Earnings Call
Oatly Group AB (OTLY)
Earnings Call Transcript - OTLY Q3 2021
Operator, Operator
Greetings, and welcome to Oatly's Third Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn the call over to Katie Turner for opening remarks. Thank you. You may begin.
Katie Turner, Investor Relations
Good morning, and thank you for joining us on Oatly's third quarter 2021 earnings conference call and webcast. On today's call are Toni Petersson, Chief Executive Officer; Peter Bergh, Chief Operating Officer; and Christian Hanke, Chief Financial Officer. Before we begin, please remember that during the course of this call, management may make forward-looking statements within the meaning of the federal securities laws. These statements are 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 company's final perspective filed pursuant to Rule 424(b)(3) on May 21, 2021, and other reports filed from time to time with the Securities and Exchange Commission 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. Please note, on today's call, management will refer to certain non-IFRS financial measures, including EBITDA, adjusted EBITDA and adjusted EBITDA margin. While the company believes these non-IFRS financial measures will provide useful information for investors, 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 a reconciliation of non-IFRS financial measures to the most comparable measures prepared in accordance with IFRS. In addition, Oatly has posted a supplemental presentation on its website for reference. I would now like to turn the call over to Toni Petersson.
Toni Petersson, CEO
Thanks, Katie. Good morning. We appreciate you joining us to discuss our third quarter financial results. On today’s call, I will briefly review our third quarter financial highlights, provide an overview of our business performance, including the continued strong consumer demand for Oatly and the oat category in our key markets, and reiterate the key reasons we believe Oatly is well-positioned for strong growth over the next several years as we benefit from an acceleration in dairy alternatives globally, and we scale our operations to meet this growing demand. Peter will provide an update on the progress we are making to build out our global manufacturing capacity footprint, then Christian will review our financial results in more detail before we open up the call to take your questions. For those that have been following Oatly since our IPO, you know that 2021 is the most transformational year in our company's history. We are adding new production capacity at an unprecedented pace for our company on three continents to meet a robust consumer demand for our market-leading brand and working to execute this during a global pandemic is no small feat. We are continuing to prioritize growth investments over profitability to best position Oatly to serve customers and consumers alike to focus on taste, nutrition, sustainability, transparency and trust with a strong emotional connection to our brand. We believe these priorities are critical for accelerating conversion from the global dairy market, which we estimate to be worth approximately US$600 billion in the retail channel alone with a large foodservice footprint and a growing e-commerce opportunity. We continue to see tremendous consumer demand for our products across each of our regions as we convert dairy users to plant-based milk consumers. The penetration of plant-based products in the dairy category has increased anywhere between 35% to 135% in core markets based on volumes. These figures highlight the transformation that is taking place in the dairy category. However, even with these significant growth rates, the overall penetration of plant-based milk in the dairy category is still very low and ranges between 9% to 11% in our key Western market, which highlights a tremendous upside still ahead of us. Once the dairy consumer is converted to plant-based milk, we also see very strong repeat purchase behaviors. According to our Consumer Insights study, 60% to 70% of the consumers use plant-based milk at least every two to three days and nearly 80% consume it at least once per week. This highlights how quickly consumers switch over to incorporating plant-based milk into their daily routines. The syndicated scanner data also continues to show that the oat category continues to prevail and gain share over other dairy alternatives across the key markets and we are driving this growth. This is clear from our market shares and leading velocity performance even with limited shelf space today. Year-to-date, we have invested heavily in our business establishing infrastructure, personnel, innovation capabilities, and partnerships to meet consumer demand and maintain and grow our category leadership position. We’ve opened two new facilities in Ogden, Utah and Singapore, and we expect to open our second manufacturing facility in Asia later this month. We are incredibly proud of our global production supply chain and procurement team’s efforts to open both the Singapore and China facilities in line with our stated timelines. We believe that adding these two new local production facilities in Asia will support Oatly's trajectory of strong future growth in the region. 