The Simply Good Foods Company (NASDAQ:SMPL) Q2 2023 Earnings Call Transcript
The Simply Good Foods Company (NASDAQ:SMPL) Q2 2023 Earnings Call Transcript April 5, 2023
Operator: Greetings. Welcome to The Simply Foods Company's Fiscal and Second Quarter 2023 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. At this time, I'll now turn the conference over to Mark Pogharian, Vice President of Investor Relations. Mark, you may now begin.
Mark Pogharian: Thank you, operator. Good morning. I am pleased to welcome you to The Simply Good Foods Company earnings call for the fiscal second quarter ended February 25, 2023. Joe Scalzo, Chief Executive Officer; Shaun Mara, CFO; and Geoff Tanner, President, COO, and CEO Elect are with me today. Joe and Shaun will provide you with an overview of results, which will then be followed by a Q&A session. The company issued its earnings release this morning at approximately 07:00 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 and an archive of today's remarks will be available.
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 filings. Note that on today's call, we will refer to certain non-GAAP financial measures that we believe will provide useful information for investors. Due to the company's asset light strong cash flow business model, we evaluate our performance on an adjusted basis as it relates to EBITDA and diluted EPS. We have included a detailed reconciliation from GAAP to adjusted items in today's press release.
We believe these adjusted measures are a key indicator of the underlying performance of the business. The presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Please refer to today's press release for a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. With that, I'll now turn the call over to Joe Scalzo, CEO.
Joe Scalzo: Thank you, Mark. Good morning and thank you for joining us. Today, I'll recap Simply Good Foods second quarter and provide you with some perspective on the performance of our business. Then Shaun will discuss our financial results in a bit more detail. Before we wrap it up with a discussion of our outlook and take your questions. As most of you know, on January 30th we announced that Geoff Tanner will be joining us as President and CEO Elect. Throughout his career, Geoff has been primarily focused on marketing, sales, and innovation within the food sector. So he brings superior experience along with credentials as a terrific leader and as you'll learn incredible passion to everything he does. The Board and I are confident that under his leadership, the company will continue its track record of growth and profitability and I look forward to partnering with him to achieve a smooth transition. I'll now turn the call over to Geoff for some introductory remarks.
Geoff Tanner: Thanks, Joe. I'm on it that on July 7, I will become the next CEO of The Simply Good Foods Company. As you know, Simply Good Foods is a special company with two great brands, fueled by passionate employees and loyal consumers. These attributes have delivered top tier sales and earnings growth and will continue to do so going forward. Although my official start date was two days ago, April 3, I was eager to get a running start to learn about the business and meet with many of the employees via Zoom and phone. I learned what many of you already know. We have a remarkable energized team who come to work every day with a strong sense of purpose. That purpose is to lead the nutritious snacking movement with trusted brands that offer a variety of convenient, innovative, great tastings, better-for-you snacks and meal replacements.
I want to say a special thank you to The Simply Good Foods team, many of whom listen into this call. It's clear their passion and dedication along with our strong brands and growth investments will continue to contribute to our further success. Both Joe and I have worked with Jim Kilts early at in our careers. So it's no surprise we have similar beliefs as to the drivers of growth and value creation. Therefore, as I transition to the CEO role, you will continue to see a focus on the core drivers of brand growth, namely marketing and media, innovation, category management and fundamental sales execution. I call this approach the brand growth flywheel and it's all in-service of expanding household penetration to accelerate growth. We participate in a unique fast-growing category fueled by strong underlying consumer trends that show no sign of slowing.
The statistics that perhaps excites me the most is that household penetration of this category is only about 50%, which is very low compared to most food and beverage categories in North America. Working with our talented team and partnering with retailers, we will continue to fuel the brand growth flywheel to increase household penetration and continue to drive growth. Also following in the footsteps of Jim, Dave West, Joe and others, I will ensure a continuous improvement mindset across everything we do to deliver results and provide the fuel we need to deliver the growth that's in front of us. I want to underscore my optimism about Simply Good's future. I couldn't be more excited to lead the Simply Good Company. While it's not prudent to me to participate in today's conference call Q&A, again this being day three to me, please note, that I look forward to working with all of you as we focus on building value for all Simply Good Foods stakeholders.
I'll now turn it back over to Joe to provide details of our second quarter results.
