we outpace the market consistently in these whitespace geographies. In addition I'm happy to report that in our core our two-year CAGR doubled from 2.9% in Q2 to 5.7% in the current quarter. Our Foundation Brands as expected had less of a negative impact on our growth and our Utz brand strength continues to improve. Moreover, ON THE BORDER growth remains robust with a two-year CAGR of over 26% in our core with broad-based strength across every channel. To that end, as we mentioned last quarter, we transitioned our primary DSD distributor for ON THE BORDER in certain key geographies to Utz in August and we are seeing very positive results. Congratulations are due to our team and to our distributor partners for really embracing these wonderful brands and driving such great growth, display, space and sales. We are also leveraging the Utz platform to not only drive increasing sales growth, but also to increase the supply of product to meet this ever-increasing demand for ON THE BORDER with the new production capabilities that have been installed, as well as the benefits from our acquisition of Festida in June of 2021 that has unlocked even more supply. Seeing as we acquired ON THE BORDER in less than a year ago in December of 2020, I couldn't be more pleased with the long-term value we are creating for the platform with the ON THE BORDER brand. And finally, from a channel perspective, in the quarter we gained share in almost every channel. Importantly, we had been lagging the mass category throughout the year, and we committed to you that the gap would narrow and that performance would improve. In the quarter, we returned to strong share gains and significantly outperformed the category due to space gains and phenomenal execution by our team in this channel. On a two-year CAGR basis, we grew 15% in the mass channel versus the category at 12% and equally and perhaps as important the entire C-store channel is rebounding positively as mobility across the US improves. We are currently underweight in this channel and we gained share in the quarter on both a one-year and a two-year CAGR basis and we look to see continued share growth in this channel into the future especially in the West. I'd now like to turn things over to Ajay Kataria our CFO. Ajay?

