Simply Good Foods Q2 2024 Earnings Call Transcript

Quartr
Provided by Quartr
April 4, 2024

There are 10 speakers on the call.

Operator

Greetings. Welcome to the Simply Good Foods Company Fiscal Second Quarter 2024 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.

Operator

I will now turn the conference over to Mark Bregarian, Vice President of Investor Relations. Thank you. You may begin.

Speaker 1

Thank you, operator. Good morning. I'm pleased to welcome you to the Simply Good Foods Company earnings call for the fiscal Q2 ended February 24, 2024. Jeff Tanner, President and CEO and Sean Mara, CFO will provide you with an overview of results, which will then be followed by a Q and A session. The company issued an earnings release this morning at approximately 7 am Eastern Time.

Speaker 1

A copy of the release and accompanying presentation are available under the Investor section of the company's website at www.simplygoodfoodscompany.com. This call is being webcast and an archive of today's remarks will also be available. During the course of today's call, management will make forward looking statements that are subject to various risks and uncertainties 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 in the company's SEC filings.

Speaker 1

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.

Speaker 1

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.

Speaker 2

I'll now turn the call over to Jeff Tanner, President and CEO. Thank you, Mark. Good morning. Thank you for joining us. Today, I'll recap Simply Good Foods' financial results and the performance of our brands.

Speaker 2

Then Sean will discuss our financial results in more detail before we wrap it up with a discussion of our fiscal 2024 outlook and your question. Simply Good Foods' 2nd quarter results were led by continued Quest growth as well as strong gross margin improvement. Net sales increased 5.3% driven by volume and due to the timing of shipments last quarter outpaced retail takeaway of about 3%. Retail takeaway in measured channels was less than our expectation. E commerce POS growth for both Quest and Atkins continued to be solid.

Speaker 2

Quest Retail Takeaway was on track with our plans, driven by strong salty snacks growth, while Atkins performance was off versus our estimate. Atkins had solid plans in place that was ultimately disadvantaged on 2 fronts during the quarter. First, it lapped a one time merchandising and promotional benefit that it had in the 2023 New Year New Year season due to the out of stock challenges of a category participant. And second, in the 2024 New Year New Year season, this category participant had adequate supply to service its base business. It then layered in extensive merchandising programs and promotions during the season, which greatly reduced the overall in store share of voice for the Atkins brand and others.

Speaker 2

In March, as we exited the New Year, New Year season and moved past the difficult lap, Atkins trends improved. More on that in a bit. We were very pleased with the Q2 gross margin of 37.4%. The 280 basis point increase versus the year ago period was primarily due to lower ingredient and packaging costs. Higher gross profit enabled investments in our business and an increase in Q2 adjusted EBITDA of 13.6% to $57,800,000 However, due to the softer than anticipated Q2 Atkins consumption trends, we have updated our full year fiscal 2024 outlook.

Speaker 2

We expect net sales to increase around the midpoint of the company's long term algorithm of 4% to 6%, including the benefit of a 53rd week. We previously expected net sales to increase at the high end of the long term algorithm. We continue to expect solid gross margin expansion and adjusted EBITDA is now anticipated to increase 6% to 8%, driven by solid gross margin expansion. Let me now turn to Quest. In Q2, retail takeaway in measured channels increased 13.1%.

Speaker 2

Growth was solid across the key product forms and retail channels, driven by an increase in both household penetration and buy rate. In Q2, we estimate total unmeasured channel retail takeaway increased about 10% as e commerce strength was partially offset by softness in specialty channels. Quest Q2 e commerce POS remained solid and increased about 14%. For perspective, total unmeasured channels in Q2 were nearly 24% of total Quest retail sales. Quest Bar and Snacks retail takeaway and measured channels increased 6% 21%, respectively.

Speaker 2

We're particularly pleased with our salty snacks POS growth of about 40%, which is a standout in the category and now represents about 25% of Quest retail sales. Additionally, we continue to see new Quest consumers coming into the brand via chips and then trying our other products such as bars, cookies or confections. The success of Quest Chips continues to be a proof point of the brand's ability to extend beyond its core and disrupt other large snacking categories, where we can offer high protein, low sugar and great tasting options for consumers. Over the remainder of the year, we continue to expect low double digit POS growth and continued household penetration and buy rate gains driven by innovation, distribution and a new marketing campaign. In March, we announced the launch of a new advertising campaign entitled It's Basically Cheating.

Speaker 2

The campaign features Academy Award and Emmy nominated writer, actor and comedian, Kamal Nanjiani, who playfully and satirically delivers a core campaign idea that Quest products are so good tasting and better for you that it basically feels like cheating. Quest has been one of the most innovative brands in the category and is supported by a best in class R and D team. The multiyear pipeline is strong and we expect innovation to be a lever of growth for a long time. In March, we launched strawberry frosted cookies and one of my favorites, iced coffee. This 10 gram protein packed 10 ounce drink has minimal sugar, only 90 calories and 200 milligrams of caffeine.

