Great. So, thank you for joining us here at the 26th Annual Needham Growth Conference. I'm Matt McGinley, I'm the analyst that covers Vital Farms, and with us today, I'm pleased to have the team from Vital Farms. We have Russell Diez-Canseco, who's the President and CEO, and I have Thilo Wrede, who is the CFO of the company.
Close enough.
German is not my strong suit. So Vital Farms is a company that specializes in ethically produced farm fresh eggs and dairy products. So Russell, can you help us frame what the U.S. egg industry looks like, and how your supply chain is different from what we see in the rest of the industry?
Yeah, sure. Great. Thanks for having us today. So the U.S. egg industry has a large TAM at retail. It's $10 billion-$14 billion annually, depending on where egg prices are on any given day. It has largely concentrated since World War II, so it's a handful of really large producers, each of which has tens of millions of chickens that lay the eggs that supply grocery and food service. There's a small export market. When we started... Actually, 7 years into Vital Farms' history back in 2014, 95% of the chickens that laid eggs in the United States were in battery cages inside kind of factory farms. And so the thing to take away from that is that it was very much commoditized and very much a lowest cost of production.
It also was, and continues to be, a somewhat regionalized business, in part because of freight economics, cold chain, logistics, et cetera. There are a lot of kind of regional operations, even within those larger companies. And it's also a heavily DSD business, so a direct store delivery model for a lot of the kind of commodity producers that are delivering product directly to grocery stores. Within that market, we have a very different model. So we produce a very premium egg from birds that have a very premium quality of life, primarily because they have the opportunity to go outside year-round, with a lot of space and a very intentionally managed environment, both outside on pasture and even inside their barns.
But what's different about our supply chain is that when we set out to build this business, we wanted to create an opportunity for small family farms, and so we decided to only scale the things that really lent themselves to scale in that model. Which means that the farmers continue to own their farms and own the means of production, and we have over 300 of them, none of which has more than about a third of a percent of our production. But we built a world-class egg packing center in Springfield, Missouri, which allows us to benefit from great talent in areas like lean production and food safety, take advantage of automation opportunities, there are a lot of robots in that plant, while still creating those meaningful opportunities for small family farms.
The net result of which is very high quality at the plant, but great supply chain resilience across 300 farms in eight states.
Vital Farms specializes in these pasture-raised eggs. How big of that total market you talked about is pasture-raised, and what are the barriers to entry for other, you know, competitors to enter that segment of the market?
It's interesting. Pasture-raised eggs as a... You know, if you wanna think of it as a, just a different commodity of shell eggs. There are caged eggs, which is still probably two-thirds of the eggs at the grocery store, and then there are what the industry calls specialty eggs. Everything from cage-free, which means I still have a really big factory farm, but now the birds are on the ground instead of in cages. And then you've got things like free-range and pasture-raised, which at the highest level means the birds go outside or have the ability to go outside, at least. Pasture-raised really wasn't a segment of note in grocery when we got started. But since we got started, it's consistently been the fastest growing segment, and we've been the fastest growing player within that segment. I still don't think it's more than...
Gosh, if we're single-digit % of U.S. shell eggs, it can't be more than single-digit % of eggs. But the question that I occasionally ask the organization is, is pasture-raised growing faster because that's the kind of egg that people want, and we got so lucky as to pick that as the thing we were making? Or is it growing faster because we're growing so darn fast, and that happens to be the thing we're making? In a sense, because consumers—a lot of consumers don't have a great command of all the nerdy details of all the different kinds of eggs you can buy, I might argue that it's less relevant which segment we're in.
There are, I think, nine states right now that either require birds to be raised in a cage-free environment or will in the next year or two.
Yeah.
There are a couple of retailers like Kroger and Walmart that have committed to having, you know, cage-free eggs. Does that shift or that, you know, with those states, does that trend help you, or does that hurt you over the long term?
