Ladies and gentlemen, thank you for standing by and welcome to Vital Farms Third Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to turn this conference call to Ashley DeSimone from ICR.

You may begin ma'am..

Thank you. Good morning and welcome to Vital Farms third quarter 2020 earnings conference call and webcast. On today's call are Russell Diez-Canseco, President and Chief Executive Officer and Jason Dale, Chief Financial Officer and Chief Operating Officer.

By now everyone should have access to the company's third quarter earnings press release filed this morning. This is available on the investor relations section of Vital Farms' website at investors.vitalfarms.com.

Before we begin, please note that all the financial information presented on today's call is unaudited and during the course of this call, management may make forward-looking statements within the meaning of the federal securities laws.

These statements are based on management's current expectations and beliefs and involve risks and uncertainties that could cause actual results to differ materially from those described in those forward-looking statements.

Please refer to today's release, the company's quarterly report on Form 10-Q for the quarter ended September 27, 2020 filed with the SEC, and other filings with the SEC for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today.

Please note that on today's call, management will refer to adjusted EBITDA, which is a non-GAAP financial measure.

While the company believes this non-GAAP financial measure provides useful information for investors, the presentation of this information is not intended to be considered in isolation or as a substitute for financial information presented in accordance with GAAP.

Please refer to our earnings release for a reconciliation of adjusted EBITDA to its most comparable measure, prepared in accordance with GAAP. I'd also like to note that we are conducting our call today from our respective remote locations. As such, there may be brief delays, crosstalk or other minor technical issues during this call.

We thank you in advance for your patience and understanding. I'd now like to turn the call over to Russell Diez-Canseco, President and Chief Executive Officer of Vital Farms. Russell..

Thank you, Ashley. Good morning, everyone. And thanks for joining today. On today's call, I will briefly review our third quarter financial highlights, provide an update on progress toward our growth strategy, and discuss our continued commitment to serving our stakeholders who, as many of you know are the fabric of our business.

Jason will then review our third quarter financial results in more detail, as well as our updated outlook for the remainder of this fiscal year. We then look forward to taking your questions. We're pleased to report another strong quarter. For the third quarter of 2020, net revenue increased 57% to $53.4 million compared to Quarter 3 last year.

We also continue to see positive trends in our key profit metrics. Gross profit margin increased over 300 basis points year-over-year and adjusted EBITDA improved 101% from the third quarter of 2019 to $3.7 million, demonstrating our continued profitability.

In the last 52 weeks ending September 6, 2020, we were the number one pasture-raised egg brands with 80% dollar share of the U.S. pasture-raised egg market and the number two overall egg brands based on retail dollar sale.

Now I'll turn to our growth strategy which includes one, expand household penetration through greater consumer awareness; two, grow within the retail channel; three, expand our product offering through innovation; and four, expand our footprint across foodservice.

With respect to food service, the headwinds that persisted in the third quarter limited our ability to attract new customers. Foodservice remains a small segment of our business and we look forward to bringing additional focus to it in the medium to long term.

We believe our continued focus on these areas will position Vital Farms for long term growth. We made significant progress on our growth strategy this quarter.

First, with regard to household penetration, we continue to see strong engagement both in the number of consumers choosing our products and in repeat purchases as a result of trends associated with COVID-19.

Repeat users are converting at a high rate which we believe demonstrates that our mission to bring ethically produced food to the table is resonating with new consumers. Our household penetration increased to 3.6% as of September 2020, up from 2.3% as of December 2019, and up 40 basis points on a sequential basis as of June 2020.

During the COVID stocked-up period, the eight weeks ending April 19, 2020, approximately 440,000 new buying households purchased Vital Farms eggs. In the following 20-week period, ending September 6, 30% have already become repeat purchasers and 72% of those repeat purchasers, purchased Vital Farms eggs multiple times during those 20 weeks.

We believe these strong household penetration metrics demonstrate consumers' willingness to pay a premium for our brand. We also believe increased demand for natural food and the willingness to pay a premium for brands focused on transparency, sustainability, and ethical values will continue to be a catalyst for our growth.

We believe that Vital Farms is positioned well to meet consumers where they prefer to shop especially given that COVID-19 has accelerated the demand for e-commerce in grocery sales of Vital Farms products.

For example, our online fresh grocery sales at a key retailer have increased 342% over the 24 weeks ending September 5, compared to the same time period a year ago. And our click and collect sales at one national brick and mortar retailer has increased 246% over the 26 weeks ending August 28 compared to the same period last year.

