Premium Brands Holdings Corporation

Good afternoon, ladies and gentlemen, and welcome to the Premium Brand Holdings Corporation Third Quarter 2022 Earnings Conference Call. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you need assistance, please press star zero for the operator. This call is being recorded on Thursday, November 3, 2022. Our speakers will be George Pagliologo, CEO and President of Premium Brands, and Will Kaludich, CFO of Premium Brands. I would now like to turn the conference over to George Pagliologo. Please go ahead.

Thank you, Joanna. Welcome, everyone, to our 2022 third quarter conference call. With me today is our CFO, Will Kaludich. Our presentation today will follow the deck that was posted on our website this morning. We're now on slide four, which outlines certain key highlights for the quarters. We're very pleased to report very good results for the quarter and year to date in an environment where the challenges of inflation, supply chain issues, and labor shortages have been moderate. This was very evident in our monthly sequential results with September coming in well ahead of schedule. Our CFO, Will Kaludich, will provide you with some color on our results later on in the presentation. Normality for premium brands and its ecosystem of great food companies means a return to the relentless pursuit of product and process innovation, capacity expansions to satisfy increasing demand, and of course, strategic and opportunistic acquisitions that complement our portfolio of exceptional businesses. Clearwater Seafood had a very good quarter and continues to perform well ahead of plan. Pricing for most of its species continues strong, with the exception of snow crab, the pricing of which deteriorated materially earlier in the year due to certain imbalances in supply and demand. Clearwater chose to hold on to its snow crab inventory instead of selling it at a loss, and this action appears to have been an astute decision as snow crab prices are recovering. Despite the challenging margins in its snow crab business and substantially higher fuel costs, Clearwater's discipline cost management and very good commercial execution helped to deliver solid results. We did not complete any acquisitions during the quarter, prioritizing capital allocations like capacity expansion and process automation initiatives instead. We will also be acting on our NCIB this quarter as we were not able to activate it during the second quarter due to our trading related blackout rules. Overall, we're very pleased with our results as we continue on our path back to normality. We're very well positioned to accelerate our growth through amazing product innovation, capacity expansion, and process automation and optimization initiatives, combined with exceptional operational and commercial execution. We remain very confident that our decentralized entrepreneurial business model, combined with our great people and culture, will continue to distinguish us from the rest. We are now on slide five. We have recently posted our 2022 ESG progress report on our website. We're making great progress in all aspects of ESG and look forward to achieving all of our ESG goals as outlined in the report. We are now on slide six to 13. I've included here some pictures of new innovative products manufactured and sold by Artisan Bakery, Cook Coating, charcuterie, culinary, snack food, and sandwich groups. Demand for these type of products remains very strong, and we're pleased to have recently had opportunities to introduce our innovations to new and existing customers in person. We're confident that some of the products you see here will eventually become multi-million dollar SKUs in both retail and food service. In regards to slide 14 in your deck, I'm very happy to report that Clearwater Seafood working closely with our various distribution groups like Centennial Food Service in Western Canada to bring new seafood based solutions to new markets. They're also prioritizing value-added seafood as a key area of focus and are reviewing both organic and acquisition opportunities in this segment. We're confident that Clearwater is well on its way to becoming a best-in-class vertically integrated seafood company on a global scale. We're now on slide As you can see, our acquisition pipeline remains robust, and we expect to complete many more strategic, opportunistic, and transformational transactions in the months and years to come. I will now pass the presentation to our CFO, Will Kaludich, who will update you on our financial results for the quarter.