I definitely don't think it hurts us. I love the fact that states are taking that action. A lot of it is through popular vote, so it's not just, government overreach, if you're into that kind of thing. But people are learning that there are different ways to produce food, and they're creating informed opinions about how they want their food produced, and that plays well. Because in order to ask a consumer to pay more for anything, they have to understand that there's a choice to be had, and then they have to make that choice. So it helps us get the story out about the possibility of a difference. What we do is still so much different than even the cage-free production that's being mandated, that the way we think about it is more that it simply creates a new floor...
for in the category. It's no longer in cages, but the reality is the buildings are even bigger, so did we really make a dent in factory farming? From a consumer's perception, probably not.
So you have clearly been very disruptive within the egg category, and I think there is this bias that Vital Farms is primarily selling just a premium version of a commoditized product.
Yeah.
Can you talk about the value proposition you provide for the farmers, for the retail customers that you sell into, and for the customers writ large, and why do those customers, you know, keep returning back to this brand?
Yeah. What I'd say at the outset is, look, from the outside in, I'd still probably describe eggs as a not very attractive category, but there are often some pretty big opportunities in unattractive categories, and I think that's what we've hit upon here. I think what we learned over time... In the early days, we thought the big job was educating consumers about all the different choices we make and how we're gonna produce these eggs. The way the birds are raised, the way we work, partner with our small family farm partners, the way we treat retail customers, the way we treat truck drivers.
But what we found was that we get 3 seconds of mind share for a shopper, and the more we tried to lean into cramming standards information into their heads, the less productive those ads became. And what we figured out instead was that... I think the turning point for our understanding of what we were doing here was when 5 other varieties of this commodity called pasture-raised eggs showed up on shelves, right? Going all the way back to 2015. You can buy lots of other brands and store brands of this thing, and they're all a lot cheaper than our version of that thing. And I learned in business school, I think, that if you make a commodity and your cost structure is higher and your price is higher, at some point, you lose.
You're gonna lose at the end of that game. And yet we're the fastest-growing with the highest price and the highest margin and the highest share of that thing we're doing. So there's something beyond the commodity, and the something that's beyond the commodity is a little bit hard to describe because there's no barrier to entry to producing the commodity we produce. There are 10,000 small family farms that would love another financial opportunity. There's no shortage of corn and soy and beautiful pasture out there in the United States. There's no shortage of retailers looking for innovation. There's no shortage of consumers who are interested in buying something better that they can trust. The shortage is in the supply of that, of that word, trust, and that's what we figured out we're doing differently.
In the United States, it's very hard to find for a consumer to find a brand they can trust to feed their family, for a farmer to find an integrator, a company they can trust to do right by them. It's very hard to find, you know, frankly, companies in general that do what they say and say what they do. So when it comes to what that looks like for our stakeholders, for consumers, we don't necessarily advertise it this way, but we do a lot more than the USDA requires us to make sure that we're not gonna make you sick when you eat our eggs.
From a farmer's perspective, we spend millions of dollars every year, not that it's contractually required, but because we believe it's the right thing to do for the business and for them, to help them be the best farmers they can be, to help them drive better outcomes, healthier birds, and frankly, at the end of the day, for them to make more money, which is probably why we have very low attrition of our farmers. For our crew members, it could be as simple as when COVID hit, our crew members didn't have to worry about coming to work and getting sick because everybody in our company is full-time with full benefits, and if they got sick, they could stay home and still get paid. So nobody worried that their coworker was coming to work sick because they didn't want to lose a paycheck.
It's 100 different decisions we make every day that creates the flywheel, which is the much harder to explain moat around what we do.
How are your eggs priced relative to, you know, commodity or conventional eggs, I should say, and organic eggs? And is there any validity to the idea that when you have narrowing price gaps, that leads to share gains, and when you see wider gains, that those share gains don't occur?
Yeah.
How did that play out when we saw those price gaps narrow in the past 18 months or so?
Great, great question. So, we certainly, as a premium egg, have a higher price. That higher price varies a lot, not so much because our prices vary frequently, but because commodity egg prices at the bottom of the price ladder vary a lot and have varied, with increased frequency and severity over the last few years, as we've seen more and more supply chain disruptions and occasionally demand disruptions. So first week of COVID, stock-up shopping, hard to find an egg on the shelf. It's an opportunity for retail, for commodity egg prices to skyrocket, but we didn't take price. So for a hot minute, our eggs didn't seem that much more expensive than everybody else's, and that you might have imagined that that would lead to trade up because we were now relatively more affordable.