Turning now to our growth within the retail channel. In the third quarter, Vital Farms' store count increased by over 600 to a total of over 16,000 stores, primarily comprising growth within the mainstream grocery channel.

We also continue to expand the number of Vital Farms products distributed at key retail customers across the natural and mainstream channels. Despite the year-over-year expanded distribution, our total brain velocities in both the mainstream and natural channels remain robust.

This expanded distribution and robust brand velocity growth has led to Vital Farms capturing an increased dollar share of the total retail egg category. Finally, we remain focused on extending our product offerings through innovation in both new and existing categories.

In August, we launched Egg Bites, our new line of single-serve refrigerated bites made from ethically sourced ingredients. And we have successfully ramped up distribution to over 850 stores.

Now for an update on our leadership team and our diversity initiatives, both components of our broader commitment to our stakeholders who include our customers and consumers, our employees whom we call crew members, our farmers and suppliers, our communities, the environment, and our stockholders.

First, I'm pleased to share an update on talent we've added to our senior leadership team. In late October Peter Pappas joined Vital Farms as our new Chief Sales Officer.

With over 30 years of experience leading sales for both multinational and emerging consumer food and beverage companies, Peter brings a deep understanding of our categories and channels, and we believe he will play an instrumental role advancing our growth strategy.

As Chief Sales Officer, Peter will oversee sales of Vital Farms products across retail and [indiscernible]. Finally, as our country continues to navigate the COVID-19 pandemic, as well as a nationwide reckoning with race, we are committed to supporting our community stakeholders, including those who are vulnerable and marginalized.

This quarter we commenced a number of initiatives including partnering with Feeding America to donate over 7 million pasteurized eggs to food banks that serve food insecure communities, donating to the NAACP Legal Defense Fund, and Boys and Girls Club of America, and partnering with the National Diversity Council to grow in our knowledge of diversity and our ability to practice empathy for others.

We believe Vital Farms is incredibly well-positioned as we remain committed to our values and stakeholders. These principles guide our day to day operations, and we believe help us deliver a more sustainable and successful business.

I'll now turn the call over to Jason, who will walk you through our third quarter financials and outlook for the remainder of the year..

Thank you, Russell. And good morning everyone. We're very pleased with our third quarter financial results and what we believe are significant opportunities ahead. We've made meaningful investments building a trusted ethical food brand that is poised for long term growth as we increase our penetration in the retail channel in particular.

Net revenue in the quarter was $53.4 million or 57% compared to the third quarter last year. Our strong quarter gives us confidence in our expectation to exceed total net revenue of $210 million for the full year of 2020, representing a growth rate in excess of 49% compared to 2019.

Growth in net revenue for the third quarter of 2020 was driven primarily by an increase in egg and butter sales, a high turnover rate of sales to our retail customers and new distribution at new and existing customers, some of which resulted from stay-at-home trends associated with COVID-19.

The increase in net revenue was partially offset by sales incentives offered to customers in connection with egg and butter sales. Gross profit was $18.4 million, or 34% of net revenue for the third quarter of 2020 compared to $10.6 million, or 31% of net revenue for the third quarter last year.

The $7.8 million increase in gross profit was primarily due to the increase in net revenue, with a portion of a 329 basis point expansion in gross margin attributable to lower material costs for eggs and butter and volume leverage of our direct labor and overhead costs.

Total income from operations was $2.4 million in the quarter compared to $1.2 million in the third quarter last year. The $1.2 million a year-over-year increase was primarily due to the expanded gross margin. Net income was $1.7 million or $0.04 per diluted share, compared $0.8 million or $0.02 per diluted share in the third quarter of 2019.

Total operating expenses were $15.9 million, or 30% of net revenue compared to $9.4 million or 28% of that revenue in Q3 last year. This primarily includes SG&A expenses of $12.2 million, a $5.1 million increase compared to Q3 last year, and shipping and distribution expenses of $3.8 million, an increase of $1.4 million year-over-year.

The increase in SG&A was primarily due to an increase in employee-related costs due to increased overall headcount to support our operations, an increase in professional fees and commercial insurance costs due in part to our status as a newly public company, and increase spending on marketing programs and associated expenses.

The increase in shipping and distribution expenses was primarily due to an increase in sales volume, which resulted in increased costs related to third party freight associated with distribution of our products.

