Oatly Group AB Q2 FY2023 Earnings Call

Good morning and welcome to the Oatly Second Quarter 2023 Earnings Conference Call. All participants will be in a listen-only mode. Please note that this event is being recorded. I'd now like to turn the conference over to Mr. Brian Kearney from Investor Relations. Please go ahead.

Good morning, everyone, and thanks for joining us on today's call for Oatly's second quarter 2023 earnings conference call. On today's call are our Chief Executive Officer, Jean-Christophe Flatin; our Chief Operating Officer, Daniel Ordonez; and our Chief Financial Officer, Christian Hanke. Before we begin, please review the disclaimer on Slide 3. During this call, management may make forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements regarding our future results of operations and financial position, industry and business trends, business strategy, market growth, and anticipated cost savings. These statements are made based on management's current expectations and beliefs, and involve risks and uncertainties that could differ materially from actual events or those described in these forward-looking statements. Please refer to the documents we have filed with the SEC for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Also, please note on today’s call, management will refer to certain non-IFRS financial measures, including EBITDA, adjusted EBITDA, and constant currency revenue. While the company believes these non-IFRS financial measures will provide useful information, the presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with IFRS. Please refer to today’s release for reconciliation of the non-IFRS financial measures to the most comparable measures prepared in accordance with IFRS. In addition, Oatly has also posted a supplemental presentation on its website for reference. I’d like to now turn the call over to Jean-Christophe.

Thanks, Brian, and good morning, everyone. Page 5, the key messages I want you to take away from today's presentation. First, I'm very excited to be Oatly's new CEO because I believe Oatly has a significant amount of potential in both growth and profitability. In my time here so far, it has become equally clear that to realize our potential we must continue to take bold actions. One bold action we are taking is initiating an improvement plan in our Asia business where we are refocusing our energy and resources on strengthening the core business to have a strong foundation to go from. We expect this will enable us to adjust to the evolving post-pandemic environment and set this segment up for profitable growth. Another action we are taking is a further reduction of our overhead costs in both corporate functions and our Americas segment. This reduction will further increase our focus and agility as a company. Finally, while we are reducing our guidance for 2023 revenue growth, these bold actions keep us on track to reach our targeted gross margin for quarter four and positive adjusted EBITDA in 2024. So let's dig in. Slide 6 outlines why I believe Oatly is a uniquely exciting company. We have an enormous sales growth opportunity in front of us as we look to revolutionize the food industry and convert consumers from dairy to plant-based. The underlying demand for the oat milk category remains strong. And Oatly is a key driver of category growth, especially in regions where we have sustained capacity, distribution gains, and bond building investments. We also have a significant margin expansion opportunity in front of us. In full year 2022, we were at just 11% gross margin. This quarter, we are at 19% and we believe we can reach our long-term target of 35% to 40%. Finally, what makes Oatly truly unique is our mission and purpose-driven culture. Here you can see the three pillars of our mission. Our employees and I know when we come to work every day that we are working to make the world a better place. Slide 7 outlines how we plan to realize our potential. First, we will achieve an appropriate balance between performance and purpose. We know that while performance without purpose is meaningless, purpose without performance is not possible. So for us to achieve our dual mandate of performance and purpose, we must have a stronger business before we are able to have a significantly bigger business. To strengthen our business, we have instituted disciplined resource allocation decision processes that are driven by rigorous fact-based analyses. We have also increased regional accountability and aligned incentives accordingly. Finally, over the past year, Daniel and I have embraced the approach of hands-on in-person management to ensure our teams have the support and resources needed to execute on our priorities and focus on execution. Slide 8 outlines where we are in this journey. If you recall on our third quarter 2022 earnings call, we laid out a plan where we would prepare for growth, increase simplicity and agility, and ultimately, drive profitability. This plan began with our EMEA business and our corporate functions. As you can see, our EMEA segment has been performing well since then with strong and improving market shares, consistently solid revenue growth and consistently positive adjusted EBITDA. We have now expanded this approach to our Americas business where we have stabilized and strengthened the supply chain, increased demand driving investments, and steadily improved adjusted EBITDA. While we are not yet all the way to where we want to be, the consistent improvement is clear. Finally, we are expanding this approach to our Asia business. We have long-term conviction in the opportunity in Asia, and taking these actions will help us capture the opportunity. This includes refocusing on its core business, improving the operating cost structure, and aligning incentives for the local management to focus on driving profitable growth. Daniel will provide additional details on our actions. Slide 9 outlines the cost savings actions we are announcing today. You can see that across the entire company we are targeting to save approximately $85 million in costs by 2024. These savings will come primarily from non-people cost expenses, such as fewer project-related expenses, and reducing our reliance on outside consultants as well as eliminating some roles, including positions that we have not yet hired for. Importantly, we are not reducing our demand-generating advertising investments. Since we expect all of these savings to contribute to the bottom line, we now expect total overhead in absolute value to decrease compared to both 2022 and 2023. Just to be clear, the $85 million in savings are calculated as a reduction in our forecasted 2024 SG&A, not as an $85 million reduction compared to 2022. We are being very surgical in these cost reductions and we are not applying a one-size-fits-all approach. Each team has diligently evaluated what is necessary to drive growth, margin, and profit, and has then eliminated the rest. We believe that this careful approach will ensure an appropriate level of support and investment to drive profitable growth. Turning to Slide 10. Daniel and Christian will take you through our performance in the quarter in more detail, but I want to give you my perspective on our updated 2023 outlook. We are reducing our constant currency sales growth outlook to a range of 7% to 12% from the prior range of 23% to 28%. Approximately two-thirds of the reduction is driven by the Asia segment with the remainder being driven by a more conservative outlook for the Americas. Our outlook for the EMEA business has not changed. We are maintaining our fourth quarter gross margin outlook as favorability in the EMEA business is expected to offset margin losses from reduced sold volume expectations in both Asia and the Americas. Importantly, we believe the bold actions we are taking across the business will keep us on track to achieve positive adjusted EBITDA in 2024 and enable our future sustained growth. With that, I would now like to turn it over to our Chief Operating Officer, Daniel Ordonez, to give you an operational update.