Will? Thanks, George, and welcome, everyone. Before I begin, I would like to remind you that some of the statements made on today's call may constitute forward-looking information and our future results may differ materially from what we discussed. Please refer to our MD&A for fiscal 2021 as well as other information on our website for a broader description of the risk factors that could affect our performance. Turning to slide 17, Our sales for the quarter were $1.624 billion, up $285 million, or 23% from 2021. The major drivers of our growth were acquisitions, which accounted for $153 million of our growth, selling price increases, which were $90 million, organic volume growth of $39 million, and the translation of our U.S. businesses into Canadian dollars contributed $18 million due to a weaker Canadian dollar. These factors were partially offset by an accrual for a claim made by a customer for products sold in the second quarter of this year that did not meet the customer specifications. Total amount of the claim is approximately $18.5 million. Our organic growth for the quarter was roughly 10%, just below 10%, and well above our 6% to 8% nominal growth objective. Turning to slide 18, our organic volume growth rate for the quarter was 2.9%. This was below our 4% to 6% long-term target primarily caused by seven temporary factors. The first and most significant was lower retail channel sales, resulting from consumer spending shifting to food service and less featuring activity in general. The cancellation of the new sandwich program, which related to the claim I mentioned earlier, also was a major headwind to our growth in the quarter. Continued development of our lobster strategies, which resulted in building of inventory that will drive future sales, but impacted our sales in the quarter because we had less trading of live lobsters. Turkey supply issues also impacted our sales as we saw significant shortages of raw materials in Canada and incredibly high prices in the U.S., A three-week shutdown of a very successful cooked protein program in the U.S. also impacted our sales due to production issues on a new line. And the final factor impacting our sales growth was a little bit of demand destruction, primarily in the C-Store channel relating to our meat snack initiatives. Turning to slide 19. This outlines all of the major growth initiatives across our different platforms. The ones we've highlighted in yellow were the ones that contributed to our growth in the third quarter. Turning to slide 20, the gold line represents our sales by week in 2022 relative to the blue line, which were our sales by week for 2021. You can see going into the fourth quarter, We continue to show good solid momentum in our sales growth. And it's interesting, the impacts of inflation have been slowing. We peaked in the second quarter of this year where our selling price inflation was about $134 million in the quarter. That fell to about $90 million, as I mentioned earlier, in this quarter. And we expect that will come down more in the fourth quarter, so our growth being more driven by volume versus price growth. Turning to slide 21, our EBITDA for the quarter was $141.2 million, which was a record level. This was up $18.6 million, or 15% for 2021. The major positive drivers were selling price inflation, as I mentioned earlier, of $90 million, acquisitions, organic sales growth, lower incentive-based compensation accruals, improved plant efficiencies, and the weaker Canadian dollar relative to the US dollar contributed about $800,000 of the increase in our EBITDA. Offsetting these factors were several challenges, the most significant of which was cost inflation across our raw materials, wages, and freight. This totaled about $78 million for the quarter. Interesting, if you look at the difference between our selling price inflation and our cost inflation in those three categories for the third quarter, that was a positive margin expansion of about $12 million. That compares to about $3.5 million in the second quarter and a contraction of $2 million in the first quarter. So we're making excellent progress in getting our pricing and our margins back to the levels they need to be. Also impacting the positive factors was some increased overhead in our plants, mainly associated with increased infrastructure to support both our current and future growth. Higher outside storage costs associated with our inventory positions, which we'll talk to on a later slide. Also, there was some increased promotional activities in our specialty food businesses, which was great to see as As the pricing returns to normal levels, we'll see them pick that spending up, and that should drive our organic growth volume growth rates higher in coming quarters. And then finally, we invested a little bit extra in SG&A infrastructure in order to support the continued growth of our company. Our EBITDA margin for the quarter was 8.7%. This was a 40 basis points decrease from 2021. And I'll talk about this decrease on the next slide. So turning to slide 22. Our targeted EBITDA margin is 10%. For the third quarter, we would normally have expected it to be above the 10% because of seasonal factors. As I mentioned earlier, we came in at 8.7%, which was 130 basis points off our target. The variance was due to primarily seven temporary factors. One was underutilized capacity, particularly in our specialty food segments, which generates much higher margins, and the growth in that segment will be a key driver of the growth in our EBITDA margin over time. Next was freight cost inflation, higher outside storage costs, as I mentioned earlier. There's also a continuing impact of the delay in getting our pricing through, especially in our specialty food segment. It takes anywhere from 60 to 90 days to get our price increases take effect from when we put them through with the major retailers. So that delay in the quarter was about $4.6 million of an impact on our EBITDA. And then finally, recent acquisitions of King's Command, Golden Valley, and Beach Grove had a fairly significant impact on our margins because all of these acquisitions are bolt-on turnaround acquisitions by our various businesses, and they're in the very early days of their business plan, and as a result, they are weighing on our EBITDA margins. Also contributing to our EBITDA margins, mainly in our premium food distribution group and much less impact on the overall margins, was a certain amount of strategy focused on the continued pricing based on recovering gross profit dollars versus gross margin levels because of the incredibly high price points of a lot of products, and then also the impact of cost plus contracts. I should mention that if you normalize for the second, third, fourth, and fifth factors I mentioned earlier, namely freight cost inflation, outside storage cost inflation, increases, retailer selling price delays, and acquisitions. Those four factors alone would normalize our EBITDA margin to about 10%. Turning to slide 23, this slide shows a chart that tracks a basket of commodity pork raw materials used mainly by our specialty foods segment. You can see the green line represents 2021, the red line 2022, Overall, pricing on a year-over-year basis was relatively stable but still at record highs. Turning to slide 24, this slide shows a chart that tracks a basket of commodity beef raw materials used primarily in our premium food distribution group. The trends in the commodities are not as reflective of the impact on our EBITDA margin as the the impacts of pork on our specialty food segment, mainly because of the dynamic pricing models in this segment. But you can see overall beef was slightly deflationary in the quarter, but continued to be at record high levels, or near record high levels. Turning to slide 25, this shows a chart that tracks a basket of commodity chicken raw materials used mainly by