Earnings Call: Q3 2020

Oct 29, 2020

Good morning, and welcome to SunOpta's Third Quarter Fiscal 2020 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.sunopta.com. This call is being webcast and this 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 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. And now, I'd like to turn the call over to SunOpta's CEO, Joe Ennen. Good morning, and thank you for joining us today. With me on the call is Scott Hawkins, our Chief Financial Officer. Before we begin unpacking the Q3 results, there are 3 key takeaways that I would like to offer. 1st, strong execution of our core strategy continues to deliver consistent strong performance across all three business segments. 2nd, our prioritized investments in plant based foods and beverages is paying dividends. We are playing offense, we are winning and we expect to continue to win as our expansion projects come online in the 4th quarter, further strengthening an already strong position. And third, we are optimistic about our future ability to deliver consistent, sustainable, above average EBITDA growth. As anticipated, the 3rd quarter results were strong, delivering our 4th consecutive quarter of more than doubling year over year adjusted EBITDA and the 3rd consecutive quarter in which each of our segments generated both revenue and margin growth. Trailing 12 month adjusted EBITDA at the end of Q3 2019 was $40,000,000 Today, our trailing 12 month adjusted EBITDA is $84,000,000 dollars With 4 consecutive quarters of more than doubling adjusted EBITDA combined with the momentum and plans we have, it is safe to say that SunOpta is no longer a turnaround story. We are quite simply a well positioned sustainability minded growth company with a clear vision to fuel the future of food. Our performance reflects strong execution of our core strategies along with investment and focus on our core strength. We have now fully transitioned from our turnaround successes to driving profitability and growth across each of our business segments. I'm pleased with our positioning and the performance across our entire organization. For the Q3, we delivered 5.4 percent revenue growth adjusted for changes in commodity related pricing and FX rate. This growth was fueled by very strong consumer demand in all three of our core segments led by robust growth in our Global Ingredients and Plant Based Business segment. Consumption in the last 13 weeks shows both refrigerated and shelf stable plant based milks growing 18% 16%, respectively. We are excited to see the continued tremendous growth in oat milk with triple digit growth rate. Oat milk is now the 2nd largest plant based milk behind only almond milk. This sentiment owed will organic food sales in many of our core markets around the world, fueling growth in our Global Ingredients segment. It is encouraging that we are so well initiative with a focus on automation, reducing from our cocoa facility in Holland to our plant based aseptic beverage facility in Pennsylvania to our frozen fruit bagging operation in Kansas are setting production records and doing it with fewer people. While these records are impressive in their own right, it's important to recognize that these results are coming at a time when we are also managing all of the challenges related to COVID-nineteen prevention in our plan. To date, we continue to have 0 confirmed cases of community transmitted COVID-nineteen. This accomplishment is something we are all very proud of as employee safety is our top priority. While the challenges of managing around COVID-nineteen are significant, the overall impact on our financial performance for the quarter were not significant on a year over year basis. When we net the headwinds and tailwinds, the impact on revenue and EBITDA offset each other. Turning to EBITDA. As mentioned, we more than doubled adjusted EBITDA on a year over year basis for the Q3 with an increase of 129 percent to $22,800,000 on 5.4% adjusted revenue growth. Adjusted EBITDA as a percentage of revenue was 7.2% and showed solid progress against our long term stated goal of 10% EBITDA margin rate. Turning to our segment results, let me begin with our plant based segment. Sales momentum continued, overcoming the impact of softer foodservice sales as COVID-nineteen continues to impact the channel as all would anticipate. Sales increased 6.6% on an adjusted basis despite our largest customer not contributing to the growth given their foodservice focus. Sunflower, which is reported within this segment, saw a revenue decline in Q3, which dampened overall segment performance. If we remove the sunflower headwind, the remainder of the segment grew revenue 10.8%. Gross margins improved to 19.9%, reflecting improved utilization and execution of our productivity initiatives. With the significant growth in consumer demand that I mentioned earlier, you will not be surprised to hear that in Q4, we will be operating as close to capacity as possible. And as a result, we expect a strong Q4 in our plant based business unit. Our 3 expansion projects, which we have discussed several times, are on time and on budget. Combined, they will further expand our leadership position in aseptic plant based beverage production through new capabilities in plant extraction and added aseptic production. These projects, when fully utilized, have the potential to add approximately $100,000,000 to our annual sales. I continue to be pleased with our sales development effort and we are in advanced discussions with several large customers who will consume a sizable portion of the incremental volume. I would like to remind listeners that adding this amount of new business does not happen overnight. In many cases, these are large new customers with complex needs and it is not as simple as flipping a switch, but we continue to believe that we can have this incremental capacity fully utilized by the end of 2022. Our new capacity additions in the 4th quarter position us for a strong 2021 2022. Our leadership in plant based beverages, our