80% of the population in Asia is lactose intolerant, and we believe Oatly can gain a larger share of the dairy alternatives market in the region over the next several years. By heavily localized production in the region, we expect to achieve much better production economics and operating efficiencies, reduce the environmental impact and increase profitability as Asia will be able to reduce production reliance on EMEA for the first time. In the first half of this year, we also doubled production capacity at our facility in Vlissingen, Netherlands. The production output in this facility was in line with our expectations in the third quarter, and this output will help to facilitate our offensive positioning in EMEA, where over the last 18 months, our commercial sales and marketing teams have consistently faced growth constraints based on our capacity limitations. In total, we produced finished goods volume of 131 million liters compared to 74 million liters for the same period last year, an increase of 77%. It's also an increase of 24% from the 160 million liters we produced in the second quarter of 2021. Now to dive into our financial highlights in more detail. For the third quarter, we reported record revenue of US$171.1 million, a 49% increase compared to the third quarter last year. Strong growth was broad-based across geographies, sales channels, and product offerings. Now most companies would be thrilled with this level of growth and execution in any operating environment. But we hold ourselves to a high standard of execution based on our bottoms-up view of our business and frankly, we expect to deliver approximately US$178 million in revenue, representing a year-over-year growth of 55%. We believe this is primarily a timing issue, and I will take you through some of the specific events that have delayed either our production output or product availability in certain geographies. So, no, we're not satisfied with our revenue growth even though we grew tremendously in the global marketplace where many companies are experiencing the impacts from COVID-19 and temporary supply chain pressures. I'd like to provide more details about the specific factors that impacted our growth in the third quarter. First, in the Americas region, we were approximately US$3 million below our plan for quarter three. This was primarily due to lower-than-expected production output at our Ogden, Utah self-manufacturing facility. We experienced mechanical and automation issues in August during our production ramp-up, which slowed our production progress versus our plan. This was further exacerbated due to COVID-19-related supply chain disruptions, which led to a delay in our team's ability to receive the required equipment to fix the issue in a timely manner. Based on these events, our sales trajectory in the region was pushed out. As a result, our sold volume was 37 million liters per month on average for the third quarter instead of our expectations for a sold volume of 40 million liters per month on average for the quarter. Second, in Asia, we were approximately US$3 million below our plan for quarter three; approximately 75% of the third quarter revenue in Asia was generated from the foodservice channel. We experienced a heightened level of COVID-19 Delta variant-related foodservice location closures in Asia. We continue to monitor the situation closely as heightened restrictions remain in effect throughout the region. The health and safety of our team, consumers, and our partners in the region remain a priority. Lastly, EMEA was approximately US$1 million lower-than-expected for the third quarter due to a truck driver shortage in the United Kingdom, temporarily delaying the distribution of products. In addition, during the third quarter, we experienced a noticeable uplift in the foodservice channel as a share of total EMEA revenue compared to the second quarter of 2021, from 13.8% to 17.7%. We believe this is a result of a higher share of out-of-home consumption within the company's key EMEA market as pandemic restrictions have been further lifted and the summer holiday season extended into the fall. We expect these key factors that delayed even stronger growth in the third quarter will abate as we head into 2022. And going forward, while we may experience some variability in our strong growth quarter-to-quarter as we scale our global operations, we are confident in the size and long-term trajectory of our business, which is stronger than ever. I'd like to share a few highlights across our key markets to support why we believe Oatly will continue to win a significant share of the conversion to dairy alternatives globally and maintain our market leading position. Our brand has continued to excel on a global scale as evidenced by the following market statistics. According to Nielsen and IRI data for the 52 weeks ended October 2021, in all our key markets, Oatly has the number one selling oatmeal SKU in terms of sales value, and the highest velocity SKU representing sales per store per week. At the brand level, Oatly continues to be a primary growth driver of the total plant-based milk category. In the U.K., our brand contributed the highest amount of sales growth to the dairy alternative drinks category, and was the second highest brand driving growth in Sweden, Germany, and the U.S. In both Germany and the U.K., our Barista Edition item has at least 2x the unit velocity levels compared to the second and third highest selling SKUs in the oat category. Our brand accomplishes this with a limited SKU range and a fraction of the total distribution