But the reality is that we saw increased demand because you, you'd buy any egg you could find, not so much because people were making a conscious decision to find a more, a better value in the egg set on that day when they were wearing their masks. The net result of which is, sure, we got some trial, and some of that trial led to consumers repeating and eventually becoming loyal consumers. But when we go back and we look at that example, we look at the example from a year ago when avian influenza had killed 44 million laying hens, which is more than 10% of the supply, and again, you found egg shortages and skyrocketing prices on the shelf.
What you found was that when our through-cycle growth rates, our through-cycle trial, our through-cycle buy rates, our through-cycle household penetration is pretty consistent in good times and bad from that perspective... when we see an uptick, as we did a year ago from avian influenza, it's not because we saw trade up, it's because we had eggs on the shelf. And, and we saw our growth rate return to what we had originally predicted when that kind of noise went away from the commodity markets.
So you mentioned avian influenza and the disruptive impact that had in 2022 and the beginning part of 2023. How was your supply chain able to adapt to that, and what were the responses from retailers and consumers? And we've seen a little bit of an uptick in the past few months, not anything, not nearly the levels we saw in 2015 or 2022. But what lessons can you apply from that last cycle to, you know, what could happen in 2024 if this continues to be an issue?
Yeah. So, you know, a few things. First, you know, we've always practiced what they call biosecurity, which is, you know, there are a lot of things that you can do from a human behaviors perspective to reduce the spread of any disease, including avian influenza, not unlike the things you might do in a city like New York around handwashing and distancing and all the other things in a time of a flu season. We're set up to be more resilient because we have this distributed network, so none of our farms has more than a third of a percent of our supply. And so, a year ago, we had two of our more than 300 farms affected by AI, and this year again, we've had...
Or in the fall of 2023, we had 2, another 2 affected, neither of which even combined, had as much as 1% of our supply, and therefore no impact on our ability to fill orders. In terms of learnings, I would say, you know, it's a reinforcement of the notion that it's an ounce of prevention, right? It's all about being great at your farm practices and your biosecurity practices when you're not scared about avian influenza. The other thing I think, you know, I think what we've seen is the vast majority of chickens that have been destroyed over the last 24 months due to AI have been those factory farm chickens, and it's not totally surprising. Those are the ones that are all crowded in a tight space. And ours get to go outside.
We believe sunlight is the best disinfectant, and we believe that healthy birds have better immune systems. So I think that helps too.
Great. So about 95% of your sales today are eggs-
Mm-hmm.
- and you do have butter, which is, you know, roughly 5% of the remainder there.
Yeah.
Historically, you've been, I think, fairly conservative in terms of innovation and extending into different brand-- or rather your brand into new products. So what's the strategy or approach here in terms of launching into other categories beyond eggs? And what categories do you think would make the most sense over time for you to expand into?
Yeah, you know, it's interesting. From a consumer perspective, there's an awful lot of interest and an awful lot of different kinds of foods that we might bring to market. Because you trust us to feed your family eggs, you'd probably be ready to trust us to feed your family other products. And anything we test has a top two box purchase intent above 50%, from ice cream to watermelons. So then the question is, well, what? Well, it's true, right? I'm not making it up. So then the question is, well, what and when? And that's when the conservatism comes in. So anything we do, we wanna make sure we're doing it in a meaningfully differentiated way because our brand is built on disruption.
And so we could put items that say Vital Farms on the shelf, but if we don't feel great about the difference we made in that product, then we're not sure we have a right to tell a story, and we don't wanna burn the trust we built. The second is that, because we have so much growth ahead of us and have seen so much growth over the last three years, four years, five years in eggs, I think we have the luxury of being really judicious with our capital allocation and driving really profitable growth. We don't need to sort of, run in 10 different directions to, to try to luck ourselves into another growth vehicle. And so, with the against that backdrop, there's a quote. I'm a big Jim Collins fan, the book Good to Great, if that rings a bell.