broad capabilities along with our strong positioning are the key drivers of these significant new business opportunities and is the foundation of our plan to double our plant based business unit over the coming years. In Global Ingredients, sales growth accelerated to an impressive 8.3% on an adjusted basis, reflecting very strong performance in cocoa, oils and juice to highlight just a few categories. We generated another quarter of improved gross margin as a result of top line growth along with executing our productivity plan. In particular, our kronachal and koppo processing facility generated record production levels with higher efficiencies. Further, our efforts in driving return on investment yielded a roughly 10% reduction in year over year inventories, while our revenue growth accelerated. Gross margin in this segment was 12.2%, again reflecting strong execution of our plan. While this business has had some historical volatility, it is encouraging to see a heightened level of discipline and execution at this time. Within our fruit platform, our focus on driving improved margin yielded significant year over year gain with gross margin improving to 7.7 percent, up 990 basis points from the prior year approximately 1% adjusted revenue growth. Our investments in automation are driving significant improvements in productivity, partially offsetting a challenging fruit procurement environment. We have wrapped up the California strawberry season. And despite the lower than expected freezer crop, our renewed focus on grower relations helped us procure a significantly larger share of the available fruit compared to 2019. We maintained our plant throughput for the whole season, utilizing roughly 40% less seasonal labor compared to 2018 as a result of our automation initiative. We remain confident in our ability to meet our expectations for further sequential margin improvement in the 4th quarter. While there were many questions last quarter on the impact of the California strawberry season, I will share that this business is different now than in the past. For context, conventional strawberries grown in California represent less than 5% of our total company gross profit. Do I wish the season had been better? Of course. See some headwinds on 5% of the business defined SunOpta? No. Our fruit business has had a history of negative Q3, Q4 surprises. Since this is not historical SunOpta, our view of 2021 has actually improved compared to last quarter as we are now incrementally more optimistic about next year. We have more clarity into customer commitments segment and produced the best consolidated gross margin percentage performance in 8 years. Further, we are seeing significant increased consistency across each of our segments, which is reflected in our quarterly results. Our positioning in key healthy, natural and organic categories, along with our leadership in plant based food, position us exceptionally well with consumers. We have successfully executed and completed our turnaround efforts, reduced leverage, invested in promising opportunities and are now focused on driving growth across our core platform. 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. Let me walk through gross profit and the rest of the income statement given Joe's discussion of the commercial activities and revenue during the quarter. I will also cover our balance sheet and cash flow results. We're very pleased to report another strong quarter. As Joe discussed, we saw 6.4% revenue growth and more than doubled adjusted EBITDA for the 4th consecutive quarter. Gross profit was $41,900,000 for the Q3 of 2020, an increase of $15,600,000 or 59 percent compared to $26,300,000 during the Q3 of 2019. The fruit based segment was responsible for $9,100,000 of the gross profit improvement. For perspective, that brings year to date gross profit in fruit to $19,800,000 or nearly 5 times the prior year's results. The improvement in fruit came from improved revenue, placing a favorable mix of higher margin retail versus foodservice revenue and the benefits from increased automation and productivity initiatives implemented in our plants. The plant based segment accounted for $3,400,000 of the increase in gross profit, mainly reflecting revenue growth of 10.8 percent in the plant based beverage and extraction businesses, offset in part by a reduction in revenue in the sunflower business. In addition to revenue growth, increased production volumes as well as strong execution of our productivity plan and higher capacity utilization drove improved margins. This was partially offset by lower revenue, production volumes and plant utilization in the sunflower operation. Global Ingredients contributed $3,100,000 of improvement, primarily due to solid execution of our portfolio optimization that resulted in increased pricing spreads and higher margin product mix for organic ingredients and premium juice products. This was supplemented by manufacturing efficiencies and productivity improvements. These results were partially by an unfavorable cocoa commodity hedging result of $1,000,000 versus the prior year and manufacturing inefficiencies related to organic avocado oil production. As Joe noted, we were quite pleased with the performance of our cocoa processing operations, which set record production volumes in the 3rd quarter with improved efficiencies. As a percentage of revenues, 3rd quarter gross margin was the highest since 2012 at 13.3% compared to 8.9% last year, a 440 basis point increase. All segments contributed significantly to the gross margin expansion with gross margin expanded 9.90 basis points in the fruit segment, 2.10 basis points in the plant based segment and 160 basis points in the global ingredients segment. Operating income was 9,400,000 dollars or 3 percent of revenues in the 3rd quarter compared to a loss of $3,500,000 last year. SG and A increased $1,600,000 to $29,300,000 in the 3rd quarter with the savings initiatives being offset primarily by variable compensation expense. Loss attributable to common