Thank you, JC, and good morning, everyone. I'm very happy to be here with you. I will begin with our EMEA segment on Slide 12. EMEA is executing well on its 2023 priorities of strengthening the core markets, growing foodservice customers, and expanding the portfolio beyond coffee and into adjacent markets. Slide 13 touches on the first two of those priorities. Our category continues to have strong growth of 14% in the quarter. The needle chart shows that we continue to gain share in our core markets of Germany, the UK, and the Netherlands, and we're very happy about the continued expansion of our foodservice customer base, including Starbucks in Italy, an expansion of our partnership with McDonald's into four new markets and Qatar Airways. Also, our new self-serve product continues to gain traction with many new customers across Europe. Our first-ever pop-up store in Amsterdam is proving a big hit with up to 2,000 cups sold every day. Slide 14 is an update on our progress in expanding our portfolio beyond coffee occasions. We're expanding our non-coffee portfolio from a somewhat limited offering that was mostly just the original Oatly product to a non-coffee portfolio that more directly replicates dairy products such as Whole Milk, Semi Skim, and No Sugars. We are calling this expanded portfolio the Go Blue portfolio. We're excited about this as it enhances our product offering while expanding margins. Our UK business is the furthest along in this shift. In the second quarter, the impact of this mixed shift is a 13% year-on-year volume growth as we increase usage and bring new consumers into the category. So while still in the early days, we're seeing good progress on volumes and margins. Slide 15 gives you an update on our geographical expansion, which is progressing well. Our new markets increased their share of total volume by 50 basis points in the quarter. I'm also excited to announce today that we have signed a partnership with Amazon that will expand our European distribution with them. We will capitalize on our success with Amazon in the UK and expand to Germany, France, Italy, Spain, the Netherlands, and Belgium later in the year. Additionally, this exciting partnership will help us further accelerate our expansion into new geographies. Stay tuned for a more formal press release with additional details. Turning now to the Americas on Slide 16. The Americas supply chain remains excellent, and they are progressing well against their priorities. We are also making good progress on our commercial priorities; our strategy is working, but at a slightly slower pace than we originally expected. We have not taken our foot off the gas, and our team is aggressively pursuing additional commercial opportunities across all channels. As JC mentioned, the Americas is further simplifying its overhead structure to drive simplicity and agility. Let me elaborate on each of these. On Slide 17, we focus on the Americas' 2023 priorities, where we are focused on supply chain execution with the Ya Ya transaction and consolidating the co-packers network. On the commercial side, we're focused on expanding distribution, high-quality in-store promotions, and accelerating our brand-building investments. On Slide 18, you can see that our transaction with Ya Ya Foods is progressing quite well. This partnership is bringing us significant improvements in operational reliability and capabilities, as evidenced by our fill rates remaining at high levels. We have a terrific relationship with Ya Ya, both at the higher strategic level and the day-to-day level. We are working closely on longer-term planning for things like innovation and continuous operational improvements. Overall, the Ya Ya transition is going very well, and I'm very pleased with our progress. Turning now to Slide 19, the Ya Ya transaction enables us to consolidate our co-packers network. This consolidation is now substantially complete, and we are driving significant savings in logistics. Since the beginning of this year, we have reduced our outbound freight per liter by about 25%, and we believe there is additional runway for continuous improvement. Terrific progress by the supply chain team. On Slide 21, you can see we have increased the Americas' brand-building investments in the quarter up to 6% of net sales in the segment. The campaigns are generating significant attention from consumers and in the media, and consumers are already loving our new cream cheese product. These investments are crucial to continue converting consumers to plant-based, and we are very pleased with the progress so far. Turning to Slide 22. With the supply chain stable and increased advertising, we have started to regain distribution. We have increased our retail distribution by 24% since our supply chain stabilized and pushed fill rates back up to about 90% in October. We're pleased to see trends moving in the right direction, but the distribution build is a bit below where we expected it to be at this time. Our sales teams have had productive conversations with both lapsed and new customers. While we remain confident that we will continue to gain distribution, it is just taking a little longer than we originally expected. As you can see on Slide 23, the distribution build has started to translate into volume growth, which is very important for driving margin improvement through absorption. Again, we're pleased to see trends moving in the right direction, but the slower-than-expected distribution build has put volume growth slightly behind our expectations, driving increased conservatism in the fiscal year outlook that JC mentioned. Turning now to Asia on Slide 24. Since joining the company over a year ago, JC and I have come to appreciate the amazing job the Asian team has done and the huge potential that still remains in the region. The team has done a terrific job building two production sites that produce high-quality products and establishing the Oatly brand as a leader in the plant-based market in China. As the region has been transitioning into the post-pandemic era, we continue to see significant opportunities for growth. However, consumers' purchasing behaviors are different than we expected. For those who have been listening to our prior earnings calls, we were positioning ourselves for a large post-pandemic tailwind across foodservice, retail, and e-commerce. This included significant upfront P&L investments in new products, distribution, in-store promotions, sampling, and advertising. This expected tailwind has not materialized as we anticipated, so we need to adjust to the current reality of consumer behaviors, and we need to improve the fundamentals of our business before we can meaningfully accelerate growth. We cannot continue to be distracted, nor can we justify these significant investments with uncertain payoffs. This is why we have initiated the strategic reset plan for Asia. Slide 25 outlines our improvement plan. We will transition the business from a mentality of rapidly expanding across all channels to a more controlled expansion. We will primarily focus our efforts on expansion within our core businesses, where we believe we have a strong position with an unrivaled brand presence, superior portfolio, and innovation agility. Nearly 60% of our revenue in Asia comes from foodservice, and we believe we have a strong position in that channel. Our foodservice business is geographically concentrated, and we believe that retail expansion in those markets makes the most sense since local consumers already know us. We will also change the team's innovation process. Historically, we tested and piloted a multitude of new products simultaneously, many of which were costly to produce and distribute, especially in the retail and e-commerce channels. Therefore, we will slow down on SKU expansion and eliminate many unnecessary SKUs. By focusing on fewer SKUs, we can better simplify our processes and optimize our operations. Finally, as JC mentioned, we will migrate to a more simplified cost structure that will streamline business processes and enable the local team to focus on execution. As both JC and I have said, we are excited about the opportunities in the Asia market. We expect that these actions will refocus the team and recalibrate how they operate, which we believe is critical for profitable growth. We look forward to updating you on our progress. With that, I will turn it over to Christian to give you a financial update.

