Earnings Call: Q1 2020

May 6, 2020

Good morning, and welcome to SunOpta's First 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 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 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. And now, I'd like to turn the conference over to SunOpta's CEO, Joe Inan. Good morning and thank you for joining us today. With me on the call is Scott Hawkins, our Chief Financial Officer. We had an outstanding Q1 delivering revenue of $335,900,000 which represents 13% adjusted revenue growth year over year. We generated nearly 400 basis points of gross margin improvement versus a year ago and more than doubled adjusted EBITDA. Adjusted EBITDA for the quarter was 24,300,000 dollars the 2nd highest quarterly adjusted EBITDA in the company's history, up from $11,100,000 in the prior year. The improved results represent traction in our turnaround plan and the key initiatives we have put into place over the last year. We are more focused on our customers than ever before. We are executing our productivity plans and we are controlling costs. Progress and improved execution is evident in each of our 3 segments. We generated $35,000,000 of operating cash flow in the quarter and we reduced total debt by over $20,000,000 from year end. Combined with the recent $30,000,000 preferred equity raise, we have significantly improved our liquidity position, while also improving our profit and cash flow profile. As we announced a few weeks ago, we completed a $30,000,000 preferred equity raise with 2 of our largest investors. This is a reflection of their confidence in the business outlook and provides us the capital to support continued investment in our plant based business unit. There is a total commitment of $60,000,000 from these investors that we have the option at our discretion to access over the coming months. We continue to invest behind our most promising and high return opportunities, while deemphasizing lower margin, lower return on capital segments of our business. We are executing well and have successfully adapted to the day to day challenges of the current COVID-nineteen pandemic. I will touch on this in a moment, but first, let me run through our performance during the Q1 and our business initiatives. Our revenue growth was led by continued strong performance of our plant based food and beverage business unit, which delivered 29.7 percent adjusted revenue growth in the quarter with strength across each primary product category. We also produced 9.1% adjusted revenue growth in our fruit based food and beverage business unit as our pricing efforts along with strong volume drove the growth. More importantly, we saw further improvement in gross margin. Similarly, we generated 5.5% adjusted revenue growth in Global Ingredients, while also delivering gross margin improvement. It is evident that our focus and investments in plant based beverages has positioned us well for continued growth. We are executing the turnaround plan in our fruit business unit, driving improved margins and optimizing our operations for further success. In Global Ingredients, we are focusing on the most promising product categories and we are seeing the results in our margin enhancement. Additionally, we see marked improvement in the output and efficiency of our cocoa processing plant in Holland. We are pleased with the improved margin and growth across each of our business units. In addition to our gross margin improvements, we continue to execute on our cost savings initiatives. We are delivering on our SG and A reduction target of $8,000,000 to $10,000,000 on an annualized basis. As we noted last quarter, this improvement does have some offsets, which occurred this quarter. Scott will provide more details in a moment. Before we talk about the individual business unit performance, I would like to summarize COVID-nineteen's impact on our people, our plant operations and the P and L. First, let me offer a sincere thanks to all of our global employees for their dedication and their ability to quickly respond and adapt to the rapidly changing environment. We responded rapidly following all government advice as it evolved and we are laser focused on the health and safety of our employees. As it relates to the SunOpta team, the phrase, when the going gets tough, the tough get going, most certainly applies. All our facilities with the exception of our Ethiopian avocado oil plant are fully operational. Beyond that, we have not encountered any plant closures, material line disruptions or significant downtime as a result of COVID-nineteen. We have kept up with the demand spikes from our customers while maintaining high levels of service. Within our plant and fruit based business units, approximately 2 thirds of our sales are in the grocery retail channel and approximately 1 third is food service. Similar to most CPG companies, we saw a surge in demand in the second half of March that was somewhat offset by declines in foodservice. Scott will unpack in detail the impact of COVID-nineteen on our financial performance in Q1. But to summarize, we estimate incremental revenue of $7,000,000 to $10,000,000 a $3,000,000 gain in gross profit and no material impact on EBITDA as currency devaluation and reserves for bad debt offset the modest gain in gross profit. While it is still early in Q2, I can share that foodservice declines are being offset by retail gains, which have moderated after the pantry loading we saw at the end of Q1. The impact of the foodservice slowdown has been more pronounced on our plant based BU and we are encouraged by the announcement of our largest foodservice customer that they will be reopening thousands of outlets in the coming weeks. Now let me walk you through each segment. The crown jewel of the company, our plant based food and beverage