Earnings Call: Q1 2021

May 12, 2021

Good morning, and welcome to SunOpta's First Quarter Fiscal 2021 Earnings Conference Call. By now, everyone should have access to the earnings press release that was issued this morning and is available on the Investor Relations page on SunOpta's website at www.sunopto.com. This call is being webcast and its 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 morning, the company's annual report filed on Form 10 ks and other filings with the Securities and Exchange Commission for 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, 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 routed to the other. Before we begin unpacking the results, let me offer several key takeaways from the Q1. First, our strategy of focusing on top line growth in plant based and margin growth in as plant based continues to be the number one global food trend. 3rd, our focus on productivity in our fruit based business continues to drive solid margin expansion. Lastly, we all know team and culture are critical to driving great performance and the efforts we have made in the last 18 months around creating accountable business units, building a high performance team with a winning culture and investing in talent have been instrumental in fueling our business. Put everything together and our team continues to excel at operational excellence, which is delivering consistently strong results. The Q1 played out largely as expected, with plant based revenues continuing to grow rapidly, margins improving and dollars was comprised of 12% top line growth in plant based, largely offset by planned revenue rationalization in fruit, resulting in aggregate to pre COVID Q1 twenty nineteen. Compared to Q1 of 2020, gross margin improved by 130 basis points to 14.4 percent and adjusted EBITDA grew 33.5 percent to $18,300,000 or 8.8 percent of revenue. Q1 saw continued transformation of our operations across the board. We continue to dial in production on the 3 capacity additions in plant based that came online in Q4 of last year. We made good progress on our latest expansion project in Allentown, Pennsylvania, which is on schedule to be fully commissioned in Q4 of this year. And we closed our fruit processing plant in Santa Maria under budget and ahead of schedule. We expanded fruit operations in Mexico and we are having a productive strawberry season there. We are also executing the closure of our fruit ingredients plant in Los Angeles, which we will cover in more detail in a few minutes. Net, the pace and impact of our operational transformation continues to put the company in a stronger and stronger position. Our new oat extraction capability is operating well and oat revenue was up oat revenue was up significantly as we continue to ramp up new and existing customers. Overall, we will exit 2022 with the additional capacity effectively utilized. We think our added capacity gives us a unique competitive advantage as we strive to provide our customers with an unparalleled combination of product quality, cost, service, capacity to grow and unrivaled technical and innovation support. These 5 ring fences are critical to our long term success. There is an opportunistic element to this acquisition as we currently manufacture all of the WebSoy products and approximately half of the Dream product line. We believe these brands have significant brand equity based on what we are seeing and believe we were able to acquire them attractively given our supply chain advantages. 2nd, we have the opportunity to in source the half of the dream product line we don't currently produce. Therefore, West soy is 100% soy milk and 8% rice milk and West soy is 100 percent soy milk and we don't produce either of these formats for any other Coman customer. It is also important to understand that shoppers are fairly loyal to one type of plant based milk, so that also reduces the potential for conflict. Finally, from a financial perspective, our forecast is that these brands next year in 2022 will add 15 $20,000,000 of incremental revenue and $6,000,000 to $8,000,000 of incremental EBITDA when we complete the in sourcing of all volumes. Our current priorities with Dream and West soy are to realize the in sourcing synergies, transition the business and build the capabilities needed to manage these brands. Turning to our segment results, let me start with our plant based business. The 12.4% increase in plant based revenue was on top of a 30% increase in the Q1 of 2020. To put Q1 into perspective, this was the highest plant based revenue quarter in company history. And compared with the Q1 of 2019, our Q1 2021 plant based revenues were up 47%. Both based offerings were a key factor in our growth, delivering roughly half of our growth on a year over year basis. We remain extremely well positioned to capture additional share in this product category where consumer demand is surging. We also benefited from increased retail sales volumes of other plant based beverages, generic oat milk creamer launched under the brand name Sone late last year. In addition to strong initial sales velocity, we also continue to build focused distribution for this brand. Gross margin in plant based was 19.4%, down only 40 basis points from a year ago as we added the depreciation increased transportation cost. These negatives were mostly offset by continued improvements in productivity. In the fruit segment, revenues were down 13% due to overlapping the initial COVID surge in Q1 of 2020 and the planned rationalization of marginally profitable business affecting customers and SKUs. Compared to 2019, fruit revenue was basically flat. We experienced 2 headwinds, COVID overlap in Frozen and customer and SKU rationalization in fruit ingredients, with a tailwind in fruit snacks as we put more emphasis on this margin advantaged business. As we have discussed in the past, we are executing 3 strategies to de risk the frozen fruit business. 