Speaker 2

Today, I'm also excited to announce a new Bakeshop platform for the fall of 2024. As we've seen with chips, this is an opportunity to disrupt a large snacking category, sweet baked goods with high protein, low sugar and great tasting muffins and a brownie. Like Quest Chips, we believe this new platform will bring new consumers to the active nutrition category and expand buy rate through another usage occasion. Based on conversations with key retail customers, we expect very strong support for the launch that will also be underpinned by a comprehensive marketing plan as part of the It's Basically Cheating campaign. Turning to action.

Speaker 2

Q2 retail takeaway in the IRI, new load plus C store universe and the combined measured and unmeasured channels was up 11% and 8%, respectively. Strong e commerce growth continued driven by Amazon whose POS growth was 13%. In Q1, e commerce was nearly 17% of total actions retail sales, up from 11% only 3 years ago. E commerce retail sales are over $2,000,000 per week, driven by a mix of new consumers and some heavy users that are migrating to this channel from brick and mortar. Atkins performance in brick and mortar channels was softer than expected.

Speaker 2

This was primarily due to greater than anticipated in store competitive merchandising and programming that also impacted several other brands. As I noted earlier, last year, Atkins received incremental one time merchandising and promotional support due to the supply challenges of a category participant, which is why the 2024 New Year, New Year was a challenging headwind. However, as you'll note in the chart in the middle of the slide, as we exited the New Year, New Year season, retail takeaway trends have improved. Over the remainder of the year, we expect more normalized level of competitive in store merchandising and programming. We also have a strong advertising plan in place and are excited about the quality of the new products we will soon bring to market.

Speaker 2

Therefore, we anticipate full year fiscal year 2024 combined measured and unmeasured channel POS to be off around 7% versus our previous estimate of 3% to 4%. We continue to have tremendous faith in the long term potential of the brand, especially given the increased cultural relevance and conversation about weight wellness. We continue to make progress against the 5 point revitalization plan we've talked about on previous calls. However, as you may recall, it's going to take time before all the elements of the plan are collectively in the marketplace. I'm particularly pleased with the progress we're making in accelerating innovation, which is a critical driver of business performance.

Speaker 2

As previously stated, our lack of quality innovation has been a headwind to Atkins' performance, but getting this back on track has been a focus area for us. The significant improvements we've made should enable us to have 15 new product launches in calendar year 2024 across all product forms. At the bottom of this slide, I'd like to point out Atkins Strong, high protein shake developed specifically for consumers on a weight loss drug or for shoppers just seeking higher levels of protein. For consumers experience rapid weight loss, either through medication, surgery or dieting, high protein levels are important to help maintain muscle mass. Atkins Strong protein shakes delivered 30 grams of protein with 1 gram of sugar and have also been formulated with 7 grams of prebiotic fiber to support gut health.

Speaker 2

This beneficial level of fiber is lacking in many RTD shakes in the market today and is a highly relevant nutrient for many folks on the new medications. Finally, research continues to suggest that the Atkins approach can be an effective off ramp for those who choose to transition off the medication and we're working to optimize our communications to ensure the brand is seen as a way to maintain weight loss benefits after taking the drugs. To summarize, Simply Good Foods is uniquely positioned as a U. S. Leader in nutritional snacking.

Speaker 2

The nutritional snacking category is more relevant today than any other time as the conversation of health and wellness continues to increase. Furthermore, our category continues to be a standout versus many other center of store categories. As such, we're leveraging our role as category advisor at most retailers and continue to work with our customers to develop and support initiatives in the aisle further accelerate category growth with a particular focus on gaining more space. Consumers trust our brands to help them achieve their wellness goals and we are accelerating our innovation and marketing plans to provide consumers with products to help them in their wellness journey. We will continue to execute our strategic priorities, focusing on doing the right thing for our customers and consumers that will enable us to deliver on our long term growth objectives that ultimately drive increased shareholder value.

Speaker 2

Now, I will turn the call over to Sean, who'll provide you with some greater financial details.

Speaker 3

Thank you, Jeff. Good morning, everyone. Total Simply Good Foods' 2nd quarter net sales of $312,200,000 increased $15,600,000 or 5.3% versus the year ago period and was driven by Quest volume growth. North America and international net sales increased 5.1% and 12.3%, respectively. As Jeff stated earlier, as expected, net sales growth was greater than retail takeaway of about 3%, primarily due to the timing of shipments last quarter.

Speaker 3

Recall in Q1 POS growth of about 8% outpaced the net sales increase of nearly 3%. Moving on to other P and L items for the quarter. Gross profit was 116 $100,000 from the year ago period, resulting in gross margin of 37.4%. The 280 basis point increase versus the year ago period was primarily due to lower ingredient and packaging costs. Adjusted EBITDA was $57,800,000 an increase of 6 $900,000 from the year ago period.