segment is composed of all of our plant based beverages such as soy milk, almond milk and oat milk, plus our broth business. This business unit also contains our extraction business, where we sell the concentrated base for making these plant based milks and it includes the sunflower business. During the Q1, the plant based beverage unit delivered accelerated revenue growth of almost 30%, up from 25% growth in the 4th quarter. We saw growth from both existing and new customers and existing and new products. The plant based business unit delivered a 1st quarter gross profit margin increase of 6.90 basis points. This significant step change in margin is a function of volume and strong execution of our productivity efforts across the entire network. Our operations team is achieving record setting production throughput and efficiencies. We are seeing broad based growth in plant based milks, broth, extraction and sunflower, all generating double digit year over year growth, including over 30% growth in plant based milks and extraction. We will continue to focus our investment and deliver innovation on our plant based portfolio given the strong category growth and the favorable consumer tailwind. We remain on track with our capital project to expand our extraction capabilities by 4 fold and we are progressing with the other 2 capital projects to increase capacity and capabilities across our national footprint. We continue to expect all three of these capital projects to come online late in Q4. Turning to fruit, the fruit based business unit, which is comprised of frozen fruit, fruit snacks and fruit ingredients, posted revenue growth of 9.1 percent driven by strong growth in frozen fruit and fruit snacks. Frozen fruit benefited from both our pricing actions and strong growth with our major customers. Consistent with last quarter, we delivered improved gross margin, which expanded 2 60 basis points year over year and expanded 3 10 basis points from the 4th quarter. Our plan to improve margins in frozen fruit is progressing and results are tracking in line with the expectations we have discussed over the last several quarters. Beyond our pricing initiatives, we are seeing significant productivity gains associated with our automation investments and overall stronger manufacturing discipline as we execute our plan to turn around this business. The Mexican strawberry harvest was in line with our expectations and the fruit season in California is gaining momentum each day. The supply of fruit looks good, our plants are ready and we are prepared to execute the 2020 season. Our fruit unit has a very high retail customer channel mix. Therefore, as we see the shifting mix of consumer purchases towards retail and away from food service during the COVID-nineteen pandemic, we are seeing strong demand. Given the strong demand and our lower level of inventory resulting from last year's poor harvest, we have sold off a significant portion of our higher priced 2019 fruit inventory. Finally, the Global Ingredients segment, which includes Tradin Organic Ingredients and our Premium Juice business also delivered a strong quarter with 5.5 percent adjusted revenue growth and a 200 basis point improvement in gross margin. The revenue growth and gross margin improvement were driven by both Tradin Organic Ingredients and our premium juice offerings. We saw good production improvements in our crown of Holland cocoa processing operation and had a strong quarter overall. Our strategy to focus on margin and the return on capital profile of our ingredients segment is in process as we have already begun to reduce our exposure in animal feed as an example. During the Q1, we generated a significant improvement in return on capital in the Global Ingredients segment with higher margin on lower inventory. We will continue to work through 2020 to rebalance the Tradin Ingredient portfolio and rightsize inventory levels to further improve the return on capital. In conclusion, I'm pleased with our Q1 performance with gains across each of our three segments. We are executing our turnaround and we are positioned to capitalize on further growth opportunities. 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 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. 1st, as Joe mentioned, we had a strong revenue performance with double digit growth. We saw some fairly significant puts and takes from COVID-nineteen in the quarter, and I will give you our estimates of the impact as we walk through each line item on the P and L. We estimate that $7,000,000 to $10,000,000 of our revenue came from COVID-nineteen, consistent with our prior estimated range. Gross profit was $43,700,000 for the Q1 of 2020, an increase of $15,500,000 or 55 percent compared to $28,200,000 during the Q1 of 2019. The Plant Based segment accounted for $10,600,000 of the increase in gross profit, mainly reflecting revenue growth, plant productivity efforts and higher capacity utilization. Fruit based segment was responsible for $3,100,000 of the gross profit improvement, reflecting pricing initiatives, productivity improvements and increased revenue. Global Ingredients contributed the remaining $1,800,000 of improvement. We estimate that COVID-nineteen added approximately $3,000,000 of gross profit in the quarter. That came from margin on the additional sales and a roughly $2,000,000 commodity hedging gain in March in our Global Ingredients segment. The commodity hedge was in a modest loss position prior to COVID. The negative impact to gross profit from the 2019 weather related shortfall in the fruit based business was in line with our previous expectation. We recognized a $1,900,000 impact during the Q1 and anticipate approximately $1,000,000 to $2,000,000 in the second quarter. As a percentage of revenues, 1st quarter gross margin was 