1st is geographic diversification of supply, where we have made significant In Q1, we sourced 3 times as much fruit from South America as 2020 And year to date, Mexico strawberry production is plus 25% to 2020. 2nd is pricing mechanism and pricing courage with our customers. We are now in a position with this business where we can confidently pass on a majority of cost inflation. 3rd, better grower relations to source more of the available fruit. In 2020, we sourced 25% more of the available fruit out of California than in 2019, and we are looking to build on that momentum in 2021. All of this may prove fortuitous as the California freezer season is off to a slow start as beautifully cool weather and strong demand for fresh has kept the growers growing for the fresh market versus switching over to frozen. Net net, no matter how the season comes in, we are better prepared to manage the Q1. Gross margin in fruit increased 170% to 7.7%. Some of the planned factors that reduced fruit based sales in the Q1 also had the intended positive impact on margins, including fruit snack growth, planned rationalization and productivity improvements. In mid April, we began the process of exiting our Southgate, California fruit ingredient plant with closure expected this June. Our plan is to migrate some of that volume to other plants within the network. It was a small older facility and its closure represents another margin business in 2021, expecting to turn to revenue growth. In summary, our strategic priorities are firmly on target and we are executing at a high level across the organization. Over the near term, we continue to prioritize plant based revenue growth, fruit based margin and increasing adjusted EBITDA. SunOpta's strong position in some of the fastest growing CPG categories and sharp focus on operational excellence underscore my continued optimism about our future. Our balance sheet remains strong, capable of supporting multiple growth drivers for the foreseeable future. But new business opportunities is robust, providing a long runway with existing and new customers. Finally, we are just starting to add M and A to our playbook with the recent completion of 2 brand acquisitions that are strategic and opportunistic as well as additive to sales and profitability. We remain committed to the previous 2021 outlook, and we believe our strategy and our team will continue to deliver as we seek to fuel the future of food. Now, I will turn the call over to Scott to take us through the rest of the financials. Scott? Thank you very much, Joe, and good morning, everyone. We're excited to report another solid quarter. As Joe discussed, 1st quarter revenues of $207,600,000 were flat year over year as the strong 12.4% growth in plant based was offset by planned rationalization of marginally profitable business in fruit based. Demonstrating the power of our strategy, adjusted EBITDA increased 33.5 percent on flat revenue aided by further improvement in gross margins as we add margin to fruit and consolidated margins benefit more plant based revenue in the sales mix. Gross profit was $30,000,000 for the Q1 of 2021, an increase of $2,800,000 or 10.4 percent compared to $27,200,000 during the Q1 of 2020. The plant based segment accounted for $2,100,000 of the increase in gross profit due to higher revenue, production volumes and productivity improvements within our plant based beverage and ingredient operations. The fruit based segment was responsible for $700,000 of the gross profit improvement, reflecting strong fruit snack volumes, pricing, rationalization of marginally profitable SKUs and customers and productivity gains in frozen fruit. As a percentage of revenues, 1st quarter gross margin was 14.4% compared to 13.1% a year ago, a 130 basis point increase. The Plant Based segment gross margin was 19.4%, down only 40 basis points from last year, primarily due to the depreciation expense associated with our 3 new projects onboarded in Q4, along with increases in freight costs partially offset by improved productivity. Recall that we added a fourfold increase in our oat extraction capacity in our Alexandria, Minnesota plant and additional processing and packaging capacities in our Modesto, California and Allentown, Pennsylvania plants. Gross margin in the fruit based segment was 7.7% compared to 6% last year, increase of 170 basis points. Gross profit dollars grew $700,000 on lower revenue, indicating the strong impact of our productivity efforts. As you know, we've prioritized profitability improvement in fruit during 2021 and the solid and customers and productivity gains in Frozen. Importantly, we were able to significantly expand fruit based gross margin during the quarter despite the impact of lower sales volumes demonstrating the merits of our strategy. Operating income was 6,100,000 dollars or 2.9 percent of revenues in the Q1 compared to $2,800,000 or 1.3 percent of revenues in the year earlier period. SG and A increased $900,000 or 4.7 percent to 20,900,000 dollars reflecting higher variable compensation costs and increased headcount to support growth initiatives. Loss attributable to common shareholders for the Q1 was $300,000 or 0 point 0 dollars per diluted share compared to a loss of 6,000,000 dollars or $0.07 per diluted share during the Q1 of 2020. On an adjusted basis, Q1 2021 earnings were $1,300,000 or $0.01 per diluted share versus an adjusted loss of $5,400,000 or $0.06 per diluted share in the prior year period. As Joe mentioned, adjusted EBITDA was 18,300,000 dollars compared to $13,700,000 in the prior year, a 33.5% increase. Note that this was after absorbing inflationary costs in transportation and insurance. I'd like to remind listeners that adjusted EBITDA and adjusted earnings are non GAAP measures and a reconciliation of these measures to GAAP can be found toward the back of the press release issued earlier this morning. Turning to the balance sheet and cash flow. As of April 3, 2021, total debt was 137,500,000 dollars down approximately $332,000,000 from the Q1 of 2020 and up from 69.7 $1,000,000 at the end of 4Q 2020 as expected from the additional