The Simply Good Foods Company (SMPL) Q4 2017 Earnings Report, Transcript and Summary

Greetings and welcome to The Simply Good Foods Company Fourth Quarter and Full Fiscal Year 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Mr. Rachel Perkins, Vice President of ICR. Thank you. You may begin.

Good morning. I’m Rachel Perkins, Vice President of ICR. I am pleased to welcome you to The Simply Good Foods Company’s earnings call for the fourth quarter and fiscal year ended August 26, 2017. Joining me on this call this morning are Joe Scalzo, President and Chief Executive Officer; and Todd Cunfer, Chief Financial Officer. The Company issued its earnings press release this morning at approximately 7:00 AM Eastern Time. A copy of the release and accompanying presentation are available under the Investors section of the Company’s website at www.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 and the Company’s SEC filing. In addition, management will make references to pro forma adjusted EBITDA, a non-GAAP financial measure that it believes provides investors with useful information with which we value the Company’s operating performance. Today’s earnings release includes a reconciliation of the most directly comparable GAAP financial measures to non-GAAP measures. And finally, the Company has included in today’s earnings release and presentation, unaudited pro forma financial information for the 13 weeks and 39 weeks ended August 26, 2017 and August 27, 2016. The pro forma adjustments are based on available information and upon assumptions that our management believes are reasonable in order to reflect, on a pro forma basis, the impact of the Business Combination transactions on the historical financial information of our Predecessor and Successor entities, as applicable. The pro forma financial statements provided results as of the Business Combination transactions have been completed as of the beginning of the respected period. In addition, the pro forma 2016 results are presented as of the Company had licensed its frozen meal business throughout fiscal 2016. All financial measures discussed today will be on a pro forma basis. With that, it's now my pleasure to turn the call over to Joe Scalzo, President and Chief Executive Officer.

