STKL - NASDAQ

Greetings, and welcome to SunOpta's First Quarter 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Reed Anderson with ICR. Thank you. You may begin.

Good afternoon, and thank you for joining us on SunOpta's First Quarter Fiscal 2023 Earnings Conference Call. On the call today are Joe Ennen, Chief Executive Officer; and Scott Huckins, Chief Financial Officer. By now, everyone should have access to the earnings press release that was issued earlier this afternoon and is available on the Investor Relations page of SunOpta's website at www.sunopta.com. This call is being webcast, and a transcription will also be available on the company's website. As a reminder, please note that the prepared remarks which will follow contain forward-looking statements, and management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance, and therefore, undue reliance should not be placed upon them. We refer you to all risk factors contained in SunOpta's press release issued this afternoon, the company's annual report filed on Form 10-K and other filings with the Securities and Exchange Commission for a more detailed discussion of the factors that could cause actual results to differ materially from those projections and any forward-looking statements. The company undertakes no obligation to publicly correct or update the forward-looking statements made during the presentation to reflect future events or circumstances, except as may be required under applicable securities laws. Finally, we would like to remind listeners that the company may refer to certain non-GAAP financial measures during this teleconference. A reconciliation of these non-GAAP financial measures was included with the company's press release issued earlier today. Also, please note that unless otherwise stated, all figures discussed today are in U.S. dollars and are occasionally rounded to the nearest million. Please note in the prepared remarks that follow, the company will generally exclude the impact of the divested Sunflower business. I'd like to now turn the call over to Joe.

