Simply Good Foods Co. — Form 10-Q Summary
Reporting period: Fiscal second quarter ended February 29, 2020 (13 weeks), with year-to-date results for the 26 weeks ended that date. Unaudited. Comparisons are with the periods ended February 23, 2019.
Business context
Simply Good Foods sells nutrition-focused snacks and meal replacements under Atkins, Quest and SimplyProtein. Quest was acquired on November 7, 2019 for approximately $988.9 million. Quest results are included from the acquisition date, so reported growth versus the prior year is not fully like-for-like.
Financial performance
| Metric | Q2 FY2020 | Q2 FY2019 | 26 weeks FY2020 | 26 weeks FY2019 |
|---|---|---|---|---|
| Net sales | $227.1m | $123.8m | $379.3m | $244.7m |
| Gross profit | $85.4m | $49.7m | $147.6m | $101.6m |
| Gross margin | 37.6% | 40.1% | 38.9% | 41.5% |
| Operating income | $25.3m | $19.0m | $22.3m | $40.2m |
| Net income | $10.7m | $12.7m | $5.9m | $28.0m |
| Diluted EPS | $0.11 | $0.15 | $0.06 | $0.33 |
| Adjusted EBITDA (non-GAAP) | $41.7m | $23.0m | $73.5m | $49.7m |
- Q2 sales increased 83.4%; management attributed 71.3 percentage points of the increase to Quest and 12.1% growth to legacy Atkins. Quest contributed $88.3 million of Q2 sales. For the first half, Quest contributed $105.4 million and sales rose 55.0%, including 11.9% legacy Atkins growth.
- Q2 gross margin fell 250 basis points; first-half margin fell 260 basis points. The company cited Quest’s somewhat lower margins and acquisition-related, non-cash inventory step-up charges ($5.1 million in Q2; $7.5 million year to date).
- First-half operating income and net income declined despite higher sales, reflecting $26.9 million of Quest-related business transaction costs, higher interest expense, integration costs and the inventory step-up. Adjusted EBITDA increased, but is a non-GAAP measure with adjustments that should be considered alongside GAAP results.
- Q2 Atkins U.S. measured-channel retail takeaway grew 6.1%, Quest grew 27.1%, and total company takeaway grew 11.8%, according to management.
Cash flow, debt and liquidity
- For the first 26 weeks, operating cash flow was negative $14.9 million, versus positive $21.8 million a year earlier. Investing cash outflow was $985.9 million, principally the $984.2 million Quest acquisition payment, net of cash acquired. Financing cash inflow was $780.7 million, including equity and term-loan proceeds.
- Cash was $46.1 million at February 29, down from $266.3 million at August 31, 2019. Current assets were $235.6 million and current liabilities $74.3 million at quarter-end.
- Term-loan principal was $635.5 million; the reported effective rate was 5.4%. The loan matures July 7, 2024. No revolver borrowings were outstanding at February 29; the $75 million revolver was available subject to letters of credit and facility terms. The company reported compliance with financial covenants.
- In March, the company drew $25 million on the revolver as a precaution and to support inventory and working capital. It reported approximately $78.7 million cash at March 28, including that draw, and said liquidity plus expected operating cash flow should fund operations and strategy for at least 12 months.
Outlook, risks and unusual items
- No quantified full-year earnings or sales guidance is provided in the filing. Management said first-half performance exceeded expectations, Quest integration was on track, and it remained on schedule to achieve identified $20 million synergies.
- COVID-19 effects were largely after quarter-end. Management reported a sharp early-March increase in retail takeaway followed by a noticeable slowdown later in March, while e-commerce sales remained strong overall. It described demand as volatile and the pandemic’s duration and severity as uncertain.
- Management said it was working with customers, manufacturers and logistics providers and expected to meet orders based on information available at filing. Risks include disrupted consumer demand, supply chain or manufacturing interruptions, retail traffic and promotional changes, and broader economic weakness. These expectations depend on conditions not materially worsening.
- The company recorded $26.9 million in first-half business transaction costs related to Quest, including advisory and financing-related costs; it also recorded $5.2 million of first-half Quest integration costs. Acquisition purchase-price allocation remained preliminary.
- A reserve of $3.5 million had been recorded for product-label-claim class action litigation in FY2019, with an additional $0.3 million reserved in the first half. The company said it was not party to litigation it considered material. It also expected $3.0 million in endorsement payments over the next 12 months.
- Management concluded disclosure controls were effective. The acquired Quest business, representing 46.2% of total assets and 27.8% of first-half sales, was excluded from the controls assessment while integration work continued.
Investor verification priorities
- Separate Quest’s contribution from organic growth and assess comparable performance after the acquisition anniversary.
- Track gross-margin recovery, including the end of inventory step-up charges, Quest mix and the realization of $20 million in synergies.
- Review cash conversion and working-capital needs, particularly receivables, inventory build and post-quarter COVID-related demand volatility.
- Monitor leverage, interest expense, debt covenants and revolver usage following the acquisition financing and March draw.
- Check final Quest purchase-price allocation, integration and transaction costs, and any changes in the product-label litigation reserve.