There's a quote in there to the effect of, "Very few companies, die of starvation for lack of opportunity, but a lot of them die from indigestion, from eating too much of it at once." I'm a Jim Collins fan. I don't wanna go into too many things at once and kind of have an unforced error. And I think that's serving us well at this time of high capital cost and difficulty in raising funds. We've got, you know, nearly $100 million of cash on the balance sheet. We have for years. We're self-funding our capital requirements right now. It's frankly a good place to be in this environment, and I won't apologize for it.
Excellent. So I know Thilo is the numbers guy here, so maybe I'll ask a few numbers-specific questions. Maybe for the fourth quarter guidance in the scanner data, why don't we start with that? So you reaffirmed your guidance back in November when you reported last to grow at least $400 million-$465 million in revenue and at least $40 million in EBITDA.
Mm-hmm.
That implies at least about a 17% or 18% growth rate in the fourth quarter. What drove the high level of growth, the 20%+ growth that you saw in 2023 overall? And if the scanner data is coming a little bit below that, what will be the difference between the scanner data probably coming in at high single-digit rate-
Yeah
... compared to the growth rate that is implied for the full year?
Yeah, the fourth quarter for us is a bit of a unique quarter. Every 5 or 6 years, we have a 53rd week. This is the first year since we went public. 2023 is the first year since we went public that we have this 53rd week. So that in itself is probably 7 or 8 points of growth. In the fourth quarter, it doesn't necessarily show up in scanner data like that. We do sell some eggs in untracked channels, be that in the natural channel or be it in food service, so that doesn't necessarily show up in scanner data either. So that would probably explain the difference between what you see in Nielsen or IRI data and why we feel so confident about the guidance for the year.
The growth this year was really driven beginning of the year, we had a bit of a one-time benefit from avian influenza. Russell just talked about it, that eggs just weren't on the shelf, and whatever we put on the shelf, consumers bought it, so that did help in the first quarter. But aside from that, the growth this year was driven, like in future years, by volume gains, by distribution gains, putting more SKUs on existing shelves, getting into a few additional doors, having a bit of growth from food service. So really, in that sense, not much of an outlier from other years.
Great. So back in the fall, you guys hosted an investor day that outlined some, you know, growth targets for 2027 that would put you, you know, I think at the leading edge of not just any company in the food manufacturing space, but, you know, in terms of the consumer space broadly, in terms of the growth rates and EBITDA, you know, growth that we should assume. Maybe we'll walk through the different elements of it and revenue, EBITDA, and then kind of the capital that will be required to get to that. But so the revenue goal is to get from $465 million to about $1 billion in revenue by 2027.
You know, part of that is, is driven by retail distribution, part of that is driven by more items, and then part of that is driven by higher household penetration. Can you kind of walk us through those assumptions and, and what... You know, I guess, what are the assumptions that underlie you being able to get to that $1 billion in, in revenue by, by 2027?
Yeah. The biggest piece of the revenue growth— And I should clarify, this is growth in existing categories, right? This is not adding anything to the business. It's just continuing the growth that we have in eggs. The biggest part of the growth will come from adding more SKUs to existing shelves. In conventional retail right now, we have about 2.5 SKUs on the shelf. In the natural channel, on average, we have 6 SKUs on the shelf. And so if you take— You know, we got our start in Whole Foods. If you take the natural channel as a leading indicator for where traditional grocery could go for us, there's a meaningful opportunity to add SKUs.
What we have seen is when we add SKUs to an existing shelf set, it doesn't cannibalize what's on the shelf already, right? We are adding incremental consumption to the shelf. So you combine that with getting into a few additional doors and then gaining more consumers, getting into more households, and, and thereby really selling, or increasing the velocity on the shelf. Those are the three main drivers that underlie the billion-dollar target. It does require investment on our side, so we need to, we need to sign up additional farms. Right now, we are working with over 300 family farms in what we call the Pasture Belt. For us, that's predominantly in Arkansas, Missouri, and Tennessee. If we want to double the business, we need to add more farms to it, right?
So a big part of where our sourcing efforts are focused is on signing up new farmers. Then we need to have the capacity to process all these eggs. The existing facility that we have in Springfield, Missouri, can process $700 million of revenue. Maybe if we make a few tweaks, we get slightly above that. But in order to get to the billion-dollar target, we need to build a new facility. We have started the process for that. You know, with close to $100 million of cash on the balance sheet, we have all the funds that we need to build that facility. We have no debt on the balance sheet, so there is that capacity if we needed it.