Good afternoon, and thank you for joining us today. If I was to summarize the quarter in 2 words, those words would be continued strength. We delivered a significant improvement in profitability with the last 12 months adjusted EBITDA now over $90 million. We continue to execute well against our 5 strategic imperatives, and we continue to see strong underlying trends in our core businesses, giving us a high degree of confidence in our outlook for 2023 and beyond. Let me offer some key takeaways before we begin unpacking the quarterly results. Our focused efforts to drive profitability across the company delivered a record level of adjusted EBITDA. Q1 adjusted EBITDA increased 50% to $23.6 million. Our core strategic growth areas, including plant-based milk products and fruit snacks continued to drive strong growth in Q1. In Plant-Based, revenue growth remains broad-based with our plant-based milk products growing 25%. The ramp-up of production in our Texas plant is progressing and will materially contribute to growth in the second half. Thank you again to the 30-plus guests who came to Texas on April 11 to see our new 285,000 square foot greenfield plant up and running. Our business development pipeline has never been stronger, supporting our long-term growth algorithm of doubling the Plant-Based business off of the 2020 base. We continue to see strong demand and growth in our fruit snacks business, which on an LTM basis is now almost $100 million in revenue, up from $50 million in 2020. Execution in our manufacturing plants continues to be strong, and execution in general, continues to be a defining factor in our performance and gives us a high degree of confidence in our outlook for 2023. Lastly, oat milk and foodservice continues to more than double quarter-on-quarter. This success is creating some reprioritization within the business as it relates to usage of our proprietary oat base and line time on our half gallon fillers. For the total company, first quarter revenues were up fractionally from a year ago as the growth in Plant-Based was offset by revenue declines in frozen fruit. Our profit expansion continues to reflect growth in key strategic categories and value-added offerings, along with pricing actions and steady progress optimizing performance across our business. Consolidated adjusted gross profit, which excludes start-up costs, grew more than $5 million in Q1 or nearly 20%. This improvement was a result of strategic mix shift and strong operational performance in our manufacturing plants. We saw operational efficiency improve. We delivered best-in-class case fill rates, and we saw improvements in employee retention. Now I'll turn to our segment results, starting with the Plant-Based Foods and Beverages segment, where we remain focused on 3 strategic priorities: #1 strengthening and fortifying our competitive advantages. #2, expanding the TAM of the business, including winning an oat milk and entering the protein shakes category and 3, building a multipronged go-to-market business model, thereby creating multiple ways to win. Plant-Based segment revenues were up over 9% in the first quarter to $129 million, driven by 2022 pricing actions. We saw strong growth in our core plant-based milk products and teas, partially offset by declines in broth and ingredients, which were trade-offs to support the rapid growth we're seeing in packaged oat milk sales. Starting with customers. We continue to see broad-based growth in the first quarter with 3 of our top 4 customers growing by 40% or more. This is a result of both their growth and SunOpta winning a larger percentage of their business. Our performance in core plant-based milk products remain strong with revenue and volume growth of 25% and 6%, respectively. These products accounted for nearly 3/4 of our plant-based segment revenue. In addition, our tea business remains extremely strong with revenue and volume growing significantly as a result of us gaining supply share. Broth revenue was down 29% in the quarter as we exited a portion of our broth business, specifically the portion that competes internally for half gallon line time that we use for oat milk for our largest customer. Taking a deeper look at our core plant-based milk products performance, oat remains the key driver with total oat up 33% and packaged oat milk up 89% on a 70% increase in volume. Oat was once again the largest product type in our portfolio. Coconut milk was also up significantly as our top customer continues to feature this product. We also saw soymilk grow low double digits. From a go-to-market standpoint, owned brands continues to deliver the highest growth rate and were up 59% versus last year, reflecting solid gains in both Dream oat barista and SOWN Organic Oat Creamers. Our co-man business was up mid-teens and private label sales were up slightly with private label plant-based milks up 31%, partially offset by broth declines previously described. While ingredient sales were off significantly, it's important to understand that packaged oat milk sales were up 101%, 46% and 89% in the last 3 quarters. This continued growth in packaged oat milk has created a supply constraint on our oat base available for ingredient customers. As such, our largest ingredient customer added a second oat-based supplier to compensate for our contracting available supply. We continue to support this ingredient customer but at a lower level. This oat base, which was used for ingredient sales will now be used in finished goods, which in total, is twice as profitable as selling it as an ingredient. Most importantly, this now creates a runway in both oat base and half gallon packaging to continue to support the strong growth of oat milk in foodservice. We expect oat-based capacity utilization to be back to full by the end of Q2 with almost all of it being used in double touch finished goods. As it relates to extraction in general, there is a customer life cycle dynamic between ingredients and finished goods, and we would expect the same dynamic to occur with our new Modesto extraction facility. Last month, many of you attended the plant tour we hosted at our new facility in Midlothian, Texas. As a reminder, there are 4 distinct phases to a project like this. #1, construction and installation. #2, validation and qualification of both equipment and products, #3, start-up ramp up; and #4, steady state production. The past 5 months have been a whirlwind of activity, and we have finally completed the gauntlet of onetime important, necessary but time-consuming elements of validation and qualification. And we are now excited to be shifting gears towards full-scale production on the first 2 lines. This Texas facility is the final piece of our broader expansion initiative to double capacity and will serve as the cornerstone of our growth agenda. Volumes will be ramping up over the next several months, including the initial production run from our 330-ml protein shake line, which started on Monday. As exciting as this is, we don't anticipate a recognizable contribution until the second half of 2023 as the initial 2 production lines hit their stride. We remain very pleased with our business development efforts. And with the additional capacity, we're able to support the planned growth for existing customers as well as bringing on several new customers in 2023. Moving on to our Fruit-Based segment. Recall our 3 strategic priorities are: 1, derisking the business through geographic diversification, customer pricing programs and better grower relations; 2, becoming the low-cost operator in frozen fruit through automation, footprint reengineering and aggressive cost takeouts; and 3, evolving the portfolio via mix shift in innovation towards more value-added offerings. The Fruit-Based business segment revenue was down 10% in the first quarter with lower volumes in frozen being partially offset by strong volumes in fruit snacks and smoothie bowls. Trends remain very strong in our fruit snacks business, with revenues up more than 20%, driven by both volume and pricing. In addition, we delivered another solid quarter of margin improvement in fruit-based led by mix shift, pricing along with driving efficiencies in frozen fruit. First quarter Fruit-Based gross profit was flat to last year on $10 million less revenue. We continue to see new growth opportunities and are very excited for our snack capacity expansion to come online in Q3, which will enable a 40% expansion of the business over time. Lastly, I'd like to make a couple of comments about our ESG initiatives as we continue to make significant progress on this journey. Focusing on our new Texas facility, it was very much designed with sustainability in mind using energy and water saving features and using recycled materials as some of you saw firsthand last month. The Texas location will help save 15 million freight miles annually from our supply chain, eliminating 59 million pounds of carbon emissions. I'm also excited to share that we published our comprehensive ESG report on May 4, highlighting progress across the business. This report is available on our website. In summary, the first quarter once again proved the power and resiliency of our model to consistently deliver strong profitability. Our go-to-market flexibility, expanding capacity and leverageable platform provide a demonstrable competitive advantage that has proven highly durable. Our outlook for 2023 is unchanged, and we remain committed to our long-term growth algorithm of annual double-digit plant-based revenue and profit increases and increasing returns on invested capital. Now I'll turn the call over to Scott to take us through the rest of the financials. Scott?

