The Simply Good Foods Company (SMPL) Earnings Call Transcript & Summary

Good morning. I'm Leah Jordan, the U.S. food retail analyst at Goldman. And it is my pleasure to introduce the management team of Simply Good Foods. We have Geoff Tanner, Chief Executive Officer; and Shaun Mara, Chief Financial Officer. Thank you both for joining us today, and thank you, everyone, for joining us as well. For a quick refresher on Simply Good Foods. It is a leader in the nutritional snacking category with its Atkins and Quest brands. And it continues to build on that portfolio with the recently announced acquisition of Only What You Need, which I know we'll dig into further today. And with that, let's get started.

So first, I wanted to start off, Geoff. You've been at Simply Good Foods for a year now. What have been some of the bigger challenges and what have been some of the bigger wins?

I'll start with the wins. As I've come to understand the category, nutritional snacking category, it is a very attractive, healthy category. It's posting mid-single-digit growth with a runway in front of it that is significant. I think we're in the early innings. Low household penetration, on the right side of the health and wellness trend, on the right side of convenience, over indexes with younger consumers. And you speak to anyone 25 to 35, they're eating protein, they're hydrating. This category has a tremendous amount of runway in front of it. So that's been, as I've come to understand that in more detail, a very positive surprise, just how healthy that category is. The second would be how well positioned we are within that category. We've got the Quest brand that is a leader in flipping the macros high protein foods. We've got Atkins that's very well positioned against weight management, and we've now picked up OWYN, Only What You Need, which is a leader in plant-based. So within that category, we are the clear leader now with a portfolio of 3 distinctly positioned brands, and we're seen that way by our retail partners, which is why we're working with them on how do we continue to grow this category. And the last surprise or not so much a surprise, I mean it was -- I did my homework before coming, but I appreciate it and credit to Shaun and team is just the profile of our P&L. 39-ish gross margins, we spent 9% in marketing, which is on the high end, and EBITDA margins of 20% and we generate a lot of cash. So those would probably be the 3 biggest positives takeaways for me after a year. The challenge for us, as we've talked about, is Atkins. On the one hand, is very uniquely positioned against weight management. I do believe that we are entering into a renewed wave of cultural relevance for weight driven by these GLP-1 drugs. But as we've looked at Atkins, we have some work to do. It's -- our innovation has not been as good as it should be. The packaging is a little dated. Some of our commercial execution was not as sharp as it should have been. Some of our products need to be upgraded. We have work to do on Atkins. We have a revitalization plan I'm probably sure we'll talk about today. So that would be the -- that's the issue that we're confronting. We've put a revitalization plan in place 12 to 18 months, and we'll get after it.

Great. That's a great overview. I think we're going to dig into all of those topics today. But I think, first, you kind of overviewed your target customer and how you're penetrating younger today. But could you provide more detail on who your core customer is? Given this focus on nutritional snacking, how do you view household penetration today? And where do you think it could go longer term?

Yes. The interesting thing about the nutritional snacking category is that it grew up as a bars and shakes category, initially primarily appealing to gym rats, crossfit junkies. And over the last 5-ish, maybe 5 to 7 years, the category has mainstreamed. And now we are appealing to a much broader group of consumers, people that have a nutritional philosophy that is about eating more protein, is about hydrating, is about low sugar. And the reason I'm so excited about the potential of the category is because we will, and the category will continue to bring new product formats that deliver against those macros. So for example, and I think Quest -- our Quest brand that's nearly $1 billion in retail, actually just crossed $1 billion in retail sales, our chips business. This is a segment that did not exist, how long, Shaun? 4 or 5 years ago, yes, and we have come out with protein chips, $300 million in retail sales. And we're flipping those macros. So we're now bringing more product forms that deliver those macros. We just launched a baked line, brownies and muffins, and you have to believe that our talented R&D team, we're looking wherever there's a large snacking category that has bad macros, you have to believe we're looking at it. We're working on how we can flip them. And as we do that, we will just continue to mainstream this category. So -- and I think we're in the early innings. Household penetration of this category is about 50% and that compares to most categories around high 80s, low 90s. So we're in the early innings. We're working with retailers on what that plan looks like. We've got innovation lined up. And I think -- I don't think it's unreasonable to think 5, 6 years from now, that we could double the size of this category.

That's great insight. I think you've talked about mainstream in the category, but we have seen a slowdown in the growth of nutritional category overall this year. Could you talk about the trends that you're seeing? And what are your expectations as we head into the back half of the year?

