Simply Good Foods Co quarterly report, Q3 FY2018

Business context and reporting period

The Simply Good Foods Company sells branded nutritional snacks and foods, primarily under Atkins and SimplyProtein. This unaudited Form 10-Q covers the 13 and 39 weeks ended May 26, 2018. Because the July 2017 business combination created a new accounting basis, current successor results and prior-year predecessor results are not fully comparable; management also provides pro forma comparisons.

Key financial metrics

Quarterly sales rose 11.1% versus the comparable prior-year period, driven by 6.5% volume growth and a 4.6% benefit from lower promotional allowances. Gross margin improved 270 basis points, which management attributed mainly to favorable trade allowances. On a pro forma basis, quarterly Adjusted EBITDA increased 21.4%. For the 39-week period, sales increased 8.2% and Adjusted EBITDA increased 9.7% versus pro forma prior-year results; gross margin improved 120 basis points. Adjusted EBITDA is a non-GAAP measure.

Year-to-date net income includes a provisional $29.0 million tax benefit from the Tax Cuts and Jobs Act; the company reported a $17.5 million income tax benefit for the period. The resulting 18.2% net margin and $0.81 diluted EPS therefore include a significant tax-related item.

Operating cash flow was $36.2 million for the 39 weeks, compared with $18.7 million in the prior-year predecessor period. Investing cash outflow was $3.1 million and financing cash outflow was $1.1 million. Cash and equivalents were $88.4 million at May 26, 2018, versus $56.5 million at August 26, 2017. Current assets were $170.1 million and current liabilities $29.0 million.

Long-term debt had $199.0 million principal outstanding ($191.7 million net of deferred financing costs); no amounts were drawn on the $75 million revolving facility. The term loan matures in July 2024 and bears variable interest; a March 2018 repricing reduced its LIBOR margin to 3.50% (or base rate plus 2.50%).

Material changes and unusual items

• Quarterly operating expenses increased 15.5% versus pro forma prior-year results, including higher distribution, selling, marketing and G&A costs. Year-to-date expenses also include $1.9 million of business transaction costs.
• Interest expense declined substantially against reported predecessor results, reflecting refinancing and lower debt, but was broadly consistent with pro forma comparisons.
• The Tax Act reduced the U.S. federal corporate tax rate to 21%. The company’s tax accounting remains provisional; it had not completed its assessment at quarter-end. The TRA liability was $27.9 million, with estimated undiscounted future payments of $32.3 million.
• Management identified a material weakness in revenue recognition controls: revenue had historically been recorded on shipment despite some customer contracts specifying FOB destination. The issue accelerated recognition for certain in-transit inventory. Management concluded it did not cause a material financial statement misstatement and expected remediation before fiscal year-end 2018. Disclosure controls were deemed ineffective at quarter-end.

Outlook, risks and contingencies

Management said available liquidity should fund operations, growth plans and expected public-company costs for at least the next 12 months. The filing provides no specific revenue or earnings guidance. Sales are seasonal, with historically lower sales in the fourth fiscal quarter. Key risks include variable-rate debt costs, potential TRA payments reducing cash available, uncertainty in final Tax Act impacts, and potential adverse effects from U.S.-Canada trade or tariff changes. Ordinary-course litigation was not expected by management to have a material adverse effect; no material off-balance-sheet arrangements were reported.

Important facts for investors to verify

• Whether revenue-recognition controls were remediated as expected and whether any subsequent period adjustments were required.
• The final Tax Act accounting, including deferred taxes, effective tax rate and the TRA’s valuation and payment timing.
• Whether sales growth and margin improvement persist after the benefits from lower promotional allowances and favorable trade expense.
• Debt service exposure to interest-rate changes, covenant terms and the company’s cash needs for TRA payments and planned growth.
• Comparability of reported results, given the successor/predecessor accounting basis and the use of supplemental pro forma measures.