Speaker 3

Selling and marketing expenses were $34,600,000 versus 29 $900,000 an increase of 15.7 percent largely due to higher marketing investments and growth initiatives. GAAP G and A expenses were $29,900,000 an increase of $4,000,000 versus last year, primarily due to higher employee related costs, stock based compensation and corporate expenses. Excluding stock based compensation, G and A increased $2,500,000 to $25,400,000 Finally, net interest income and interest expense was $4,700,000 a decline of $3,600,000 versus Q2 last year. The decline was due to lower debt balances versus the year ago period. Our Q2 tax rate was about 24% versus 25% in the year ago period.

Speaker 3

As a result, net income was $33,100,000 versus $25,600,000 last year. Moving on to year to date results. Net sales were $620,900,000 increasing about 4% versus last year. This is slightly below year to date retail takeaway in the combined measured and unmeasured channels, which is growing approximately 5.5%. The difference is principally due to some incremental trade investment made in the first half of fiscal twenty twenty four.

Speaker 3

That said, we expect POS growth and net sales growth to be largely in line for the full year. Gross profit was $232,000,000 resulting in a gross margin of 37.4 percent, a 160 basis point increase versus the year ago period. We have good visibility into supply chain costs over the remainder of the year and anticipate gross margin will continue to improve and could approach 39% in the second half of the year. Adjusted EBITDA was $119,800,000 an increase of 7.3% from the year ago period. Net interest income and interest expense was $9,600,000 a decline of $5,700,000 versus last year.

Speaker 3

The year to date tax rate was 24.1% versus 22.7% last year. We continue to anticipate the full year effective tax rate to be around 25%. As a result, net income was $68,700,000 versus $61,500,000 last year. The next slide provides you with a reconciliation of reported and adjusted diluted EPS. 2nd quarter reported EPS was $0.33 per share diluted compared to $0.25 per share diluted for the comparable period of 2023.

Speaker 3

Adjusted diluted EPS was $4 compared to $0.32 in the year ago period. Note that we calculate adjusted diluted EPS as adjusted EBITDA less interest income, interest expense and income taxes. 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 24, 2024, the company had cash of $135,900,000 Year to date cash flow from operations was about $94,000,000 an increase of 76% or $40,600,000 principally due to adjusted EBITDA growth and improvements in working capital.

Speaker 3

During the quarter, the company repaid $35,000,000 of its term loan debt and at the end of the second quarter, the outstanding principal balance was 240,000,000 Capital expenditures in Q2 and year to date period were $300,000 $1,100,000 respectively. In fiscal 2024, we continue to expect CapEx to be in the $8,000,000 to $10,000,000 range. In fiscal 2024, we anticipate net interest expense to be around $17,000,000 to $19,000,000 including non cash amortization expense related to the deferred financing fees. Now to wrap up, as Jeff stated earlier, due to the softer than anticipated consumption trends in Q2, we updated our full year outlook. We continue to expect that ingredient and packaging costs will be lower in fiscal 2024 compared to last year and drive solid gross margin expansion.

Speaker 3

This provides us with the flexibility to invest in marketing initiatives that we expect will drive near and long term growth and generate solid earnings growth. Therefore, for full year fiscal 2024, we anticipate net sales growth driven by volume to increase around the midpoint of the company's long term algorithm of 4% to 6%, including the benefit of the 53rd week. And adjusted EBITDA is now anticipated to increase 6% to 8% versus last year. We appreciate everybody's interest in our company and we're now available to take your questions.

Operator

Thank you. We will now be conducting a question and answer Our first question has come from the line of Matt Smith with Stifel. Please proceed with your questions.

Speaker 4

Hi, good morning, Jeff and Sean.

Speaker 3

Good morning. Good morning.

Speaker 4

The overall active nutrition category growth slowed in the 1st calendar quarter of the year. That's during the key diet season. You talked about the competitive dynamic impacting Quest and Atkins. But from a high level, was the performance of the overall category in line with your expectations? And are you seeing any signs of a pickup in growth in the category as we move past March?

Speaker 2

Yes. No, the category continues to show strong growth. It certainly has slowed versus the past couple of years. If you look backwards, you see a bump coming out of COVID and then you had a lot of inflation driven growth. We're now back to around 6% or 7%, which is where the category was pre COVID.

Speaker 2

And additionally, it continues to be a standout category versus most of the same store, whereas volumes are flat. And that reflects some underlying drivers, health and wellness trends, snacking and convenience. It's got low household penetration that we've talked about before and it over indexes with younger consumers. So we continue to be excited where the category is just performing. It's right where we expect it to be.

Speaker 2

And retailers see that too. That's why we're working with them on how to even further accelerate that growth.

Speaker 4

Thank you, Jeff. And as a follow-up, the lowered revenue guidance includes a 7% reduction in POS for Atkins for the year. Does that outlook consider improving dollar consumption from here? Are you looking at dollar consumption for the Atkins brand and believing you can hold that level and then you benefit from easier comparisons in in

Speaker 2

January, February. Obviously, we've in January, February. Obviously, we walked into some tough competitive merchandising comp. We still remain confident in the long term vitality of the business. And as we look forward, we certainly have seen trends and proven to come out of January February.