Yes. I wouldn't characterize it as a slowdown. I would say we're back to pre-COVID levels coming out of COVID. So the category contracted a little during COVID. It was post COVID bounce. And then there was obviously inflation that was a boost to every food and beverage category. So if you look at growth, we're 6-ish, mid-single-digit growth rate, which is consistent with where category was and very healthy versus in the store. As you look at the different segments within the category, you are seeing different growth rates. So you're seeing the highest growth rates in newer categories like chips. Our chips business is growing 40%, 50% right now. Shakes is doing very well. Bars is mid-single digits. I think over time, these different segments are going to grow at different rates. And one thing I love about the profile of our company is that we have a strong footprint now in every single one of those segments. So we've a strong footprint in bars, particularly with our acquisition of OWYN, a strong footprint in shakes, and we obviously lead in newer salty platforms and baked. And I think that, that positions us extremely well, diversified in some respects, to ensure that wherever the growth happens and how it happens and the profile of that growth, we're well positioned to benefit from it.

Okay. Great. And as the category has normalized to pre-COVID levels, we've also seen the competitive environment step up a little bit. So I guess [Audio Gap] impacted both Quest and Atkins this year? And how do you think the competitive environment will evolve as we go through the year?

Maybe I'll start with Quest. Quest is the disruptor in the category. I've worked on many brands and I've never seen anything like Quest. It's -- we just crossed $1 billion in retail sales. And Quest has proven -- it's one of those rare brands that has proven that it can extend beyond its original format. So if you look at, take Walmart, sometime this quarter or next quarter, our salty business will be larger than our bar business at Walmart. And that's why we're excited about bake platform. So I say that in the sense that Quest is a little bit of a pioneer out on its own. We don't really feel like there's a credible competitor because we're inventing new categories that don't exist. Now on Atkins, and we talked about this on our last quarterly call. We -- certainly a year ago, Atkins benefited from a large shake competitor's out-of-stock challenges. And so when we rolled into the diet season this year, we had a double hit. We did not get the benefit that we received when they were out of stock and then they came very strong. And that was why we saw declines on Atkins accelerate into the high-single digits through January, February, March. Now as we've come through that period of that difficult lap, you've seen Atkins stabilize. But that was very much a space allocation challenge that we were up against with Atkins as we came into the new year.

Great. I think that's a great overview into the brands. So I think we'll dig in a little bit further to each. So starting with Quest, and this is a brand that you guys acquired in 2019 and have expanded to several categories beyond the initial bars, as you mentioned, and chips has been a big grower. And it has grown double digits to the latest quarter. So looking forward, why should it continue to outpace the category? And how big do you think the Quest brand could ultimately be?

Yes. So Quest has been growing double-digits now -- well, I don't think it's ever not grown double-digits since we acquired it. So in 4 to 5 years, we've doubled the business. And we've done that, as I said, by being the pioneer of new segments. And chips is the poster child, iced coffee business is in early stages. Bake, we're very excited about the bake shop platform. So you can have a brownie with 10 grams of protein, less than 1 gram of sugar, and it tastes phenomenal. So I call it the iPhone of food in some respects. And we have an innovation pipeline that is unbelievably strong. And so I think that we will just continue to grow these new segments and invent new segments. Another driver of Quest is advertising, hadn't really advertised the brand prior to dropping advertising this March. And for a brand as large as Quest, its awareness level is significantly below brands like Kind and Clif and other better known brands. So we dropped this new advertising. I don't know if you guys have seen it. It's all about Quest being a cheat on chips with chips. And while it's somewhat early, the indications are that, that advertising has really driven the business. And we've seen -- now, we will have to wait for the MROI results to come back, but that early indications are that advertising is working. And on Quest, there just distribution, this channels were just not even in. So on Quest, I think that, look, is there any reason why we couldn't double the sales of Quest over the next 5, 7 -- I don't think there's any reason why we couldn't.

Great. Helpful. And then I think we'll switch over to Atkins. This is your legacy brand that you started with The Simply Good Foods. And as you mentioned, there were some softer trends recently. But you have a revitalization plan in place, so where are you in the process of that? What are the next steps you're taking? And when should we start to see that translate into some improvement?

