Earnings Call: Q2 2018

Apr 10, 2018

Greetings, and welcome to The Simply Good Foods Company second quarter 2018 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to Mark Pogharian. Thank you. You may begin. Thank you, Sherry. Good morning. I am pleased to welcome you to The Simply Good Foods Company earnings call for the second quarter ended February 24, 2018. Joe Scalzo, President and Chief Executive Officer, and Todd Cunfer, Chief Financial Officer, will provide you with an overview of financial results, which will then be followed by a Q&A session for sell-side analysts. The company issued its earnings press release this morning at approximately 7:00 A.M. Eastern Time. A copy of the release and accompanying presentation are available under the investors section of the company's website at thesimplygoodfoodscompany.com. This call is being webcast live on the website, and an archive of today's remarks will also be available for 30 days. During the course of today's call, management will make forward-looking statements that are subject to various risks and uncertainties that may cause actual results to differ materially. The company undertakes no obligation to update these statements based on subsequent events. A detailed listing of such risks and uncertainties can be found in today's press release in the company's SEC filings. In addition, management will make references to adjusted EBITDA, a non-GAAP financial measure that it believes provides investors with useful information with which to evaluate the company's operating performance. Finally, the company has included in today's earnings release and presentation unaudited financial information for the 13 weeks and 26 weeks ended February 24, 2018, and unaudited pro forma financial information for the 13 weeks and 26 weeks ended February 25, 2017. The pro forma adjustments are based on available information upon assumptions that our management believes are reasonable in order to reflect, on a pro forma basis, the impact of its business combination transaction on the historical financial information of our predecessor and successor entities as applicable. The pro forma financial statements provide results as if the business combination transaction had been completed as of the beginning of fiscal 2017. All financial measures related to the fiscal 2017 discussed today will be on a pro forma basis. With all of that out of my way, it's my pleasure to turn the call over to Joe Scalzo, President and Chief Executive Officer. Thank you, Mark. Good morning. Thank everyone for joining us. Today, I'll recap our second quarter highlights. I'll provide an update of our business. Todd will discuss a summary of our second quarter and year-to-date financial results. We'll open the call to your questions. Before I do that, let me welcome Mark Pogharian to our team. Mark joined us just last week as VP Investor Relations, Treasury and Business Development. He brings significant experience in these areas and broader finance after nearly 25 years in the consumer packaged goods industry. I know he'll be a great addition to our team. I look forward to the contributions he'll bring to our business and to working with him. Welcome, Mark. Our second quarter continued the strong business momentum we experienced in the first quarter. For the second quarter, net sales grew 6.9% year-over-year, with adjusted EBITDA up 3.9%. This growth continues to underscore the strength and the resilience of our core business. The powerful, nutritious snacking macro tailwinds of convenience, meal replacement, and low-carb, low-sugar, protein-rich products. We generated U.S. POS growth of 5.1% in the first 26 weeks of our fiscal year as a result of continued growth in our core U.S. nutritional snacking business and strategic marketing efforts to target a broader consumer audience. As expected, our measured channel POS growth continued to be solid in the second quarter, increasing 4.7%, resulting in year-to-date growth of 5.1%. This excludes our e-commerce business, which continues to accelerate. While still early, our POS momentum in the first month of the third quarter is accelerating. The most encouraging part of our strong retail performance is that it's coming entirely from base velocity growth, which more than offset planned distribution losses. We believe our strong velocities are driven by a number of factors. Number one, our new marketing campaign is resonating with and bringing consumers to our franchise. Number two, the packaging refresh, improved shelf presence, and aisle shopability. Number three, our clean label initiative delivers on consumer preferences for fewer and recognizable ingredients. Number four, our new product trial and repeat are in line with our expectations and have become some of our top velocity items. As many of you know, in January, we announced Rob Lowe as our new brand spokesperson. Rob authentically has lived an Atkins low-carb lifestyle for decades. He is the epitome of the Atkins self-directed lifestyle consumer. He emphasizes desire for living a healthy life for family, health, and wellness. He demonstrates how healthy living is possible by following the Atkins nutritional principles of eating delicious foods with optimal protein and fewer carbs and sugar. With our shift towards targeting both self-directed low carbers as well as programmatic weight loss consumers, Rob was our first lifestyle brand. We're encouraged by his ability to appeal to both consumer targets. We continue to communicate what we