points versus competitors. In the Americas, demand for Oatly products continues to be incredibly strong. According to Nielsen for the 24 weeks ended October 16, Oatly remains the number one fastest churning brand in total dairy, plant-based dairy, and oatmeal. Oat is the number two dollar sales oatmeal brand in xAOC and we also reclaimed the number two spot in total U.S food, SPINS in the latest period. Oatly is the number one dollar sales oatmeal brand in the U.S natural channel and in major retailers including Whole Foods and Target. In Walmart, Oatly Original is the number one velocity oatmilk SKU and the number two velocity plant-based milk SKU, with an additional 1,200 stores planned in April of 2022. If you look at Slide 13 in our earnings presentation, you will also notice that velocity has nearly returned to pre-distribution surge levels. Normally, velocity gets diluted when increasing distribution. We expect to see this continue to improve as more cases enter the system. It has been proven that the demand from existing customers is there to absorb incremental cases. Oatly weekly dollar sales have increased more than 25% since July 10, three months ago and continue their upward momentum each week. The oatmilk category has increased only 15% during that same period. Oatly velocities have increased more than 21% since July 10, far more than any competitive brand, while the oatmeal category grew only 3%. For year-to-date, quarter three represents approximately 6% of Americas revenue. This is an area we continue to be excited about. For example, in the plant-based ice cream category, excluding competition, Oatly frozen desserts are number one in dollar growth and number three out of the top 10 highest dollar velocity flavors in U.S food. We will be launching frozen novelty desserts, which are expected to arrive on shelves beginning mid-december and into the spring. The U.S commercial teams are in the midst of growing distribution acceptance with over 8,000 points of distribution confirmed so far. In foodservice, Oatly is the brand partner of Starbucks in the U.S, and growth of Oatly and oatmeal has exceeded both of our expectations to date. Current projections from Starbucks continue to escalate based on the success of Oatly’s oatmeal, and we have aligned with them on an ongoing supply plan to continue bringing our products to the broadest possible audience. Starbucks is a strong collaborative partner, and we look forward to growing with them across existing and new geographies. With their partnership, we're able to reach many more people with oatmilk beverages and in doing so we can continue to do great things for the planet together. And finally in Asia, growth in this region demonstrates the effectiveness of our proven multi-channel expansion strategy. The awareness and trial achieved in the specialty coffee and tea segment is critical to educate the market about plant-based dairy and establish our leadership in Asia. We continue to maintain our market-leading position on Tmall, demonstrating Oatly's ability to consistently outperform in a highly competitive marketplace. In foodservice, we're now fully distributed in Starbucks in mainland China and KFC. We also have great opportunities to expand with existing customers. McDonald's is just one example of where we can expand distribution as we are in approximately 40% of their locations today. Last week, we launched in the U.K. with a top two modern tea brand in China with the market's first oat cap tea drink. This product will be available in more than 700 stores nationwide. At retail, Oatly can be found in anywhere from 10% to 50% of total available existing customer doors. For example, we are present in 800 of 1,500 total stores with Yonghui, one of China's largest retail chains. This significant group of distribution expansion in retail will scale capacity, with just existing retail customers alone. Due to our supply constraints, we have not prioritized the retail channel in Asia so far, but still have been able to make significant progress. Our successes across the U.S., Europe, and Asia demonstrate the strength of our product portfolio across multiple categories and the increasing consumer appetite for Oatly and the brands' ability to travel, as consumers choose to shop. Our mission and core belief in driving societal shift towards a plant-based food system unifies our company and our quest for purpose-driven growth. As humanity faces massive challenges of climate change and lifestyle disease, our mission is even more relevant and powerful. We aim to inspire people to make small changes in their lives that are beneficial to themselves and the planet. Our in-house creative teams create ways for Oatly to connect emotionally with consumers who are increasingly health-conscious and environmentally aware. We have a proven disciplined and thoughtful multi-channel strategy that we believe sets us apart from competition because we're already building our brand successfully across three continents with a tremendous amount of whitespace to add new markets. In summary, I'd like to thank our global team for their efforts in achieving this growth. We believe a strong foundation and business fundamentals will help us capture a disproportionate amount of growth over the next several years as consumer demand continues to accelerate for plant-based alternatives. I will now turn the call over to Peter.