lease obligations related to our capital projects as well as the seasonal inventory build we discussed last quarter. Total debt reflects $88,900,000 drawn on our asset based credit facility with the balance representing smaller credit facilities, lease and other financing arrangements. Leverage stood at 2.2x at the end of the first quarter versus 7.7x a year earlier. From a cash flow perspective, cash used in operating activities of continuing operations during the Q1 of 2021 was $7,000,000 compared to cash generated of $23,700,000 during the Q1 of 2020. As we discussed on the Q4 call, we expected to see a seasonal build of inventory in the quarter. Cash used in investing activities of continuing operations was $7,900,000 compared with $9,000,000 in last year's Q1. In addition, we paid over $13,000,000 in the quarter to settle accrued transactions costs associated with the Global Ingredients divestiture. Prior to discussing our current outlook, let me add some color on the Dream and Westlake acquisitions from a financial perspective. These brands generated approximately $40,000,000 of external revenue in 2020. Since we produce all of the WestSoy and half of the Dream volume, this represents $15,000,000 to $20,000,000 of incremental revenue to SunOpta. As Jill pointed out, with synergies, we expect perspective, with the acquisition and our continued momentum in plant based, we could see growth in the 20% area for the balance of the year. In fruit, as a reminder, we closed the facility, ensured that we would be rationalizing a second plant, customers and SKUs and are therefore forecasting revenue declines as a result. Given some uncertainty in the fruit business, it would be conservative to assume single digit revenue declines for the rest of 2021. From a margin perspective, we would expect plant based to remain in the high teens area and fruit based to make year over year improvements each quarter from a more efficient portfolio of manufacturing plants and customers. Finally, from an adjusted EBITDA perspective, given some of the tailwinds we are experiencing, we could see growth of up to 50% in Q2. Our outlook for the balance of the year is solid double digit EBITDA growth. With that, I'd like to turn the call over to the operator for Q and A. Great. Thank Your first question here comes from the line of Bill Newby from D. A. Davidson. Please go ahead. Your line is now open. Good morning, gentlemen. Thanks for taking my questions and congrats on a solid Q1. Thanks, Bill. Good morning. Joe, I was hoping we could start here and just kind of get maybe your kind of broad state of the union on domestic oat milk capacity. I mean, obviously, you guys bring on a ton of capacity. We saw the Oatly filing and then talking about bringing on a lot of capacity additions this year. I guess, as you stand today, maybe what does the supply versus demand picture look like? And maybe if you could compare that to what it looked like a year ago and maybe what you expect it to look like a year from now? Anything there would be super helpful. Yes. So we're seeing incredible consumer demand, triple digit increases in demand across the board. You're seeing a very robust competitive landscape with really kind of 4 or 5 brands procuring the vast majority of the market share. We partner with several of those leading brands as they are going to market with oat milk offerings. So we feel like from a demand standpoint, we are in a really good position in terms of who our brand partners are. As it relates to capacity, we were incredibly fortuitous with the investment that we made in 2019 around oat milk. We are seeing really strong business development and utilization from both existing and new customers around our oat milk production. At this juncture, we still have available capacity. We still have the ability to take on new customers. And as you might imagine, given a market that's growing triple digits, we have a real eye to the future in terms of understanding how high is up with oat milk and if we'll need to add additional capacity or capabilities in oat milk. But right now, we're in a really good position with that facility that we stood up at the end of last year, really starting to crank out volume and helping our brand partners drive growth in oat milk. Great. That's super helpful. And then I guess just wanted to touch on this the acquisition of the Dream and WestSoy brands here. I mean, I guess help me understand a little bit what the plan is for those going forward. I mean, was this just an opportunity to kind of consolidate some of the brands that you are already manufacturing for and get a little benefit in the P and L with that? Or is there more that we should be thinking about here from innovation or building the brands going forward? It was largely opportunistic. We saw a real in sourcing opportunity to take on the volume that we don't manufacture. And we've also talked about interest in expanding beyond plant based milk and Dream especially has strong consumer brand equity and gives us optionality if we were to look to categories outside of plant based milk. That gives us some optionality as far as the brand platform to access some of those opportunities. But our priorities at the moment relative to these brands are very simple, which is in sourcing the volume and standing up the internal capabilities to manage these brands. Great. And then I guess if you look across your partners, your manufacturing for today, I mean, are there similar opportunities with the relationships you guys have or is this kind of a one off? When you say similar opportunity? Yes, similar opportunities to brands that you're with brands transaction? I wouldn't see us executing anything beyond this just because it gets a little bit entangled with existing customers. Part of what made this an easy access opportunity was the fact that 90% of the volume of Dream is right milk and 100% of West soy is soy. And but beyond that, I think we would get into a pretty entangled position if we were to do something