The Simply Good Foods Company (SMPL) Q1 2018 Earnings Report, Transcript and Summary

Greetings and welcome to The Simply Good Foods Company First 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. [Operator Instructions]. As a reminder this conference is being recorded. I would now like to turn the conference over to your host, Ms. Rachel Perkins, with ICR. Thank you, you may begin.

Good morning. I am pleased to welcome you to The Simply Good Foods Company’s earnings call for the first quarter ended November 25, 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 adjusted EBITDA, and 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 financial information for the 13 weeks ended November 25, 2017, and unaudited pro forma financial information for the 13 weeks ended November 25, 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 provide results as of the Business Combination transactions have been completed as of the beginning of fiscal 2017. All financial measures related to fiscal 2017 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 everyone for joining us. Today, I will recap our first quarter highlights and provide an update on our growth initiatives. Then Todd will discuss a summary of our first quarter financial results. After that, we’ll open the call to questions. We started off the fiscal year well and are pleased with our first quarter financial results. For the first quarter net sales grew 6.8% year-over-year with adjusted EBITDA up 6.6%. This growth underscores the strength and resilience of our core business and the powerful nutritious snacking macro tailwinds of convenience meal replacement and low-carb, low sugar, protein-rich nutrition. You may recall the nutritious snacking category is still relatively under penetrated in about 50% of US households, leaving what we believe is plenty of room for future of snack. We generated US point-of-sale growth of 5.5% as a result of continued growth in our core US nutritional snacking business and strategic marketing efforts to target a broader consumer audience. Importantly, as we expected, this POS growth represents an acceleration from our reported total fiscal year 2017 POS growth of 4.2%. I will talk in a moment about our strategic initiatives. However, I will note that based on our confidence in these initiatives, we stepped up our marketing investment during the quarter by 7% behind new advertising and investment in strong merchandising support and key retailers to synergistically support our new campaign. We believe Atkins represents a compelling growth opportunity as we expand our marketing to address a 4x consumer target. You may recall, since 2008, our core target has been problematic weight loss consumers. In 2016, we identified a large group of low-carb lifestyle consumers already buying our brand as a nutritious snack. We began targeting this group during 2016 and ‘17 resulting in strong total buyer growth during the past two years. Our strategic initiative reflects this opportunity and we remain intently focused on the execution against these initiatives including improved efficacy, education and activation of our core program users, targeting a new group of self-directed low-carbers who represent a 4x opportunity in terms of size when compared to our core program users, driving product innovation and portfolio expansion and pursuing white space opportunities. The centerpiece of our strategy for educating consumers is a new integrated ad campaign that targets programmatic as well as self-directed consumers with messaging designed to update and contemporize Atkins’ brand imaging. The spots are focused on the theme of today's Atkins and the simple idea that the positive effects of Atkins on your health can be enjoyed even if you are doing [ad]. During the first quarter, we ran copy and targeted at our core consumers featuring country western star Lauren Alaina and the positive effects Atkins has had on her. We also ran a lifestyle ad targeting self-directed low-carbers featuring our breakthrough hidden sugars in sight, reminding consumers that some seemingly healthy protein bars are actually loaded with hidden sugars that can negate the positive effects of protein. Importantly, we learned that even though each ad was targeting a specific group, each worked deeply well against both groups. We’re pleased with the copy. As we head into the balance of the year I’m incredibly excited to announce our new partnership with actor Rob Lowe. Rob is our new brand spokesperson having authentically lived in Atkins' low carb lifestyle for decades. Advertising featuring Rob started last week and builds on the successful campaign we began in September being around today’s Atkins. Rob is the epitome of the Atkins lifestyle consumer. He emphasizes desire for living a healthy life for family, health and wellness and how healthy living is possible by following the Atkins’s nutritional principals of eating delicious foods with optimal protein and fewer carbs and sugar. As a devotee of Atkins’s products with a self-proclaimed killer sweet tooth, Rob describes the Atkins portfolio of bars and shakes as a secret weapon free of any deprivation while also allowing him to indulge a lifelong taste for chocolate milk shakes. We have learned that the universal teams that ‘s eating right for health and a better quality of life while not sacrificing taste in its entirety, appeal to both programmatic and self-directed consumers. We also recently launched a new book targeting self-directed low-carbers entitled Eat Right, Not Less. This fully illustrated book is a guide to living a low carb, low sugar lifestyle and is packed