Peter Bergh, COO
Thanks, Toni. I will focus on our global production and capacity build-out. As we have previously communicated, production capacity has been a major constraint on our growth. We have made substantial investments to scale our production capacity and address supply shortages due to the massive demand for our products globally. In the third quarter, our consistent production output in EMEA enabled us to begin to build supply to meet the consumer demand across the regions for our products. Our expanded facility is progressing well, and it generated production in line with our expectations for the quarter. As Toni discussed, the main reason for our lower-than-expected total production output was related to mechanical and automation delays at our new self-manufacturing facility in Ogden, Utah. Beginning in late August, as we continue to scale up production there. As we discussed on our quarter two call, in July, we opened our Singapore hybrid manufacturing facility, representing our first local production available in the region. This is an important corporate milestone. The facility will have 75 million liters of annual finished goods capacity at full production. Since 2018, we have been shipping our products from Europe to support growth in Asia, and we are excited about the operating and financial efficiency we expect to gain from our new Singapore facility. In addition to Singapore, this month, we will open our second facility in Asia. Maanshan, China will be our first self-manufacturing facility in the region, creating the opportunity for a total of 225 million liters of production capacity in Asia. For the year, we expect little to no financial contribution from Maanshan as they perform initial test runs required before ramping production. Despite the short-term headwinds we have discussed, October was our highest production month in the company's history. We expect our production output to increase again for the months of November and December. We continue to expand the capacity of our existing facility and we are currently in planning stages to open additional facilities in the U.S., U.K, and China in 2023. These three facilities are estimated to add an increment of 450 million liters of finished goods by the end of 2023 to support the demand for our products globally. Like other companies, we are noticing longer lead time for certain required equipment related to our planned capacity investments for 2022 and 2023. We are seeing some delays in 2022 capacity expansion projects and are closely monitoring and assessing any potential impact on projects in 2023. Based on the strong demand we continue to experience across our market, we expect to strategically prioritize our oat base for the production of oatmilk versus other food products to drive growth and conversion. We believe this speaks to the growth potential we have and establishes the case for our growth trajectory. However, the revenue mix from these items could slightly impact the revenue and gross margin in 2022 if we sell less food products and rely more on co-packers than planned. For the first nine months of 2021, self-manufacturing was 21% of total volume compared to co-packing at 47%, and hybrid at 32%, demonstrating continued progress toward our production goals. As we grow, we believe owning and controlling our global operating footprint is paramount to addressing the significant consumer demand for Oatly products. Our goal is to have 50% to 60% of our total volumes come from self-manufacturing, reducing co-packing to 10% to 20%, with 30% to 40% from hybrid manufacturing. We expect to drive profit growth through increasing our self and hybrid manufacturing model, as well as localizing our production footprint, which will improve our production and supply chain economics, economies of scale, and service levels. Going forward, we intend to continue to invest in our innovation capabilities, build our manufacturing footprint, and expand our consumer base, all supporting our growth trajectory. I'll now turn the call over to Christian to review our financials.
Christian Hanke, CFO
Thanks, Peter, and good morning, everyone. It's nice to speak with you today. Turning to the financials. Revenue for the third quarter of 2021 was $171.1 million, an increase of $56.4 million or 49.2% compared to revenue of $114.7 million in the third quarter of '20. As Toni described, short-term headwinds impacted the rate of growth we delivered in the quarter. There was a minimal foreign exchange benefit to revenue of approximately $4.4 million in the quarter. However, excluding foreign exchange on a current quarter versus prior year quarter comparison, we grew at a faster rate in the third quarter compared to the second quarter of 2021 on a consolidated level in Americas, but also in EMEA. The foodservice channel continued to increase in the third quarter of 2021 compared to the prior year period with the reopening of on-premise outlets from the relaxation of COVID-19 restrictions in our key markets, partially offset by certain COVID-related food service location closures in Asia. For the third quarter of 2021, the foodservice channel accounted for 35.8% of revenue compared to 27.3% in the same period last year. The retail channel accounted for 59.4% of third quarter 2021 revenue compared to 69.4% in the third quarter of 2020. Consolidated net sales per liter was $1.55 compared to $1.51 in the third quarter of 2020, primarily driven by positive foreign exchange in EMEA and Asia, positive customer and channel mix in Asia, offset by customer and channel effects in EMEA and the Americas. Our highest regional net sales per liter is in Asia followed by the Americas and EMEA. The net sales per liter was in line with our expectations except for in Asia, where it exceeded our expectations driven by channel and customer mix. Gross profit in the third quarter was $44.9 million, compared to $36 million in the prior year period. Gross margin decreased by 510 basis points to 26.2% compared to 31.3% in the prior year period. The gross margin decline in the third quarter of 2021 compared to the prior year period was primarily due to higher logistics expenses in EMEA and the Americas, as well as higher container rates for shipments from EMEA to Asia, a change in segment channel and customer mix, primarily in Americas, and short-term challenges related to scaling up our production capacity at our