Greetings and welcome to the Simply Good Foods Company Second Quarter 2019 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, Mr.

Mark Pogharian, Vice President of Investor Relations for Simply Good Foods. Thank you. You may now begin..

Thank you, Melissa. Good morning. I am pleased to welcome you to The Simply Good Foods Company earnings call for the second quarter ended February 23, 2019. Joe Scalzo, President and Chief Executive Officer; and Todd Cunfer, Chief Financial Officer, will provide you with an overview of results, which will then be followed by a Q&A session.

The company issued its earnings press release this morning at approximately 7 a.m. 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 the subsequent events. A detailed listing of such risks and uncertainties can be found in today's press release and 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 the useful information with which to evaluate 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 with that out of the way, it's my pleasure to turn the call over to Joe Scalzo, President and Chief Executive Officer..

Thank you, Mark. Good morning. And thank you for joining us. Today, I'll recap our second quarter highlights and then provide an update on our business. I'll turn the call over to Todd who will discuss our second quarter, year-to-date financial results. And after that, we'll open the call to your questions.

I'm pleased with our financial and marketplace results, both of which exceeded our expectations. In the second quarter, we maintained the strong business momentum we've experienced over the last 12 months. Net sales and gross profit have increased double digits on a percentage basis versus last year for four consecutive quarters.

This has enabled us to make investments in marketing and capability, while delivering strong EBITDA growth. Our growth in consumer offtake or point-of-sale as measured by IRI continued to be strong across all products, all channels, and all major customers. And our e-commerce business also continued to do well, up nearly 50% over the last six months.

As we discussed last year, given supply constraints due to unexpected double-digit base POS growth, we dialed back the frequency of bar promotions in Q2 to focus on on-shelf inventory. This strategic choice resulted in favorable, retail promotional spending and improved customer inventory level.

While early, our fiscal third quarter is off to a good start. Our advertising and marketing continues to drive strong volume growth and our improved customer inventory levels, access to increased supply, and lower promotional volume on bars have enabled us to keep pace with strong consumer demand.

Turning to the second quarter, net sales grew 13.2% year-over-year with adjusted EBITDA up 22.1%. Similar to last four-plus quarters, our business continues to be driven by strong base velocity gains on core products.

The increase in our top line underscores the strength and resilience of our brand against our large consumer target that includes both core programmatic weight loss consumers as well as lifestyle-oriented low carbers.

Our successful marketing campaign is resonating with both groups of consumers and complements the megatrends supporting our growth, including convenience, meal replacement, and low carb, low sugar, protein-rich snacking. Volume was the biggest contributor to growth in Q2, up 12.2%.

As expected, lower frequency on bar promotions was a 3.5-point benefit that was partially offset by the non-price-related customer promotion accounting shift from G&A that we discussed last quarter. Todd will have a bit more on this in a moment. The increase in adjusted EBITDA is a direct result of the sales growth.

These gains were partially offset by higher direct media investment as well as an increase in G&A. Measured channel US POS growth continues to be strong giving us confidence in the effectiveness of our marketing to drive consumption and growth volumes. Our strong retail performance continue to come almost entirely from base velocity growth.

Distribution was up slightly, driven by our new 30-gram protein shake. These gains were partially offset by the planned lower frequency of bar promotion. I'm very pleased that our growth continues to be well balanced across all product forms. As a reminder, our marketing strategy is unique among traditional food brands.

It is based on Atkins' distinctive nutritional philosophy whose benefits are supported by over 100 independent peer-reviewed clinical studies. The brand stands distinctively for low-carb, low sugar, protein-rich nutrition designed to avoid blood sugar spikes and help the body burn stored fat.

Our marketing strategy focuses on communicating the benefits of this nutritional philosophy, while offering delicious convenient snacks that help consumers seeking to live a low-carb lifestyle.

Not surprising given our brand's unique positioning and our marketing approach, we are the only nutritious snacking brand that is well developed across bars, shakes, and confections, and that is achieving balanced growth across all these forms. Although not as expected, our bar POS growth slowed sequentially from the first to the second quarter.

As we stated last quarter, we made a strategic decision to curtail the frequency of promotion on bars in January and February. Our strong results have given us the financial flexibility to invest in the business. As such, we're committed to increasing advertising and marketing at least in line with sales growth.