So Atkins, obviously been around for a while. In some respects, Atkins pioneered this category. Atkins invented net carbs, for example, that's now ubiquitous. And its primary job for consumers is helping them lose or manage their weight. And when I came on to the business, the trends had started to soften and took a step back and said, well, what is the health of this brand. We heard that it's very trusted. We heard weight loss is still a need for consumers. But what we heard is it's seen as a bit dated. The innovation had not been as good as it should have, that some of our bars were not -- some of the formulas were somewhat dated. We heard the packaging looked a bit old. So we put in place a revitalization plan, about a 12 to 18 months timeline to get all those elements into the market. What I will say since joining Simply Good is, I do believe, and I alluded to it before, that the cultural conversation on weight has changed dramatically even in -- and I haven't even been CEO for a year, even in my time here at Simply. And that is driven by these weight loss drugs. It's driven by the amount of media advertising that's put behind these drugs, where there is a renewed focus on weight wellness. And that, I believe represents a potential next wave of relevance for Atkins if we can execute on the elements of this revitalization plan. And there's 2 particular elements to that. One is for consumers on the drugs, when they're on the drugs, we know, we've done our research, but I think it's widely known that people worry about losing muscle mass. So they want protein. They want hydration and many experience gut health issues when they're on these drugs. We just launched a product, we call it Atkins Strong, designed specifically against those 3 needs. It's been very well accepted at retailers. I think the bigger opportunity for Atkins is when people lose the weight, where do they -- when they want to come off the drugs, what tools, what solutions are available to them to hold on to those gains. And we are in the midst right now of sharpening our positioning and sharpening our advertising to be seen by these consumers as a sustainable way to hold on to the physical and emotional gains of the weight loss drugs. And in sum, we call it a life free of dieting. So once you've gone through the process of losing the weight, you've got to your goals, consumers are going to be looking for a way to hold on to those gains. And I think -- I don't want to get too over our skis at this point. But we do see this as a potential next wave of relevance.

Early innings for GLP-1 too and we hope that's still very early.

Yes. That's very helpful. And then I think we'll switch over to your third brand, which is new, and as we previewed at the top, you recently announced the acquisition of Only What You Need or OWYN, which is a ready-to-drink protein shake brand. Can you talk about how this fits into your overall portfolio? What is the opportunity you see? And how does this factor into your longer-term algorithm as well?

So if you take a step back, Shaun and I did a lot of work on -- we generate a lot of cash. And so one of the first things we does is, we said, okay, if we wanted to look at M&A, what kind of criteria would we be guided by. And we wanted something that would be more incremental to our portfolio, that would either get us into a new segment, reach a new consumer that we can't reach today. And so we did a lot of work, we screened a lot of potential assets. And OWYN popped right to the very top for those reasons. One, we have a gap in high protein shake as a company. So this helps us close that gap. Second, this is a clean label, plant-based business. Neither Quest nor Atkins are clean label or plant-based. So it's highly incremental. It's a new consumer, it's a younger consumer. So very simplistically, if you look at our portfolio, Atkins skews little older towards boomers. Quest, simplifying here, but Gen X, millennial. OWYN is Gen Z, right? It's a younger consumer group. And so that combination also helps us with retail as a category captain and adviser when we now add this new brand into the portfolio. And then you just look at the strategic and financial rationale behind it, they operate on the same operating model as we do. So the synergies are not -- I mean they're not difficult to get, these synergies. The -- we have, I think, a very -- a lot of credit to Shaun and the team, the Quest playbook that they ran to integrate Quest was very successful. And the other thing is we're a growth company. Our investors expect us to grow our top line. And OWYN has in the last 4, 13, 26, 52 had triple-digit growth. And we think that we -- because of our platform, because of our scale, for example, in sales, we can continue to maintain a very high growth rates on that business and help them accelerate their ambitions and their plans. Anything you'd add, Shaun?

No, I think the models are exactly the same, right? I mean the co-mans are the same co-mans, the customer base is largely the same customer base. So it fits right into our distribution logistics model, we'll have some pretty easy synergies on that. As Geoff said, the playbook is something that we've done before for Quest, distribution opportunities, our expansion into other categories. And as Geoff said, I think the best thing is it just kind of balances the portfolio across the consumer as well as kind of this is an area we couldn't go with brands that we have. So it will be a positive impact for us, and I think it will be a big win for our portfolio overall.

Great. And just as a follow-up to that discussion, how do you think about balancing this integration of OWYN with also the revitalization plan at Atkins at the same time?