Thank you Dylan and good morning everyone. I would like to begin by thanking Dylan, Cary and the entire Utz team for helping me transition smoothly into this new role. I am excited about the opportunity ahead of us at Utz and humbled to participate in the next century of growth of our incredible brand portfolio. I'll start with a very high-level summary of our third quarter financial performance. And then we will dig deeper into our net sales and margin drivers. Third quarter net sales increased 26.1% to $312.7 million, primarily due to the impact of our acquisitions over the past year. We delivered organic net sales growth of 1%, which would be 2% excluding the impact of converting company-owned DSD routes to independent operators. As a reminder, when we convert routes to IOs, certain selling expenses moved to sales discounts, thereby benefiting SG&A and reducing net sales and gross profit. Adjusted gross margin contracted to 35.8% largely due to the higher input costs and the aforementioned impact from our IO conversions. In addition, adjusted SG&A improved to 21.1% of sales versus 24.6% of sales. The SG&A improvement in the quarter was primarily driven by lower corporate G&A, synergy benefits from our recent acquisitions, higher route conversions and optimized marketing spend given the continued strong demand environment. Adjusted EBITDA increased 17.3% to $44.8 million or 14.3% of sales, which was a nice sequential improvement from our second quarter margins of 12%. Finally, adjusted net income increased nearly 40.7% to $25.6 million and adjusted EPS was $0.18 based on fully diluted shares on an as-converted basis of $142 million. I will note that we benefited from a lower-than-expected tax rate in the quarter. Briefly turning to our balance sheet and other key points. At the end of the quarter, our liquidity remained strong with cash and cash equivalents of $26 million and $133 million available on our revolving credit facility providing close to $160 million in liquidity. Moving down the balance sheet. Net debt at quarter end was $796.4 million or 4.7 times normalized further adjusted EBITDA of $170.2 million. Additionally, as we indicated in the acquisition announcement we intend to use balance sheet cash and our revolving credit facility to fund the $56 million purchase price of RW Garcia. Excluding the impact of RW Garcia acquisition and based on our expectation of full year 2021 normalized EBITDA, we now expect to end this year with a net leverage ratio of approximately 4.5 times. Our target net leverage ratio remains between three times and four times and we expect to return to this level within one year to two years. Moving to cash flow. Capital expenditures were $17.8 million through the first three quarters. And we continue to expect this to accelerate further in the fourth quarter to support our ongoing and increasing productivity initiatives. Moving back to the P&L for some additional details starting with net sales. Our net sales growth in the quarter was 26.1% driven by acquisitions of 25.1% and organic growth of 1%. Our organic net sales growth was driven by price/mix of 4.2% partially offset by volume declines of 2.2% and the impact of IO route conversions which reduced the net sales growth by 1%. Like the rest of the industry, we faced several supply chain disruptions during the quarter. Despite a challenging environment, our frontline procurement, manufacturing, logistics and selling teams have done an incredible job in meeting the continued elevated demand for our growing brands. The team was able to deliver top-line growth and execute pricing actions. Wrapping up on sales. Given the significant impact of several acquisitions over the past two years, we provide pro forma net sales growth as another indicator of our performance. Our pro forma net sales growth on a two-year CAGR basis was 6.4% and this was an acceleration from the second quarter rate of 6.1% and first quarter rate of 4.3%. Moving down the P&L to adjusted EBITDA. In the third quarter adjusted EBITDA margins contracted by 110 basis points to 14.3%. I'll note that we are lapping very strong performance last year when our adjusted EBITDA margins expanded by about 170 basis points decomposing the decrease in adjusted EBITDA margin for the quarter positive drivers include price/mix of 360 basis points as we take pricing actions to offset inflation, SG&A excluding transportation of 70 basis points, acquisitions of 100 basis points and productivity improvement of 100 basis points. Partially offsetting these positive drivers were headwinds related to volume of 80 basis points as we lap COVID-19-related growth from last year and supply disruptions noted earlier and inflation including transportation costs of 650 basis points. Consistent with industry trends, our inflation impact versus last year was comprised of elevated labor and transportation costs as well as higher commodity input costs. These include continued pressure on all varieties of edible oil, wheat flour, corn based items and pork related items. As with our agricultural goods, our packaging components such as film, resin and corrugate continue to see meaningful cost increases. To that end as you will recall at the beginning of the year our expectation for commodity inflation was 4% of cost of goods. That expectation increased throughout the year as the industry conditions began to worsen and we now expect commodity inflation of about 7% of cost of goods for the fiscal year. While we have most of our raw material supply under contract, several disruptions at our suppliers has resulted in higher costs as we work to secure supply from alternate sources. Similar supply chain pressures at our co-manufacturers are driving costs higher in areas where we do not have covered positions. When we layer on incremental labor and transportation costs due to higher-than-expected supply chain pressures, we now have total input cost inflation of low double digits in the second half of the year versus comparable costs in the prior year. As we learn more about rising input costs we reacted quickly early in the year and began planning pricing actions to help offset these costs. We have been implementing these pricing moves throughout 2021 and you're seeing these buildings in our sales results, as price mix contribution to net sales was at 1.9% benefit in Q1, 2.3% in Q2 and 4.2% in Q3. As we continue to implement new actions this contribution will increase in the fourth quarter and will build into fiscal 2022. And to reiterate what Dylan mentioned earlier, if costs continue to rise next year, we will continue to take pricing actions accordingly. Now turning to our outlook for the remainder of the year. We continue to expect full year 2021 net sales to be consistent with 2020 pro forma net sales. As a reminder our 2020 pro forma net sales is on a 52-week comparison basis assumes we owned H.K. Anderson and TruCor on the first day of fiscal 2020 and assumes $20 million of net sales were witnessed to align with expectations for fiscal 2021. We continue to expect modest organic sales growth year-over-year even as we lap fiscal 2020 organic growth of over 8%. Moving to adjusted EBITDA. Reflecting our updated assumption for incremental pricing flow-through offset by higher-than-expected supply chain inflation, we now expect to be towards the lower end of our previous range of $160 million to $170 million. For adjusted EPS, we are reaffirming our previous range of $0.55 to $0.60. This reflects lower-than-expected interest expense and a lower-than-expected tax rate. Turning to our additional assumptions. On Slide 20 of our earnings presentation, you will find a detailed list that supports our 2021 outlook. Notable assumptions that have changed include, raising our commodity inflation to approximately 7% versus 6% previously, higher-than-expected transportation costs, cash interest expense of approximately $30 million versus $33 million previously, an effective cash tax rate of 15% to 17% versus the prior expectation of 17% to 19%. And finally, our net leverage is expected to be at the high end of our previous range and we now expect it to be approximately 4.5x. This excludes the impact from the RW Garcia acquisition. With that I'll now turn the call back over to Dylan.