Ogden, Utah facility, resulting in a higher share of co-packing production, partially offset by positive channel and customer mix in Asia and the minor positive impact from foreign exchange. We have experienced an increase in trade costs, driven by the effects of the pandemic and the shortage in capacity primarily in the Americas and EMEA, but also related to our shipment from EMEA to Asia. We continue to expect that the localization and expansion of our production capacity within the region will help to offset some of these trade costs headwinds. Going into 2022, we expect inflationary pressure to impact our cost of goods sold more broadly, with oat prices and other commodity prices as well as packaging materials increasing as a result of several different factors, such as poor harvests in Canada and supply chain disruptions more broadly. As a reminder, oats account for 8% to 9% of our total cost of goods sold. Even with the adverse conditions, we are well-positioned with an adequate food supply to meet our anticipated growth this year and for fiscal year 2022. Rapeseed oil, which accounts for approximately 3 to 4 percentage points of our total cost of goods sold, continued to be higher compared to second quarter and the third quarter of last year. We expect the geographical localization of our production capacity, including bringing more of the production in-house to provide some offset to inflationary pressures. We also expect to increase prices for certain products and in certain regions where necessary to help offset some of the commodity and logistical inflationary headwinds. We continue to expect variability in our gross margins quarter-to-quarter, based primarily on the mix of revenue by geography and sales channels, as well as the mix of our manufacturing output. On an annualized basis, we expect to continue to see improvement in our gross margin year-over-year starting in 2022 with a long-term goal of reaching 40%. Now focusing on our balance sheet and cash flow. As of September 30, 2021, we had cash and cash equivalents of $403.1 million, $305.2 million in short-term investments, and total outstanding debt to credit institutions of $6.7 million. Net cash used in operating activities was $148.6 million for the nine months ended September 30, 2021, compared to $20.4 million during the prior year period. Capital expenditures were $186.7 million for the nine months ended September 30, 2021, compared to $85.1 million in the prior year period. Cash flow from financing activities was $958.7 million, reflecting the proceeds from the IPO, net of repayment of liabilities to credit institutions, and repayment of the shareholder loan. The company invested a portion of the IPO proceeds in secure short-term investments. Turning to the guidance. For fiscal year 2021, we now expect revenue to exceed $635 million, an increase of greater than 51% compared to fiscal year 2020, with strong growth across regions and balanced contribution from each of them. It is important to note that based on our previous annual revenue outlook, we expected $178 million in revenue for Q3, as Toni mentioned, and $226 million for Q4, which would get us to $690 million in revenue. The primary reason for the revised revenue of $178 million, or growth of 40%, which is now the implied revenue for the fourth quarter, is due to a reduction in our forecasted revenue of approximately $48 million. This reduction is broken down by region as follows: First, in EMEA, we are starting to build supply to meet consumer demand. Still, the pace at which we expected to increase revenue in new and existing retailers and to open up new markets has been slower than we anticipated as we navigate a dynamic COVID operating environment. We believe this is primarily a timing issue, lowering our revenue in EMEA by approximately $31 million. In the first half of 2022, we expect to have an increased share of shelf space at retail, given our strong velocities and current supply levels. For greater context on EMEA, it's important to remember that during this time last year, our commercial sales team was working with our regional partners on shelf space and distribution plans for 2021 at a point at which our business was incredibly supply constrained. As a result, we started 2021 with less shelf space than prior years, based on our lack of inventory and the fact that we have historically sold all that we have produced. Further evidence of our supply constraints last fall is the fact that for 2021, we had to scale back distribution of our products for 12 countries in EMEA. We are excited about the discussions we are having with our regional partners in EMEA, and we expect to have a better share of the shelf once the products become available. We are entering new countries, and we will continue to drive industry-leading velocities across the region, all of which we expect will benefit us in 2022. Second, in the Americas, we are pleased with the weekly production output improvement at our Ogden, Utah facility today in the fourth quarter. Although we are navigating a challenging supply chain environment, we expect lower production sales volume versus our prior outlook, reducing revenue by approximately $13 million. Finally, in Asia, strict public health measures remain in effect due to an increase in cases of the COVID-19 Delta variant. We are closely monitoring the situation and remain focused on the health and safety of our team. However, given the ongoing restrictions, we are taking a more conservative view on our growth for the fourth quarter, reducing our revenue by $4 million. Assuming no significant changes from where we are today, we expect the fourth quarter exchange rates to be a single-digit tailwind compared to the second half of 2021. We expect capital expenditures to be between $280 million to $320 million, a decrease from our previous estimate of $350 million, all due to the timing of cash flow. We expect production capacity to be approximately 600 million liters of finished goods by the end of fiscal 2021, with a sufficient amount of capacity to reach our annual revenue outlook. Long-term, we continue to expect to generate a gross margin greater than 40% and an adjusted EBITDA margin approaching 20%, as we benefit from a much lower self-manufacturing footprint globally, greater economies of scale, and continued strong revenue growth. With that review, Toni will now provide a few closing remarks.