believe is a big consumer idea, namely hidden sugars, with two new ads, one featuring Rob Lowe in a spot entitled "Secret Weapon," and another that focuses on a group of women cyclists whom we refer to as the Biker Gang. After today's conference call, I encourage you to come back and click on the hyperlink embedded in the photos to view the ads. You may recall hidden sugars are carbs in foods that your body converts into sugar in the bloodstream. We believe this consumer idea is an ownable one for Atkins and can more easily explain to consumers the impact of non-fiber carbs on their body, and why managing carbs is an important factor to eating right. The new marketing campaign began airing January 1. We're extremely pleased with the early results. Base POS dollars are up high single digits on a percentage basis versus last year. Web visits to atkins.com are up 25%. Our PR campaign tied to our partnership with Rob created 500 million impressions. Most importantly, our total buyer growth is accelerating since the start of the campaign, up nearly 6%. We have learned that the universal themes of eating right for health and better quality of life, while not sacrificing taste and satiety, appeal to both programmatic and self-directed consumers. You may have also seen our newly refreshed packaging graphics at retail, modernizing our Atkins logo while also improving our taste appeal, shelf impact, and product benefit communication. Here you see the before and after of our leading meal bar, chocolate peanut butter. We also believe the new packaging stands out on the shelf and communicates the brand in a positive way to a broader set of consumers. A third driver of base velocity growth, we believe, is the success of our clean label initiative. Consumers increasingly are demanding products having cleaner labels, which means fewer ingredients and ingredients recognizable to them, while still delivering the high taste profile and fewer net carbs that Atkins consumers are accustomed to. To date, seven of our 10 meal bars and four out of our 11 snack bars have been converted to clean labels and rolled out. Based on improved velocities with the cleaner products, it's clear to us that this benefit is extremely important to our current and future consumer base. We're also encouraged by the success of our recent product launches, which we believe deliver the type of added benefits many consumers are seeking. We launched a line of new bars last spring, which include almond butter. These snack bars, lemon and white chocolate macadamia, are currently our number 2 and number 4 snack bars where they are in distribution. We recently launched two meal bars with almond butter, chocolate almond caramel and vanilla crisp, both which are now our number 1 and number 2 highest velocity items in our meal bar portfolio. We're excited about our new protein shakes, which began shipping in February. They have 30 grams of protein and seven grams of fiber, giving consumers the protein and fiber they seek while still low in sugars and net carbs. Early consumer and customer response has been very encouraging. With this overview, I'd like to turn the call over to Todd. Thank you, Joe, and good morning, everyone. Let me start with two points as it relates to the numbers you see on the slides to follow. First, for comparative purposes, we will review unaudited financial statements for the quarter and year to date end of February 24th, 2018, and pro forma financial statements for the quarter and year to date ended February 25th, 2017, which presents our results as if the business combination had occurred as of August 28th, 2016, including amortization expense based on the fair value of assets after the purchase and interest expense based on the new capital structure. We believe this discussion provides helpful information on the performance of the business during this period. All financial measures discussed today will be on a pro forma combined basis. Second, we also evaluate our performance on an adjusted EBITDA basis based on our asset-light strong cash flow model. We have included a detailed reconciliation from GAAP net income to adjusted EBITDA in today's press release. We believe this measure is a key indicator of the true underlying performance of the business. The second quarter results are as follows. Net sales were up 6.9% to $109.3 million, driven by organic core growth of 5.8%. The acquisition of Wellness Foods' SimplyProtein brand contributed 1.1% to sales growth in the quarter. Recall, the year ago period only captured one month of Wellness Foods sales. Gross profit increased 7.9% to $50.3 million, with gross margin up 50 basis points to 46%, driven by lower supply chain costs. Net income increased $35 million to $41.4 million due to higher gross profit and two impacts from the Tax Reform Act, specifically a $29 million gain on the revaluation or remeasurement of deferred tax liabilities and a $4.7 million gain in the fair value of our TRA, or tax receivable agreement. Due to the Tax Reform Act, our effective tax rate in the second quarter was about 15%, reflecting a true-up of our year-to-date tax rate to about 28%. Note that this excludes the aforementioned $29 million gain. Additionally, in the second quarter, we incurred slightly higher distribution and customer service costs, $1.9 million in transaction costs as a result of our secondary offering in February, and M&A due diligence expenses. As a reminder, our legacy shareholder exercised their right to sell their shares in the second