Yes, it's a good question. We talked long and hard about that. We have drive the growth on Quest. To your point, we have a revitalization plan to execute on Atkins. We don't want to get distracted from that. So we've made a decision that we will largely run OWYN separately for a year. In part, that reflects the strength of the OWYN leadership team, the plan, but it also will enable us to maintain focus where we should, right, which is pouring gasoline on Quest and the revitalization plan on Atkins.

And if you remember correctly, for Quest integration, we kind of had to step away for about 9 months. So it's not that dissimilar as kind of how we approach the whole thing. And the way the synergies sort of work here is most of them, almost all of them are we call it the big bangs when you get them onto the same platform, our systems, our warehouse, our trucks and everything else, it will -- that's where the synergy pop. So we want to make sure we get to that, but we want to make sure we actually run the business separately for a little while, and we need to learn about it, obviously, as well. So I think it will be -- it will fit right into that and as Geoff and I have talked, we want to make sure we don't distract the organization. We got a $1.4 billion business over here, a $100 million business over here. So let's not lose focus with this. So it will be a small team that will be involved with the integration, but we feel very confident in the integration.

That's very helpful. I just wanted to go back to something you were talking about earlier on innovation. It seems like that's stepping up this year across all of the brands. Just you had mentioned forms, but just wanting more detail, what are the plans for this year? What's the opportunity you see around innovation? And then as you execute, what are the signs that we should be looking for that these efforts are gaining traction?

I'll start with Quest. I'd say expect us to continue to focus on that salty platform. I'm very excited about our salty business. And I look at the total -- think about the size of the total addressable market. And we know from our source of volume studies that the majority of consumers who were sourcing were sourcing from mainstream chips. And that is an enormous market. So expect us on Quest to continue to support that with new products, new sizes, channels. I mentioned on Quest, we're also trying to disrupt the $4 billion sweet baked goods category with brownies and muffins. So those would be the 2 larger areas we're looking at, but we need to continue to bring new news on bars and keep that business vibrant. So the Quest is an innovation machine, and as I said, our strategy is not that complicated. You look across the store, you see a large snacking category with bad macros and where we can flip them, we flip them. right? And on Atkins, and I've been quite public about this, disappointed with the recent innovation that's come out of that business over the last couple of years. So came in and really tried to jump start innovation on Atkins. I'm pleased with the team's response to that challenge. I believe the recent innovation that we're bringing to market is significantly better than it's been in several years and I agree with that, Shaun. We're launching gummies, truffles...

Baked bars...

Yes, baked bars. The innovation on Atkins I'm actually most excited about is this strong platform, Atkins' strong 30-gram shake with fiber designed primarily for consumers on the drugs, but more broadly for consumers looking for a 30-gram shake. And look, we know that with Atkins, we needed this innovation to try to maintain shelf space. We were under pressure given our performance. And one of the drivers of accelerating the pipeline on Atkins was to try to hold on to that shelf space. We'll probably lose a little bit at a few customers. But overall, I've been pretty pleased with the response of retailers to the new innovation we're bringing.

Yes. I think a couple of points on innovation. I think when we go back to the Quest integration, I think the R&D team and the R&D leaders that we had from that acquisition is really a competitive advantage for us. And we've seen that repeatedly through the last few years on that. I think a complement to Geoff, I think we've really accelerated the pipeline on Atkins since he's taken over. And I think that's been a positive from both a retailer standpoint as well as a consumer standpoint. Last point I'll make is, I think, as we think about growth, it's innovation, it's the brand, but then it's also the space at retail. And so I think the other initiative that we have kind of working behind the scenes is what we call [ Campaign 3.0 ], which about gaining more space at retail, convincing our retail partners why this makes sense to invest more space in -- rather than being an 8-foot linear spot for nutrition stacking, it's going to be, I'm making up numbers, whatever those numbers would be. So you kind of have to work both of those in parallel to kind of get there at the end of the day. So I think we see the great opportunity for the category, which will allow us to be a bigger part of the category.

You didn't ask about -- or I didn't talk about innovation on OWYN. It hasn't -- deal hasn't closed yet, but the thing -- perhaps the one thing that excited us most about OWYN was their product enhancements that have been made on that brand over the last couple of years. There are a lot of plant clean label brands that don't deliver on taste and as a result, can remain somewhat niche, okay? OWYN, based on our own independent testing, and this is probably the factor that made us say we're going to get this deal done, when we did our own independent testing, we found that OWYN products had gotten much closer to the dairy-based mainstream product. And when that happens, that is when you start seeing a business crossing over and the total addressable market becomes much larger. So that -- and then the other aspect on OWYN is right now, it's a shake business. We also see the potential potentially to go into other formats.