Thank you, Rachel. Good morning and thank you for joining us. This morning, I am going to recap some highlights of our fiscal year, provide a brief overview of the Company, and an update on our growth initiatives. And then turn it over to Todd for a summary of our financial results. After that, we’ll open the call to question. Fiscal 2017 was an eventful and productive year for Simply Good Foods. We delivered strong financial results as a result of the implementation of our new growth strategy. Targeting a broader consumer audience and introducing new and reformulated products led to our ninth straight year of POS growth in the U.S. And finally, we became a publicly traded company, strengthening our balance sheet, and positioning the company for long-term profitable growth. For the full-year, pro forma combined net sales grew by 7.4% year-over-year with adjusted EBITDA up 12.9%. These results were generally in line with our expectation. It was our ninth consecutive year of positive POS growth in our core U.S. nutritional snacking business. Total year POS growth in the U.S. was up 4.2%. Importantly, as we entered fiscal year 2018, our growth is accelerated to 4.8% for the eight-week period ending October 22. This growth primarily reflects improvement in velocity and it underscores the strength and resilience of our core business and the fact that we are writing some pretty powerful macro tailwinds. And by the way, the nutritional snacking category is still relatively under penetrated at about 50% of U.S. households leaving plenty of upside. For those of you who are new to our story, let me provide a brief overview of our Company, so you will have some context as to where we have been relative to where we are going. The Simply Good Foods Company is an asset-light business model that generates strong free cash flow with low working capital requirements. The Company was formed by the July 2017 merger of Atkins Nutritionals with Conyers Park Acquisition Corp., a stack founded by Jim Kilts and Dave West. Our flagship Atkins brand is a leader in the nutritional snacking space that commands a substantial portion of the retail shelf primarily in the health and beauty section. But we're in important profit center for most of America's leading food retailers. The brand is comprised of premium priced products with increasingly cleaner labels and high quality ingredients. We have roughly 60 SKUs that include bars, ready-to-drink shakes, and other snacks. Atkins enjoyed 85% aided brand awareness and a very high level of consumer loyalty. The Atkins brand is at the confluence of consumer mega trends around health and wellness, higher protein consumption, lower consumption of carbs and sugars, nutritious snacking, convenience and on-the-go meal replacement. As consumers continue to move away from three meals a day, snacking has been outpacing overall package foods growth and healthy snacking our sweet spot is growing at even faster rate. In addition the brand dovetails with the growing consensus that lower carb and sugar consumption can help arrest the spiraling obesity and diabetes rates in the United States. The second brand in our portfolio SimplyProtein was a bolt-on acquisition we made last December that figures predominately into our growth strategy. We're really excited about SimplyProtein and think it's a nice compliment to our portfolio. As we told you on our first earnings call last quarter, we're pursuing it four pronged organic growth strategy that includes; number one, improved efficacy, education and activation of our core program users; number two, targeting a new group of self-directed low-carbers, who represent a 4x opportunity; number three, driving product innovation and portfolio expansion; and number four, pursuing white space opportunities. You may recall that in 2015 when our new buyer rates started to stagnate at a time when we were only targeting program consumers, we initiated a research project that provided insights that quadrupled our target consumer base. So beginning in 2016, in addition to targeting the 8 million weight conscious program consumers who are open to a low-carb approach, we began targeting another 31 million self-directed consumers, who are open to low-carb eating. As a result in 2016, our total buyer base grew 15% with another 7% increase in 2017. The centerpiece of our strategy for educating consumers is a new integrated advertising campaign that targets programmatic as well as self-directed consumers with messaging designed to update and modernize Atkins brand imagery around the themes of today's Atkins and the Atkins effect. For programmatic consumers the effect is reaching a sustainable way with the simple delicious Atkins program. And we use rising country music star Lauren Alaina to share her story. For self-directed consumers, the effect is the health benefits of Atkins without following the program. You don't have to be doing Atkins to get the benefits of Atkins. And although these two executions are targeting separate audiences, the result has been synergistic. We have learned that both executions are equally effective with each audience. The new also incorporate our hidden sugars team. The idea that hidden sugars at enemy of protein will undo the good you might think you're doing by eating something as seemingly healthy as a leading protein bar. And of course both at approaches highlight our core principles of low-carb, low sugar and high protein. Our third growth strategy focuses on product innovation and portfolio expansion. We are responding to consumer demand for cleaner labels, which means fewer ingredients and ingredients recognizable to consumers, while still delivering the high taste profile and fewer cars that Atkins consumers are accustomed to. Here you see an example with our chocolate peanut butter bar, where we've reduced the number of ingredients by 44, taking it down to just 18 ingredients from the previous 62. That's a big change that we think consumers will respond to. To-date seven over 10 meal bars have been converted to clean labels and rolled out. We're also working on our snack bars and have converted four of 11 thus far. Our fourth area of focus is expanding in the white space opportunities. E-commerce has been showing steady growth for us. In fiscal 2017, our gross sales at e-commerce increased 50% year-over-year. In 2017, we stepped up investments in this area including digital media to drive top of funnel traffic and new product development to customize our offerings. At present, e-commerce represents only about 3% of our revenue, but we think we can grow it into the 10% range over time, so again, a lot of runway here. Additionally, we are excited about our December 2016 acquisition of SimplyProtein. The business is growing nicely in candidate and we are contemplating a future broad-based U.S. launch. On that note, I'd like to formally introduce Todd Cunfer, our Chief Financial Officer. Todd joined the Company as VP of Finance in July of this year, following a 20-year career with The Hershey Company, where he served in a succession of Senior Finance roles and built a track record for successfully managing and growing his businesses. In August, Todd was promoted to CFO. And with that, I will 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 pages that follow. First for comparative purposes, we will review unaudited pro forma financial statements for the quarter and year ended August 26, 2017 and August 27, 2016, which presents our results as if the business combination had occurred as of August 30, 2015. Including combining predecessor and successor periods for comparative, treating the frozen business as if it had been licensed effective August 30, 2015, amortization expense based on the fair value of assets after the purchase, interest expense based on the new capital structure, and a tax rate of 39.6%. We believe this discussion provides helpful information on the performance of the business during this period. And 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. Management believes this measure is a key indicator of the true underlying performance of the business. The fourth quarter results are as follows. Net sales were up 10.3% to $97.6 million driven by core growth of 2.6%, the acquisition of SimplyProtein which contributed 4% in the quarter and a 3.7% benefit from a 2016 product recall expense and corresponding reimbursement in 2017. Gross profit increased 15.3% to $47.4 million with gross margin up 220 basis points to 48.6%. The recall contributed 210 basis points of the gross margin expansion. Net income increased 80.2% to $7.8 million driven by the gross profit improvement partially offset by a 13.1% increase in marketing spend and higher public company costs. Adjusted EBITDA, which excludes the recall benefit, was up 3.5% to $17.4 million. As you remember, our Q3 adjusted EBITDA was up 20% due to the timing of marketing and G&A expenses that shifted to Q4. Let's now turn to our full-year results, which are presented in the pro forma format consistent with the methodology we used for the fourth quarter numbers. Net sales were up 7.4% or $27.1 million to $396.2 million driven by core growth of 4.6%, the acquisition of SimplyProtein, which contributed 1.9%, and the recall, which added 0.9% of net sales growth. Gross profit was up 9.8% to $186.2 million with gross margin up 110 basis points to 47% of net sales driven by cost savings initiatives, favorable mix, and the recall. The recall contributed 60 basis points of gross margin. Net income was $28.7 million for 2017, an increase of $7.4 million or 34.8% driven by the increase in gross profit and operating expenses that grew slightly less than net sales. Adjusted EBITDA which once again excludes the benefit of the recall grew 12.9% to $72.5 million. SimplyProtein contributed 1.9% of the increase with the remaining 11% organic growth. The Company benefits from very attractive cash flow characteristics. We have an asset-light business model with strong cash flow generation. Consistent with previous years, we had minimal capital expenditures of approximately $1 million in fiscal 2017 and modest working capital needs of 10% of net sales. Moving on to the balance sheet. As of August 26, 2017 the Company had cash of $56.5 million and a $200 million term loan outstanding, resulting in a pro forma net debt to adjusted EBITDA ratio of 2.0 times. The Company also has a $75 million revolving line of credit available with no borrowings outstanding as of August 26, 2017. As a reminder, as a result of the merger with Conyers Park on July 7, all of the former debt was paid off and a new $200 million term loan was issued. The new term loan has favorable terms to the old debt where the current interest rate of LIBOR plus 400 basis points. Back to you Joe, for closing remarks.