Thank you very much, Joe, and good afternoon, everyone. First quarter revenues of $224 million were up slightly versus last year. Plant-based revenue increased 9%, with pricing up 10% and volume 1% lower. Fruit-Based revenues were down 10% as growth in fruit snacks was more than offset by lower volumes in frozen. It's important to remember that we called out in the first quarter of 2022, a significant onetime order from a major frozen fruit customer that was not repeated, so the comparison is somewhat skewed. Gross profit, as reported, was $28 million, removing the $6 million of start-up expenses, gross profit was $34 million, up 18%. Consolidated gross margin was up 80 basis points to 12.6% as reported, despite the impact of 260 basis points of start-up costs. On an adjusted basis, removing the impact of start-up costs, gross margin improved 320 basis points to 15.2%. In Plant-Based, segment level gross margin was up 60 basis points to 15.6% and would have been 470 basis points higher or 20% excluding start-up costs for Texas. The increase in gross margin reflected approximately 170 basis points of benefit from the divestiture of our low-margin sunflower commodity business, combined with operational efficiencies and the positive gross profit and margin impact of a favorable mix shift. In Fruit-Based, segment level gross margin increased 80 basis points to 8.5%, mainly driven by strong revenue growth in fruit snacks, partially offset by a higher mix of lower margin bulk frozen fruit sales. Earnings from continuing operations were $1.4 million compared to $1 million in the prior year period. Adjusted EBITDA increased over 50% to $23.6 million and was up 400 basis points as a percent of consolidated revenues to 10.5%. Turning to the balance sheet and cash flow. As of Q1, total debt was $326 million with leverage of 3.6x, down slightly from Q4 and in line with our target leverage of 2 to 4x. We continue to expect to be within that range at year-end with the first half of the year towards the high end of the range, followed by improvement as we continue ramping the production capacity that came online over the last couple of quarters. Cash provided by operating activities during the first quarter of 2023 was $4 million compared to $16 million in the prior year, primarily reflecting an increase in working capital resulting from payables timing. Cash used in investing activities was $25 million and flat to last year. We would expect a significant step down in capital expenditures for the balance of the year. Let me close with comments on our outlook, recognizing the environment remains very fluid. From a guidance standpoint, we are reaffirming our prior outlook introduced on our Q4 call, expecting revenue in a range of $1 billion to $1.05 billion, representing 14% to 20% growth. We are expecting adjusted EBITDA in a range of $97 million to $103 million, which represents 16% to 23% growth. We expect the pacing of both revenue and adjusted EBITDA in 2023 to be a roughly 45-55 split in the first and second half of the year with the back half benefiting from the ongoing ramp-up of our growth initiatives. Reflecting on the business dynamics that Joe outlined, we thought we would provide some color that we would expect Q2 revenue to look a lot like Q1 revenue. Finally, we would expect to incur $5 million to $7 million of additional startup costs related to our capital expansion projects with the flow being approximately $4 million in Q2 and $1 million each in Q3 and Q4. From a balance sheet and cash flow standpoint, we would expect capital expenditures on the cash flow statement of roughly $35 million to $45 million, assuming no material new growth investments. Free cash flow is expected in a range of $25 million to $35 million with year-end leverage in the low to mid-3s. Each of these estimates are consistent with our outlook provided on the Q4 call and with what we laid out at our Investor Day in June of 2022. As a reminder, the investment cash flow and leverage outlook assume no newly identified growth investments. That could change in 2023 as we assess further investment opportunities in Texas, for example. Before opening the call for questions, just a reminder that for competitive reasons, we do not provide detailed commentary regarding customer or SKU level activity. And with that, operator, please open the call for questions.