Toni Petersson, CEO
Thanks, Christian. I want to reiterate that our long-term outlook and objectives remain unchanged. Although from time to time, we will experience variability in our top line growth based on our pace of new production coming online. What remains clear is the tremendous opportunity still ahead of us to continue converting dairy users into Oatly consumers. All of the syndicated scanner data continues to highlight our clear velocity outperformance on shelves when we have the supply and the distribution. Although we're currently navigating a more turbulent and COVID-driven operating environment, we continue to expect to capture a disproportionate amount of the category growth going forward. I'd like to thank our global employees for their efforts and dedication that continues to advance the reach and impact of Oatly's mission on a global scale. With that overview, Peter, Christian, and I are now available for your questions.
Operator, Operator
Thank you. We will now be conducting a question-and-answer session. Our first questions come from the line of Andrew Lazar with Barclays. Please proceed with your questions.
Andrew Lazar, Analyst
Thank you very much, everyone. To start, you're aiming for a capacity of 1.075 billion liters as a run rate for 2022. I'm curious about how much flexibility you’re incorporating into that expectation, considering the challenges you've mentioned regarding getting capacity operational within your desired timeframe. Also, if you achieve that capacity, I'm still a bit unclear about how the issues you've raised that are affecting the third and fourth quarters of this year will carry over into next year. It appears that some shelf resets in EMEA have been delayed. Does this, along with other factors, affect your revenue expectations for 2022 compared to your earlier projections? Thank you.
Toni Petersson, CEO
Peter, please maybe you can address Andrew's first question? Hi, Andrew, by the way.
Peter Bergh, COO
Hi, Andrew. Yes, in terms of 2022, I want to reiterate that our long-term outlook and objectives remains unchanged, although from time to time we experienced variability in our top line growth based on our pace of new production coming online. What remains constant is the robust industry tailwind we have globally as consumers increasingly use plant-based milk alternatives and Oatly. Also, bear in mind, we are moving from a transition year with significantly more volume in 2022 compared to 2021. In terms of 2022, coming back to what I said earlier, we expect to strategically prioritize our oat base for the production of oatmilk versus other products to drive growth and conversion. So, we believe this further speaks to our growth potential we have and makes the tale for our growth trajectory even longer. But the revenue mix, as I said, from these items could impact the revenue in terms of net sales per liter and gross margin in 2022, if we sell less food products and rely more on co-packers and plants. So we are still monitoring the situation because there are many supply chain disruptions right now. For example, we are seeing longer lead times for certain equipment and we are closely monitoring the situation and we are working hard to make the impact as little as possible. So, we will have much more volumes in 2022 compared to 2021. We just need to monitor our expansion plans for next year when expanding Ogden, Millville, and the Landskrona facilities. It's a matter of months, maybe delays, but we are still monitoring. So not a huge impact. And we also look at the possibility to bring in co-packers to mitigate the risks.
Andrew Lazar, Analyst
It seems that the target of 1,075 million liters remains in place, but it's important to keep an eye on developments since there could be fluctuations due to various supply chain challenges. Regarding my follow-up question, how many of the issues you mentioned in the fourth quarter related to the revenue shortfall do you anticipate carrying over into next year? Will these issues be resolved by then? Additionally, how delayed are the shelf resets in EMEA, and do you expect that to affect your revenue expectations? I'm also curious about the shift to oat milk in relation to other oat products.