Thanks Todd. In summary, we are confident in the growth opportunities for the business moving forward as well as our ability to execute against our four strategic growth initiatives. Based on this, we believe we are well-positioned to deliver our 10th straight year of snacking POS growth in the U.S. in fiscal year 2018. We expect to deliver 2018 net sales consistent with our previously stated long-term growth algorithm. We anticipate adjusted EBITDA growth at a rate slightly higher than that of net sales including an incremental $2 million of public company expenses. So with that, I will open the call to questions. Operator?

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Jason English with Goldman Sachs. Please proceed with your question.

Hey. Good morning, folks.

Hey, Jason.

Good morning, Jason.

Thank you for allowing me ask question. I want to understand the sales guide a little bit better. You're guiding to 4.6% up top. Correct me if I'm wrong, but you've got about a point in there from M&A, and maybe depending where FX falls, maybe a little bit of a tailwind there. Implicitly it's like – if 3.5% organic you're picking up around 150 basis points with online momentum and now I'm kind of backing into a brick and mortar point is still number of 1.5% to 3.5% implicit within your guide. But I juxtaposed that to the momentum that you've delivered that you show on the charts that you’ve carried in 2018. So I guess the question is it's early is there just sort of a bit of a wait and see on this one, or is there anything to be aware of to be cognizant enough that could cause a bit of a deceleration in the measure point of sale that as we move forward throughout the year?

Yes. So we’re comfortable with 4.6% as you correctly point out. We have almost a point of growth not quite a point of growth coming from the last four months of the acquisition of SimplyProtein. We're confident in our e-commerce as you also pointed out, we're anticipating about – once again about a point of growth as well coming from there. So the range that you depicted is pretty accurate. We feel comfortable with that number right now and we'll see how it goes.

And where do we stand in terms of capturing some of the white space both in terms of channel, clearly good momentum on e-commerce, great to see. I know you are still heavily over indexed to Wal-Mart. There was some focus on trying to drive some better momentum outside of that. Walmart looks like it's even a higher percentage of sales this year than once last. So can you give us a little more both on terms of channel kind of feeling diversifying, driving growth there to distribution and also touch on SimplyProtein the expansion plans throughout the U.S.?

Good morning. This is Joe. Yes, I think going forward from a channel standpoint, we would expect to have pro forma little bit better in grocery just given the momentum we’ve got in the business there. We are going to continue as you mentioned to perform well in e-commerce. And so we expect over time that those channels will improve relative to our Walmart development. We expect frankly another good year of Walmart. We think our business momentum there is pretty solid. So from a channel perspective we think that's what we're looking at going forward. As it pertains to SimplyProtein, we're still in the – as we mentioned I think in the last earnings call, we hit the pause button on SimplyProtein, it’s a predominantly Canadian business. We do have some distribution in the U.S., the folks in New York maybe able to pick it up in the up and down the street to take the business through UNFI, but we've hit the pause button there just to assess the components of the brand and against the U.S. consumer. So we're completing our work there and based on that assessment will determine what our go for plans are in the United States.