Speaker 2

And certainly, for the balance of the year, we do have easier comps. And that's why we expect the business to return more to that mid single digit decline.

Speaker 3

And Matt, if you look at it by for Q3 and Q4, then Q3 is relatively in line with what we saw in Q2, slightly better in Q4 because we get some easier laps, as you said, overall. So we're not expecting drastic changes in the trajectory in the next period of time.

Speaker 4

Thank you. I'll leave it there.

Speaker 5

Thanks.

Operator

Thank you. Our next question has come from the line of Alexia Howard with Bernstein. Please proceed with your questions.

Speaker 6

Good morning, everyone.

Speaker 5

Good morning.

Speaker 6

Okay. Just a couple of quick questions here. You've got innovation stepping up and it feels as though we've been through a few cycles of innovation over the last few years, some of which haven't worked, some of which has. What metrics do you use to make sure innovation is successful and sustainable in the marketplace? And how do you track that over time to make sure that you're calling things that aren't going to work and obviously supporting things that are?

Speaker 2

Yes. I mean, Alexia, I'd probably point to the innovation on Quest, which has been, I think, a standout and a major driver of growth and very successful. If you look at chips, for example, we're seeing 40% growth in that business, and it continues to be highly incremental. We're excited about the Bakeshop platform that we have coming up on Quest. I'd say the innovation on Quest has been incredibly successful and certainly retailers view it that way and continue to reward us with more space.

Speaker 2

If you look at Atkins, and I've been quite transparent about this on previous calls, we were very disappointed with the quality and level of innovation on Atkins over the past couple of years, which has contributed to the slowdown in the brand. It's why we have jump started innovation on Atkins, was certainly one of the my priorities coming into the role. And I think the quality of the innovation we're bringing to market on Atkins over the next yes, we'll start in the fall and thereafter is much stronger. Where we've tried to push is innovation that's more incremental to the business, more platform focused. But we do know that on Atkins, what we're trying to do is hold on to shelf space and replace underperforming items with that with the innovation.

Speaker 2

So the jobs are different on innovation for both businesses. Right now, on Atkins, it's replacing underperforming items with better items. On Quest, it is about innovation that is incremental to the business and incremental to the category.

Speaker 3

And Alex, just to touch on your process question, I think a little bit there. When we kind of launch any new innovation, we go through a process internally. What the metrics we kind of look at as we go out there are ACV build, then turns per week and then related to that kind of repeat purchase. So those are the metrics we kind of model out before we launch anything and then we evaluate that performance if you want to call it that over the 1st 6 months or so of the launch see how successful it would be.

Speaker 6

Really appreciate the detail from both of you. I'll pass it on. Thank you.

Speaker 3

Thank you.

Operator

Thank you. Our next questions come from the line of Steve Powers with Deutsche Bank. Please proceed with your questions.

Speaker 5

Hey, thanks guys. Sorry, I was on mute there. Hey, a first question on Atkins and weight management category dynamics in general. You talked about the expectation that the competitive environment and competitive dynamics would normalize as we go through the calendar year. I guess a little bit more perspective on where your confidence comes from in that and

Speaker 7

yes, we'll take it from there.

Speaker 2

Yes. No, the reality is that this time last year, as we talked about in the prepared remarks, one of our major competitors had supply challenges. And that was particularly acute over the January February period. And as a result, Atkins benefited significantly, particularly in a few customers from outsized merchandising and promotional support, which we obviously didn't get this year. So that was going to be a difficult lap.

Speaker 2

And that competitor is now back and able to service the business. So it was an inevitable difficult New Year, new season, but we will lap that. And as we've come out of January, February trends have improved. And I'd say by around the summer, we should be largely lapped. That effect should be largely lapped, which is why our comps should get easier.

Speaker 2

Okay. Yes. Okay. Makes sense.

Speaker 5

And then pivoting over to Quest, you highlighted, Jeff, the ready to drink coffee innovation, which is interesting to me. I guess as you think about the pipeline for Quest from an innovation perspective, what do you how big a role do you think beverages will play versus further endeavors in food? And if beverages are envisioned as kind of a material driver of the franchise going forward, How do you think about prioritizing future consumption occasions versus immediate consumption occasions and just see the complexities of reaching different channels, especially on the immediate consumption side?

Speaker 2

Yes. I mean, the thing that has driven the success of Quest Innovation is the brand flipping we call them flipping the macros on large snacking categories. So flipping the macros from high sugar, high carb to high protein and low sugar, which is what we've done with our iced coffee launch, and I'm excited to see how that performs. It's certainly early days and we'll monitor it closely. And if we continue to do well, we'll continue to double down there.

Speaker 2

Your question on beverage,

Speaker 1

just by rest assured, we're looking

Speaker 2

at it. It's obviously it's a large category. And if we can find a way to go in and disrupt that category in a way similar to how we plan to disrupt sweet baked goods, we would certainly look at that. And even drawing a broader circle, where we see those opportunities to give Quest consumers the same quality and taste that they desire of large snacking categories, we're looking at it.