Thank you, Daniel, and good morning everyone. Slide 27 gives you an overview of the P&L for the quarter. We reported 10% year-over-year revenue growth and 11% constant currency revenue growth. Gross margin for the quarter was 19.2%, which is a 340 basis point improvement versus the prior year quarter, and a 180 basis point sequential improvement from Q1. Adjusted EBITDA was a $53 million loss, which was a $1 million improvement versus the prior year. This came in slightly below our expectations. Slide 28 shows the bridging items of our second quarter revenue growth. Volume grew 3%, price mix grew 8% for a constant currency revenue growth of 11%, which was partially offset by a 1% foreign exchange headwind resulting in 10% total revenue growth for the quarter. Slide 29 breaks down the revenue growth further by segment. We are pleased to see that both EMEA and Americas posted constant currency sales growth in the high teens, which was offset by an 11% constant currency sales decline in Asia. As a reminder, as we move through the third quarter, we will lapse the Americas price increases that were implemented in August of last year, so we expect that strong price mix number to decrease going forward. Slide 30 shows you the sequential quarter-over-quarter gross margin bridge. A year-over-year bridge is provided in the appendix of this presentation. The sequential improvement in gross margin was driven primarily by improvements in our supply chain costs and absorption rates in the Americas and EMEA. To a lesser extent, we also benefited from the impact of a full quarter of the EMEA price increases. These benefits were partially offset by the slower than expected post-COVID-19 recovery in China and a slight segment margin mix headwind. Turning to profitability and cash on Slide 31. In the left-hand chart, you can see our adjusted EBITDA by segment with EMEA continuing to report good profitability. The Americas segment also improved to a $9 million loss despite the increase in promotions and advertising. The Asia segment reported a $22 million loss as it continues to be impacted by the slower than expected post-pandemic recovery. Corporate expenses of $28 million came in largely as expected and approximately in line with the prior year and prior quarter. On the balance sheet, I'm happy to report that all previously announced financing transactions closed during the quarter and we raised $465 million. After paying down our revolving credit facility balance, transaction-related fees, and funding the business, we now have over $340 million in cash and cash equivalents on our balance sheet at the end of the quarter. Additionally, we have approximately $200 million available in our amended revolving credit facility. Slide 32 shows you our updated guidance. For 2023, we now expect constant currency sales growth in the range of 7% to 12% with an approximately 130 basis point headwind from foreign exchange. We continue to expect sequential improvement in gross margin and to reach the high 20s by the fourth quarter, with the largest quarter-over-quarter increase occurring in the fourth quarter. We also now expect to spend $110 million to $130 million in CapEx this year. The reduction is primarily related to an adjustment in the timing of projects to better align with expected demand, as we have enough production capacity to support growth for the next couple of years. As we move forward through the balance of the year, we expect EBITDA dollars to improve slightly from the second quarter as gross margin improves sequentially, and the SG&A savings will be a more meaningful driver of EBITDA dollar improvement in the fourth quarter. The bold actions that we are taking are expected to strengthen the business and keep us on track to achieve positive adjusted EBITDA in 2024 while enabling our future sustained growth. This concludes our prepared remarks.