Thank you. Yes, thank you for adding that on. That is great. And then as we're talking about investing in the business behind innovation, you're also investing more in advertising. We're seeing that spend pick up a little bit this year as you're investing behind all the brands. Should we think this is the new level that the business needs longer term? Or how are you thinking about that? And then how do you balance investments overall between advertising and brand building as well as innovation?

Yes. I'll talk advertising and pass it to Shaun. I think the level we're at is probably right where we need to be, give or take. I know we throttled it back a little bit. So we increased it this year. It's always intrigued me when we talk advertising, people always measure it in how much are you spending, which is certainly a factor. But the 2 biggest drivers of how effective advertising is how good are the creators and how good is your -- what's your reach levels, okay? And I think if you look at Quest, Quest had been advertising. Judgmentally, I don't think it was any good. Creatively, we put out new creative with cheat on X with Y, the business responded. We had been too narrow in our media targeting. We increased our reach, the business responded. So I think our levels are right. What we need to make sure is that creative is consistently brilliant and we are prioritizing reach versus frequency, but I'll kick it to you for now.

Yes. I mean the shape we kind of like is around 40% gross margin, around 20% EBITDA, as Geoff said, and then around 9%, 10% in terms of advertising or marketing spend, right? So we kind of use that as sort of the anchor. I mean, there are times when it's plus or minus 1 or 2 points, but generally speaking, we do that. We spend a fair amount of time looking at the investment choices that we're making in terms of trade, advertising, G&A, innovation, and we're a pretty lean organization. So those -- that also is how much you can get through the organization and make it effectively work well overall. So I think we're at -- the model we have is pretty much where we go right now from a P&L standpoint.

Okay. Great. That's very helpful. And I think as we're on the margin topic, I just want to lean into that a little bit more. Over the last couple of years, we've had significant input cost inflation, but now some of that is starting to moderate, maybe even some reversal there and you reported a gross margin expansion last quarter. So just seeing if you could talk about what you're seeing across your various commodity costs today? And then how much you could see that maybe drive gross margin expansion throughout the year?

Yes. I think Q2, we reported better than we expected for gross margin, which was great. I think if we look to the rest of fiscal '24, we're pretty much locked in on commodities at this point in time. We usually buy out about 6 months or reserve about 6 months. We'll be probably 150 basis point improvement versus last year for overall gross margins for the year. Second half will be 39 -- around 39 for Q3 and Q4. So we feel really good about where that is. I think commodities overall, it kind of come back to, I'd say, more pre-COVID levels. If you look at the averages where it is now, most of the commodities are pretty much where you think it will be. Pre-COVID, the way we kind of looked at the inflation was it was pretty mild inflation and we have productivity kind of offset that inflation which we did pretty much before COVID. I think we're getting back to that model with the exception of cocoa. Cocoa has been a challenge. It's not -- it's about 5%, give or take, of our overall cost of goods sold. So it's not a huge piece, but it's kind of crazy right now. I think it's come down a little bit in the last couple of weeks. So we need to figure that out as we get into next year and with the implication, we're starting '25 planning right now.

Okay. Great. That's very helpful. And I think we have time for 1 more question, so I'll sneak 1 more in. Just to wrap this up, if you could provide an update on how you're thinking about capital allocation going forward? Even going back to the OWYN acquisition, it sounds like at close, you're expecting a step-up in net leverage to 1.5x. So any update there would be helpful.

Yes. I mean, I think we'll end up far above 250. We threw off about $94 million in cash from operations in the first half of the year. That will be likely about the same amount in the second half of the year. So as Geoff said, we have a very nice model in terms of cash generation. We'll probably be a little bit less than 1.5x levered if I had the gas by the time we finish this thing. We'll pay that off in a couple of years, give or take. And I think we spent a fair amount of time on cash and return to our shareholders. So we look at acquisitions, we look at share buybacks, we look at potentially dividend and then M&A. So I think we'll continue to do that going forward. I don't think this takes us out of anything and we can look at all those different options that are there overall. And we're very comfortable with 1.5x leverage, if not lower than that overall. It will be paid down pretty quickly.

Great. Thank you, both, Geoff and Shaun. This has been very helpful and insightful today.

Thank you.

Great. Thank you.