But just to fund the growth that we have laid out at our Analyst Day, we have all the funds that we need for that.
Something I would call out is the capital intensity. It's still a very light capital model. I think, you know, very conservatively, a production facility like the one we've got in Springfield might get to maybe $0.10 on the dollar of productive capacity, so $0.10 of CapEx for a $1 of revenue, annual revenue capacity. And, you know, I think that's a great reflection of the thoughtfulness we've put into each of our in-source versus outsource choices.
There's an EBITDA margin expansion opportunity over the course of that.
Yep
... three-year time period. Where's the operating leverage in this model, and kind of what does this look like in terms of EBITDA margins today and what you expect to see in 2027? And where does that primarily come from? Is that from manufacturing leverage that would be primarily in gross margin, or is that mainly leverage of your fixed cost and transportation costs, which would be primarily in G&A?
Yeah. Yeah, so the guidance that we have for this year is at least $40 million of EBITDA on at least $465 million of revenue, so it's very high single-digit EBITDA margin. So to get to the 2027 numbers, we need to grow EBITDA margin some 300-500 basis points. Beginning of this year, we were already at close to 12% EBITDA margin. Due to the egg shortage, we could cut back on promotions, and so that gave us a bit of a benefit on the revenue and the profit side. But really, where we will—how we will get to this 12%-14% margin sustainably is leverage in SG&A. Our gross margin target for 2027 is 35%.
We are close to that right now, and so really to bring EBITDA margin up, it will come from SG&A, and there are two main drivers. One is distribution. As we grow, we can put more pallets on trucks. That reduces the cost per pallet to ship them. And then, our headcount doesn't need to grow in line with revenue. And, there are certainly investments that we want to make in capabilities, but overall, SG&A should grow slower than revenue. Some of that will get reinvested in marketing spending. In order to get into these additional households, we need to continue to drive awareness of the brand and ultimately convert that into purchase.
Not all of the scale benefits that we'll get go into marketing, so whatever doesn't go into marketing will flow to the bottom line, and that's the margin expansion.
Yeah. And you, you'd mentioned a little bit before, but you have about $100 million in cash on the balance sheet. You will be building a new facility that, you know, I guess, can you walk us through kind of the rough costs of that, and talk about the cash flow generation profile of the company? I mean, even though you have the cash on the balance sheet, do you expect to generate cash over the next few years, and can that also, you know, be used to fund your growth?
Yeah.
I guess maybe more broadly beyond that, what are the prospects for capital return?
Yeah
... if you have excess cash to either shareholders or other investments?
Yeah. Yeah, so we are operating cash flow positive. This year, we'll generate $30 million-$40 million of operating cash flow. We expect that to continue to grow as the business grows and EBITDA increases. Uses of cash, first, we'll put it into continued growth in existing categories, right?
Mm.
So building the additional facility to increase processing capacity, that's the first area where cash would go. After that, we would look at anything that improves margins through productivity, through automation. After that, we would look at investments in new categories, and if we then have money left over, we would think about how do we return it to shareholders. So at some point in the future, there will be returns to shareholders through share buybacks, through dividends. But I think with the growth opportunities that we have, with the conviction that this brand can travel to other categories, I wouldn't bake any returns to shareholders into models anytime soon.
I think there are plenty of investment opportunities that we have to drive growth and drive profitable growth, and so that's the focus for our cash spending.
So Russ, one question I'm sure we're all dying to know is, what came first? Was it the chicken or the egg? I'm kidding. You, you got nothing, no. So-
That might be a trade secret.
Ah, okay, yeah. That's, that's a good one. Maybe we'll talk a little bit about the 2024 outlook. I know you're not providing guidance today, but, you know, I think, I guess, what are, what are some things we should expect in 2024? I know that, you know, feed prices are broadly coming down a little bit. I think they're still quite a bit higher than they had been pre-, pre-pandemic, but-
Yeah
... you know, they're down a little bit. I know that you're planning to increase marketing spend. I don't know if that's weighted to any given year in that cycle. I guess, you know, I guess what should we expect broadly from both you and the industry this year? Yeah.