Operator

Our next questions come from the line of Pamela Kaufman with Morgan Stanley. Please proceed with your questions.

Speaker 8

Hi, good morning.

Speaker 3

Good morning.

Speaker 8

How are you thinking about your revenue progression over the back half of the year and what gives you confidence that you can deliver on the updated revenue guidance? I guess, and where do you see potential for upside or downside to your new outlook?

Speaker 2

I'll start and maybe turn it over to Sean. I'd say the upside is we are moving into easier what we believe will be easier comps on Atkins. And we do remain confident in the revitalization plan, the new advertising. We're confident in the new innovation that's launching, albeit towards the end of our fiscal. And we're going to walk into easier comps.

Speaker 2

So there could be some upside there. And on Quest, the momentum that we've seen just looking at March, mid double digit is very encouraging. We've just launched new advertising that launched in the beginning of March. So that gives us a lot of confidence. And then Quest 2 is bringing some pretty exciting innovation to market.

Speaker 2

So there could be some upside there. But I'll turn it over to Sean.

Speaker 3

Yes. I mean, I think if you take a look at the brands, I mean, Quest, we're assuming from assumption standpoint, low double digits, and as Jeff said, through March, so only 4 weeks in, we're at 13%, a little bit higher than that. So feel like we're trending a little above where we thought. We'll see what happens. So feel pretty good with that.

Speaker 3

We also have the advertising we turned on, which I think is going to help overall from a consumer awareness and household penetration standpoint. So I feel very comfortable with where we are with Quest. On Atkins, I think we put ourselves in a position where we have a, I'll say, realistic target to chase in the second half of the year. As I mentioned, Atkins is basically consistent with the decline we saw in Q2. For Q3, slightly better.

Speaker 3

And as of in Q4, I'm sorry. And then as it relates to the 1st month of the quarter, we're trending down about 6%, as I think you saw on the slides, which is better than what we thought from a standpoint of the quarter. So again, early 1 month in, but feel what we're tracking ahead of where we thought we were going to be.

Speaker 8

Okay. That's helpful. And then can you talk about any adjustments that you're making to your strategy this year given the performance and competitive dynamics you saw during the Q2? You mentioned that you're accelerating some innovation like the protein shakes. Can you expand on any other changes in your innovation timing or changes to advertising or promotional plans for the year?

Speaker 2

Yes. I might say at a high level, we're not really changing our strategy. The impact that we felt on Atkins in January, February, it was a one time difficult lap as we talked about in the prepared remarks. But we remain confident in the future vitality of the brand. We remain confident in the revitalization plan we've talked about, the innovation we're bringing to market, the new packaging graphic work that's underway, the product upgrade work that's underway, the new advertising, and we're certainly going to stay the course there.

Speaker 2

We'll make adjustments if we need to, but certainly wouldn't overreact to a merchandising difficult merchandising lap in January, February.

Speaker 8

Thank you. I'll pass it on.

Speaker 5

Thank you.

Operator

Thank you. Our next questions from the line of Jim Salera with Stephens. Please proceed with your questions.

Speaker 5

Hi, guys. Good morning. Thanks for taking our question. I wanted to drill down a little bit on the Atkins strong offering. Exciting to see you guys expand the RTD shake offering.

Speaker 5

Obviously, it's been a really hot category. At the same time, it's also a category that has pretty well known capacity constraints. So if you could offer any color on co manufacturing partners, how much capacity you guys think you'll have when that product kind of comes to market and if we should expect it to be maybe just in club or just in mass or kind of how channel rollout will be as you expand that 30 gram offering?

Speaker 2

Yes. We're also really excited about this launch. It was designed as we've seen these weight loss drugs emerge and adoption increase and we've learned that consumers on those drugs are seeking higher levels of protein to maintain muscle mass when they lose weight. And we've also heard that when they're on the drugs, many experience gut health issues. So we developed this product, the primary consumer with those on a weight loss drug.

Speaker 2

But we know that there's consumers out there who are seeking high levels of protein. So we're excited to bring that to market. We're going to put a lot of support behind it. Retailers have been candidly very impressed with how quickly we moved to develop a product for consumers on these drugs. To your question on capacity, we feel we're in a good spot.

Speaker 2

It's not a limited launch. We will launch it nationally, and we've had extremely strong support.

Speaker 3

Yes. I think on the capacity side, just to take a step back, when I go back about a year, year and a half ago, we had some capacity constraints, basically got another co man on board in terms of additional capacity. So we have expanded the capacity that we have for RTDs in general overall and we're actually think we have enough to support both that business as well as the continuing business we have overall. So we feel like we're in pretty good shape there.

Speaker 5

Okay, great. And then maybe if I could ask a broader question just on the consumer. We've heard from other companies there's kind of this bifurcation of the higher income consumers still powering forward and lower income consumer maybe feeling a little bit more pressured. Since your products tend to skew towards middle to higher income consumer, do you have what's your confidence level as the year progresses that the higher income consumer will continue to be resilient relative to the overall kind of economic uncertainty?