Our adjusted EBITDA was $3.7 million for the third quarter of 2020 compared to $1.9 million in the third quarter of 2019, which represents 101% increase. The improvement in adjusted EBITDA was primarily due to volume increases to our distributors, expanded gross margin as well as leverage over fixed operating costs.

The increase was partially offset by an increase in SG&A due to increased overall headcount to support our operations and an increase in professional fees and commercial insurance costs due in part to our status as a newly public company.

With all this in mind, we expect adjusted EBITDA to be in the range of $16 million to $18 million for the full year of 2020. Now, shifting to our capital structure. At September 27, 2020, we had a cash balance of $112.6 million, and total debt outstanding of $7.6 million.

Adjusted net cash from operations was $15 million for the 39-week period ended September 27, 2020 compared to adjusted net cash from operations of $0.1 million for the prior year period. CapEx was $6.7 million for the 39-week period ended September 27, 2020 compared to $3 million for the prior year period.

The increase in CapEx was primarily driven by purchases of equipment used in ongoing operations as well as our continued expansion of a central station. As we look ahead at what we believe will continue to be a robust market for ethically produced food.

We remain confident in the opportunity Vital Farms has to achieve strong results today and for many years to come. With that now, I'll turn the call back over to Russell..

Thanks, Jason. We remain focused on driving value for shareholders as we stay true to what consumers trust and expect from our brand, a commitment to pasture-raised ethical food production. Thanks for joining the call today and your interest in Vital Farms. We now look forward to taking your questions..

[Operator Instructions] First question comes from Pamela Kaufman with Morgan Stanley..

Hi, good morning. I wanted to ask about the assumptions embedded in your growth outlook for the fourth quarter. Obviously, it implies a deceleration relative to the growth that you've seen year-to-date. So I just wanted to get a sense for how conservative the outlook is and what assumptions you're embedding about the virus into the back half..

Russell, you want me to start there?.

Yes, that'd be great..

Okay, so great question, Pam. So I can't really comment specifically on the quarter. But I think the way that we're looking at it is we - we definitely saw a change from Q2 and the peak of what we saw in the midst of the kind of pantry stocking trends we saw in that quarter.

I think, as we look forward in this through the end of the year, we're kind of just pulling through a very similar thing that we saw in Q3 and having that exist throughout Q4, as we close the year out.

So I think that the range that we're giving, gives us confidence in that to deliver within that range and not be I wouldn't say it's ultra-conservative, I would say we're extremely confident about delivering in the range, but not a ton outside there..

The only thing I would add to that is if you remember our kind of integrated supply chain, we buy eggs exclusively from our small family farm partners and so there's a lead time to changing our volume. So in the short run, our supply is pretty darn predictable and there isn't unlimited upside in any given quarter..

Got it, that's helpful. And then can you - obviously, it seems like you've added a lot of new retailers during the quarter.

Can you talk about your visibility on further distribution gains and what the consumer reception has been like within the new retailers added in the quarter? How did the velocities and skew counts compare at the new customers?.

So it's early days to see how our business is trending in our newest doors. But in terms of kind of our playbook, we've got a pretty historically successful playbook around launching in new retailers, and ensuring that we get off to a good start. I can't remember the last time a retailer wasn't pleased with the results.

Beyond that, in terms of visibility to kind of future retail growth, as we mentioned in the last quarter, these are sort of the dynamic nature of COVID and the eating trends resulting from it.

We're having to be a little flexible in terms of the portion of our growth that we see from increased velocities and just general household consumption and in the amount that we see from new doors so reflecting that and monitoring that to make sure that we're striking the right balance between new doors and really taking care of our trusted retail partners..

Great, thank you..

Our next question comes from Christopher Growe with Stifel..

Hi, good morning..

Good morning, Chris..

I just had a question for you if I could around the new consumers you're attracting to the brand and basically how you're hoping to keep those consumers so you've got this nice repeat rate amongst these new consumers.

Is there incremental marketing? Obviously, related to it, did you restart some promotional spending in the quarter? Is that helping kind of sustain these new consumers in the franchise?.

Yes, thanks for that.

It was really gratifying, frankly, to see not just the repeat rate, but then the multiple repeat rates, which to me says at least with my maths right that we were able to convert about 20% of those COVID trier's at a time when maybe we were one of the few eggs available on the shelf into what looks like potentially loyal customers, which I think is a healthy conversion rate, considering it didn't involve a lot of marketing spend.

And in the early years of building the Vital Farms brand, we were focused very strongly on education and helping new consumers understand why they should try something so different.