In January, our new advertising began to air. Specifically, there are three new spots with Rob Lowe that builds off our successful today's Atkins campaign from a year ago. Similar to last year, the ads are designed to target both programmatic and self-directed low-carbers.

Importantly, the ads tested better than last year's copy while early marketplace results are encouraging. Over the last 12 months, evidence of our successful advertising campaign has been the solid POS growth as well as our ability to grow total buyers, while maintaining loyalty and buy rate consistent with historic levels.

New products are an important element of our marketing strategy. Here you see some of our innovation such as the Atkins wafer bars and our new 30-gram protein shakes.

New products are an important lever that allows us to bring news and excitement to consumers and also enables us to introduce the brand and our nutritional philosophy to potential new buyers. Additionally, new products allows us to provide the needed variety to our current buyers, who typically consume on average 35 servings in their first year.

This increases significantly in year two. So, you'll continue to see us introduce flavor, line extensions as well as value-added new forms from time to time. Overall, I'm very pleased with our performance in the quarter and the first half of the year.

Second quarter and year-to-date results were strong with sales and profitability meaningfully greater than our long-term target. For the balance of the year, we're confident in the effectiveness of our marketing, improved supply situation, and our ability to invest in proven growth initiatives.

However, beginning in our fiscal third quarter, the year-over-year comps begin to get more challenging. We're focused on driving topline growth, especially with new lifestyle self-directed low carbers and believe the plans we have in place positions us to deliver on our objectives. Now, I'll 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 that follow. First, for comparative purposes, we will review financial statements for the quarters ended February 23, 2019 and February 24th, 2019.

Second, we 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.

Now, for review of second quarter across major metrics. Let me start with net sales. Core volume growth has been solid over the last year and continues to be the primary driver of our sales increase. Specifically, in the second quarter, volume increased 12.2%.

As expected, trade promotion or price realization was 3.5 points favorable in the second quarter, driven by reduced frequency of promotions on bar products versus last year. Last quarter, we mentioned this was a lever to managing through some of the capacity constraints, particularly on bars.

These gains were offset by the change in how we account for services provided by some of our customers. As we discussed last quarter, in the year-ago period, this cost was recorded as selling expense. We expect the impact in the second half of the year to be less than what we incurred in the first half.

Turning to the rest of the P&L, gross profit increased 14.7% to $57.6 million, with gross margin up 60 basis points to 46.6%. The increase in gross margin was primarily due to the favorable trade promotion, partially offset by the non-price-related customer activity that is a shift from selling expense.

As we stated last quarter, this shift only impacts fiscal 2019 amount and resulted in an unfavorable impact on 2019 gross margin of about 110 basis points.

The increase in gross profit was partially offset by a 21% increase in marketing, driven by increased media and e-commerce investment, as well as a 24.7% increase in G&A due to costs associated with the strategic sourcing initiative and utilization of fiscal year 2018 investments to enhance organizational capabilities in key function and higher incentive compensation.

Note that selling expense was lower than last year due to the aforementioned shift of non-price-related customer activity. Income tax expense in Q2 was $4 million versus a benefit of $26.8 million in the prior-year.

Recall in the second quarter of 2019 results, we recorded a $29 million one-time gain related to the remeasurement of deferred tax liability, as well as the $4.7 million gain on fair value of a tax receivable agreement.

Our effective tax rate in Q2 2019 was about 24% versus 15% in fiscal year 2018, excluding the aforementioned gain in the year-ago period. We anticipate that the full-year tax rate will be in the 24% to 25% range. As a result, reported net income in the second quarter was $12.7 million versus $41.4 million last year. Year-to-date results are as follows.

Net sales were up 13.3% to $144.7 million and adjusted EBITDA increased 16.8% to $49.7 million. As I mentioned earlier, the year-to-date net sales increase was driven primarily by organic core volume growth. Year-to-date gross profit increased 13.3% to $115.7 million, with gross margin in line with the prior-year.

The shift in non-price-related customer activity from selling expense to trade resulted in an unfavorable impact on 2019 gross margin of about 80 basis points, offset by reduced frequency of promotions on bar products of about 80 basis points as well.

This was partially offset by other expenses, including an 18.9% increase in marketing expense and a 20% increase in G&A due to costs associated with strategic sourcing initiatives, annualization of FY 2018 investments to enhance organizational capabilities and key functions and higher incentive compensation.

The year-to-date increases in taxes is primarily driven by the Q2 2018 gains mentioned earlier. As a result, year-to-date net income was $28 million versus $51.6 million last year.

Moving on to the balance sheet and cash flows, the company's solid balance sheet and cash flow provides us with continued financial flexibility to support future organic growth and participate in value-enhancing M&A. Year-to-date cash generated by operating activities was $21.8 million, driven by net income, partially offset by higher inventory.

In the second quarter, we rebuilt inventory to acceptable levels through a combination of supply improvements and reductions in promotional activity. Going forward, we are in an improved position to meet retailer and consumer demand and reinstate some promotional activity over the remainder of the year.

As a result, we expect finished goods inventory to be lower in the second half of the year. Year-to-date CapEx was $0.9 million and net cash provided by financing activities was $86.2 million, primarily driven by the cash received from the warrant exercise. Share buybacks in the quarter were nominal.

Additionally, note that our full-year CapEx forecast is about $2 million. Therefore, as of February 23, 2019, the company had cash of $219 million. There is $197.5 million remaining on the outstanding term loan resulting in a net cash position of $21.5 million.

The company also has a $75 million revolving line of credit available with no borrowings outstanding. I would now like to turn the call back to Joe for brief closing remarks..

Thanks, Todd. In summary, our results in the first half of the year were strong and we have entered the third quarter with significant momentum and an improved supply chain position. Given the strength and our momentum, we're more optimistic than last quarter in our ability to exceed our long-term net sales target of 46% growth.

Specifically, we anticipate full year fiscal 2019 net sales and adjusted EBITDA to both increase double digits on a percentage basis versus last year.

This full-year outlook reflects significantly more challenging POS comps in the second half of the year, continued lower promotional volume on bars versus prior year as we manage bar demand within our available supply and incremental strategic investments in marketing and brand building initiatives that will continue to drive growth over the long term.

Additionally, please note that we anticipate the increase in net sales in the second half of the year will outperform point-of-sales growth due to year-on-year customer inventory changes as we entered Q3 this year with lower levels of inventory than the prior-year.

And as previously discussed, the fourth quarter benefits from the year-over-year positive impact of sales in transit and a 53rd week. We're excited about the growth opportunities that exist in our business and in our category. We're executing against our strategies well and growing buyers while delivering on our financial objectives.

We appreciate everyone's interest in our company and we're now available to your questions..

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

Hey, good morning, folks. Thank you for letting me ask a question. Congratulations on the strong start here – not the strong start, but another strong quarter. The revenue growth you delivered was certainly impressive, kind of if you strip out the accounting, you're a bit north of 15% all in.

It's still lagging the consumption by a fair amount, the point-of-sale value that you're showing and you mentioned that online is growing like 60% or so year-to-date.

What's driving that delta? Why are we still not seeing net sales track closer to consumption all in?.

So, what typically has happened in our business is, we have built inventory at the end of Q1 and in Q2 for a strong promotional period in our calendar year. Because of our supply constraints and you heard us talk about how we basically pulled back on all bar promotions in Q2, we did not build – so think of it almost as a new product pipeline build.

We're shipping in a lot of volume into our retailers for all this promotional activity. We did not do that this year, and we did it in the prior year, sowe're lapping that inventory build.

So, what is going to happen – what typically happens then is, in Q3 and Q4, that inventory comes out of the system, and because we did not build as much this year, we will not obviously have to deplete as much in the second half of the year.

And as Joe mentioned, POS will – net sales will outstrip POS in the second half of the year, and that's what's causing that. So, it's a tailwind in the second half, obviously it was a headwind in the first half, but that's really what it is. It's a shift in inventory at our customer level..

Any sense of magnitude there that we should expect for the third quarter?.

I don't know specifically about the third quarter, but you can think of it in the first half – the second quarter probably about 4 or 5 points..

Got it. Okay. And you guys made some interesting comments about buy rates stepping up in year two once you've brought new consumers into the fold.

Can you elaborate a little bit more on that and give us – tell us if you're seeing it now with the new consumers you brought in last year and give us any sense of magnitude?.

Jason, this is Joe. Historically, we've seen a significant step up in year two, year three buyers. So, our year one buyer is buying in the mid-30s. You kind of think about it as every-other-week consumer of our product. As they move into year two and year three, they eat it twice a week.

So, you see a pretty significant step up in year two and year three and beyond buyers stay at that more-than-weekly-buyer consumer. And so, it's hard to tell what 2019 is going to look like because you don't know the answer to the total year until you get to the total year.

But the comment that we made was around why innovation is important to our business. You have two components to it. One, it's a way of introducing the brand to new buyers, but more importantly when you're consuming a snack twice a week, you need a fair amount of variety.

So, new products are very important, especially to those year two buyers who are eating our products twice a week. And that's the average buyer, right? So, you can imagine, heavier buyers are eating it daily..

Sure, sure. Got it. That's really helpful. Thanks, guys. I'll pass it on..

Thank you. Our next question comes from Chris Growe with Stifel. Please proceed with your question..

Hi. Good morning..

Hi, Chris..

Hi. Nice quarter here. Two quick questions for you. I don't want to get too far ahead of ourselves, but the sort of consumption growth and the base velocity growth usually suggest an increase in shelf space, and there was – as part of one of the slides you showed, some increase in points of distribution. You said it was positive in the quarter modestly.

Is that accelerating? And if it does, I guess, in relation to your answer to Jason's question, do you have a supply that you're able to accommodate more facings, for example, more distribution if you're able to get that from retailers?.

It's a good question. We have, for the last 12 months, as we've mentioned on our remarks, built our business on core velocity. In fact, in some forms, we've actually seen fewer items on the shelf. So, we've seen some pairing back. That's kind of stabilized. We're seeing some growth now in our ready-to-drink shake business.

Hard to say, with the resets, what the net is going to be at this point. I suspect we'll do a little bit better than we've done year-to-date over the next 12 months just because we've been able to – we've actually forced some pairing of items as we focused on our supply issues.

That will stabilize, and I would suspect we'll be stable, if not a little bit positive, as we move into the next 12 months..

Okay.

And then, just a question for you in relation to marketing in the quarter which was up, and I'm just curious, in terms of your supply constraints, which you don't have any more, I guess, would you have increased marketing more or does it lead you to think about for the second half of the year as you get into more normalized supply that you'd want to increase your marketing at an even greater rate than what you did here in the quarter?.

Yes..

Okay..

Good question, Chris. Yes. With our supply constraints, we had a few levers we can pull. The demand – a slowdown in demand. So, we focused on on-shelf inventory, pulled out of a lot of promotions on bars, and we held back on marketing. Now, you don't, obviously, want to go to zero there because it generates new buyers, creates future growth.

So, we try to modulate the marketing spend. As we've emerged out of the supply situation, we're in a stronger position. We're not out of the woods, but we're in a stronger position. You can expect us to lean in on marketing investments in the second half of the year..

And Chris, just a point of clarification, the way we talked about this before, the way we account for advertising is we peg it as a percent of sales based on a full-year forecast of what our total spend will be. So, what you're seeing coming through the P&L, again, is based on our full-year estimate. It's not what we're actually spending on media.

The spend on media in the first half was not up very substantially. We will enjoy as now we're in a much better position on inventory. We actually have more on-air advertising in the second half of the year and, hopefully, that will bring new buyers in as well..

Chris, also one thing I would mention is we don't just spend [indiscernible] and go to the end of the year. So, we're reading end market. We have an attribution model that we can follow that ties to POS. We get real-time data on our website as people, the website, register.

So, we're going to modulate the media up or down based on in-marketplace results as we're spending the money. And you should expect us, if we have the financial flexibility – and the results are coming in really positive – to lean in. And then, if that is not the case, you would expect us to be more modest in our investment..

That makes a lot of sense. Thank you for that color..

Thank you. our next question comes from the line of Eric Larson with Buckingham Research Group. Please proceed with your question..

Yeah, good morning all and congratulations on a really good quarter. A couple of follow-up questions.

To alleviate some of your supply constraints, have you committed to some capital to your co-packers? Did that happen with this or were you able to get your co-packers to put most of that capital upfront given the kind of the quality of your product line?.

It's not a really capital-driven business. So, as we saw our business start to accelerate last summer, it becomes really more about a negotiation to get access to available capacity. So, as you can imagine, suppliers, co-manufacturers try to lock in 100% of their available capacity with their customers.

And then, when some of their bigger customers like us are accelerating, then it's a negotiation to get access more of that. We will, as we move – and we have some success in doing that. Our available supply increased in the 20% range from the summer to where we kind of are today, which has helped us to keep pace.

As you look at this longer-term, it's around what you're going to need in the future and what you're willing to promise as a minimum, right, in order to meet surge that you may not anticipate. So, it's much more about negotiating.

We will be bringing on some other manufacturers over time to help provide us a little bit more available capacity and also some surge capacity..

Okay. And just to follow-up on how you've been managing that inventory. It's primarily been in bars and I think your goal was to get that POS growth down to kind of the low to mid-teens, which is kind of exactly where it is right now. But I also thought that you had capacity constraints in other product lines. I thought you also had some in beverages.

Is that not correct? Am I incorrect in that assessment?.

We had available supply in shakes. And as we moved into January, to happen to hit some stores, you will have seen us out on display and promotional exchange [ph]. Again, our available supply – we pull two levers, right? So, we try to focus first on core items on the shelf on bar.

So, we dial back promotion just so we could get it back and in stock and we leaned in on supply. So, the combination of those two things put in a pretty good position as we exited January and are now moving into the second quarter. We're not out of the woods. If our business really stepped up again, we would not have sufficient supply.

So, we're going to – expect us to continue to manage that, but we're certainly in a much better position than we were going into the second quarter..

Okay, great. And then, just one final follow-up, just so that I'm perfectly clear, and I think it was part of Todd's explanation here, so your first half marketing spend was up just under 19%. Q2 was up plus 21%. It sounds like a lot of that was what was an accrual –what was accrued expense.

So, are you effectively going to have more heat into the market, more actual marketing, more impressions in the market in the second half?.

Yes. Media actual spend was in the mid-single-digits in the first half and it will be up substantially more than that in the second half..

Thank you..

Thank you. Our next question comes from the line of Bill Chappell with SunTrust Robinson Humphrey. Please proceed with your question..

Hi. This is actually Grant on for Bill. Thanks for taking the question.

How are you?.

Good..

First one, just kind of following up on the supply questions that have come for us here, did you guys need to go back when you were negotiating for additional capacity and maybe give some margin back to the copackers? And if so, would we expect those kind of margin pressures to abate going forward?.

Really good question. So, we gave up, I would say – I'm not saying – I wouldn't phrase it we gave up margin. As we take on more volume in our co-management, we tend to get larger and larger rebates. We gave up a little bit of that upside just to secure some more capacity, but the impact was very, very minor. And we will be back.

Once we get the normal capacity engaged for the next 12 months, we will have the full impact of our margin and there should not be any issues. So, again, a tiny bit of an impact to secure more in the very short term, but it was very minor..

Got it.

And then, just a second one, on the clean label initiative, how far along are you guys in that process and have you seen a real impact at retail from that program?.

Yeah. We're mostly complete on meal bars and just about complete on our snack bars. So, as we close out the year, the initiative will mostly be done. Really hard to tease out the components that started driving our business January a year ago. I would certainly highlight three of them. The first one would be a clean bar initiative.

Second would be we updated our graphics which was the first refresh of our brand in over 10 years. And then, our new advertising campaign with media way. I think those three things kind of simultaneously hit the market in January. Hard to know what each of the components contribute frankly..

Got it. Thank you..

You bet..

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

Hi. Good morning. It's Matt on for Rob. Thanks for the question..

Sure..

Wanted to know if you can give us an update on your cost inflation outlook for the balance of the year.

And given the potential moving in on marketing investments in the second half, is it safe to assume that all your EBITDA growth is now expected to grow more in line with sales growth rather than slightly ahead like you've previously expected? Thanks..

Yeah. So, we have good visibility now in the second half for input cost to continue to be benign. We see some inflation, but it's very modest. So, that continues to be really positive news. Hard to say at this point what the relationship between net sales and EBITDA growth are going to be for the full year.

As Joe has mentioned earlier, we will continue to invest in our business as we continue to see really, really strong gains and new buyers growth and velocity growth. So, we see an opportunity to invest in the short term. We will absolutely do that, but we feel good about both net sales and EBITDA growth for the year..

Fair enough. And if I can ask one more, have you noticed any changes to the M&A environment since the beginning of the year in terms of maybe valuations or availability of assets? And that's it from me..

No big change. Still a very, very active market. We continue to look a lot of assets. Valuations for the best assets continue to be fairly high. I think they're probably coming down a tiny bit. But still a very, very active market out there..

Great..

Thank you. Ladies and gentlemen, that concludes our question-and-answer session. I'll turn the floor back to Mr. Scalzo for any final comments..

Thanks again for your participation on the call today. We look forward to updating you on our results in April. Have a good day..

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