our specialty food segment. This was an incredibly deflationary commodity. You can see coming down from all-time record highs in the second quarter down to close to 2021 levels, or actually by the end of the quarter below 2021 levels, but still, again, on a historic basis, very high levels. You know, this deflation did help our specialty food segment margins, helped counter some of the headwinds I mentioned earlier. but the impact was limited because of inventory positions going into the quarter, as well as just the normal time it takes to process the product and sell it. Turning to slide 26, this slide shows a chart of lobster input prices and relates primarily to our premium food distribution group. Our lobster prices tend to be also fairly dynamic in their pricing, our businesses with their lobster products. However, we move more and more into processed lobsters. It's becoming a little more stickier than the pricing around this product, as a lot of that product is going into the retail channel. As a result of that stickiness, you can see the significant deflation from the second quarter going into third quarter, shown in the red line. And so this really did help the margins of our premium food distribution group in the quarter. Our last commodity slide on slide 27 shows a chart of salmon input prices. And again, this relates primarily to our premium food distribution group. You can see on a year-over-year basis relatively stable pricing and continue to be at very high levels. Turning to slide 28, our earnings for the quarter was $61.3 million. This was an increase of $3.5 million, or roughly 6% from 2021. The increase was driven by our EBITDA growth, as well as a small decrease in our income tax expense. And these factors were partially offset by increased amortization and depreciation, mainly relating to acquisitions and increased interest costs. Overall, our interest costs were up $10.9 million. Majority of the increase related to our higher debt balances, which has been driven by the capital investments we've been making in recent times as well as some of the acquisitions, recent acquisitions. So we've yet to leverage the full benefit of those investments yet. That accounted for about $7.4 million of the increase. FX translation was roughly half a million dollars. and the balance related to rate increases, and that was about $3 million. Turning to slide 29 and our five-year targets, which focus on 2023 for sales. This slide, the starting point we did in this analysis was the midpoint of our 2022 guidance, which is from $5.75 billion to $6 billion for our sales for 2022. We expect to be at the top end of that guidance, so we're starting at a relatively conservative point. If you adjust that then for the impact of delayed pricing over the course of the year, which was about $33.5 million for the first three quarters of the year, add in some nominal organic growth at a rate of 6%, which we feel very confident based on our historic performance. And you can see our pro forma 2023 sales would be roughly $6.3 billion, well ahead of our $6 billion five-year target. Turning to slide 30, our five-year 2023 adjusted EBITDA target. Again, going through a similar calculation. We started at the low point of our 2022 guidance range of $510 to $530 million. This is what we're currently guiding to. I adjusted that for the retroactive impact of delayed pricing increases and that gave us a normalized adjusted EBITDA of $543 million or an EBITDA margin of roughly 9.2%. Added to that the contribution margin associated with the 6% nominal growth and that gives us a pro forma 2023 adjusted EBITDA of $614 million. Again, ahead of our target of $600 million for 2023. Turning to slide 31, our inventory levels continue to be at record highs. They've been driven by hedging strategies by our different businesses in this incredibly inflationary environment, as well as some hedging against supply chain disruptions. So our inventory at the end of the quarter was $821 million. This was down from the second quarter of $836 million, which was about a $15 million increase. The actual progress made by our legacy business was about a $24 million increase, or sorry, decrease in their inventories from the second quarter. And then that was offset by the impacts of FX translation because of the weaker Canadian dollar and acquisitions. If you look forward to the end of 2022, we're projecting inventory of roughly $718 million. That's in line or a bit favorable relative to our plan that were presented in Q2. So we are still very focused on bringing down our inventories and expect to make a lot of progress in the fourth quarter. If we do achieve our $718 million, that'll bring our days cost of sales and inventory down to 53 to 54 days. which is still above our targeted level of about 49 days, but certainly good progress from where we are today. Turning to slide 32, we continue to maintain very strong liquidity. Our unused credit facilities at the end of the quarter were $455 million, giving us great flexibility for our executing of our various growth plans. Our senior and total debt to EBITDA ratios, however, continue to stay at the elevated levels from Q2. Our total debt to EBITDA ratio was 4.5 to 1, which was a bit ahead of our long-term target range of 3.5 to 4 to 1. And our total debt to EBITDA ratio at the end of the quarter was 3.3 to 1. Again, a little ahead of our long-term targeted range of 2.5 to 3 to 1. We actually did make some solid progress on bringing down our ratio over the quarter, these ratios over the quarter. However, if you turn to slide 33, the impact of this progress was offset by kind of an anomaly in the translation of our U.S. currency balances. What this chart shows is the gold line on the left was the end of the second quarter and then we're showing the blue line is our exchange rates and the gold line on the right is the end of the third quarter. So you can see for most of the quarter the exchange ratio was within a fairly reasonable band and then at the end of the quarter it spiked dramatically. So what this did was we translated our EBITDA at a average rate that was much lower than the rate at the end of the quarter. So when we translated our U.S. debt balances, the net effect of these two factors was our covenant ratios got impacted negatively. If you normalize for this effect, our debt EBITDA ratio would have been 3.0 to 1. senior debt to EBITDA ratio, so back within our targeted range. So we look forward for the end of the year, we do expect to be within our targeted range by the end of the year. Turning to slide 34 and our free cash flow for the quarter was $286 million and increase, or sorry, our free cash flow for the trailing 12 months was $286 million. This was a $22.6 million increase or 8.6% from 2021. Our free cash flow per share for the trailing 12 months ending the third quarter was $6.45. This is an increase of 40 cents per share or 6.6%. Our payout ratio for the trailing 12 months was 42.8%. And subsequent to the quarter, we declared a dividend for the fourth quarter of $0.70 per share or $2.80 per share on an annualized basis. Turning to slide 35, this slide outlines our project capital expenditures. We differentiate project capital expenditures from maintenance capital expenditures. by the fact that these are all projects that are expected to generate a 15% internal rate of return after tax unlevered. Maintenance capital expenditures are those that don't meet that test. So during the quarter, we spent $44.1 million on project capital expenditures. And year to date in 2022, we spent $125 million. You can see from the chart, virtually all of these are relating to capacity expansions across our many platforms. So lots of growth opportunities ahead, and we continue to invest significantly in the future. That ends the financial presentation, and with that, I will turn the call back over to Joanna. Joanna?