Toni Petersson, CEO
Absolutely, Andrew, we do. Looking at the performance, we feel very confident in our business fundamentals, which is recognized by all our retail partners. It’s a very dynamic environment that we are currently navigating. However, based on the discussions we are having with our retailers across Europe, we feel optimistic about resets and expansion in the first half of 2022.
Andrew Lazar, Analyst
Thank you.
Toni Petersson, CEO
Yes.
Operator, Operator
Thank you. Our next question comes from the line of Rupesh Parikh with Oppenheimer. Please proceed with your questions.
Erica Eiler, Analyst
Good morning. This is actually Erica Eiler for Rupesh. Thanks for taking our question. So, first, I just wanted to touch on pricing. So, obviously, in light of the inflationary pressures, it sounds like pricing is now a lever, you're putting on the table. So maybe you could just talk a little bit about how you're thinking about pricing power for your business, and what you're seeing from competitors in regards to pricing to date?
Christian Hanke, CFO
Sure, I'll first address inflation. It's currently affecting all our markets, but we've only seen a moderate impact on our results for 2021. We anticipate increased inflationary pressures in 2022. Looking at our outlook for the fourth quarter, we expect the prices of oats and rapeseed oil to remain relatively stable compared to Q3, except in the U.S., where we project a 20% rise in rapeseed oil. Additionally, we expect packaging material costs in Europe to increase by 4 to 5 percentage points in the fourth quarter. However, these levels are still manageable for us. For the upcoming year, we predict that inflation will raise our total costs by approximately 5 to 6 percentage points in 2022. This will significantly impact some of our key ingredients and cost components, particularly the cost of oats, which could increase by 10% to 35% depending on the region and site. We also expect rapeseed oil to rise by 25%, along with packaging material costs increasing by 4% to 10%. Overall, the core input material inflation will affect our cost of goods sold by 3 to 4 percentage points in total for 2022 compared to 2021, with additional impacts from freight and other costs adding another 2%. Most of the inflationary effects we anticipate will be offset by price increases in EMEA and the U.S., combined with optimizations in our channel and product mix, and savings initiatives within the supply chain. Importantly, we expect our gross margin to improve quarter-on-quarter in 2022, despite the inflation challenges, mainly due to the ramp-up of our new facilities and localization of production. I hope this gives you a high-level view in response to your question.
Erica Eiler, Analyst
No, I was just curious about what you're observing from competitors regarding pricing to date. Additionally, do you have any thoughts on how you're approaching pricing power for your businesses as you implement these price increases?
Toni Petersson, CEO
Yes, we still believe we have a premium brand, and that we expect our premium to be a premium brand going forward, and we expect to maintain price precision, because I think that's what you're asking for. So that's not going to change.
Erica Eiler, Analyst
Okay, great. Thank you guys so much.
Toni Petersson, CEO
Thank you.
Operator, Operator
Thank you. Our next question is coming from the line of Kaumil Gajrawala with Crédit Suisse. Please proceed with your questions.
Kaumil Gajrawala, Analyst
Hi, everyone. Good morning, or good afternoon, depending on your location. I want to ensure that I understood something from the prepared remarks correctly. It seemed like there were some losses in shelf space. While I realize that production might not be increasing as quickly as you expected, it sounded to me, unless I misunderstood, that there might have been a reduction in shelf space. This seems particularly relevant to EMEA, where production may have actually declined instead of just not growing at the anticipated rate. Can you clarify that for me?
Toni Petersson, CEO
Yes. We did not lose shelf space as expected, and we anticipated greater space and more distribution in Q4 for various reasons. To provide clarity on the situation from Q1 to Q4, in Q1 and Q2, we faced significant challenges due to supply constraints that resulted in lower growth rates, reduced fill rates, strained relationships with retailers, lost market shares, and the impact of losing 12 markets in 2020. During Q3, supply output improved, leading to increased sales and growth, and a recovery in velocities and market shares. However, Q4 has proven to be quite turbulent in the retail environment across Europe, influenced by pandemic-related factors, such as a general decline in food consumption at home, increased out-of-home eating, and a trucker shortage in the U.K. Additionally, the ongoing pandemic in the U.K. has made it difficult for us to achieve the expected facing distribution post-summer. We are still navigating this challenging COVID environment and cannot make significant changes to grocery shelf space for the rest of the year, despite our velocity levels being noticeably better than those of our competitors. For instance, at a premium retailer in the U.K., we achieved 27% sales with only 7% shelf space, a deal negotiated back in 2020 when we faced severe supply constraints. Typically, changes in shelf space occur after summer in Europe, but that has not materialized this time, which is a timing issue affecting us right now.