The first question comes from Christian Junquera with Bank of America.

Good morning, everybody. How much of the reduction in your organic sales outlook was driven by Asia versus the Americas segment? You mentioned on the call earlier that you have a more conservative outlook for the Americas business. Is that entirely driven by slower-than-expected distribution build that you guys talked about? Or are you also assuming slower growth for the oat milk category in the U.S.? Scanner data for the U.S. shows that retail sales just continue to slow sequentially.

Hi, Christian. Jean-Christophe speaking. The first part of your question is that 66% of the guidance reduction is due to the Asia reset, and the rest is related to the U.S. I'll hand it over to Daniel to give you the detailed answer to your question on the U.S.

Thank you, Christian. We see sustained progress in our ability to continue to fulfill distributions both in TDP. You saw in the recorded remarks about 20% and ACV now reaching the 40s for oat milk, which is very good progress. As you can expect, we're working on a range reset in the rest of the calendar year, so expect more to come. When it comes to promotions, we have seen good volume growth over the past two months, which is slightly behind our expectations, but it's solid progress after resolving our supply chain and fill rate issues. What you're seeing is a more muted performance for plant-based in general. But our oat milk continues to outperform all other crops. As we move forward and continue to stimulate category growth, as we have proven in EMEA, we're very confident that we will continue to gain share.

The next question comes from Michael Lavery with Piper Sandler.

I just wanted to come back to your launch in McDonald's in several European countries and just to get a sense of what could be next. I know you don't want to get ahead of yourselves on that. But is this a little bit of a test that could have a broader rollout or how do we think about that relationship and what it would take to translate into other markets?

Very good, Michael. It's great to speak to you this morning. Indeed, as you saw, we started with Austria, and now we are expanding. There’s more to come on a country-by-country basis. And as you know, it's part of our strategy. There is substantial room for growth in EMEA and around the world in foodservice. Less than 20% of our volumes come from foodservice in EMEA, and it’s a priority strategy. So you should expect important names coming in the upcoming quarters, not just McDonald's, but others, as it is a priority of our strategy.