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star, followed by one on your touchtone phone. You will hear a three-tone prompt acknowledging your... If you are using a speakerphone, please lift the handset before pressing any keys. First question comes from Derek Lessard at TD Securities. Please go ahead.

Yeah, good afternoon, gentlemen. Just looks like you did hit... Hey, guys. it looks like you did hit some some operating snags in in the quarter you know the cancellation of the the new launch products and turkey shortage and the production shut down um maybe just could you maybe add some color to those and maybe some of the mitigation efforts you took and whether those issues are are now behind you yeah hi derek um

Yeah, again, I think that, as Will mentioned, and as I said in my prepared remarks, the last two and a half years, the last 30 months have been very disruptive. I think that there were a lot of supply chain issues, a lot of, not just logistically, but a lot of suppliers are having labor shortages, et cetera. They're not able to execute at the level that they need to. And, you know, I think that the cancellation of the launch was a result of that. Basically, the third-party supplier did not deliver a raw material that was based on the spec that they had agreed to. So, it was unfortunate for us, of course. It meant that there was a huge opportunity cost there, right? We do have a lot of demand for assembly services because of the labor shortages issues in QSR, as we've talked about before. But we do have to keep capacity for our large customers, of course. And, you know, so it's a huge opportunity cost there for us because effectively that capacity remained unutilized and not as utilized as planned. You know, I think with, you know, Turkey that you mentioned in particular, sort of a different type of situation. The avian flu has impacted the turkey industry in North America worse than, you know, in the chicken segment, and that's resulted in shortages in raw material. I think that one will pass as well. What was the other one, Derek?

Well, yeah. Hey, so, Derek, just in terms of the ongoing issues, Like George says, the turkey is really the only one that's ongoing. The impact of the claim, that's been fully accrued. We're working with the customer, hopefully for the relaunch of that program in 2023, and we're excited about that opportunity. So that'll be a big driver next year. And then the other production issue relating to the cooked protein, that was a three-week issue, a very specific window. It's been fully addressed, and that program is... back and going incredibly successful.

Over the last couple of years, Derek, we've invested a lot of effort and capital into new lines and new processes, and again, you expect to have some startup issues with some of these lines. Again, it's back operating today, and actually the line is doing extremely well.

Yeah, thanks for that. And Derek, a little bit more color on George's point on the sandwich issue. You might have noticed our restructuring costs were a little higher this quarter than in previous quarters. That's because we started up several new production lines in anticipating some significant volume increases. And again, so we've got a lot of capacity sitting there ready to go and and it's going to take a little time to grow into that capacity.

Okay, that all makes sense. You also pointed at probably for the second time to some demand destruction in certain categories, I guess meat snackings and M.C. store. Just wondering, you know, how material is that and have you seen it, are you seeing it spread to other categories as, you know, the Fed or Bank of Canada start tightening the purse strings?

Yeah, you know, the demand destruction was really, there was a little bit of it in the chicken category, which would have been the only thing outside of the C-Store meat stack category. And that was, as you saw in that chart earlier, when chicken prices were just absolutely, absolutely record highs. They're coming off. Our business is starting to feature again. So that was really kind of a temporary anomaly, and we're very comfortable that you're not going to see that impact. That demand destruction has been addressed. In terms of the C-Store channel, yeah, that channel has been hit hard, and particularly the consumer that picks up the meat snack product So the year-over-year impact of that was not that significant. It was a little bit of an impact. It was more a growth headwind because we really see long-term great growth opportunities in that channel.

This is quite typical, Derek, to what happens in our business with the run-up in certain input commodities. I always mention the case of... pork bellies when they shoot up, you know, ultimately the price of bacon to food service and retail goes up and demand goes down and the underlying commodity comes off as well. And this is pretty well what happened with beef jerky, you know, but the underlying commodity got way too high and retail pricing was very high as well. And it impacts, of course, demand and that's how you bring down the commodity. So that's really what's happening with beef jerky in particular in the C-Store channel.