Thank you, Ajay. In closing I want to reiterate that I truly believe that we are doing all the right things to grow our business for the long term that in return will drive great results. As a company we have seen inflationary periods in the past and we've weathered supply chain challenges many times over our 100-year history and we are committed to building an even stronger more resilient infrastructure for continued growth as we begin to move towards the new year and I'm very thankful to our incredible associates to make all of this happen. We are excited about our future and we look forward to continuing to create value for all of our stakeholders. Thank you again very much for joining us today on our earnings call. And I'd now like to ask the operator to open up the call for questions.

[Operator Instructions] Your first question comes from Andrew Lazar with Barclays. Your line is open.

Great. Thanks so much. Good morning, everybody.

Good morning.

I guess I'd like to start out. I understand it's obviously early to go into too much detail on 2022 at this stage but I guess, when that sort of de-stacked I know gross margin was expected to expand significantly in 2022 due to productivity ramping up and optimizing revenue and trade and improving the margin mix. I guess, my question is would those levers still be expected to be in play which along with pricing that you've talked about be enough to keep gross margin stable in 2022, or should we now anticipate some year-over-year compression? And I ask I guess because consensus still has sort of gross margin expanding for next year. So any even just directional thoughts on that would be really helpful.

Hi, Andrew. This is Ajay. Thank you for the question. I'll take that. Listen, before I answer that, I do want to note that we are not providing guidance for 2022 today. Now having said that, the environment remains incredibly dynamic. And as a company, we are focused on a couple of things. First, demand is strong and we are doing everything possible to maintain supply to our customers and consumers. We have done that throughout last year and this year through COVID and through the dynamics here. And secondly, our pricing program is ramping up. As I noted in my prepared remarks, that's working. And third, Dylan outlined, in his remarks that we are executing on our long-term strategies. And to answer your gross margin question, specifically if I look at these focus areas they are all delivering for us pricing, trade optimization, productivity everything that we talked about when we went public they're all coming through for us. So based on what we know today, about inflation, about the environment and all of these things delivering for us I do believe that we will cover inflation and gross margins in 2022 should not contract. I'll remind you that transportation costs are fluid and they are in SG&A for us. So again we are talking about gross margins and we are not providing guidance for next year at this point, but I do believe that they won't contract.

Very helpful. Really appreciate that. And then I guess just a follow-up would be, I saw that you brought on a new supply head of supply chain. And obviously in light of just all the challenges that the entire industry is facing at this point. I guess I'm trying to get a sense of what would be the roadblocks if any to moving even faster on productivity maybe than you had initially planned? Thanks so much.

Yes, great question, Andrew. This is Cary. I'll take that. Look I think we feel really good about productivity. You referenced Chad White, we recently hired to run logistics for us. We're super excited about that. He ran logistics for Pinnacle Foods and some other companies. He's consulting with us right now and have been since 2020 on value creation initiatives. So we're thrilled to bring him on. He's got a great depth of experience and a network of relationships that will benefit us. With that we're able to put Brian Greth, our Senior Vice President, currently in charge of logistics into an enterprise integration role to help with M&A integration. He's been here for 30 years and has basically held every position in supply chain you could think of. So we're really excited about the move from a roadblock perspective. Look I don't see any roadblocks per se. We've given guidance that will be 3% to 4% of COGS and productivity by 2023 that's still a good number. We feel great about that, we're going to put more emphasis on continuous improvement and get that program up and running more robustly. So we feel good. I mean, I think we're on track to hit our targets and we've got the liquidity and the capital and I think the team to drive it.

Thanks so much.

Your next question comes from Rupesh Parikh with Oppenheimer. Your line is open.

Good morning, guys. This is actually Erica Eiler on for Rupesh. Thanks for taking our question. So I'm going to just start with sales. So as you look at the sales acceleration here in Q3 and your expectations for Q4 has anything surprised you in terms of what you're seeing. And then your team has also called out supply disruptions. And I apologize if I missed this, but is there any way to quantify the impact on the top line during the quarter. And if maybe you could just dive a little bit deeper kind of on what you're seeing here and your expectations on these going forward. Just curious on when you think these could potentially get resolved?