And as we have continued to grow household penetration, we've continued to broaden our marketing efforts to look at every part of that consumer journey from awareness all the way through to loyalty.

And so I wouldn't say that we're doing a lot different in terms of retaining this particular consumer versus others that we'd want to retain, we're focused that at all points from an education message for a new consumer to the franchise, to really fostering great community and giving them great reasons to come back.

It's all rooted in our values and our transparency..

Thank you for that. And then just a quick question, as you got your sales guidance going up, call it $5 million EBITDA up about $2 million and those ranges there. I do get there's some variability within that. But that incremental margin, just from the midpoint looks pretty strong.

I guess I just want to understand, is there just kind of, I guess, the costs for the business underneath that? Is that something that's 80 in that incremental margin? And maybe related to that? The degree to which sort of incremental fix costs, leverage is what's helping drive this better margin for the business on these incremental sales?.

Yes, great question Chris. I think it's twofold. I think we're still, I mean, you saw this in the quarter. Our gross margin, while sequentially has come down from what we saw on the Q2 is still higher than I think we had talked about our journey of getting to the mid-30s would be at this point in time.

Absent a lot of movers like us being able to better monetize off side the Eggs and things like that and just getting through efficiencies at Egg Central Station. So I think there's a portion there for sure and then from a fixed cost perspective. I mean, the incremental volume we're getting there, it's just giving us a leverage over those costs..

Okay. And then anything around just input costs.

So you mentioned some of your input costs were down is that incremental, if you will from the third quarter, you've seen those move down further or just to get a sense of where your overall input costs outlook stands?.

Again, can't get specific to it. But we would expect things to look very similar to what we're currently doing in this quarter..

Thanks so much for your time..

Our next question comes from Adam Samuelson with Goldman Sachs..

Yes, thank you. Good morning, everyone.

So I guess first, I was hoping to get I know it's early, but any kind of early sense on the traction with the Egg byproduct and just what you've seen with the retailers that who we've launched with and momentum in terms of putting that in more doors over the next several quarters?.

Yes, I think I would call out two things. One is that, relative to our expectations at launch, I think the results have been strong; we're pleased with the results. And I recently saw and it's just a single data point, I'll keep it disguised.

But at one of our launch customers, we've seen that we are in the lead relative to a couple of other products that launched this year as well that appear to be competing.

We've taken a clear lead despite having a premium price point and so the early evidence shows that our positioning in the market with premium products and a premium price point is resonating in this new product..

Okay, that's really helpful. And then just going back to some of the details that was in the slide. The gains in household, it has full penetration this year seem to be kind of tracking well ahead of kind of where they had been in the last couple of years. And you talked to the strength and repeat rate, post COVID stock up.

And I just want to get a sense of, do you think about the marketing plan and the growth plan in 2021.

Does those kind of gains can continue or you think there was just one-time opportunity we capitalize it? Capitalize on it and now it's a matter of driving the sales velocity in the doors and distribution that we have and driving new products or how do I think about the push there in terms of getting new people into the brand versus driving distribution and sales velocity with the customers that you have?.

Now, that's terrific, Adam. So my headline would be that acceleration of new households has not changed our stance on the pillars of growth. So we've been on a steady march of increasing household penetration year after year after year. And while we may have pulled some of them forward, we're going to leverage that and continue to build.

I mean, we're still in as you've seen, low single digit household penetration, and there's still so much room ahead of us.

In addition, with the addition of Peter Pappas to lead our sales function, I think, we are really in putting even more focus on driving successful retail partnerships, growing doors, growing penetration of our products and existing in new retailers. So we've got our foot firmly placed on the gas pedal in both areas..

Okay. If I could just squeeze one last one in.

It's been a pretty notable run up in freight costs and LTL truck pricing over the last several months and just wanted to just get a sense on any sensitivity or step up in the shipping and distribution costs that we should be mindful of moving forward?.

Yes, that's a great question, Adam. We haven't seen anything that would be outsized, that specifically impacted us that we would call out. Again, as we continue to look at putting together our plans for next year, we'll certainly be mindful of that and communicate anything as we see fit..

Great. I appreciate the call. I'll pass it on. Thanks..

Our next question comes from Robert Moskow with Credit Suisse..

Thanks, I had a couple of questions. Regarding the repeat rates, can you repeat the timeframe that you measured to repeat activity, because when I look repeat rates, they tend to go higher, the longer the timeframe that you're measuring.