You're not seeing it going to other categories so far?

No, actually quite the opposite, Derek. We're actually seeing deflation as as Will explained earlier, with a lot of the underlying commodities. We think that inflation has peaked. And, you know, in some cases, even after the end of the quarter, commodities are coming off and, you know, freight rates are coming off and container rates are coming off. And I think we've seen the peak of inflation. And, you know, we actually expect demand to go up for a lot of these products as the pricing comes down.

Okay. Thanks for the call, Earl. I'll reach you.

Thank you, Derek. Thanks, Sharon.

Thank you. Next question comes from George Dumais at Scotiabank. Please go ahead.

Yeah, hi. There was a significant increase in the margins. Hey, guys. There was a significant increase in the margins at PFD. I think you called out lobster and a shift of value. Can you maybe talk to that and try to get a sense of the sustainability of those margins, I guess, over the medium to longer term?

Yeah, so longer term, we do expect to have PFD margins expanding. They were accelerated a bit in the quarter because you saw that big drop in lobster prices did create some expanded margins. Longer term, We do see PFD as sort of a 7.5% to 8% EBITDA margin business. So they were roughly in that range. They're a little bit above it because of the lobster benefits.

Okay, that's helpful. By my math here, to hit the low end of this year's guidance, we would need to see a similar margin profile in Q4 and Q2 and Q3. Q4 is usually a weaker quarter. So maybe can you just help me understand kind of the building blocks to the guidance for the year?

Yeah, again, I think it'll be a similar story. There's continued to be some pressure on the sales side in retail at the beginning of the quarter that that's going to hit the margins because of that sales mix issue I talked about earlier. But overall, we are expecting to hit the bottom end of that range

I think that the dynamics there, George, that are playing out today is, as I mentioned earlier, deflation. So you have a lot of underlying commodities that shut up. We adjusted pricing and now they're coming off. The pricing doesn't come off quickly. Effectively, margins contract on the way up and expand as the underlying commodities go down. So that should help the quarter. And, you know, as I mentioned before, I think that there's a lot of pent-up demand for large gatherings. The downtowns are back. Downtown crowds are back. Office crowds are back. And, you know, we expect quite a strong end of the year, December in particular.

But again, George, with that side of the equation, that's PFD, right, which our PFD margins are below sort of our average, our specialty foods is above our average, right? So again, that goes to that sales mix issue.

Yeah, thanks for that. George, just one last one, if I may. I'm just wondering how you prioritize the NCIB versus M&A, kind of given where the stock is and given where the balance sheet is.

Yeah, again, we, as I mentioned in the prepared remarks, we will be acting on the NCIB in the fourth quarter. Unfortunately, we we missed the window in terms of our blackout in the third quarter. You know, we obviously always look at the allocation of capital and where we get the highest returns, and we find the value of our shares today very compelling for our long-term shareholders. So we will certainly be biased in the fourth quarter.

All right, thanks, guys.

Thanks, George. Thanks, George.

Thank you. Next question comes from Martin Landry at Stifle GMP. Please go ahead.

Hi, good morning, guys. Hey, Martin. My first question is on your M&A pipeline. Looking at the slide that you put on a regular basis, it looks like there's less M&A files active currently, and I was wondering if you can discuss a little bit that dynamic.

Yeah, there are many, many active files, Martin, at Premium Brands. I can tell you that our M&A team is extremely busy. As I mentioned, again, in my prepared remarks, we are not prioritizing acquisitions at the moment. We're focusing internally. Things are getting back to normal. We're adding capacity. We're investing in process automation to deal with some of the ongoing labor issues, particularly in the U.S., We have a lot of companies that would like to be acquired or partnered with premium brands. You know, the M&A environment is very benign right now, I would say. There's not a lot of buyers out there. There's not a lot of sort of transactions taking place out there. So we don't feel that any pressure to do anything. We're moving some possible deals into the new year. And anyway, we will be very busy over the next 12 months with M&A, not just immediately, as we speak right now.

Okay. And just to be clear, why is it that you're not prioritizing acquisitions right now?

Well, again, I think that what we saw earlier in the year, we saw a lot of transactions where the expectations of value was relatively high, and you know, in an inflationary disruptive environment. And we didn't feel the need to act. But, you know, those are good deals as we think that time favors us at this time. And, you know, as expectations for value moderate, then we will be more active.

Okay. Okay, and the other question, you've been talking a little bit about deflation, you know, being in a deflationary environment with your commodity costs. I was wondering, and you touched a little bit, you're saying there's usually a lag when prices go up and there's a lag when prices go down, you lagging, you know, some of the pass-throughs. But I was wondering when do you think or at what point are you going to start thinking about maybe reducing some of your selling prices to reflect lower commodity costs?