quarter. Also, we had higher customer-specific selling expense to engage online customers, as well as greater levels of in-store activity. As we stated last quarter, we're incurring higher G&A expenses as a result of public company costs and the acquisition of Wellness Foods. Lastly, adjusted EBITDA increased 3.9% to $18.8 million versus $18.1 million in the year ago period. Year-to-date results show similar growth as well. Net sales increased 6.8% to $215.9 million, driven by organic core growth of 4.9%, and the acquisition of SimplyProtein, which added 1.9% to net sales. Gross profit increased 8.1% to $103 million in the first half, with gross margin up 60 basis points to 47.7% due to lower supply chain costs and favorable product mix. Net income increased $36.1 million to $51.6 million due to the previously mentioned $29 million gain from the deferred tax liability remeasurement and the $4.7 million gain on the TRA, in addition to the gross profit improvement. This was partially offset by slightly higher distribution costs, the $1.9 million of previously discussed transaction costs, a 7.3% increase in selling expense, which includes efforts to increase in-store activity, and a 10.8% increase in G&A as a result of Wellness Foods and public company costs. The company continues to benefit from a very attractive cash flow characteristic underpinned by our asset-light business model, which enables strong cash flow generation. Capital expenditures for the first half of 2018 were approximately $0.9 million, driven by our investment in our new website and digital media application. We estimate full-year CapEx of approximately $1.8 million. As we discussed in January, we will see a benefit from the Tax Reform Act signed into law on December 22nd. As I stated earlier, the benefits to Simply Good Foods are both one time and ongoing in nature. For fiscal year 2018, we estimate a blended, adjusted effective rate of 28%, which is lower than our previous guidance of 31%-32% due to the one-time book gain on the TRA, which is not taxable. While preliminary, we anticipate our adjusted tax rate in fiscal 2019 will be in the 26%-28% range. The decline of our effective tax rate in fiscal 2018 is about a $4 million benefit to cash flow and net income. Given our solid cash position and balance sheet, we have financial flexibility to reinvest a portion of this benefit that results in building our business and long-term shareholder value. Specifically, in the second half of fiscal 2018, we will reinvest a portion of the tax savings in the form of brand building, capabilities, and people. This will include incremental strategic investments in marketing and brand-building initiatives to drive further top-line growth and carry momentum into fiscal 2019. Investments to enhance organizational capabilities and key functions, including preparation for compliance requirements in the future. While we are not required to be SOX compliant in fiscal 2018, given our status under the 2011 JOBS Act, we have decided to accelerate our preparedness, as we believe it will help us as we look to integrate and scale future M&A. In appreciation for their hard work during the past year, an employee bonus of $1,000 in cash for all employees below the director level. Given this, we now expect fiscal 2018 adjusted EBITDA to increase at a rate slightly lower than net sales growth, which we still target at 4%-6%. Moving on to the balance sheet and cash flows, as of February 24, 2018, the company had cash of $79 million and a $200 million term loan outstanding, resulting in a pro forma net debt to adjusted EBITDA ratio of 1.6 times. The company also has a $75 million revolving line of credit available with no borrowings outstanding as of February 24, 2018. We also successfully repriced our term loan on March 16th at LIBOR plus 350 basis points, a reduction of 50 basis points from the previous spread. One-time costs associated with are more than offset by interest savings in the first five months. That concludes my financial overview. I will now turn the call back to Joe for brief closing remarks. Thanks, Todd. In summary, we remain confident in the growth opportunities for our business moving forward and our ability to execute. We're pleased with our year-to-date 2018 performance. We believe we're well-positioned to deliver our 10th straight year POS growth in the U.S. As a result, we expect to deliver fiscal 2018 net sales consistent with our previously stated long-term growth algorithm of 4%-6%. Regarding adjusted EBITDA with a tax benefit reinvestment and the previously communicated incremental $2 million of public company expenses, we now anticipate adjusted EBITDA growth rate of slightly less than net sales. We appreciate everyone's interest in The Simply Good Foods Company. With that, Todd and I are available to take your questions. Operator? Thank you. At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Jason English with Goldman Sachs. Please proceed. Hey, good morning, folks. Thank you for letting me ask a question. I've got a couple of questions. I'll try to keep it tight to leave room for others. First, you mentioned strong velocity offsetting plan distribution losses in prepared remarks. When we look at the Nielsen data, there's no evidence of distribution losses, at least that we can see in the data. Can you elaborate on the source of these losses? Are they relatively recent, perhaps not showing up in the data, so something we should anticipate going forward, or is it possible that