[Operator Instructions] Your first question is from the line of Andrew Strelzik with BMO.

I'd like to start on the exit of the broth business and also the transition with the ingredient customer. I guess what I'm trying to figure out is how much that impacted your 1Q and maybe how you're thinking about 2Q, whether from a sales or an EBITDA perspective? Like was there a mismatch on broth? It sounds like there was maybe an ingredient and how long some of that last quarter?

Sure. So to summarize, simply, it will be a first half headwind second half tailwind. The impetus for the change and the thing that we are executing is we have the opportunity to increase our market share to deliver long-term growth with our largest customer in oat milk. And in order to do that, we needed to free up both oat base and half gallon packaging to be able to serve our largest customer. And so we need to make those pivots. So we didn't exit broth completely. We just exited 1 of the 2 sizes of broth that we do in that category. So we do a 32-ounce and a 48 ounce, we exited the 48 ounce because it shares the packaging line time with the half gallon. Maybe more detail than you want but it's -- the details are important there.

That was exactly what I needed. And then I guess the other question, you continue to have really strong growth among your top customers. I think you said 3 out of 4 growing 40% plus this quarter. I guess -- and I think at the event down in Texas, you said you had 100 customers, and I think I might have asked this, but I'll ask you again. I mean how is that impacting you or how you're managing your customer base? Are you having to reprioritize even more? Is there more of this on the horizon? Obviously, you have a lot more capacity coming online. But again, I'm just curious how you're thinking about managing the customer base.

Yes. So the $100 million was a reference to all customers, which includes frozen fruit, fruit snacks, Plant-Based the whole business. And there are quite a few customers. It's a fairly long tail on the oat base, the ingredient sales side of things. So in core plant-based milks, it's a more concentrated list, and we would not expect to have to make a pivot like this, especially with Texas capacity coming online, we don't anticipate the needs to make any kind of big shifts other than the one I just described. And again, that is our largest customer, and we're simply prioritizing the most strategic stickiest business that we have.

Your next question is from the line of Bobby Burleson with Canaccord.

So I was just curious, was mid-low seen as that ramps. And you talked about a more meaningful contribution in the second half. Can you maybe just give us a sense for what the dollar growth contribution might be of that facility to your overall Plant-Based revenue in the second half?

Bobby, it's Scott. We refrain from sharing too much in the way of plant level or line level economics. Probably the easiest way to think about it would be if you think about 2022 stripping out Sunflower, Plant-Based business was around a $500 million business. And we've pretty consistently said we would expect, on average, circa 15% growth per year. Obviously, Texas, then to your core question, would be a meaningful part of that journey, but it's not all of the journey because recall, we had a handful of other projects we've executed.

Okay. And then clearly, your customers are outgrowing growth in the plant-based milk category that we're seeing out there. And you, as a result, are also outgrowing that growth. Maybe characterize like where that share gain is coming from? Is it simply the outperformance within oat? Or is there something more nuanced happening maybe across other formats?

I think there's a couple things to appreciate, Bobby. #1 is we're seeing significantly higher growth rates in non-tracked channels than tracked channels. And as it relates to our business model, we would estimate roughly 2/3 of the business flows through non-tracked channels. Second, we've been very public about communicating that we want to win without. We've taken that business from circa $1 million of sales in 2019 to $120 million last year. So we are certainly winning in the winning segments. We're winning in non-track channels. And the third piece, which is hard to report out on, but we are gaining share within the supply base. So we have customers who have more than one supplier, so they would use SunOpta and someone else. And as we've added capacity as we've consistently demonstrated great customer service, product quality, cost containment, et cetera, that is affording us the opportunity to win a larger percentage of their business.

Your next question is from the line of Ryan Meyers with Lake Street Capital Markets.