Yeah, so Martin, over the last couple of years, as you know, we've got a lot of questions around inflation and how are we going to manage this hyperinflation. that we've seen in the last couple of years. And I have to say that in my 35 years in the business, I've never seen so much inflation in the last couple of years. And we don't really get too excited about that because we have demonstrated in the past that we can pass on pricing. Again, we're not trading in commodities. We're trading in differentiated products, generally branded products, unique products. And again, once again, as Will mentioned earlier, we've demonstrated our ability to pass on pricing. Having said that, you know, we make it back as the underlying commodities begin to come down. And in the end, you know, we'll end up with our normal margins. We do pass on the pricing, of course, but we want to make back what we gave on the way up sort of thing. And that's generally what happens, Martin.

Okay, so no expectations of price declines in the near term?

Well, I think what you'll see in the near term, Martin, is a lot more featuring by our businesses. So to the extent that they are passing on some of that price benefit, the offsetting gain from that will be higher organic volume growth. So a better margin from a contribution margin perspective.

which drives our plant efficiencies, drives our optimization of our operations, optimization of our labor, et cetera, right? So those are positives in terms of the bottom line overall.

Okay, perfect. Thank you. Thanks, Michael.

Thank you. Next question comes from Stephen McLeod at BMO Capital Markets. Please go ahead.

Good afternoon. I think good afternoon. Hey, Steve. It sounds like, based on your commentary, and I think what you had in the press release as well, it sounds like your momentum sort of accelerated through the quarter. And I'm just curious, and even into Q4, I think is what you said. So I'm just curious as we think about the top line and maybe the organic volume growth rate into Q4, do you expect it to accelerate sequentially from Q3?

We do expect to see some improvements, Steve, but it is much, it is seasonally a slower quarter. So, you know, what would happen in the third quarter was, you know, a lot of that strength in retail around sort of outdoor activities, barbecuing, all those things that drive our protein business and the seasonality of it, you know, we didn't see them in the early parts of the quarter. And because people weren't at home, they were all going out, dining out, traveling, you know, just post-pandemic sort of that demand of getting out of the home. So we did see that significant shift and improvement over the course of the quarter. But again, that dynamic isn't going to play out as much in the fourth quarter just because it's different seasonal factors.

Oh, okay, I see. That's helpful. And then maybe just turning to the gross margin, I know you talked a little bit about the mix, but just with some of the slides that you showed on commodity prices, it looks like they've come off, but they're still historically high. So do you expect that that should be reflected in gross margin improvements as you move forward and then into next year as well?

Yeah, so, you know, again, looking at the two different segments, right, Steve? So if you look at the specialty food segment, the two key commodities we talk about is pork and chicken. You know, pork we're expecting to be relatively stable. So, you know, probably no wins there. Chicken, yeah, you know, we do expect to see good margins in there as we get back to normal levels. with our pricing and hopefully with some featuring, we get a good solid growth out of that. But chicken is a much smaller component of our overall basket, right? So although it's helping to offset some of those retail mix chain issues, it's not as dramatic of an impact on our business. So hence why we're being a little conservative around our expectations of EBITDA for the fourth quarter. Right, okay, but you're more confident in the PFD margins sort of based on... Yeah, and sorry, so going over to PFD, the commodities there, the lobsters, salmon, and beef, again, we do expect to see some continued deflation in beef, salmon stable, and lobster possibly inflationary, So, you know, relatively overall, you know, a stable situation. Although, again, the dynamic pricing model of our premium food distribution businesses tends to make inflationary or deflationary cycles less of kind of an issue than it is in our specialty food segment.

And Stephen, you're focusing on The commodity pricing, of course, or the pricing of the underlying commodities we use, which is what we'll explain. Again, don't forget that in the last couple of years, we've had tremendous issues with labor shortages, which impacts the efficiencies and the productivity and the optimization of output out of our facilities, which seems to be abating now as labor, particularly in Canada, seems to be plentiful. Not so as much in the U.S., but we're making progress there as well. And, you know, that should help the overall margins.

Okay. As we go forward. That's really helpful. Thank you. And then maybe just my last one. You know, on slide 21, you showed the selling price inflation outpacing raw material and wage and freight inflation. So that was a net positive impact to EBITDA. But then you cited it as a margin headwind on the next slide. And I'm just curious if you can explain that difference.

Sorry, I don't quite understand your question, Steve.

Well, you were saying on slide 21, you showed selling prices outpacing raw material inflation, so a net positive EBITDA impact. But then you cited it as a... the delay in putting through price as a margin headwind on slide 22. So I'm just curious how that dynamic works.

Oh, yeah. So on slide 22, what we're talking about is that $4.6 million I mentioned earlier. So in Q3, we were still, you know, at the beginning of the quarter, we were still waiting for some price increases to take effect. And that's that $4.6 million impact on the quarter now. For Q4, we're not expecting that to be a factor. All the pricing's in, commodities are stable. From just a pure selling price relative to raw material commodity prices, we should be back at normal margins for the quarter because of that. Subject then to some of these other factors like are outlined on slide 22, such as the freight situation, which does seem to be stabilizing and the impact of the acquisitions and outside storage costs.