Joe Scalzo: Thanks, Geoff, and welcome to the team. We are pleased with our second quarter performance that was greater than our expectations. During the important New Year, New Year season, Simply Good Foods Q2 retail takeaway in the US combined measured and unmeasured channels increased about 16%. As expected, US retail takeaway growth outpaced the net sales change principally due to the significant prior year retail customer inventory build. Shaun will provide more details on the difference between net sales and POS growth in just a bit. POS growth was driven by both brands. Quest performance was solid across key forms, customers and channels. Atkins continues to show growth in both measured and unmeasured channels. Additionally, Atkins e-commerce growth continues to be additive to measured channels.
North American net sales performance was better than our expectations due to solid retail takeaway, although net sales were affected by some customer inventory reductions in the quarter. Additionally, international net sales were softer than our estimates due to the impact of the second price increase initiated earlier this year. Second quarter gross margin was 34.6% versus 36.6% in the year ago period. The 200-basis point decline was greater than expectations due to lower ingredient costs flowing through at a slower rate than anticipated and marginally higher other costs within our supply chain. Importantly, our supply chain team performed well with customer service near target levels. Adjusted EBITDA in the quarter was $50.9 million versus $54.2 million in the year ago period.
The $3.3 million decline was better than our estimates due to North American sales performance greater than our expectations and solid SG&A cost control that was partially offset by supply chain cost inflation. International softness was greater than our forecast. Simply Good Foods retail takeaway in measured channels increased 14.2% with a good contribution from pricing and volume. Specifically, we estimate that Q2 measured channel POS was driven by about 9 points of price and 5 points of volume. Similar to the last few quarters, total unmeasured channel growth was additive to total company point of sale, resulting in a combined measured and unmeasured channel growth of about 16%. In the second quarter, Atkins and Quest combined measured and unmeasured channel growth were about 6% and 26% respectively, with performance top tier within the measured channel segments of weight management and active nutrition.
Turning to Atkins second quarter performance. Atkins second quarter retail takeaway in the combined measured and unmeasured channels sequentially improved versus the first quarter and increased about 6%. Atkins second quarter POS at Amazon increased 35%. We estimate total unmeasured channel retail takeaway increase more than 25% and is about 13% of total Atkins retail sales. The brand continues to benefit from shopper channel shifting to e-commerce, as well as improved digital marketing initiatives. Brand relevance and loyal remained strong, supported by a growing base of new and total buyers. Buy rate was down slightly in Q2, although it improved from the first quarter. Moving on to measured channels in the IRI MULO and C-Store universe, Atkins second quarter POS increased 3.3% and as expected sequentially improved from the first quarter.
Consistent with recessionary shopper channel shifting, performance was driven by solid trends in the mass channel offset by softness in the food class of trade. By form, Q2 shapes retail to takeaway increase 13.5% driven by solid growth across all major channels. Total Atkins bars were off 3.9%, a 300-basis point improvement for the first quarter. Meal bars, about two-thirds of the bar business increased 2.5% and were offset by snack bar distribution losses that we discussed last quarter and some pricing sensitivity from our July price increase. As expected, confection POS improved from the first quarter and Q2 confections retail takeaway was off 1.5% as we lapped the strong year ago performance of our dessert bar innovation. Importantly, the commitment to our brands in nutritional snacking category by major retailers remain strong.
Although in the third quarter, we expect POS to slow as we faced tougher e-commerce comps on Atkins and anniversary promotions in the club channel that will not repeat. Let me now turn to Quest second quarter retail takeaway with the combined measured and unmeasured channel growth was 26% and continues to outpace the nutritional snacking category. In the second quarter, we estimate total unmeasured channel retail takeaway increased 21% as e-commerce strength was partially offset by softness in specialty channels. But second quarter POS at Amazon increased about 30% driven by growth across all forms. For perspective, total unmeasured channels in the second quarter were about 24% of total Quest retail sales. In measured channels, Quest retail takeaway increased 27.2% in the IRI MULO and C-Store universe.
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Growth was driven by solid performance across all major forms and retail channels as well as increases across all major metrics, specifically household penetration, base velocity, distribution and continued new product success. In the second quarter, Quest core bar business retail takeaway increased 24.1%. Growth was solid across original bars as well as the new minis. Consumer response in the new recipe that provides a much softer original bar is positive and driving growth. Additionally, the Hero bar is beginning to gain momentum, driven by distribution gains and higher velocities. The snackier portion of Quest products that's cookies, confections and salty snacks continued to do well with second quarter measured retail channel takeaway of 30%.