First one for me. I'm curious what kind of feedback you guys have gotten from your existing customers so far as you guys have begun to ramp the 330 ml production line? I mean, does it seem like they're pretty excited to see that getting kicked off and kind of how they're thinking about the demand for that product.

Yes. We hosted the entire management team of the principal customer that we'll be partnering with on 330 I think, 3 weeks ago. Super pleased with the progress. It's been very collaborative and very supportive. As I mentioned, we started the very first saleable production on Monday. So this is definitely going to ramp over time. So -- but we're excited to get going so far, so good. And we have a lot to learn in this space. So we're approaching it with a fair amount of humility and understanding that we're going to learn, but the partnership has been really incredible. They've been incredibly supportive.

Got it. And then as you've ramped the 330 ml and maybe some other adjacent product categories, have you seen any inbounds from new customers that are interested in what you guys have going and the fact that you can sort of fill the demand and the capacity there?

Yes. It is -- sorry, the second part of your question, I didn't really touch on your first question. So we continue to see very, very strong growth rates in tracked channels for protein shakes and protein beverages. And it is a supply-constrained category. So not surprising as the knowledge of us putting 330 ml and getting into that space has gone out into the market. We have received a large number of inbound calls of people interested in working with us. So at the moment, that 330 ml production line, all of the volume is spoken for. But if and when we were to put in a second system, we feel like there is certainly robust demand in the marketplace to fill that.

[Operator Instructions] Your next question is from Jon Anderson with William Blair.

I wanted to ask on the Texas, I think it's Line 2 or the second line to come up, which is part of the TAM expansion into 330 milliliter. From an industry perspective, it's a supply-constrained industry right now. Is this Texas location unique or geographically advantaged from an industry perspective? I guess does it put production in a place where there hasn't been production historically? Yes, I'm just trying to get a sense for that whether there's kind of a bigger value proposition here to this particular customer that you're partnering with and maybe others down the road.

Yes, Jon. Texas is and was a very strategic choice in that regard. As it relates to 330 milliliter production, there are other co-manufacturers around the U.S. I believe the nearest one to Texas is in the kind of southern Midwest. But Texas being the second largest state in the union and one of the fastest growing, as you might expect, all of the brands have pretty big and robust businesses in Texas. It is a heavy product to ship. And so having production and manufacturing in Texas certainly represent supply chain savings for our customers and also additional capacity. So it's a double win in that regard. It's capacity to fulfill the unmet demand that they have as well as it should afford them some supply chain cost savings, not having to ship the product from several states away.

I think there was -- I think Scott may have mentioned during the prepared remarks on guidance that we should expect the Q2 sales comparable to Q1. I'm assuming that was in dollar terms, and that would kind of imply an upper single-digit revenue decline year-over-year in Q2. Is that -- am I reading that right? And what are some of the puts and takes there that would cause that?

Jon, it's Scott. So you heard the statement correct. So what we're trying to point out is we would expect on a dollar revenue basis, Q2 total company to look a lot like Q1. So to make the statement. A couple of puts and takes. The headwinds, as I think Joe laid out, was we'd have the continuing diminution from the broth and ingredients business as we make that pivot. We also will have, like we do every year, a sequential Q1 to Q2 decline just in the absolute consumption of broth, not very popular in the summer, as you know. When you were talking about percentages though, don't forget we've got a back out Sunflower from the last year numbers. So as you're calculating growth rates, we think about the comp being last year's number x of Sunflower compared to this year's number x of Sunflower, just as a reminder.

So if I was to kind of boil down the transition that's going on, I mean you're essentially kind of your capacity constrained right now. You're making some decisions around how to allocate that capacity to the highest value, biggest opportunity customers and then those capacity constraints get released in the second half of the year has been broth in scales, and we kind of -- there's a step change in the revenue run rate in the back half of the year. Is that fair?

Yes, very fair. And as Midlothian ramps, but also, Jon, don't forget, we also have oat extraction or extraction coming online in Modesto at the end of Q3, which will also bring a relief valve to some of the oat base constraints.

There are no further questions at this time. I would now turn the call back over to Mr. Joe Ennen.

Great. Well, thank you, everyone, for your interest and attention this afternoon. Look forward to hearing and connecting with all of you again soon. And again, thank you, and have a good evening.