Okay. That's great. Thanks, guys. Appreciate it. Okay. Thank you.

Thank you. Next question comes from John Zamparo at CIBC. Please go ahead.

Thanks. Good morning, guys. Hey, John. I wanted to start with the $19 million order that you ended up refunding in two parts to this. First, did quality control issues on that order, has that impacted the relationship at all with that customer? Have you seen any change in volumes or orders with that customer since? And then second, has finding other suppliers presented any challenges in Q4 so far?

The relationship with that customer, John, has never been better. And Again, we will continue to grow with that customer.

This is an issue, John, that is black and white in the supplier's eyes, our eyes, and the customer's eyes. We were the assembler, and there's absolutely no doubt what part of the process was broken, and it wasn't one of our processes.

Effectively, the product was delivered out of spec, and again, it was very clear. The supplier is not denying it, so again, there was a lot of opportunity cost to us, but it was clearly not a PP issue.

Okay, that's helpful. Thanks. I wanted to ask about inventory and one of the reasons inventory is so important is it's strategic and it's a choice to mitigate cost inflation. I wonder if you could just take a shot at quantifying the impact of that or even just broadly describing how material a benefit that has been to you.

Yeah. So, you know, it's really, it's the strategic element from what I mentioned earlier relating to supply chain challenges and inflation. And then there's also the element of the shift in retail in the quarter. So there's some inventory built up from that. So, you know, it's a combination of those three factors. If you go to that slide on the inventory, it was slide... Sorry, John, give me a sec. Slide 31, you know, we kind of isolate a little bit. You know, so $37 million was... specific plans to build inventory for the fourth quarter by different businesses. And then that other number, the $59 million, that was kind of a combination of the safety stock relating to the inflation and the supply chain challenges issues.

Okay. I wanted to clarify on SG&A, your press release, and I think the prepared remarks referenced the promotional and variable selling costs associated with driving organic volume growth. I'm just wondering if you can elaborate on what those were.

It's a whole range of things, John. Nothing individual is significant. So it's participating in ad campaigns. It's in-store demos. It's... working for different coupon programs. It's a whole range of different initiatives across our many businesses.

Okay. Is it just that those were – you're always doing those, but they were incrementally higher this quarter?

Well, no, because, you know, a lot of that stuff we had – cut back significantly over the last six quarters because the business's pricing wasn't where it needed to be. They didn't have the margin. They were struggling to get back to their normal margins, and one way they were addressing that was cutting back on promotion. Last thing they wanted to do is promoting a product at nominal margins. Why bother doing that? So it's really a step back to getting to normal levels of activity. They're still not there yet. They're still below sort of historic levels for promotion just because, like I say, Q3 was still a transitory quarter and getting margins back. And the fact is a lot of these programs, you need to work with the retailer three to six months out to put in place that program. So this would have been stuff you had to start planning in the middle of all that inflation. But like I say, the upside, it's good money spent. We love it when we can promote product because it always drives organic volume growth. We're just very responsible. We're only going to do it when there's a decent margin to still be made.

Got it. Okay, that's good color. And then my last one's on capital allocation and specifically the dividend. And you have a track record here of 10% annual increases, but I wonder with leverage where it is currently, it's higher than you'd like. your investments in working capital elevated, most of your debt is variable. Is there a reason to think you'd put more priority on deleveraging? You've also mentioned the NCIB, rather than seeing a similar increase in the dividend next year.

Well, for starters, we expect our balance sheet to delever pretty quickly in 2023, John, with the expected growth in our EBITDA. Again, you look at our EBITDA for this year, And just the pricing delays alone was $34 million impact on EBITDA. So we're very bullish on our EBITDA for next year. That is going to have a dramatic impact on leverage levels. We did generate a lot of free cash flow. That will continue to go towards some of it invested internally, some of it to pay down debt. And then finally, the inventory issue. Again, we expect to see a fairly significant amount of cash come out of our inventory. When you put that all together, we've got very good flexibility on the balance sheet.

We have no plans, John, to change our dividend policy or strategy in terms of sharing our growth with our shareholders.

Okay, that's very helpful. That's all from me. Thank you. Thanks, John.

Thank you. Next question comes from Vishal Sridhar at National Bank. Please go ahead.

Hi. Thanks for taking my questions.

Hey, Vishal.

Hi. With the management indicated right off the top on the strong acquisition backdrop, including potential transformative acquisitions, understand nothing immediately in the pipeline, or at least that's what I understood in terms of immediacy, but Just on the transformational deal, does that suggest that management would consider issuing equity around current levels, if that's the case?

We have no plans to issue equity at current levels, Vishal. Again, we're always in discussions with possible partners for strategic opportunistic and transformational acquisitions. The timing of Well, these deals tend to be driven by the seller many, many times, but what we're conveying effectively is that, you know, we have a few transformational ones in the pipeline that meet our criteria. We don't know when they'll happen, possibly in 23, possibly in 24, but we're always working on transformational deals and building relationships to be able to ultimately do them and execute them and make sure that they're... the accrued benefits to our shareholders.