they're happening in our measured channels? The biggest discontinued losses, Jason, were we had a Lift, a sub-brand called Lift, which we discontinued about a year ago. That's been a bit of a drag on our retail takeaway for the last year and some other just normal in and out products that we've replaced. In the data that we see, there are some discontinuation losses. As Joe pointed out, the base velocity gains have more than offset that, and we're really, really pleased with that. That's helpful. Thank you. You mentioned the due diligence expenses that you incurred this quarter. Is it fair to assume that they're in relation to prospective acquisitions and not expenses tied to previous activity? If so, can you give us a little bit of color of what you're seeing out there in the marketplace? Obviously, nothing specific, but as we look across the M&A environment, it looks to be much more of a seller's market than a buyer's market, given some of the multiples out there. Are you seeing any quality available assets out there at reasonable prices? Yeah. First of all, the $1.9 million of transaction expenses was a combination of the self-registration where secondary offering, where Roark was able to sell their shares, which went well in February. There was also some M&A expenses. Obviously, now we need to incur those expenses as incurred. I obviously can't speak specifically on a particular asset, but we have a very active portfolio. We feel good about the opportunities that are out there. We're continuing to engage with people. We feel there's going to be opportunities throughout the year. We're going to be smart buyers and we're only going to purchase things that we feel are good value. Very good. Thanks, guys. I'll pass it on. Our next question is from Chris Growe with Stifel. Please proceed. Hi. Thank you. Good morning. I just had a bit of a follow-on to Jason's question on M&A. There was an outline, at least, of a potential acquisition in that secondary filing in the proxy, I believe it was proxy. Do you have any update on that, or will you further disclose maybe perhaps in the 10-Q that would come out around that? Yeah, we really can't, Chris. We can't comment on any kind of pipeline in M&A other than we have a pretty active pipeline at this point. We continue to pursue opportunities where we think we can add value. If and when we're able to talk about it, you guys will be the second ones to hear about it. There's nothing in today's Q that will give any more color on that. Yeah. Okay. Yep, that's good. Thank you. Just to understand, with the increased investments you're making, especially those investments related to the brand, if you will, marketing, that kind of thing, is there a desire to try to accelerate revenue growth, or is that an investment required support 4%-6% growth going forward? Just curious how you look at that going forward and the benefit that investment could provide. Chris, hard to parse that apart other than we're happy right now with what we're seeing in the investments that we're making. Right? First and foremost, what I would tell you is we feel like we have ideas and areas that are worthy of investment. The tax reform benefit gave us a little bit extra flexibility to lean in on those things that we know have a pretty good return. We're making those investments. From our perspective, it's hard to really parse apart, is it late 2018, 2019? Is it going to accelerate us past the 4%-6%? That's difficult in this category. Where we see the opportunity to make the investments and we have the wherewithal to do it, we're going to do it. We saw the- Okay. Just one little follow-on to that then. As you have talked about some distribution declines that have occurred across the business, and they were planned, should we expect distribution increases to occur as you're investing more heavily? Velocities remain very strong. I know maybe some one-time things to get around, but it would seem like that should start to pick up a little bit, maybe not radically, but just curious what you see there. Yeah. The interesting thing in this category is the bifurcation of retailers resets. We see pretty evenly split between spring and fall. About half reset their shelves in the spring, half reset their shelves in the fall. It takes about a year from the time we decide to launch something to really get it into, be able to present it and let customers make decisions in 100% of ACV. If you're losing items, that takes kind of a year to play out. As you're gaining items, again, it takes about a year to play out. We like our product innovation that we talked about today. We think it's interesting and compelling. We'll start to see, I think, some impacts of that on shelf resets in the spring and then, fully as we close out the calendar year and move into next calendar year. Okay. Thank you very much. Yeah, you're welcome. Have a good day. Our next question is from Rob Dickerson with Deutsche Bank. Please proceed. Thank you very much. Good morning. Morning, Rob. Welcome, Mark. Very happy to have you at SimplyProtein. Just want to say that up front. A few questions, all pretty basic. I guess first is just in terms of organic sales for the year. You are now, I guess, close to 5% in the first half. Guidance is 4%-6%. You are right at the midpoint of guidance. Is there anything that we should be aware of, Q3 or the back half, that could cause potential acceleration or deceleration? Thanks. Yeah. The only thing I really want to point out is obviously, we have benefited from