Speaker 2

Yes. I mean, we continue to see the category perform. The category performed year after year after year. And I think in part it is for the reason that you cite is that we do over index with higher income consumers. So I think we're a little more insulated.

Speaker 2

I would point to the relative lack of private label in the category. I would point to the relative lack of heavy promotional activity in the category. And I think it shows the underlying consumer demand, which to your point, I think is reflective that we over index with higher income or educated consumers.

Speaker 5

Great. Appreciate the color guys. I'll hop back in the queue.

Speaker 3

Thank you.

Speaker 2

Thank

Operator

you. Our next questions come from the line of John Baumgartner with Mizuho. Please proceed with your questions.

Speaker 5

Good morning. Thanks for the question.

Speaker 3

Good morning, John. Good morning, John. Good morning, John.

Speaker 5

Maybe first off, Jeff, you mentioned the heightened category competition around New Year, New You. I think you called out one specific competitor. But I'm curious, can you expand a bit on competition more broadly? Are you seeing competition based solely on pass through of a lower input cost and that moderates throughout the year as those tailwinds also moderate? Or is there also any heightened activity from new innovation hitting the shelves or a larger intensity also impacting feature display activity?

Speaker 2

Yes. I mean, I would probably take a step back and say the level of activity in this category, I think, is what you would expect, right? Innovation can play a role and you've certainly seen what we've been able to do with Quest Chips, which was essentially to create a category or segment that didn't exist. The heightened level of competitive activity that we talked about in the prepared remarks really does relate to some out of stock challenges on shakes. And the industry constrained, had been constrained for a couple of years.

Speaker 2

And obviously, with that being turned back on, you've seen demand being able to be supplied. But I wouldn't say that this is a new level of competitive activity. I think it was an inevitable lap, and one that we were always going to be on the wrong side of and in the New Year period. But now with supply back, I'd say we're going to return to normal level.

Speaker 3

Yes. I think, John, if you take a step back and look at last year with one of the key competitors in this marketplace for RTVs having less availability or capacity. The shelf space they had was less. So now they got that back and they've actually added not so much innovation, but if you want to call it pack size configuration, so 4 packs to 8 packs to 12 packs as well as maybe more space devoted to that competitor for display. So you're really seeing, I think, 2 years of growth in 1 quarter versus what we've usually see out there.

Speaker 3

So we stepped up our merchandising activity and programming. It's just the share of voice was less than what it was comparatively to everybody else. Does that help?

Speaker 5

Yes, definitely. And I guess sticking with that theme, I guess last quarter it sounded like your initial perceptions on new marketing coming out of autumn was pretty encouraging in the early days. I guess building on your point there Sean, do you get the sense that the ROI in that marketing, does it require further increases in spending from here to sort of maintain share of voice? How do we think about that? And then for the Atkins brand milestones going forward, I guess how impactful are you expecting the autumn shelf resets to be in terms of jump starting sales?

Speaker 5

Should those autumn resets really be viewed as material catalyst or to the point?

Speaker 2

Yes. The advertising, we're really pleased with the new advertising. It debuted in October. We saw the business respond. Certainly, it's probably too early to draw a hard line on that.

Speaker 2

But just given the magnitude of the merchandising lap that I talked about in the prepared remarks, it's very difficult, if not impossible to judge the effectiveness of that advertising in January February. And as a proof perhaps of that, we've come out of the New Year and New Year period and trends on the business have improved. As I said, the ads tested very well. They tested well with both current buyers and potential new buyers. But with that being said, we'll continue to monitor performance over the coming months.

Speaker 2

And if we try to make changes in the advertising, we will. To your question on distribution, I recall we're category advisors to the majority of our key retailers. And as such, we have a lot of dialogue with them about the category and brand dynamics. We recently wrapped up a road show, visiting all those customers, talking about the brands and in particular Atkins. An emphasis of those conversations was the new conversation and renewed cultural relevance, I would say, of weight because of these weight loss drives and what consumers on those drives are looking for and how they want an off ramp.

Speaker 2

The retailers get it. They appreciate our transparency. They are supportive of the revitalization plan. And we're currently in conversations with them about the modulars and they will play out over the coming 2 to 4 months.

Speaker 3

Yes. John, just one more color here. I think as you think about the rest of the year and the guidance we gave on EBITDA, one thing should be clear on that I hope overall, the gross margin should meaningfully improve in the next couple of quarters, approaching 39% in both Q3 and Q4, a little better in Q4 than Q3. With that, we're continuing to invest in the brand. So we did not reduce marketing spend to get to that number.

Speaker 3

That wasn't what we did. We basically took the benefit that we had for gross margin in Q2 and what we're seeing in Q3 and Q4 that allowed us to continue to invest and you're going to see meaningful increases particularly on Quest with new advertising in Q3 and Q4.

Speaker 5

Okay. Thanks, John. Thanks, John.

Speaker 3

Thank you. Thank you.

Operator

Thank you. Our next questions come from the line of Kaumil Gajrawala with Jefferies. Please proceed with your questions.