Okay. And just changing topic here, a lot of volatility on debt, including the interest rate impacts on free cash flow, translation impact on the debt ratio. Wondering if this backdrop has caused management to reflect on some of its debt policies and do things a little bit differently. And if so, if that's the case, just wondering what management would be thinking about.

Yeah, again, we're very comfortable with our current policy, you know, our two ratios for our total debt TB dot ratio and the senior debt TB dot ratio. You know, again, you know, a lot of the stuff going on is noise, Michelle, in terms of the impacts of FX. You know, it's just kind of math in the quarter. You know, and the reality is as we, you know, we've invested a lot in capacity and growth. And we're just in the early days of that. And as that unfolds in 2023, that's going to address a lot of the issues you're talking to.

Okay. And in terms of the variable versus fixed on rates, is that something that is more of a transitory impact as well, do you imagine? Or is that something that management is going to look at in the future?

Again, as you saw in the quarter, the impact of the higher interest rates on our interest expense is only $3 million. And the reality is we've always been in the philosophy that long-term variable rates are more beneficial than fixed rates. And yeah, if you time things perfectly, it can be vice versa, but you have to time things perfectly and no one ever gets that right or rarely gets that right without just being lucky. Again, where we see rates going to and we see our historic rates of interest we've paid, they're certainly within the band of normality and it's really the absolutely incredibly low rates we've just come off of that was the abnormal environment.

Again, Vishal, sometimes we have to look at things in terms of materiality. We've put through in excess of $600 million in price increases this past year. Or six quarters. The last six quarters. Again, our business has grown and continues to grow. We're still getting organic growth in the most difficult, awkward environment we've seen in probably our career. $3 million in increased interest costs is not material to us.

I appreciate that, Keller. Thank you.

Thank you. Next question comes from Kyle McPhee at Cormac Securities. Please go ahead.

Hi, guys. A question on your growth CapEx project. I noticed that a big sandwich production facility investment disclosed in your list of projects last quarter. It disappeared from the list of projects this quarter, referring to a new sandwich production facility that was being built in Hilliard, Ohio. Looks like now replaced with a smaller investment, Columbus. So am I interpreting this right? And why might you be scaling back the sandwich platform growth spend?

Yeah, no, you are definitely interpreting right. This was a unique opportunity, John. We had been going down the path of building this satellite facility to our Columbus facility to kind of bridge our capacity for the next evolution in our sandwich platform. And before starting on that satellite plan, an opportunity presented itself with this brand new storage facility that came on the market. Right by our Columbus plant so so that's allowing us now to instead of building a another satellite production facility moving the distribution. element of our Columbus facility to this new facility that's right by it, which will provide us with much needed distribution capacity. and then keeping all of the production and the production growth in the Columbus facility. So it's a great solution. It gets us the bridge that the Hiller project would have gotten us, and it's $49 U.S. cheaper.

Effectively half the cost, so we couldn't pass it up.

Okay, so I saw that it was half the cost, but it sounds like it doesn't result in less production square footage.

It is slightly smaller, but the key is it's the bridge we need to as we elevate the next evolution of our sandwich platform. Because when we look out at our growth opportunities in that platform, we need more capacity to meet our next three to five-year plan. So we're starting to look at a new major facility down the road a couple of years from now somewhere on the east coast of the U.S. The southeast of the U.S. And this is the capacity that bridges that need, which was the strategy of the original Hilliard project.

Understood. Okay. Thanks for the color. That's it for me.

Thanks, John. Or Kyle, sorry.

Thank you. Next question is from Derek Lessard at TD Securities. Please go ahead.

Just a few follow-ups for me. Maybe a housekeeping question, Willie. I think you alluded to it on depreciation. It's up $4 million, quarter over quarter. I'm curious just how much of that is Forex versus M&A or acquisitions and capital projects.

Yeah, it's almost all acquisitions. There's some FX in there, and if you go into our MD&A, it'll break out the FX impact. Derek, I don't know it off the top of my head, but from the actual growth in CapEx, it is almost all acquisitions related.

Okay. And just one final one on the sandwich business. Just to be clear, you guys are the assemblers, but the the suppliers are chosen by your customers?

They're chosen in collaboration with the customer, right? So basically by both.

Okay. Yeah, so we have to make sure that the supplier fits in with our production standards and all that sort of thing versus the customer makes sure that that's the product they want for their end component or their end product.

Okay, so I guess my question is, at the end of the day, when something does go wrong with a supplier, how is blame, I guess, shared?

Well, again, as George mentioned earlier, the supplier has taken full responsibility for the issue. But just because of the contractual structure, the customer makes a claim against us, and then we make a claim against the supplier.

Okay, understood. Thank you.

Thank you. There are no further questions. I will now turn the call back over to George Pollo-Logo for closing comments.

I'd like to thank everybody for attending today. Thank you very much. Bye-bye.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating, and we ask that you please disconnect your lines.