13% compared to 9.2% last year, a 380 basis point increase. The largest contributor to this margin expansion was the plant based segment, which saw 6.90 basis points of margin growth to 19.8%. Operating income was $11,500,000 or 3.4 percent of revenues in the 1st quarter compared to $300,000 last year. Excluding approximately $1,000,000 of non recurring costs, SG and A was consistent with the prior year in terms of dollars. We realized approximately $2,600,000 of savings this quarter associated with our reorganization work last year. These savings were offset by approximately $1,000,000 of bad debt expense, $1,000,000 of higher stock compensation and $1,000,000 of nonstructural costs during the quarter. The COVID-nineteen impact to SG and A was approximately $1,000,000 as we provision for potential bad debt given the current economic climate. Earnings attributable to common shareholders for the Q1 were $1,300,000 or $0.01 per diluted share compared to $23,700,000 or $0.26 per diluted share during the Q1 of 2019. Again, the prior year's income benefited from the one time gain on the sale of the corn and soy business. On an adjusted basis, earnings were $900,000 or $0.01 per diluted share compared to a loss of $7,900,000 or $0.09 per common share in the prior year. As Joe mentioned earlier, for the Q1 of 2020, adjusted EBITDA was $24,300,000 compared to $11,100,000 in the prior year, excluding disposed operations. The COVID-nineteen impact on adjusted EBITDA was flat with $7,000,000 to $10,000,000 of revenue, dollars 3,000,000 of gross profit, including a $2,000,000 commodity hedging gain in March, offset by $1,000,000 of increased SG and A for bad debt and a $2,000,000 FX loss from the devaluation of the peso in the month of March. 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. At March 28, 2020, total debt was 469 $300,000 down approximately $21,000,000 from December 28, 2019. Total debt reflects $218,800,000 net of issuance costs of our senior secured 2nd lien notes due in 2022, dollars 223,500,000 drawn on our 1st lien global asset based credit facility with the balance representing smaller credit facilities, lease and other financing arrangements. From a cash flow perspective, during the quarter, cash generated from operating activities was $34,700,000 compared to cash generated of $1,000,000 during the Q1 of 2019. The $33,800,000 increase in cash provided by operating activities primarily reflects improved operating performance and more efficient working capital management as inventory declined $51,000,000 during the Q1 from Q4 2019. The sequential reduction in inventory included $40,000,000 due to strong Q1 sales, greater efficiencies in our Global Ingredient and Fruit segments and the normal seasonal decline in fruit inventories ahead of the annual harvest season. As a reminder, we generally see working capital increase from Q1 to Q2 based on seasonal inventory purchases, particularly in fruit. For the full year 2020, we would expect working capital to be relatively flat to 2019. Cash used in investing activities was $9,700,000 compared with $8,000,000 in the Q1 of 2019 adjusted for the proceeds from the sale of the corn and soy business. The increase in capital investment primarily relates to the expansion of our extraction capabilities that are currently underway as well as investments in new automation for our frozen fruit facilities. Finally, let me touch on the recent preferred equity financing. As Joe mentioned, we received a commitment of $60,000,000 in Series B preferred shares from 2 of our largest shareholders, Oaktree and Engaged Capital. The first $30,000,000 closed on April 24. At our discretion, we can require the investors to purchase a second tranche of up to $30,000,000 on or before July 15, 2020. This investment provides the capital for us to continue to invest in our plant based foods and beverages platform and provides additional liquidity. We are very pleased with the successful transaction. Now turning to our outlook, let me address our expectations going forward. While we don't provide guidance, given these uncertain times, let me give you some insight into what we are seeing right now. We did not experience a material COVID impact in Q1 from our foodservice customers, but we are feeling the impact of reduced foodservice orders in Q2. The short term result of this is the plant based segment's growth moderating from the 20s down to the mid single digits for the Q2. This likely leaves total revenue roughly flat to last year for the Q2. Beyond the Q2, it would be pure speculation and too early to comment now. However, we do expect adjusted EBITDA to be materially greater on a year over year basis for the remainder of the year. With that, I'd ask the operator to please open up the call to questions. Your first question comes from Jon Andersen with William Blair. Yes. Hi. Good morning, guys. Good morning, John. Good morning, John. Congratulations on the start to the year. Thank you. I guess, maybe I'll start with the plant based business. You saw terrific growth in the quarter. You've seen terrific growth, frankly, there for the past couple of quarters, a few quarters. And I'm wondering if you can give us a little bit more color around the various product categories, the components of that business, where you're seeing particular pockets of strength? And then, I think the second question on plant based is the extraction capacity that you're bringing online, what's the opportunity around that? I know that that will probably not really come to fruition until 2021 given that the capacity comes online late in 2020. But how do you think about the market opportunity around that extraction capacity and how quickly you can fill that? Sure. In terms of where we're seeing the first part of your question, where we're seeing strength in the