Speaker 7

Maybe if I could follow-up on the comment on ad spend.

Speaker 2

Could you maybe just talk

Speaker 7

a little bit more about what's the right percentage of sales for ad spend, particularly in the context of there's so many new innovations this year. Does it need to be at some higher level for a temporary period of time and then sort of taper off? Or is where you're going linked to what you mentioned before, some of that GM benefit that you're about to feel?

Speaker 2

So we would historically target spending 9% to 10% on marketing. What I will say is that is a high level of spend in the food beverage category in general and certainly a very high level of spend within our category. And that's the role that we play as category leaders. As to your question on how to support innovation as well as the core business. What you'll see in both campaigns is that they have been developed to enable us to do that.

Speaker 2

So I don't know if you've seen the new ads on Quest, but they have been constructed to enable us to support the multitude of different products on the brand, while also driving the overall brand awareness and delivering the positioning of the brand. So what we don't like having to make a choice between support the core business or innovation, what I like to do is have advertising that you can input innovation into that ad and it still works.

Speaker 3

A couple of data points for you just as you take a step back and look at this. I mean, I think our model has been since the beginning in terms of the P and L profile, try to get to gross margins around 40%, try to get to advertising or marketing spend in the 9% to 10% range and EBITDA margins around 20%. And I think we're getting back to that after some issues we had last couple of years for some commodity inflation. As it relates to the total marketing spend, you probably saw in the results were up 100 plus basis points for the quarter in the first half of the year. That will continue in the second half of the year.

Speaker 3

So you'll see marketing spend closer to 9 ish percent for the rest of the year.

Speaker 7

It's useful. Thank you. And just a quick follow-up boring question. 53rd week, any context on contribution? And do we just take it out of next year?

Speaker 3

Yes, absolutely take it out of next year, yes.

Speaker 2

Let me answer that

Speaker 3

one first. So then the 53rd week, I mean, I think historically we've said it's a little bit more point of growth. You just can't take 52 or 1 divided into 2 and I'd say here's how much they're worth because with the way our fall resets work, we generally speaking ship those sort of early August, mid August. So we don't get the replenishment of that probably till mid September. So it's just a little more than one point of growth overall.

Speaker 3

We don't have the specifics of that at this point in time. We'll have better clarity on that I hope in Q3.

Speaker 7

Got it. Thank you.

Operator

Thank you. Our next has come from the line of Brian Holland with D. A. Davidson. Please proceed with your questions.

Speaker 9

Yes, thanks. Good morning. I wanted to go back to the competitive dynamic component, because we're seeing a pretty clear divergence between bars and shakes. The entire bars category has been softer of late. And then within shakes, there's sort of a bifurcation between the weight management and some of the other heavier protein products.

Speaker 9

So maybe a 2 part question here. 1, I guess I'm a little bit surprised to hear the attribution for the weakness when it's coming from the I guess the growth is coming from shakes that you're talking about. That's where the supply is improving. So the impact it's having on bars and everything else. So maybe a little bit more color around just understanding why you think that is particularly impacting Atkins because I guess I'm surprised that we would see that level of shopping, cross shopping between those brands?

Speaker 9

And then the second one is not necessarily a new dynamic. We knew that supply was coming It's something that had been communicated, something that's been ongoing. So maybe so I guess to the extent that it's hitting your business at a level or at a magnitude greater than expected. So was the impact of that supply coming back online just greater than what you thought and the consumer response to it greater than you thought? Because it doesn't seem like something that we didn't know was coming.

Speaker 2

Yes. No, that's fair. And I'll address your first question, which is the observation on bars. I guess the first thing I would comment is, while bars growth have slowed, Quest has proven to be an exception to that. Quest bars are up mid single digits.

Speaker 2

And we're very pleased with that level of growth. But certainly, you have seen shaped growth outstripped a bar growth. And honestly, as we've talked about, that's not really a supply not a surprise because supply was constrained for 2 years. So I think as Sean said in response to an earlier question, what you're seeing was shaped essentially 2 years of growth in 1. And that dynamic has played out January, February and will until we've finished with that lap, which is more towards the summer.

Speaker 2

So and then to your question on I think your question was should you have known more than we did about the dynamic that we were going to walk into in January February, and I'd say the answer is yes. And looking forward, going forward, you should expect us to perhaps be more attuned to competitive dynamics and to think about merchandising as a share of voice versus just looking at our own plans. So you should expect that change moving forward.

Speaker 9

Appreciate all the color. And then just back to Atkins, just your messaging has been fairly consistent for the past since you talked about the revitalization plan and the potential opportunity over time with the GLP-one complement. Just curious if you've picked up anything anecdotal to increase your conviction to that end because I do think that seems to be a point of contention with investors who I hear a lot of inbound kind of inquiries about, hey, they feel like this

Speaker 5

is a head that this would be

Speaker 9

a headwind to the business because of the overlap of the consumer and maybe that they'd be changing their routine away from an Atkins just using the GLP-one. So clearly the innovation seems to be the 30 grams of protein that seems to be resolving some of this. But just curious what you've picked up anecdotal that gives you increased confidence that Atkins indeed will be a complement and GLP-one will be a tailwind for that business?