shareholders for the Q3 was $2,800,000 or $0.03 per diluted share compared to a loss of 13,800,000 dollars or $0.16 per diluted share during the Q3 of 2019. On an adjusted basis, net loss was $1,300,000 or 0 point 0 $1 per diluted share compared to a loss of $9,900,000 or 0 point 1 $1 per common share in the prior year. As Joe mentioned earlier, for the Q3 of 2020, adjusted EBITDA was $22,800,000 compared to $9,900,000 in the prior year, bringing the trailing 12 months adjusted EBITDA to 84,000,000 dollars 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. Q3 total debt was $443,800,000 down approximately $47,000,000 from Q4 2019. Total debt reflects $219,500,000 net of issuance costs of our 2nd lien notes due in October of 2022, $199,700,000 drawn on our global asset based credit facility, with the balance representing smaller credit facilities, leases and other financing arrangements. Leverage has improved to 5.3x from 10.3x as we entered 2020, and we are now nearing completion of the refinancing of our ABL, which matures in March of 2022. Following this, we will begin the process of refinancing our second lien notes, which are due in late 2022. Our significant improvements in adjusted EBITDA over the trailing 12 months is a significant asset in the refinancing process, and we are very confident with our refinancing prospects. From a cash flow perspective, during the quarter, cash generated from operating activities was 20,200,000 dollars compared to cash generated of $4,300,000 during the Q3 of 2019. The $15,900,000 improvement reflects improved operating performance and continued working capital management. It is worth pointing out that our Global Ingredients segment reduced nearly 10% of its inventory position versus Q3 of last year. Cash used in investing activities was $11,800,000 compared with $7,600,000 in the Q3 of 2019. The increase in capital investments primarily relates to investments to expand capacity in our plant based operations. As we look forward, we continue to expect that our executional excellence will generate strong P and L flow through. In the 4th quarter, will likely see high single digit revenue growth, creating robust double digit gross profit growth cascading to what could approach a nearly 50% increase in EBITDA versus Q4 2019, which was in turn a doubling of EBITDA versus Q4 of 2018. With that, I'd ask the operator to open up the call to questions. Thank you. At Our expectation on ramping that production utilization, We put a marker out there that we expect it to be fully utilized by the end of Q4 2022. At this juncture, we are making good progress. In terms of working with significant capacity would be a bit of a headwind to gross margin. However, both customer mix as well as our productivity efforts will both be tailwinds And then those 2 tailwinds should net or negate any kind of negative impact from the added capacity. So we would expect 2021 gross profit margin to look broadly like 2020? I appreciate the color there. And then so another question on fully up and running and utilized. And if we find that in kind of some point in 2021 that we feel like we've got a 12 month view out of the business where we think we're going to sell that out. We're certainly willing and able to make further investments in that space. Got it. Fair enough. Switching over to Foodservice, a bit of a headwind or an offset to the growth this quarter, not surprising. But just curious if you could maybe kind of give us a little bit of incremental color on sort of the pace of recovery in that channel. I think high level what seeing is obviously a trough first half of the year immediately following lockdown. And then we saw some steady progression, moderating declines that seem to have sort of peaked depending on what channel you're talking about, maybe in the high single, low double digit range. So I'm curious if specific to your business that that kind of mirrors what we're seeing high level? And then secondly, with the concerns about 2nd wave and new cases and maybe new measures being implemented, how you're kind of thinking about the plan going forward here and the pace of recovery in that channel as it pertains to your business? Yes. So yes, we're seeing a consistent pattern to what you articulated. In aggregate, the service was neither a headwind or a tailwind for the quarter. It looked broadly similar to 2019. As it relates to the impact of a second wave of COVID, we're all certainly different about that at multiple levels, 1st and foremost, for our associates and the operations of our facility. But we're going to continue to monitor it and work with our customers and respond to their forecasts. And to date, we have not seen any significant adjustments in their forecast as they think about a potential second wave, but we'll certainly be ready to respond to that. And last one for me. I really appreciate the color and the clarity that you provided with respect to the food segment this quarter. But just to confirm, you are lapping pricing that you took, I believe, this time last year. So just curious, have you taken or would you need to take more pricing this quarter? And if so, how have those discussions progressed? So, yes, we are in a position where we have been able to pass through the majority of the impact of higher cost fruit from this season and many of those prices will go into effect here in the Q4. That's a result of a lot of great work by our sales team over the last 12 months to get better relations with our customers as well as different pricing mechanisms in place and certainly has aided our efforts in mitigating the impact of the higher cost fruit. Appreciate all the color. Best of luck. Thanks again. Thanks, Bryan. Your next question comes from Ryan Myers of Lake Street Capital. Your line is open. Thanks for taking my questions. First, just a clarification. You gave some commentary on the 4th quarter for revenue, gross profit and adjusted EBITDA, but I just want to make sure this is year over year growth, correct? Correct. Okay. And then can you discuss