plant based business, It is certainly across every customer, both existing customers and new. So we're doing a good job on the business development front. Roughly 2 thirds of the growth this in the Q1, 2 thirds of the growth came from existing customers. And importantly, a third of the growth came from new customers. And we see a similar balance between new products and existing products. So really strength across the board. Last quarter, we spent considerable time unpacking the underlying consumer drivers of the plant based business and we certainly continued to see and experience those tailwinds in the Q1. So really in summary, just strength across the board. On the extraction side, I'll explain it this way. We produce think of it as like a concentrated base that you then add water to make it in the form that you would pour it out of a carton from. There's 2 opportunities. I mean, on one side of the business, we produce the concentrated base. We then add water and package it aseptically ourselves. There is obviously a significant business done in plant based milk that is outside of products that are packaged aseptically. If you think about the refrigerated aisle and the gable top carton dial packaging, we will sell producers or manufacturers the concentrated base, which to which they then add water and put it in their package format, be it a carton, a bottle, etcetera. So that's how that business is going to be monetized is think of it as an ingredient sale. Okay, interesting. And is that how does it work? You have capacity coming online. How much visibility do you have into your ability to kind of sell out or sell into that capacity in 2020? Does it come online quickly because you have arrangements kind of in place? Or is it a longer business development timeline? We feel good about where we are right now with our business development efforts against that. Part of the thesis for that investment was we were experiencing we have a small extraction capability right now and we were experiencing significant demands, customer interest and demand certainly in excess of what we could produce And that was really the underlying premise for making the capital investment. So we feel good about our ability to stand up that plant and we certainly wouldn't expect it to be full on day 1, but we do have customer commitments that allow us to open that facility up and start running. Terrific. Again, on plant based, could you talk about the mix of that business? It sounds like it skews more away from home or foodservice. Is that the case? And then if so, how are you thinking about the return of that larger customer in foodservice for your plant based beverages? Is that looking like it's going to be happening here over the next several weeks? And how should we yes, I mean, what's your expectation around that piece of it, the foodservice side? Yes. So our plant based business in total is, call it, roughly 60% retail, 40% foodservice. We do a significant business in that foodservice channel with large coffee chains. I won't wade into speaking for individual customers, but there's been some recent public announcements from some of the bigger coffee chain about their plans over this week and in the coming weeks to start to aggressively reopen their outlets. And so we're optimistic. Obviously, the big question mark will be how quickly do consumerscustomers return. But we're encouraged by their announcements and we're ready to play. Great. Okay. So shifting over to the fruit business, strong quarter, sales and margin progression. It sounds like very much in line with the kind of the cadence that you've described for some time now. Is there and I understand it's very early, but is there anything you can talk about with respect to fruit availability and or pricing more broadly, I guess just in the both in the context of what you've seen year to date in Mexico and early in California and also in light of the fact that there's probably less fruit going into foodservice, maybe less demand for fresh fruit, which may have an impact, I would guess, on the fruit availability for the freezer market, which is where you primarily play, I believe. Yes, good question. You're absolutely correct in that the foodservice contraction has impacted the fresh market pretty significantly. And so we remain optimistic that the supply of fruit is going to be within historical ranges. And as far as pricing goes, again, pricing is in historical ranges about where we would have forecasted it to be at this point in the year. So we're it's not there's no real concerns on either the pricing front or the supply front as it relates to the California fruit season. Okay. And it sounds like from your commentary that there's been some nice progress on both demand from existing customers, but perhaps also pricing. I know this was an area that you really emphasized when you came in that there was probably a better way kind of think about structuring pricing arrangements extent you've been able to make that happen? And how much of the extent you've been able to make that happen? And how much of the demand you're seeing maybe in fruit right now is this stock up or at home acceleration given the COVID situation? Yes. So, the fruit business is more retail oriented than foodservice, call it 75% retail, 25% foodservice. So we definitely benefited towards the end of March with some stock up type purchases and saw that. But we were having a strong quarter 11 weeks into the quarter before really the COVID orders started slamming the system. So it didn't all come in the last 2 weeks of the quarter. So pretty strong growth. And we've seen inventories kind of pull back on our side with the strong orders have really helped us work through some of that expensive 2019 inventory and put us in a strong position going into this 2020 