with 100 delicious whole food recipes to achieve optimum health and looking better while doing so. Our website which in 2017 had 11 million new visitors, just received a complete overhaul and offers content for both programmatic as well as self-directed low-carbers including great information on hidden sugars. It also features a video from Rob Lowe where he shares his thoughts on living the Atkins lifestyle. Our third growth strategy focusses on product innovation and portfolio expansion. We continue to respond to consumer demand for cleaner labels which means fewer ingredients and ingredients recognizable to consumers while still the delivering the high case profile and fewer net carbs that Atkins consumers are accustomed to. Today seven of our 10 yield bars have been converted to clean labels and rolled out. We are also working on our snack bars and has converted to four of 11 thus far. Most importantly, we’re introducing new products in both our Atkins ready to drink shakes and bars. Our new shakes are focused on delivering against consumer needs and providing superior taste. Here you see our plus protein shakes which will be hitting the shelves soon at 30 grams of protein and seven grams of fiber giving consumers the protein and fiber they seek but still low in sugars and bad [ph] carbs. You may have also seen new lever fresh packaging graphics modernizing the Atkins logo, improving our taste appeal, shelf impact and product benefit communication. Here you see the before and after of our leading meal bar and our leading shake. Our fourth area of growth focus is expanding in white [ph] space opportunities. e-commerce has been showing a steady growth for us. First quarter, our gross sales in e-commerce increased 67% year-over-year, continuing the growth trajectory from fiscal year 2017. As many of you know, in 2017, we stepped up e-commerce investments including digital media to drive tight top of funnel traffic and new product development to customize offerings. For fiscal year 2017, e-commerce represented approximately 3% of Atkin's gross sales. Overtime, we believe our strategic initiatives to help grow this to the 10% range, this remains an exciting opportunity. These initiatives we discussed today are designed to accelerate growth, and we're pleased with our execution so far. With that as an 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 pages that follow. First for comparative purposes, we will review unaudited financial statements for the quarter ended November 25, 2017 and pro forma financial statements for the quarter ended November 26, 2016, which presents our results as if the Business Combination had occurred as of August 28, 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 and all financial measures discussed today will be on a pro forma basis. Second, we also evaluate our performance on an adjusted EBITDA basis, based on our asset like strong cash flow model. We have included a detailed reconciliation from GAAP to net income to adjusted EBITDA included in today's press release. We believe this measure is a key indicator of the true underlying performance of the business. The first quarter results were as follows. Net sales were up 6.8% to $106.6 million, driven by core growth of 4%, and the acquisition of Simply Protein which contributed 2.8% in the quarter. You'll recall, our consumer takeaway for the quarter was up 5.5% ahead of our core growth rate. Gross profit increased 8.3% to $52.8 million with gross margin up 70 basis points to 49.5% driven primarily by favorable product mix and lower input costs. Net income increased 11.7% to $10.2 million driven by the gross profit improvement, partially offset by 7% increase in margin spend and a 17.5% increase in G&A due to the addition of Wellness Foods and higher public company cost as we embark on our first full year as a public company. Adjusted EBITDA was up 6.6% to $23.7 million from $22.3 million in the prior period. The company continues to benefit from very attractive cash flow characteristics. We have an asset like business model with strong cash flow generation. Capital expenditures for the first quarter of 2018 were approximately $0.7 million, driven by investment in our new website and digital media application. We estimate full year CapEx of approximately $1.5 million. Moving on to the balance sheet. As of November 25, 2017, the company had cash of $62.9 million and a $200 million term loan outstanding resulting in a pro forma net debt-to-adjusted EBITDA ratio of 1.9 times. The company also has its $75 million revolving line of credit available with no borrowings outstanding as of November 25, 2017. As a reminder, as a result of the merger with Conyers Park on July 7th, all 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 with a current interest rate of LIBOR plus 400 basis points. Before I turn the call back to Joe, I would like to briefly touch on the recent corporate tax reform legislation and our initial view of it. While we continue our thorough evaluation and review of the potential tax benefit with our auditors, based on what we know today, we estimate our fiscal 2018 blended effective tax rate to be approximately 31% to 32% compared to a 39.6% effective tax rate for pro forma fiscal 2017. As a reminder, based on our August fiscal year end, we only have two-thirds of our 2018 fiscal year under the new corporate tax law. For fiscal 2019, we expect to realize the full benefit of the corporate tax reform. And as a result, we estimated 26% to 28% effective tax rate. That concludes my financial overview. I would now like to turn the call back to Joe for brief closing remarks.