bigger in the space as far as acquiring a brand. Great, great. No, very helpful. I got a couple more, but I'll jump back in queue for now. Thanks, guys. Your next question comes from the line of Alex Fuhrman from Craig Hallum Capital. Please go ahead. Your line is now open. Great. Thank you for taking my question and congratulations on a strong start to the year. I wanted to ask about the food service recovery that's going to be coming here. You're already operating at record revenue levels on the plant based side of your business. And I would imagine a lot of your foodservice customers are right on the verge of showing pretty strong double digit comps for the rest of the year. So as that demand starts to come back, you have enough capacity for all of that in existing to your existing customers? And just as you start to think about incremental capacity coming online over the next year, where do you see that incremental product going out the door to? Yes. So, we are in a good position relative to available capacity to support foodservice recovery, absolutely. I mean, again, 3 capital projects that came online in Q4, an additional capacity addition that will come on line in Q4 of this year puts us in a very comfortable position to support our customers' growth. And as I mentioned, that is one of the core components of our service offering to our customers is making sure that we have capacity available for them to drive growth as hard and as fast as they want to. So it is a pretty violent shift in demand that we saw during COVID and now kind of coming back again. But I'm pleased to report that the operations team and the whole business has done an outstanding job in filling customer orders, especially on the foodservice side of things as they, I think, candidly have been a bit surprised by the rapid nature of the recovery of their business and we are doing an excellent job in keeping them in stock, filling orders. Our case fill rate is very, very high and speaks to one of the core themes that I covered, which was execution. And right now, we're nailing it. That's great to hear. Thanks very much. And I guess just curious, given that it is such a kind of dramatic shift and now shift back in demand, what are the biggest concerns you're hearing from your foodservice partners as they tool up for the next couple of years and their menu? Is it just having consistent access to supply? Is it variety of products or particular formulations? Just kind of curious what restaurants are really thinking about from you as they look to kind of reopening in the next leg of their businesses? I would say there's 2 things that we're hearing pretty consistently. 1 is, are you guys ready for a pretty dramatic snapback in demand? And our answer is absolutely we're ready. The second thing is on the upstream availability of ingredients, and I think there's been innumerable news stories of kind of upstream raw material shortages from computer chips to copper, etcetera, etcetera. I mean, we've all seen the story. And so that would probably be the second theme we're hearing, Alex, is just do you have any upstream pinch points or supply constraints? And again, to date, we feel very confident in our procurement and sourcing efforts to make sure that we have good flow of raw materials. We obviously source raw materials from around the world, and we feel good at this point that we have the right flow of raw material ingredients into our manufacturing plants to support the snapback and growth. That's great. Thanks very much. Your next question here comes from the line of Mark Smith from Lake Street Capital. Please go ahead. Your line is now open. Hi, guys. First question for me, just wanted to check on kind of the cadence of in sourcing on the Dream products. It sounds like you expect this to be complete by the end of next year, but any additional details you can give us would be great on the timing. Yes, we expect to complete it by the end of this year. Perfect. The EBITDA, the incremental EBITDA would be fully affected and in place for 2020 22. Excellent. And then you just talked a little bit about logistics and supply chain. It sounds like you're in good shape there, but are you seeing anything on kind of an inflationary pressure in pricing? Yes, it's Scott. I would say, we had modest headwinds, which we talked about in Q1. It's something as Joe talked about a moment ago, we're looking at actively. And probably the easiest way to think about it is we have really 3 categories of costs. There's raw materials, operations and supply chain and they behave a bit differently between the 2 channels. So co man, if you think plant based, a significant amount of insulation from raw material volatility as those are generally pass throughs. Of course, our operating costs are for our account. And then lastly, I'd say supply chain, there's some insulation because a fair amount of co man business is pickup. And then we think about the 2nd channel or private label, as we've talked about, we could be passed on the majority of raw material costs. Again, operating costs are for our account. There's probably a little more exposure on supply chain since that tends to be delivered business. So net net, we've been in a pretty good place for Q1, but the headlights are up. Okay. And then the last question for me, just any update on kind of this kind of branded products? Velocities on phone. We're in the right accounts, which I think is important. This is an organic offering, but I would just tell you that the early velocities that we're seeing out of the lead accounts are exceeding our expectations. And we're being systematic and surgical as we look to add distribution to make sure that we're putting it into the right accounts that have a shopper profile that's going to fit a premium product like this. And I'm not showing any further questions, Doctor. We appreciate it and look forward to speaking to you again soon. Thank you. And this concludes today's conference call. Thank you for your participation. You may now disconnect.