season. Great. All right. I'll have a couple more here. I don't know how many people we have in the queue, but I will do want to ask about Global Ingredients because that too you've made solid progress in the quarter and how much of this is coming from better performance, better productivity out of the Krone Holland plant, the cocoa processing facility? I think there might have been some headwinds that you experienced last year there that maybe you kind of overcome. And then you did mention that there was one facility, I think the avocado oil plant in Ethiopia that's not up and running. Maybe you could give us a little bit more color around your expectations for that and just the Sandmarc acquisition in general? Yes. So the Crown of Holland throughput and output, the operations team in Holland have done a great job in getting that plant up and running and into a very nice productivity zone for the business and a sizable percentage of our pickup in gross margin in the quarter was a result of that. And we're encouraged by the continued progress that's being made. As it relates to our avocado facility, not a massive portion of our revenue, but it's something that we've spoke about on previous calls and so wanted to touch on it. The availability of public transportation in Ethiopia, The closing of public transportation has made it difficult for our workers to get to our production facility. And as such, we made the decision to close until public transportation resumes in Ethiopia. Okay. The last one for me is really some of the comment the forward looking commentary that you provided at the end of the prepared comments. I just wanted to make sure I understood this clearly. So understand the rationale for kind of a flatter year over year top line in Q2. On the EBITDA comment, do you does that am I interpreting that right that you mean EBITDA dollars increase on a year over year basis for the rest of the year or EBITDA dollars increase sequentially? How do we interpret that? Hey, John, it's Scott. I'll take that one. So the comment was that we'd see some muted levels of growth as Joe just talked about. But notwithstanding that on a year over year basis, we would expect still to produce meaningful year over year EBITDA dollar improvement. Terrific. Super helpful. Thank you guys and again great start to the year. Congrats. Your next question comes from Mark Smith with Lake Street Capital. Hi, guys. A lot of mine have been answered, but wanted to talk kind of big picture. Food supply chain is certainly in the news, seeing issues in dairy, especially meats. Can you guys talk about any potential risks that you see out there outside of some of the fruit things that you've talked about, but more so potential opportunities that you see in the short term and long term? Yes. So we don't anticipate any supply chain disruptions. I touched on fruit on the plant based side of things. We've had pretty decent crop weather in the U. S. So far this year as far as planting goes for soy and oats. So no material disruption expected there. As it relates to opportunities, I think the opportunities that we have in front of us are really about keeping up with consumer demand. And we continue to experience, I know there were some news articles recently about the meat shortages and the shift over to plant based. Again, we've been seeing that trend for the better part of a decade with consumers on a slow migration towards plant based and substituting dairy products with plant based. And so it's representing a great trial opportunity for us as people stock up. We saw with concerns around and people wanting to pantry load, the aseptic side of it, which is obviously shelf stable, benefited from that consumer behavior. And we hope that the new trial that we got in the Q1 translates into loyal consumers going forward. Okay. And we're kind of in unprecedented times, but if you can look a little bit in your crystal ball at consumer behavior as we've seen this shift kind of force shift to home based food away from food service, how sticky do you think these consumers can be and how much you can hold on to them in kind of home based grocery food versus a migration back to food service once it reopens? Yes. I mean, I think we will return to, I think, the pre COVID-nineteen kind of pattern between foodservice and retail? The question of when is that's the $64,000,000,000,000 question that I wish I could give you a great answer to, but unfortunately, my crystal ball is a little cloudy this morning. No problem. And then last one for me, and sorry if I missed it during the commentary, but can you give any insight into kind of FX, what you expect from currency impact here, maybe near term in Q2, but maybe even as we We realized a call it a $2,000,000 unrealized impact from the decline of the peso. It's I'm no better currency forecaster than anybody else, but we did take the step of trying to protect ourselves a bit from that or if you will lock in that benefit. Meaning because we have production facilities in Mexico and a lot of peso denominated costs, we would actually root for a weak peso. So we've taken some steps to try to preserve that relationship for the balance of the year. I guess the other comment to make probably today would be the euro has been weak of recent vintage down in the 109 type area. That's at least been comparatively more consistent. So these would be my thoughts. Okay, great. Thank you. At this time, there are no further questions. I will now hand the call back to Joe Inan for closing remarks. Great. Thank you, operator, and thank you all for participating in our Q1 conference call. Look forward to speaking with you in the future and appreciate your interest and support in SunOpta. Have a great day. That concludes today's conference. Thank you for your participation. You may now disconnect.