Yes. Erica this is Dylan. And I'll just maybe take the first part of the question on demand and what we're seeing in sales and then Ajay can quantify perhaps some of what we're seeing is from a supply challenge standpoint and try to quantify that, if it's even quantifiable. As you can see from our IRI consumption data across both our core and our emerging and expansion markets, we're actually really seeing a nice pickup in two-year CAGR rates and one-year CAGR rates in many of our subcategories in many of our channels. So I think from a sales demand perspective, we're very excited about what we're seeing. We're seeing it continue into October, which I noted in my remarks, we see demand there. I mean the consumer is buying. They're buying our brands. You can see it across the channels, across the geographies and across the subcategories. So I won't go into too much repetitive detail. But as you know, there are supply challenges. Our ability to meet that increased demand. We're leaning in. At the end of the day, the last thing that we want to do is not supply a customer we believe in the long-term benefit supplying our customers the demand that they are asking for. And so we're spending a lot of time investing in that. And really at the end of the day putting our dollars against that in terms of just making sure that we're securing the inputs and the supply chain that we need to meet that demand. In terms of quantifying what we may have missed out on in terms of sales. I don't think we really have a number for that. We may know that every single week, if it's some part of our component that's not there, right? It could be film, it could be seasoning. It could be other oil supply, it could be the ability to move freight. There's always going to be that, especially in today's environment, I'll say luckily, I believe we have a fantastic team and we have a 100-year platform that's been dealing with supply chain issues in the past and commodity issues past and we're very good at that. So I don't really have a number to quantify it. But the good thing is that I'd say demand is outstripping our ability to supply. And as we look forward and solve some of that in the industry itself solves some of that as we go forward then that portends for good things for us as we look into the future.

Okay. That's helpful. And then just on the core, I mean you made nice progress this quarter in closing the performance gap on the core versus the category. Can you maybe just remind us of the key efforts that have helped you achieve this? What we should be thinking about going forward? And then just any new insight on when the core could potentially be back to being at least in line with the category?

Yes. I mean we made – we're really happy. I mean we've been saying this in last few earnings calls about the fact that we have a little bit heavier Foundation Brands waiting in our core that we have to go against. We've also noted in the past that as part of our M&A strategy in some cases we're buying Foundation Brands that were risky rationalizing and we're executing on, making sure that they have the right pricing, the right display and the right items and the right innovation. And we're doing a lot of work around Foundation Brands. And you'll see in the data that we supply to that has improved at our core. We've really put a lot of effort on focus, right? We have a lot of transition from route salespeople, the independent operators that occurred in the core. And once we get through that transition period, we really start to ramp up in our productivity for that. So there's a lot of effort a lot of work by our sales team that's gone into the core on execution. And lastly, included in there is ON THE BORDER, right? The TruCo acquisition, opening up ON THE BORDER to our core. That was one of the core tenants of that purchase back in December 2020, where we talked about only 14% of their sales was in our core and we thought that our DSD network can really support and grow that exponentially. And I think you'll see that data as well in the deck, where we can really see that start to expand the core. So if you think about a few of those happening the core is about 50% of our business, roughly speaking in terms of IRI retail sales. So as we continue to move forward, I think we'll compress much more closely the difference between our overall Utz platform sales but also our Power Brands are right on the cusp of breaking into being share gainers as well in the core. So we're really looking forward to seeing that continue and expect it to.

Great, great. Thank you so much.

Sure.

Your next question comes from the line of Michael Lavery with Piper Sandler. Your line is open.

Thank you. Good morning.

Good morning.

Good morning.

Just wanted to stay with On The Border for a second and you have a nice slide on to showing its momentum and some of the geographic split, but maybe just talking to the acceleration that's broad based, how much of that is moving into DSD. I guess I'm just trying to understand some of the drivers and how sustainable it is and what to expect looking ahead a little bit?

Sure. Great question, I mean, yeah, the -- as you can see on the chart page 11, in our deck the exponential growth on a two-year CAGR basis that's occurring for the border is in our Core. That really is helped and driven by our DSD, right? You'll note that back in August of 2021, we converted our third-party distributor to the Utz distribution system for a number of states. And most of those states were in our Core. And if you think about the fact that we not only made the conversion to our DSD, but we also are looking and making great strides in vertically integrating the production. So when you produce something and you vertically move it directly into the DSD stream and it's available, and it's in stock, and it's on time. It really helps your DSD to expand. And we have a much larger sales team not just the sales team but a much larger sales team that's out selling the brand to the customers at the end of the day. So you couple the two of them together and we're really seeing that exponential growth in the core. However if you look at expansion and emerging we're seeing double-digit growth there too on a two-year CAGR basis. So, it's across the board. We have some great retail partners that continue to do fantastic at it. We're doing a lot of work on the supply side as noted in the acquisition of Festida that we announced back in June of 2021 or closed in June 21 as well as the recently announced RW Garcia. We have opportunities here to really increase the supply of the products which has been an issue where demand has supply. And as we build that supply I think we'll continue to unlock the ability to grow ON THE BORDER. And somewhat on a side note you'll see even the Salsa and Queso ON THE BORDER branded Salsa and Queso. Combined that's actually a $69 million IRI retail on an annual basis and it's growing exponentially as well. So we're unlocking opportunities on the chip side or ON THE BORDER but really also unlocking on the Salsa and Queso side which is sort of icing on the cake for that brand and our growth prospects for that brand continue.