potential headwinds that you guys might see in plant based beverage, including food service that you could potentially see going forward that maybe slow the growth a little bit? Yes. I mean, I certainly think a second wave of COVID could have an impact. I mean, I will remind, vendors of what a COVID environment looks like. And so I don't really have any material forward looking insight that would suggest it would look different than our Q2 and Q3 results from this year. I think there is obviously an offset with retail growth and we see very, very strong growth on the retail segment. And I would, I guess, expect the 2021 to look like 2020 if we were to kind of go pick. That's helpful. Or is it kind of going to be what's been reported this quarter? Or is there further room for improvement? Yes. As I mentioned, Brian, we think that the 2021 gross margin will look broadly like 2020. There is a bit of a headwind with just some added capacity, which will be a kind of short term headwinds to our gross margin rate, but there are 2 strong tailwinds, our productivity initiatives certainly being one of them. So and we also think mix, both product mix as well as customer mix will be a tailwind in 2021. So net net, 2021 will look broadly similar to 2020. Okay. And then last one for me. Any updates on new product performance such as the Arbor Guard? Yes. I mean, we continue to monitor and look for additional customers to roll it out. We're happy with the product and are actively engaged in putting promotional efforts against it to drive trial and we're encouraged by the repeat that we're seeing on the product, but we're looking for additional ways to drive trial. Your next question comes from John Anderson of William Blair. Your line is open. Nice to have some fellow questioners on the call. I wanted to ask you about the oat base extraction oat extraction process. Can you talk about the quality of your process in producing the out base? And is there an equivalent player in the market that does this? My understanding is there products themselves. Yes. Without getting too technical here where I might need some diagrams and schematics, there's 2 ways of making oat milk. 1 is you start with oat flour and add water. The result of that process is you get a very gritty, bitter tasting product. The other way to do it is you start with raw oats, you soak them and you add enzymes that basically break the oat down into soluble and insoluble components. Obviously, the soluble components are turned into oat milk to get a much cleaner tasting product. None of that gritty texture that consumers complain about and we think it's a superior process to the way many of the people are manufacturing I certainly don't have detailed information into how everyone does it, but we are aware that one of the leading oat milk manufacturer that we don't make product for also does it in a similar process to the way that we do it. That's great. It's tough to go technical and do it in terms laymanlike I can understand. So I appreciate that. Your plant based beverage business, it was interesting. I thought it was great that you provided some of that consumption data, syndicated consumption data that showed both aseptic and refrigerated growing at very healthy rates. You know, we're going to be changing a little bit with your oak based capabilities because that may allow you to serve the refrigerated market perhaps our added extractor capability opens us up to being a supplier on the refrigerated side. Both of them are important to us. Obviously, we have significant aseptic manufacturing assets and that is a core business for us. But the oat extraction projects and capability certainly affords us the opportunity to start to work with customers in the refrigerated space, who aren't current customers today on the shelf stable aseptic side. Okay. Thanks on that. Fruit, in terms of fruit, what led you to upgrade, willing to kind of upgrade your outlook for gross profit in 2021, some of the specifics maybe in a prioritized form? Yes. Our success in working with customers to pass through the increased cost of fruit. Our clarity around the customer commitments that we have for 2021 would be probably the 2 biggest ones that gave us confidence to suggest that 2021 is going to be better than previously forecasted. And given that you're through the season, the harvest this year, the 2020 harvest, does that provide you cost visibility through the bulk of 2021 at this point? Typically, it would provide us insight certainly into kind of Q1 and Q2. And then as it relates to our overall cost structure for the balance of 2021, while the fruit input cost is still a variable, we certainly understand the overall cost structure of our supply chain network, labor, etcetera, etcetera. Okay. That's helpful. Last one, just on the debt Scott's comments on the debt refinancing. So my understanding, the ABL is in process and the second lien is soon to come. And I think you expressed confidence around the 2nd lien. Is your expectation on the 2nd lien there would be an ability to get better pricing? Yes. Good morning, John. So the comments that I was offering was really focused around here in the home stretch and getting the ABL done, recognizing that that has the March 'twenty two maturity date. And just keep in mind that the 2 loans are due about 2 years from now in October of 2022. So we're working on them sequentially. So I would expect that if all else were equal in the capital markets, I'd like our chances to have some rate reduction on the 2 well notes, but that'll follow the work on the ABL. Okay. Thanks so much. Congrats on a great stretch here. There are no further questions at this time. I will now return the call to our host for closing remarks. Okay. Thank you, operator, and thank you all for participating in our Q3 conference call. I look forward to speaking to you in the future and appreciate your interest and support SunOpta. Have a great day. This concludes today's conference call. Thank you for your participation. You may now disconnect.