Thanks, Todd. In summary, we remain confident in growth opportunity for the business as we move forward, as well as our ability to execute against our four strategic growth initiatives. We are pleased with the start to our fiscal 2018 and we believe we are well positioned to deliver our 10th straight of snacking point-of-sale growth in the US. We expect to deliver fiscal 2018 net sales consistent with our previous stated long-term algorithm and adjusted EBITDA growth at a rate slightly higher than that of net sales, including an incremental $2 million of public company expenses. We appreciate everyone’s interest in The Simply Good Foods Company. And with that, Todd and I are now available to take your questions. Operator?

[Operator Instructions]. Our first question comes from the line of Rob Dickerson with Deutsche Bank. Please proceed with your question.

How’s going? A couple hopefully more housekeeping items given for Q1 and top-line seems to just come in pretty decently. I guess just in terms of the marketing spend year-over-year, is that -- should we expect that now to increase as the Rob Lowe campaign is now launched or let’s say was launched in January and that progresses, with further -- potentially further ad as the year goes on or is that 7% rate more of a quarterly bump and then we kind of normalize that?

Yes, the 7% right now is our -- not only was that what we hit in the P&L in Q1, that’s our current estimate of the full year increase as well.

Okay, perfect. And then just kind of more broadly I kind of hate to dive into the tax issue or tax reform but obviously it seems to be a material impact for you going forward. Just what you just said -- Todd you said in ‘18 that would be blended, would be 31%, 32% but then ‘19 would be more like 26%, 28%. But it seems like its blended upfront in the first half of ’18 and maybe the back half of ’18 is a little bit better than kind of what you’re looking for in all of ’19. So just trying to get any color you can provide around the process you’ve done so far to get to those numbers and just it sounds like the level of confidence is pretty high as to what those numbers would be?

Yeah, so you’re correct. So, what you saw in the P&L in the first quarter was a tax rate close to 39% so you’re correct if you get to 31%, 32% blended for the full year, we will see that rate go down as the year goes on. So, for Q2 for example we have one-month December in our fiscal Q2, so you’ll get a third under the old tax rate, two thirds under the new tax rate and then as we get into the second half of the year we anticipate the full benefit of that tax rate to come through. The other piece out there Rob is as we finalize our Q2 financials we will be taking a deep dive into our deferred tax assets and liabilities, the TRA and those will likely get revalued under the new corporate tax laws as well and you’ll see someone-timers come through our P&L in Q2.

Okay, and then just last question, just in terms of M&A for acquisition pipeline and the thought process going forward now that tax reform has occurred. Is there a different expectation internally potentially as to the number of assets you think could come to market from potentially some larger cap companies or do you believe valuations might shift a bit, or just any conversation you can provide about maybe how you and others internally are taking it back to the M&A landscape more broadly within US food given what’s happened on the tax side now?

Yeah, Rob this is Joe. You know first of all as you’ve seen in the deals that have been announced in the last few months, seemingly the activity has picked up. So, some certainty around tax now I think will if there has been larger cap looking to realign their portfolios, certainly tax is one of the issues that was uncertain for that. And I would think for those that we’re thinking that way certainly that provides more certainties of that about what their options are. So, I can’t imagine that the M&A activities that we’ve seen most recently is going to slowdown.