That's great color. Thank you. You also touched a little bit on the second question. I just wanted to cover with RW Garcia. And I think it's clear you're getting -- you're interested in that for the capacity and the capabilities there. But can you just help us understand a little bit how much it's needed to keep up with demand or support growing demand or if it also can support a margin lift from repatriating production that's co-manufactured today?

Yeah, I'll take that, great question. So we're thrilled about the RW Garcia acquisition. So that is really first and foremost a supply chain enhancement acquisition. They have the ability to start making some of our brands today right away. They've got the excess capacity. So we don't have to wait and order a new line or anything like that. So it's a very immediate increase to our capacity and that allows us to in-source some things that we can make more margins on. And then, from a -- currently they don't really do any co-man for us. So it's different than Festida whereas Festida was for instance ON THE BORDER they currently don't do any manufacturing for us but they have the ability to do it in a short period of time. So we're thrilled about what it can do for our supply chain well-placed plants in the West and East of the United States which helps us focus on minimizing land and cost. It helps with logistics as well as manufacturing costs. And then it's got a great I think a nice BFY brand right? It's all organic for the most part corn-based crackers. And so we look forward to adding that to our portfolio and certainly takes us over $100 million in retail sales on the BFY side as well.

Great. Thanks so much.

Your next question comes from the line of Jason English with Goldman Sachs. Your line is open.

Hey folks. Thanks for spotting me in. A couple of quick questions. First on M&A, I heard you mention you leverage now 4.5. You want to get back down to that three to 4x range in the next year or two. Are you implicitly suggesting that you may be out of the game of M&A for a while until you get that leverage back in there?

Hey, Jason this is Cary. Good to hear from you. I wouldn't say we're out of the game though. I mean, I think we're going to continue to do smart acquisitions that make sense for us. Obviously, we're committed to that three to four range long-term. But it hasn't prevented us from doing things like an RW Garcia. I wouldn't say capital structure in and of itself is a limiter for us. But look we are focused on making sure we have the right long-term leverage profile and we're very disciplined about how we approach acquisitions. We want to make sure we pay the right price for things and that they drive -- they deliver the strategic value for the price we pay. So I don't think it takes us out of the game. I think our set of opportunities in front of us is very unique in terms of what we're able to do and how we're able to create value. So I think we continue to do some smart things while at the same time making sure that we stay disciplined.

Got it. Make sense. Thank you. And the price growth you guys realized this quarter, certainly surprised me to the upside and congrats on achieving it. It's better than I expected. Can you unpack a little bit of it? How much of it was list price? How much is coming from perhaps lower trade et cetera. As we think about the forward, how should those components progress?

Hey, Jason thanks for the question. This is Ajay. I'll take that. So I think the way to think about that is we are effectively touching our entire portfolio of brands and product categories that we play in across all our customers. So the pricing levers that we have, you talk about rate outs list price increases, trade optimization we are pulling all of them. So it will be tough for me to pick one over the other. It's all being deployed. We have already taken two or three rounds of pricing this year and a couple more are coming in the next three months. So by the time we get to February of next year, we would have touched our entire portfolio and activated all the levers we have.

Make sense. Thanks for detail. I’ll pass it one.

Thank you.

Your next question comes from the line of Bill Chappell with Truist Securities. Your line is open.

Thanks. Good morning.

Good morning.

Good morning Bill.

Just want to get a more housekeeping. As you look forward on the IO conversion, how much pressure is I guess left, or do you expect on gross margins from that over the next 12 to 18 months, or are we largely done with that? I'm just trying to understand how much that comes into play?

Yes. Thanks for the question. So I'll say, we are going to convert about 200 routes this year and we have another 200 to go. So the pressure to your question that we should expect is about the same as what we would get in 2021.

Is there any way to quantify the basis points? So as we're looking into next year of, obviously, commodities and pricing will have a downdraft but I'm just trying to understand if that's much bigger or similar?

Yes. Yes, absolutely. So far this year we have been looking at 80 to 100 basis points of pressure on gross margins and net sales. And then there is an offset to that in SG&A and we should expect about the same next year.