Speaker 2

Yes. I would start by saying we are in the early innings of GLP-one and we're still learning. We're doing our own studies. We're talking to consumers. We're talking to customers.

Speaker 2

We do believe that GLP-one does represent a tailwind for Atkins and a tailwind for the category. We know that when consumers are on these drugs, as I answered earlier, they have a need for higher protein products, and they have got health issues, which is why we accelerated the launch of Atkins Strong to market and we're excited about the launch of that platform. And retailers have given us a lot of credit for moving quickly and coming to market with something that specifically addresses that need. I would say that I am equally, if not more excited about Atkins as an off ramp for consumers who want to get off the drugs. There's a battle going on with insurers as you know.

Speaker 2

Our own research suggests that most people, once they've hit their weight loss goal, want to get off those drugs. They know there's a good chance they'll put the weight back on and they're desperate to find some sustainable program or sustainable way of eating to keep that weight off. And I think that's where Atkins can shine. And moving forward, you should expect us to more clearly position the brand as that off ramp, as that sustainable way to keep that weight off. So I continue to believe that these GLP-one drugs are a tailwind, but I would reiterate we are still in the early innings.

Speaker 9

Got it. And forgive me if I could just take a really quick one in. If you stated this earlier, I apologize. Was Quest in line with expectations in the quarter?

Speaker 3

Yes.

Speaker 9

Okay, great. Thank you.

Operator

Thank you. Our last questions will come from the line of John Anderson with William Blair. Please proceed with your questions.

Speaker 5

Thank you very much for squeezing me in. A question about household penetration. You talked about the category of active nutrition being relatively low relative to other center store categories. Where are you today with Quest and where is Atkins with respect to household penetration? And then as you look forward, what's the goal or opportunity around each of the brands?

Speaker 5

So as you're innovating, as you're marketing, are you looking to drive household penetration and buy rate across both brands? Is there a greater opportunity within one of those areas, thinking that that may that opportunity may differ by brand, but a little color around that would be helpful. Thanks.

Speaker 2

Yes. I'll start with the categories. So, pallet penetration of the categories are in mid-50s and that compares with high 80s, lower 90s with most same store categories, which is why we continue to see a long term runway. And if you look at where the category over index is, it is with younger consumers, millennials and Gen Zs. So we continue to believe that penetration of the category is only going to increase and certainly retailers see that, which is why they're excited to work with us on initiatives to accelerate category penetration.

Speaker 2

As you look at the respective brands, Quest is around 16% or 17% household penetration. But as we've talked about, for a brand of its size, awareness is significantly below most of its competitors, which is why we're excited about our new advertising. And then as you click one level lower with Quest, we believe there's an opportunity to drive increased Telstra penetration and buy rate, In particular, the new innovation platforms are helping to drive buy rates, right, because we're offering consumers additional snacking occasions, and that just increases buy rates. So I think on as you look on Quest, there's an opportunity to drive household penetration up as we focus on increasing awareness. Advertising is the big driver there.

Speaker 2

There's an opportunity to drive buy rate up. And in particular, I would point to the new innovation platform, salty and the new Bakeshop platform, which is offering a completely new usage occasion, right, disrupting sweet baked goods. On Atkins, the awareness levels are quite high. And so that is less of an opportunity on that brand. The opportunity on Atkins, I think, is to continue to ensure that consumers see the brand as a sustainable way to maintain weight.

Speaker 2

And I continue to believe innovation better innovation than we have launched in the past is an opportunity with that brand.

Speaker 3

Just real quick on the penetration, just a reference point for you. We're at almost 17 points for Quest right now for household penetration. If you go back a couple of years, we're actually a little bit low 14, right? So I think we made tremendous part of our growth to that brand has been distribution, but also household penetration and awareness. And I think we see that for future as we look at Quest as well as an opportunity.

Speaker 5

One housekeeping. So the balance sheet's in good shape. Your leverage ratio, I think, is below half a turn at this point. You've paid down more debt in the quarter. What is the how are you prioritizing use of excess free cash flow going forward in the business?

Speaker 5

Thanks.

Speaker 3

Yes, we had a great quarter obviously for cash generation and cash from operation. We continue to see that as a competitive advantage for us and we'll continue to see that in the second half of the year. We spent a fair amount of time evaluating the best return of cash for our shareholders, debt pay down, share repurchases, potential M and A opportunities. We'll continue to evaluate that for the second half of the year and do what we think is best for return to our shareholders.

Speaker 9

Thank you.

Operator

Thank you. We have reached the end of our question and answer session. I would now like to turn the floor back over to Jeff Tanner for closing remarks.

Speaker 2

Yes. I just want to thank everyone for their participation on today's call and we look forward to updating you on our Q3 results in late June. So have a great day.

Operator

Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect at this time. Enjoy the rest of your day.

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Earnings Conference Call
Simply Good Foods Q2 2024
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