So for six months, the repeat rate is higher, because you just have more time to capture a repeat sale from the people who initially try to do. It seems that your data is around 30%, which is pretty consistent with what you had in June. So I wanted to know if it's a different timeframe, or a longer time frame that you're measuring or not..

So the stock up, sort of the repeat rate that we presented today is based on first, a new buyer in the eight weeks ending April 19. And then the 30% repeat, and the 72% of those who made multiple is in a 20-week period or a five-month period ending September 6, 2020..

Okay. I believe you did a similar measurement back in June; the number was around 30%. Actually, I think you said 36% back then.

Are you if your analysis of this repeat data that this is pretty typical, or am I wrong that maybe post stock up? It could be higher, because you have a more of a chance to get those households to repeat again?.

I think your logic makes sense in terms of an extended period of time, I think we don't have enough data historically in order to make meaningful comparison between people that tried us for the first time during COVID and people that try this for the first time a year or two or three earlier.

My focus is simply on the fact that we retained, it appears to be as much as 20% of those triers [ph] with frankly, very limited investment and attracting them to the franchise. And so I think in essence, this was a little bit of a tailwind in terms of reaching new consumers and we'll take it, we're going to fight like hell to hold on to them..

Okay.

And then my other question is, can you give us an update on your new CFO? I believe that there's was mention of that a couple of months ago?.

Absolutely. So, Bo Meissner joined us I believe back in August, and with the intent that he would transition to CFO at the beginning of 2021. That plan is still on track. He's performing well. And we're excited to have him take on that role and allow Jason Dale to focus specifically on the COO portion of his role.

So everything's on track and more to come on that as we get closer to the New Year..

Our next question comes from [indiscernible] with Bank of Montreal..

Good morning, everyone.

Just a couple of questions, one is, how quickly can you increase your Egg production for 2021? Do you have any constraints? It sounds like just what you said earlier that you were limited in this quarter by and I might have misheard, but can you talk about that?.

Yes, so we've talked about this previously, the lead time to put down new supply for us comfortably is about a year, we can definitely speed that up a little bit closer to the eight months' timeframe. But again, 12 months is comfortable for us.

And so we have actively been working as we always do on looking forward and measuring what we think we need to have down in terms of growth to support the demand profile that we see in the business ahead of us.

Again, I mean, as you remember, previously, we have to be very mindful about how we do that, because of the long lead times and forecasting out what that demand looks like in the future. We don't get in a situation where we end up too long or too short.

And so, we're doing that work kind of every week, every month looking out beyond the year and planning about what forms we need to put down..

Would you think that given the household penetration, increasing higher, would you think about increasing what you would have thought your initial plans would have been for the next four or eight months? It seems reasonable to believe that would there not be a reason to believe that on our side as well?.

Well, I think so again, if you just do the timeline on that lead time, that takes us I think, a lot of what we're seeing in that growth rate, we can start to put some of that down in 21, and support that. But most of that will actually start to come to fruition in 22..

Okay. My next question is given the volume increases, how sustainable is the margin given the volume, leverage and the operating leverage versus how much is short term in nature? It seems like if the volume stays at these levels, and you're able to grow into it, your margin structure should be more sustainable.

If it's operating leverage, if it's not the operating leverage, maybe it's the left sustainable. Can you talk about the sustainability of your margin structure? And I'll leave it there. Thank you very much..

You bet. So again, I think, we directionally talked about our long-term goals for gross margin for the business and for the brand in the mid-30 range. We are hovering around that range. I think, we certainly are still getting some tail winds from the leverage side, I would say that's probably a smaller portion of it.

But we also still have some noise just in promotional spend and things like that just because of the COVID-19 environment and what's happening out in the retail space. So I think it's sustainable within a range. It's not dramatically different than what we're seeing where we're at today..

Great, thank you very much..

And I'm not showing any further questions at this time. I would like to turn the call back to Russ for any closing remarks..

Well, thanks, everybody, for joining us today. You know, Vital Farms embarked on a mission to bring ethical food to the table 13 years ago. And our core has always been a commitment to our stakeholders.

We wholeheartedly believe that treating our stakeholders as partners delivers positive outcomes for everyone, whether it's our small family farmer partners, our crew members, consumers, the community or shareholders. I appreciate your interest in our business and your belief in ethical food.

Finally, as we approach the end of this extraordinary year, I wish you all good health and happiness. We look forward to speaking with you again soon..

Ladies and gentlemen, this concludes today's presentation. You may now disconnect and have a wonderful day..