The situation in Asia has not met our expectations, especially regarding the macroeconomic environment. The reopening process has not gone as favorably as many had anticipated. Can you provide more detailed insight into how consumers are adjusting? Given that your primary focus is foodservice in that region, are individuals staying home more often? Are they reducing their at-home purchases? Is there an increase in price sensitivity among consumers? What trends are you observing? Do you have an estimate of how long this challenging period might continue? What insights do you have from your observations on the ground?

Thank you so much, Michael. This is a great opportunity for me to share a bit deeper what's happening in our view on this region. Over the past five years, our business in greater China and Asia has been building and driving the category. We have been leading the plant-based innovation and sustainability and establishing quite a presence there. As the pandemic hit, our Asian business was doing everything they could to sustain their growth. They placed numerous bets to benefit from the post-pandemic boom. What has happened is that as the region moved from zero COVID to zero restrictions, we were surprised because consumer behaviors were not aligned with our assumptions. Consequently, we quickly realized that the bets we had placed were not paying off as we expected. We need to quickly reset. We decided to act swiftly because in such circumstances, waiting to see is not a strategy. We found that while we have a strong brand, a dedicated team, and a great manufacturing facility, we also had too many distractions and unprofitable activities. Thus, we are implementing a reset plan with three clear objectives: refocus on our core business, rationalize our portfolio of products, and recalibrate our cost structure. By doing this, we will improve our long-term business and double down on what works. The market moves fast in China, and we have a responsive Oatly China team, which gives me confidence in building a strong future once we complete this reset.

And this concludes the question-and-answer session. I would like to turn the conference back over to Mr. Kearney for any further observations. Please go ahead.

So, there were a couple of questions that I've received that I think might be helpful to tackle. The first would be, probably for Daniel. In the prepared remarks, we stated our outlook for EMEA's sales has not changed. Could you elaborate on what we're seeing in that market and what leads us to continue to be confident there?

With pleasure. Thanks, Brian. What we see in EMEA now, you're becoming familiar with the consistency of our solid performance in the segment. We see all metrics moving in the right direction, with volume growth in core markets and continuous share gains year-on-year. Oat milk continues to grow at more than double digits in growth. What makes us more excited moving forward is the opportunities to expand in this segment and across other regions as well. We only started to explore three main factors that excite us. First, our portfolio; we have a non-coffee portfolio that is only in the early innings, expect much more. Secondly, foodservice is less than 20% of our revenue in EMEA, and we are only beginning to explore the opportunities to generate consumption in large foodservice accounts. We are investing in capabilities in route to market and innovation. Thirdly, our new geographical opportunities have started to see our products in major cities across Europe, and only the beginning. Oatly Barista is already the number one SKU in key markets. With patience and strategic execution, there's a bright future ahead in EMEA.

The other question would be for Christian concerning our path to profitability. Could you remind everyone of the key drivers and how to think about that moving forward?

Happy to do that, Brian. We are confident that with the actions we've taken and will take during the second half of 2023, we are still on track to achieve positive adjusted EBITDA in 2024. The key drivers of our path to profitability consist of gross profit margin expansion throughout 2023 and beyond. Our sequential gross profit margin expansion is on track to achieve a margin in the high 20s in the fourth quarter. We have identified the four main buckets that will drive gross profit margin improvement. Three of these buckets are largely behind us: implementation of price increases in EMEA has been completed, improved channel mix effects as we expand distribution, and improvements in our cost per liter as we optimize our supply chain operations. We believe that our improvement plans in China will enhance margin performance as well as the bucket related to COVID-19 recovery in that segment. We remain on track to see sequential improvement in gross profit margins over the next four quarters. In terms of streamlining our organization, we have identified $85 million in annualized SG&A expense savings, with $45 million already realized. Thus, we expect to see an $85 million reduction in our forecasted '24 SG&A expenses, and as highlighted, our total SG&A in 2024 will be lower than in 2022. We are confident these combined actions will yield positive adjusted EBITDA in 2024.

Thank you, Christian. I just wanted to echo that we have one guiding North Star—profitable growth. The leadership team and the organization are focused on delivering positive adjusted EBITDA in 2024 to fuel growth. The clarity of having this as our guiding star shapes our decisions and actions daily, which is why we are confident in executing these necessary actions.

Terrific. Thank you. This concludes our conference call today. Feel free to reach out to me and investor relations if you have any follow-up questions. Have a great day.

This conference has now concluded. Thank you for attending today's presentation. You may now disconnect.