Those are two very different answers, by the way. In fairness.
I'll start with us, and you can talk about the industry. So for us, you know, when you do the math, getting from the guidance that we have for 2023 to the guidance that we have for 2027, that implies a revenue CAGR of over 20%. So we have an ambitious growth trajectory ahead of us. 2024 will have to play its part in getting to the billion-dollar number. There are a few puts and takes that we have to keep in mind. We don't have this 53rd week again, so that's a bit of a headwind for us. Hopefully, we won't have another avian influenza outbreak like we had last year. Even though it benefited us, I think for the industry overall, it's not a positive.
And so,
Definitely not for the chickens.
Definitely not for the chickens, and not for the farmers either. So there's going to be headwind for us lapping first quarter 2023. Combined with the volume benefit that we had, we reduced our promotions in 2023 simply because we didn't have to promote. There weren't any eggs on the shelf, so why subsidize the ones that are there? So those are some of the puts and takes that we have to think about. But we're continuing to put additional SKUs on shelves, right? So the volume growth that we have had in the past will continue with that. The last two years, because of commodity prices, our growth was maybe a bit more price-driven than we want it to be for the longer term.
So the focus this year, in 2024, will be return much more to volume growth than what we've had the last two years. And so that's how we think about 2024 right now. As Matt said, we haven't given guidance yet. We'll announce earnings in early March, and you should expect guidance then. But those are some puts and takes to think about.
Are there any... I'm sorry.
I won't pretend to know what's in the minds of the leaders of the industry incumbents more broadly, but if history is a guide, you know, it will continue to be a price minimization, you know, cost minimization, price minimization game, selling commodity products, largely private label. It's very capital intensive, and it's really very vulnerable to short-term supply or demand shocks and to input cost shocks. And so I think you'll see big swings in gross margins and potentially big swings in prices as we've just seen an acceleration of volatility more generally in the economy.
Are there any questions from the audience? So maybe one broad-based one, and maybe this is, you know, when you look at what Vital Farms trades at, it trades at a discount to your protein-based food manufacturer peers by about a point or so. When you look at, you know, peers, either CPG companies or food manufacturers, it trades at about a 5-point discount to that. Yet you have the highest growth rates, among the highest growth rates, and a very big margin expansion opportunity that will drive, you know, EBITDA about 4x higher over the next few years. What do investors miss when they look at Vital Farms compared to their peers, and why do you think that that's undervalued?
So Thilo will have the more fulsome answer, but my-- what I would say is, when I was in high school in the eighties, nerdy, still a nerd, but very nerdy high school kid, I was excited to read One Up on Wall Street by Peter Lynch. And I learned some pearls of wisdom: buy the thing that may be undervalued, buy the thing you know, buy the thing that is gonna be maybe a steady compounder, and you'll get a ten-bagger out of it. I was excited that of the five people that came to our ICR discussion after our presentation a few weeks ago, he was one of them. Maybe he knows something that the rest of them don't.
I don't know how to follow that answer, but
You'll be in the next book.
Yeah, exactly. No, I think the we have shown that we say what we do, and we do what we say. The targets that we laid out at our IPO in 2020, we're ahead of schedule delivering those targets. And you know, you reference our growth rates relative to the broader industry, and yet we trade at a discount. I think there's still a bit of skepticism about, hey, how do you do a branded product in a commoditized category like eggs?
You know, after 3.5 years as a public company, I would have hoped we would have demonstrated by now that you can do that, but maybe we need a few more quarters of high volume growth and increasing household penetration, and convincing retailers that carrying our eggs is good for them, is good for the consumer.
That's easier than the investors.
Yes, it is. I think there's still a little bit of, "What have you done for me lately?" Every quarter we announce earnings, I think we prove that we've done quite a bit lately. That the pattern or that intention of proving that we can do something every quarter will continue.
Great. Well, gentlemen, we're out of time here, so appreciate your time and insights here today, and best of luck in 2024.
Thank you.
Thanks for having us.
Thanks.