the acquisition in our numbers in the first half. That will go away in the second half. It is all going to be core growth. Everything else being equal, it will be down just because of not having that Wellness Foods to benefit. We are still in that 4%-6% range. Feel really good about recent POS growth. As Joe pointed out, it is hard to project this category because it is pretty volatile, but at this point, we are feeling very good about where we are in the second half. Okay, great. Just in terms of the Lowe effect, so to speak, just initial results, better than expected, kind of in line, good enough to extend a contract potentially, or just any thoughts you have as to how that is progressing. Thanks. Yeah, great question. The Lowe effect is high. We feel really good about what he's done for our business. I think, as we mentioned in our remarks, pleasantly surprised by kind of the key leading indicators of his impact, his ability to appeal to both groups of buyers, his ability to generate PR. Website is a early indicator, and probably the best and most favorable indicator is our buyer growth is up. This is a category, to remind everyone, that is still relatively under-penetrated, under 50%. There's a lot of headroom to bring people to the category and to our brand, and that is something we pay attention to very closely, increasing penetration. The early indicators, January, February, and March are he accelerated buyer growth, which is very important to us. Exceeded our expectations, and we're very encouraged. One of the reasons that we're leaning in on marketing investment. Okay. Yeah, that was kind of my point is obviously organic sales growth did well in the quarter, you're also tapping into that self-directed consumer more because you're bringing new buyers into the category, the brand partially probably driven by packaging, the commercials look pretty good too. Is that kind of a fair summary? Well said. Yes. advertising for the year, I think before was up seven. Expectation, is that, given the bit of a reinvestment, is that number up to eight or nine? It'll be slightly higher than we've talked about previously. Yes. Okay. I may have missed this. Is just SimplyProtein, I saw some of the innovation at Expo West. Looked, tasted great. What is the kind of specific timing, such that that would be on shelf? More to come on it. We're close. If things go well, we'll have some news at the next conference call. We expect something to happen before calendar year 2018 on SimplyProtein. Okay, great. Lastly, e-commerce growth. Did you mention that in prepared remarks? If not, could you? Did not. Year to date, on shipments, we're about up 75%. Lovely. All right. Thank you. That's the number. Perfect. Thank you. As a reminder, if you would like to ask a question, it is star one on your telephone keypad. Our next question is from Bill Chappell with SunTrust Robinson Humphrey. Please proceed. Hi, this is actually Grant on for Bill. Our first question was just on the timeline for the packaging update, reformulation, where are we in that process and how much more time do we have to go there? This is Joe. Packaging is 75% on the shelf today. When you refresh packaging, it's typically a run behind, so you're working through old inventory, moving in new inventory, new packaging. Faster velocity retailers, faster velocity SKUs transition quicker. Slower velocity retailers, slower SKUs slower. It'll be key SKUs in our big retail stores have already changed. It'll be through the spring and probably early summer before everything else is current on the shelf. From a reform standpoint, I think we mentioned in our comments, most of our meal bars have been reformed, and about half of our snack bars have been reformed to date. The challenge there, why it takes so long is that we've got to reform test product against current and make sure that we have at least parity liking, if not preferred preference on the reform. If we don't get to that, we go back to the drawing board until we do. We feel good about it. I think we mentioned in our comments that where we're seeing the new forms on the shelf, velocity of those items are accelerating. Got it. Following up on that, is there any way to parse out the impact from those forms versus maybe the marketing spend Rob Lowe impact? I wish I could do that for you. I cannot. Okay. Then actually just our last question here. We've been hearing a lot on freight costs increasing, maybe what's your outlook here for the rest of the year? We've had, as I mentioned, we have had some impact on higher freight and distribution costs, probably not to the magnitude you're seeing from others. The good news from our standpoint is we have some projects in place that have enabled us to mitigate some of the inflation and cost pressures we've seen on distribution. We're doing some direct ships from some of our co-mans to major customers' warehouses. That's been a bit of a benefit for us. Yeah, we're seeing pressure. I'm sure we'll continue to see some pressure on that in the second half, but fortunately to date, the inflation we have seen has not been dramatic. Great. Thanks so much. Ladies and gentlemen, we have reached the end of the question and answer session. I would like to turn the call back over to Mr. Scalzo for closing remarks. Thanks again for your participation on today's call. We look forward to updating you on our third quarter results in July. We hope everyone has a good day. Thank you. This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation.