Business context and reporting period
The Simply Good Foods Company’s fiscal 2020 first quarter was the 13 weeks ended November 30, 2019; comparison is the 13 weeks ended November 24, 2018. The company sells nutrition-focused snacks and meal replacements under Atkins, Quest and SimplyProtein. Quest was acquired on November 7, 2019, so reported results include Quest only from that date.
Key financial results
| Metric | Q1 FY2020 | Prior comparable quarter |
|---|---|---|
| Net sales | $152.2 million | $120.9 million |
| Gross profit / margin | $62.2 million / 40.9% | $51.9 million / 42.9% |
| Operating income (loss) | $(3.0) million | $21.2 million |
| Net income (loss) | $(4.8) million; $(0.05) per diluted share | $15.3 million; $0.18 per diluted share |
| Adjusted EBITDA | $31.8 million | $26.7 million |
| Operating cash flow | $(7.9) million | $12.9 million |
Cash and cash equivalents were $72.7 million at November 30, 2019, versus $266.3 million at August 31, 2019. Term-loan principal was $655.5 million, with no revolver borrowings; the company reported covenant compliance. The $75 million revolving facility had $5 million of letters of credit reducing availability. Management said liquidity was sufficient for operations, its growth strategy and expected expenses for at least the next 12 months.
Material changes versus the prior period
- Sales rose 25.8%, driven by volume growth, strong U.S. retail takeaway and Quest. Quest contributed $17.1 million in reported-quarter sales; its full-quarter sales are not reflected in reported results.
- Atkins U.S. measured-channel retail takeaway grew 10.7%; Quest’s grew 24.0%. Management noted that measured channels cover about 90% of Atkins sales but only about 50% of Quest sales.
- Gross margin fell 200 basis points to 40.9%, primarily reflecting a $2.4 million non-cash Quest inventory fair-value step-up and Quest’s somewhat lower gross margins.
- Operating expenses rose to $65.2 million, chiefly because of $26.2 million of Quest-related transaction costs. That amount included advisory fees, banker commitment fees, non-deferrable debt issuance costs and other expenses.
- Net loss contrasts with higher Adjusted EBITDA, which increased 19.1%. The company’s non-GAAP measure excludes, among other items, transaction costs, stock compensation, inventory step-up and Quest integration costs; it is not a substitute for GAAP results or operating cash flow. Adjusted diluted EPS was $0.22, versus $0.22.
- Quest acquisition consideration was approximately $988.9 million, funded with cash on hand, approximately $350 million of net equity-offering proceeds and new term debt. The October offering issued 13.4 million shares.
Comparative prior-year cost-of-goods-sold and expense figures were adjusted for a change in presentation of shipping and handling costs, which are now included in cost of goods sold.
Outlook, risks and unusual items
- No quantitative earnings or sales guidance was provided. Management described the quarter as a good start to fiscal 2020 and cited growth in Atkins and Quest.
- Quest’s specialty channel, about 18% of its sales, continued to decline amid store closures and lower retailer foot traffic. Management described convenience-store and e-commerce performance as solid.
- Quest integration, acquisition-related debt and interest expense, and the company’s ability to realize the acquisition’s benefits are important considerations. The credit agreement includes financial and other covenants and limits certain actions.
- The preliminary Quest purchase-price allocation includes $848.4 million of acquired intangible assets and $96.0 million of goodwill; valuation and customary purchase-price adjustments remained subject to finalization.
- A $3.8 million reserve had been recorded for potential settlement of class-action litigation concerning product-label claims, including an additional $0.3 million in the quarter. The company said it was not aware of material litigation expected to have a material adverse effect.
- Quest’s internal controls were excluded from management’s controls assessment following the recent acquisition. Quest represented 47.5% of total assets and 11.2% of net sales as of and for the quarter, respectively. Management concluded disclosure controls were effective.
Important facts for investors to verify
- Quest’s subsequent full-quarter sales, channel trends and integration progress; reported Quest sales cover only the period after November 7.
- Whether operating cash flow improves as acquisition expenses and working-capital movements normalize.
- Debt repayment, interest costs, covenant headroom and the effect of acquisition financing on liquidity.
- Final Quest purchase-price allocation, including intangible-asset valuations, goodwill and any purchase-price adjustments.
- Progress on the Quest specialty-channel decline and the outcome or further provisioning for product-label litigation.