Thank you. [Operator Instructions]. Our next question comes from the line Jason English with Goldman Sachs. Please proceed with your question.

I wanted to understand the consumption off take a little bit better, you pointed to the retail brick-and-mortar, I think the IRR data showing 5.5. With 67% growth online at 3% of sales, that’s should add around two points suggesting that will all channel consumptions tracking in the 7%, 7.5% range. Is that consistent with what you’re seeing in the market overall or are there offsets elsewhere that we’re going to see in the data?

I think you’re looking at it correctly. I mean obviously we also have, we have an international business that’s declined slightly. So, there is a little bit of an offset there. The way our business works in the first two quarters, we actually we built inventory as we get ready for new year's resolution, things of that nature, the promotional activity. So, what you're seeing is a little less build of inventory in the first quarter. But I think the way you are thinking about it is correct, very strong takeaway in the first quarter and obviously the e-commerce numbers were really strong as well, and we're pleased about that.

Yeah, I can build on that. I think there was a lag, the timing of the trade inventory build that happens around the seasonal kind of merchandising season was a little bit delayed relative to prior years. So, we would expect in second quarter, that kind of the balance itself out overtime.

Have you see enough flow through so far into the second quarter?

A little bit, yes. It's hard, yes to careful on week-to-week kind of thing so you want to look at it on the total quarter basis. So, there is a lot of, as you can imagine, as POS grows in January and February, the amount of inventory retailers has to have just to keep the same weeks of inventory has to be pretty considerable. So, when those shipments happened by customer can vary week-to-week. And so, we would expect that to kind of right itself as we go through the second quarter.

Got it. And exciting news on the marketing plan, the Rob Lowe endorsement here. Can you give us to the updates and a couple of the other growth enablers particularly your development work against the Club business and the plans with the Simply Protein launch in the U.S. restage launch in the U.S.

Yeah on Club, we continue to have a really good business with Sams & BJs and we continue to knock on the door at Costco, that's going to take some time. We have seen some progress there but still slow. Interesting, I think we may have shared with you we are [indiscernible] last book is actually in every Costco Club in the United States, but no products yet. And your second question was around Simply Protein. We continue to complete the validation work for Simply Protein from a consumer, products, pricing, packaging standpoint, as well as moving the products into our supply chain, that work continues, we're pleased with the progress as soon as we're ready, we feel like we're ready to go, we'll go in the launch in the U.S. and we'll let you guys know when that is.

Perfect. And last question for me then I'll pass it on. I'm curious in your thoughts in sort of the second derivative implications of the lower tax rate. What are you expecting on the competitive landscape retail pressure, in other words, what I'm trying to get to is how much of the benefit do you think you are likely to retain versus how much do you think it's going to have to be reinvested to remain competitive?

Yeah, I'm it's obviously a great question we just started to think through some of those outcomes and reading a lot of analysis out there, guessing of whether people will reinvest some of that money back or not. So, we're going to have to be nimble on it, it's something Joe and I were actually just talking about yesterday as a matter of fact. So, no plans right now has changed the algorithm. But we obviously need to be competitive, and we'll adjust if necessary.

Yes, it's interesting. I think that we like the level, we feel like the level of marketing support that we have in our business is appropriate. And we're always evaluating the effect of marketing in the marketplace. So, I kind of view the opportunity, if we have things to invest in that give us a good return regardless of kind of what the external forces are, we would always evaluate those and consider those as we go forward. Right now, we feel like the level of marketing support in our business is appropriate and I don’t anticipate a major change relative to the new tax law.

Thank you. Mr. Scalzo, at this time, there are no further questions. I will turn the floor back to you for any final comments.

Thank you very much, operator. Thank you for joining our call. We appreciate your interest in The Simply Good Foods Company. We hope you have a good day. Thank you.

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.