Okay, great. Thank you. And then on the freight side, I mean, obviously it's a widespread issue and not unique to your company. But how do you see this playing out over the next six months. I mean, are more drivers going to be available? Do you think prices will come down or go even higher? Just trying to -- I mean, you're obviously dealing with this day in day out. I'm just trying to understand if you see any light at the end of the tunnel on that side?

Yeah, I'll take that again. This is Ajay. So I think if I had a crystal ball, it would be nice. But our assumption going into this thing is first half of next year is going to look very much like what it looks now. So we are not expecting things to improve meaningfully. Now that said, there could be changes to this environment in either direction positive or negative. And let's see what shakes out.

Got you. But you aren't seeing things accelerate in the past month or two?

In terms of positive...

Freight costs. Negative I guess it's not getting meaningfully recently.

Well, no, freight costs have gone up and we have -- transportation is the big variable in our inflation costs that we called up in our conversation this morning and transportation is going up. We have seen it gone up.

Got it. Yeah, I was hoping if you had seen a ceiling, but I guess not yet. But thanks for the color.

Yeah. Thank you.

[Operator Instructions] Your next question comes from Ben Bienvenu with Stephens. Your line is open.

Hey, thanks. Good morning, everybody.

Good morning.

I want to ask about the price mix versus volume balance. As we see the pricing action contribution build, as we go through the fourth quarter and presumably into the first half of next year, is sustaining volume on call it a two-year stack level reasonable? Do you think that gets harder to sustain? Where do you think we are with demand elasticity that you see? And how does share gains factor into that and channel mix as well factor into that equation?

Well, I take it from a high level and then maybe Ajay can layer in afterwards. Ben thanks for the question. I mean, what we are seeing I've been into the snacking industry for 26 years and in my role almost for 10 years. And I think that it's partially something that Utz has the benefit of which is great brands, but other people have great brands as well. And the other part of it is that we're in a fantastic industry of snacking where the elasticities are relatively low. It's a simple pleasure for the most part. It's an impulse item in many cases. And we've had at least from what we can see elasticities are pretty low. We have room to increase because of our great brands. We have price-back architecture that we are executing on. I think Jason referred to it in the previous question about the price mix and the benefits that we're getting there. And I think that as the industry is relatively rational from a pricing perspective then we'll have opportunities to continue to look at ways to take more price, if it's warranted. And I think long-term obviously we want to provide a good that consumers want to buy and that's what we're in the business of doing and we will take our knowledge and history of being in this industry and apply it across our price-back architecture, but I think from a high-level elasticities have shown to be pretty resilient to the increases. And they're not -- these aren't 20% or 30% increases. I mean, we're talking about 4%, 5%, 6% increases. So we feel really good about that.

Okay. Perfect. And then Ajay revisiting your comments on kind of expectations around gross margins as we head into next year. And combining that with what you said around freight, could you talk about, when you look through the components of your costs, the various buckets, the level of visibility you feel like you have into next year at this point? And then if you could, rank order the buckets of cost pressure as you see it now that would be helpful.

Sure. So, let me -- when I look at 2022 again, we are not guiding to 2022 today. We have more work to do and we'll come back to it in March. But what we know today about 2022 is that, all of our pricing actions, productivity, et cetera these things are working. We'll have a meaningful carryover benefit going into 2022. And secondly, first half is going to look a lot like the second half of 2021 in terms of inflation, in the environment we are in and the volatility and the dynamic nature of transportation. So those are two things that we know. What we don't know is what's going to happen in the second half. So to your question, the visibility that we have is probably the lightest on the second half of 2022. And it is very light on transportation specifically. And the impact that we have in our P&L in terms of inflation, I would say is about half commodity, half labor and transportation. And within that commodity, we have good visibility into, even though we're not liking what we are seeing. Resin prices are at all-time highs, consumer price index is the highest it has been in 30 years. So, we don't like that, but we at least see it. Transportation, on the other hand, very dynamic. We find new information on a weekly basis that we are working through.

Thank you, so much. Very, very helpful and best of luck for the rest of the year.

Thank you.

Thank you.

There are no further questions at this time. I will now turn the call back over to the Chief Executive Officer, Mr. Dylan Lissette.

Great. Thank you all very much for joining us today on our third quarter earnings call. We truly appreciate your support of Utz Brands, and are as excited about our future and hope that you are as excited about our future as we are. So, thank you very much.

Ladies and gentlemen, this concludes today's conference.