Makes sense, looking forward to the update, one last question and then I'll pass it on leased on for others. Your business can be a bit lumpy from time-to-time. Certainly we saw that last year with a strong first quarter, a slightly softer second quarter. I know you're not in the habit of giving quarterly guidance, but is there anything we should be aware of where we should be thinking about as we set expectations for the cadence of both the sales and earnings growth throughout the year?

Nothing right now, but we will keep you aware if anything changes, but you're correct, the business is dynamic. It tends to be a little bit lumpy as say, but we feel very, very good about the year.

Very good guys, thank you.

Thank you. Our next question comes from the line of Rob Dickerson with Deutsche Bank. Please proceed with your question.

Thank you very much. Good morning.

Hi, Rob.

So just a few question maybe a bit bigger picture I think Jason actually covered a lot of the guidance question I had pretty well. So just in terms of your self-directed strategy with kind of point to this 31 million user or this 31 million buyer bucket that you maybe able to tap incrementally into and I think now you say you have about 3 million of that 10%. So I just want to make sure like the math is right as you think about internally that if you just capture let's say 5% of that new 31 million self-directed bucket, right that obviously gets you to 1.5 and 15 on top of the 3 million you have in self-directed and 3 million you have in your traditional kind of in a more diet four user base on the Atkins. It’s still 25% upside on your buyer base. I'm just trying to kind of align that with the 4% to 6% topline growth?

Yes, I think your math is roughly right. So I think it's a matter of over what period of time do we think we feel like we can capture. Today we roughly have about that 10 share of those 31 million self-directed low-carbers. And we expect over time given the fact that we've brought more buyers into our brand since we started targeting that group in 2016. We expect that progress to continue I think the real question for us is over what period of time, how successful our initiatives and then last question is as we as we bring him into the portfolio, what's their buy rate relative to what the program consumers are?

Okay, that makes sense. And then just in terms of – where you are now with the new advertising campaign. Have you seen any upfront initial traction or are you seen if you're able to see it, I'm not sure kind of how that translates into potentially different demographics on e-commerce purchase rate or is it too early to tell?

Really too early to tell, I think if you look macro at our business, our point of sale, since we've turned the advertising on in September has steadily improved from the summer, so we're pretty optimistic as we mentioned in our opening comments, we're looking to surprise actually that the two or running ad – one ad specifically, the Lauren Alaina ad against the programmatic consumers, and then we’re running a second execution against the self-directed users when we did testing, copy testing among the two targets with the two ads, they were equally persuasive to the opposite group, which kind of surprises us a little bit, which just tells us kind of the synergistic aspect of the campaign is working for us pretty well. So overall macro trends are testing, going in and putting it on air was pretty good. Our POS, there are obviously other factors driving POS, but our POS has been steadily improving. So we're pretty optimistic going into the year that the creative is going to be – is going to work for us really well. And we're actually considering right now some different executions as we move into the calendar year maybe producing a few more executions that we're starting hiring after the first of the calendar year.

Okay. Great. And then just a bit of a larger strategic question. Obviously, Atkins is the first asset company purchased through the – there will be another prior Conyers Park stack to make The Simply Good Foods as the holding company. Let say when I look at the business and the management team and using the board, I kind of view this potentially like a larger cap ask management team and board relative to a smaller [ZAP] company. So just in terms of the longer term strategy, is the thought process here, right Atkins is the first asset and we've managed – we think we have a great strategy going forward on the topline then also there's great cash flow generation asset-light model, but then now as we speak you're being extremely proactive and looking at other acquisition possibilities either in healthy snacking or away from it maybe and not so healthy, but just try to get a perspective of where we are now and kind of where this company can be in two or three years?

Yes. Great question. First, I'd say we love this asset, we love this business, we're very optimistic about the growth potential of the business. This is the initial asset and makes it very logical as we look to grow the business non-organically, nutritional snacking becomes a core platform that we'd like to add assets to in fact we did that in December 2016. We will continue to look for those assets and build out a nutritional snacking pure play from a growth standpoint. I think the next logical area that makes some sense given the composition of the management team, the composition of the board is a pure snacking play, less good for your snacking over time. And I think that as we've been focusing in on what we want to look at and how we want to look at it. Those are the two areas that I think come into focus the easiest. Would we reject broader food? No we wouldn't. But it's much easier to understand the former to over time.

Fair enough. All right. Thanks so much. I’ll pass it on. End of Q&A

Thank you. There are no further questions at this time. I would like to turn the floor back over to Mr. Scalzo for any closing remark.

Again, we appreciate your participation on today's call and your interest in our Company. We look forward to updating you on our first quarter results early next year. We hope you have a good day.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.