Growth was strong across all snack forms as distribution gains and marketing investments continue to drive awareness and trial. Consumer response to the price increase initiated in late July is tracking mostly as expected, although elasticity on chips so far has been slightly greater than our estimates. The snacks portion represents nearly 45% of total Quest measured channel retail sales. It is already roughly equal to Quest bars in household penetration. We expect Quest snacks to continue to be a driver of the brand's growth over the next few years, driven by household penetration, as well as a solid pipeline of innovation. However, given the meaningful size of this part of the business, we expect the rate of growth over the next few quarters to moderate from its current levels.
In summary, the company is uniquely positioned as a US leader in the fast-growing nutritional snacking category. We have two scale lifestyle nutrition brands that are well developed across multiple forms and snacking occasions. Our brands are aligned with the consumer mega trends of healthy snacking with the nutritional profile that's protein rich and low in carbs and sugar. This profile has broad appeal to consumers interested in health and wellness as a means to achieving their goals whether they're at home, in the office or on the go. This category remains well under penetrated from a consumer standpoint indicating a long runway for growth. This is evident in our second quarter retail takeaway of 16% that exceeded our forecast. However, as I mentioned earlier, net sales were affected by some retail customer inventory reductions.
This is a watch out as we make our way through the third quarter. Our positive business momentum continued into the third quarter as March retail takeaway increased about 12%. We remain cautiously optimistic about our prospects over the remainder of the year. That said, we expect retail takeaway will moderate from current levels as we mark -- as we lap large year-ago comps and continue in an uncertain economic environment. While we expect full year fiscal 2023 gross margins to be below last year, we anticipate an improving cost environment in the second half of the year with sequentially improving margin from the second quarter to the fourth quarter. We will continue to execute against our priorities and remain committed to doing the right thing over the near and long term for our brands, our customers, and our consumers.
Now I will turn the call over to Shaun, who will provide you with some greater financial details. Shaun?
Shaun Mara: Thank you, Joe. Good morning, everyone. I will begin with an overview of our net sales. Total Simply Good Foods second quarter net sales of $296.6 million was about the same as the year-ago period. This resulted in year-to-date net sales of $597.5 million, an increase of 3.4% versus last year. Looking at the Q2 drivers of growth, net price realization was about 8.2 percentage points and volume was off about 6.9 percentage points. The March 2022 agreement to license the Quest frozen pizza business was a headwind of 1.3 percentage points. As Joe stated earlier, retail takeaway growth outpaced the net sales change. On the bottom of this slide, we attempt to reconcile Q2 POS growth of 16% to Q2 North American net sales growth of 0.3%.
The biggest driver of this difference is the impact of the year-ago period retail inventory build. As a reminder, in a typical year, we see retailers build inventory by one to two weeks in the first half of the year to support the New Year New You season. This bill typically comes out in Q3. Last year was atypical as most retail customers elected to build significantly higher inventory levels in the first half of fiscal 2022 and did not depleted until the fourth quarter of 2022 due to their supply chain concerns last year. We estimate the impact of this change in retail inventory compared to last year to be about an 11% -- percentage point headwind or about $30 million for the second quarter of fiscal 2023. Additionally, as Joe mentioned, the current period inventory reduction by some retailers was about a 3 percentage point impact or approximately $10 million.
Lastly, the licensing of pizza was about a 1 percentage point drag. Moving on to other P&L items for Q2, gross profit was $102.7 million, a decline of $5.8 million from the year ago period, resulting in gross margin of 34.6%. The 200 basis points decline versus the year ago period was primarily due to higher ingredient and packaging costs. Versus our forecast, gross margin was off by about 50 basis points or $1.5 million due to lower ingredient costs flowing through at a slower rate than anticipated and marginally higher other cost within our supply chain. Net income was $25.6 million versus $18.5 million last year. The year ago period was impacted by the fair value change of private warrant liabilities of $12.7 million. Adjusted EBITDA was $50.9 million, a decline of $3.3 million from the year ago period.
Selling and marketing expenses were $29.9 million versus $32 million last year, a decline of 6.3% largely due to the timing of spend within the year. GAAP G&A expense was $25.9 million and declined 1.3% versus last year. Excluding stock-based compensation, executive transition costs, restructuring and integration expenses, G&A declined 1.8% to $22.5 million. The $400,000 decline versus last year was primarily due to lower employee related costs. For the full fiscal year 2023, we expect selling, marketing, and G&A expense to be slightly down versus the year ago period. Moving to other items in the P&L, net interest income and interest expense increased $3 million to $8.3 million due to higher variable interest rates related to the term loan and our tax rate in Q2 was above 24.7%, about the same as last year.
The tax rate in the year ago period excludes the impact of the change related to the warrant liability. Year-to-date results are as follows. Gross profit was $213.7 million, a decline of 5%. Gross margin of 35.8%, declined 310 basis points versus the year ago period. The decline was primarily due to higher ingredient and packaging costs. Net income was $61.5 million versus $39.6 million in the year ago period. The year-ago period was impacted by the fair value change of private warrant liabilities of $30.1 million. Adjusted EBITDA declined 6.8% to $111.7 million, primarily due to lower gross profit. Selling and marketing expenses were $58.5 million versus $62.5 million, a decline of 6.4% due to timing of spend within the year. G&A expenses increased 2.1% or $0.9 million.
This excludes charges of $6.8 million related to stock-based compensation, executive transition costs, integration and restructuring expenses. Moving to other items in the P&L. Net interest income and interest expense increased $3.7 million to $15.3 million due to higher variable interest rates related to the term loan. Our year-to-date tax rate was about 22.7% versus 24.9% in the year ago period. The tax rate in the year ago period excludes the impact of a charge related to the warrant liability. We anticipate full year fiscal 2023 tax rate to be about 25%. Turning to EPS. Second quarter reported EPS was $0.25 per share diluted compared to $0.18 per share diluted for the comparable period of 2022. In fiscal Q2 2023, depreciation and amortization expense was $5 million and similar to the year-ago period and stock-based compensation of $3 million was about the same as last year.
Adjusted diluted EPS, which excludes these items, was $0.32 compared to $0.36 for the year-ago period. Note that, we calculated adjusted diluted EPS as adjusted EBITDA, less interest income, interest expense and income taxes. Year-to-date second quarter reported EPS was $0.61 and adjusted diluted EPS was $0.73. Please refer to today's press release for an explanation and reconciliation of non-GAAP financial measures. Moving to the balance sheet and cash flow, as of February 25, 2023, the company had cash of $63.2 million. Year-to-date cash flow from operations was $53.3 million. In Q2, the company paid down $35 million of its term loan debt. And at the end of the second quarter, the outstanding principal balance was $365 million, resulting in a trailing 12-month net debt to adjusted EBITDA ratio of 1.3 times.
Note, subsequent to the end of the quarter, we paid down an additional $15 million, so the current outstanding balance was $350 million. We anticipate net interest expense for the year to be about $28 million to $30 million, including noncash amortization expense related to the deferred financing fees. Year-to-date capital expenditures were $1.7 million. I would now like to turn the call back to Joe for closing remarks.
Joe Scalzo: Thanks, Shaun. In a challenging economic environment, we are well positioned to maintain our marketplace momentum. Over the remainder of the year, there are solid plans in place for both of our brands that we believe will drive sales and earnings growth, particularly in the fourth quarter of the fiscal year. Therefore, we anticipate the following for fiscal 2023. We reaffirm net sales increased slightly greater than our 4% to 6% long-term algorithm. We continue to expect fiscal 2023 gross margins to be lower than last year, however, the overall cost environment is improving, including ingredients in the second half of the year and, in particular, in the fourth quarter. However, full year fiscal 2023 gross margins will decline greater than our previous estimate due to the year-to-date gross margin performance and slightly higher costs within our supply chain over the remainder of the year with most of this headwind in the third quarter.
We have made significant marketing and organizational investments in the business over the past three years and believe it will result in the growth of our consumer base, distribution and market share. As such, we believe total SG&A expense will be slightly lower than last year. Full year fiscal 2023 adjusted EBITDA will increase, but slightly less than the net sales growth rate. And adjusted diluted EPS will increase less than the adjusted EBITDA growth rate due to the company's expectation of higher interest expense from an increase in the variable interest rate related to its term loan debt. As we look to the third quarter of the fiscal year, retail takeaway is off to a good start with March POS up about 12%. We have customer programming in place that should enable us to maintain marketplace moment.
We expect Q3 net sales to increase slightly versus last year due to the typical retail inventory drawdown related to the first half of the year inventory build and year-ago promotions in the club channel that will not be repeated. Q3 gross margin is anticipated to decline around 100 basis points and adjusted EBITDA is expected to be about the same as the year-ago period due to lower ingredient costs flowing through slower than anticipated and slightly higher cost in other areas of our supply chain. Importantly, the retail takeaway growth in our category and our brands remain compelling. As such, we are excited about the near and long-term growth prospects and we'll continue to execute against our strategies as a path to increasing value for our shareholders.
We appreciate everyone's interest in our company and are now available to take your questions. Operator?
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