Kaumil Gajrawala, Analyst
Thank you. It's helpful. Can you share your thoughts on the supply situation in the United States compared to your competitors? Are domestic companies in a better position, or are they facing similar challenges? What insights can you provide on how your supply capabilities stack up against theirs?
Toni Petersson, CEO
Well, as far as we know, we haven't heard about supply issues. We do know that we are balancing our system of demand building across multiple channels, and that's all we know. And we know that we ship every case that we produce in the U.S. We know that demand is stronger than ever and it's growing and that we are bringing more capacity on board here in the coming months, especially entering 2022.
Kaumil Gajrawala, Analyst
Okay, great. Thank you.
Toni Petersson, CEO
Thanks.
Operator, Operator
Thank you. Our next question is coming from the line of Bryan Spillane with Bank of America. Please proceed with your questions.
Bryan Spillane, Analyst
Hi. Thank you for taking my question, and good afternoon or morning to everyone. My question relates to co-manufacturing capacity. It seems like you may want to keep more co-packing manufacturing capacity than initially expected. So I have two parts to my question. First, is there sufficient co-man capacity available to retain? Second, is it becoming increasingly competitive to hold onto co-man capacity with more competitors entering the market? I'm trying to understand the feasibility of this approach and how much capacity has already been taken by competitors. Additionally, could you explain if co-manufacturers are increasing oat capacity?
Toni Petersson, CEO
Peter, is there anything?
Peter Bergh, COO
Yes, hi, Bryan. As mentioned previously, this is our core technology, and we will always handle that in-house. Our focus is on formulation and filling co-packing, which we are actively examining. Our team consistently evaluates our co-packing network for new opportunities in all regions. We are likely to pursue new partnership deals, primarily related to opening new facilities. This will allow us to introduce oat base in additional areas, creating more co-packing opportunities. We continuously assess what is most efficient and how to accelerate our market entry.
Bryan Spillane, Analyst
Is there more available capacity? My concern is regarding the influx of new entrants into the market, particularly in EMEA and the U.S., and the increase in third-party capacity. Is this actually true? Is there more capacity entering the market that could pose a risk?
Peter Bergh, COO
Yes, it's more that we now, for example, in the U.S have outpaced production, both on the West Coast and East Coast. And that opened up co-packing opportunities on the West Coast, as we now have Ogden. And in China, now we have outpaced production in China and then we can utilize more co-packing if we want to and need to. So it's mainly about that. We have been constrained from an oat base capacity because of where it's localized. Now we open up new facilities and get into more regions.
Bryan Spillane, Analyst
Understood. Understood. And then just one clarification. On the reduction in CapEx for this year, did you say that it's down because of cash flow? Or I didn't quite understand or maybe hear completely why the reason for capital spending to come down in '21.
Christian Hanke, CFO
Hey, Bryan, it's Christian here. To clarify that point, for the full year, we anticipate a range between $280 million and $320 million, compared to the previously stated low end of $350 million to $400 million. This reflects a cash flow timing effect with actual cash outflows shifting to 2022. This is primarily due to the timing of payments related to our 2023 capacity expansion projects in the U.K., our third plant in the U.S., and our third plant in Asia. Overall, compared to what we communicated to you during the roadshow process, that total remains unchanged.
Bryan Spillane, Analyst
Okay. Understood. Thank you.
Toni Petersson, CEO
Bryan, can I just clarify also? Within our network today that we have in the U.S., for instance, we know that our co-packing network in the ecosystem capacity are built out, and that is something we are going to benefit from going forward.
Bryan Spillane, Analyst
Understood. Thanks, Toni. Thanks, guys.
Toni Petersson, CEO
Thanks.
Operator, Operator
Thank you. Our next question is coming from the line of Ken Goldman with JPMorgan. Please proceed with your questions.
Kenneth Goldman, Analyst
Hi. Thank you. I wanted to expand on one of the earlier questions from Andrew. I understand that visibility is limited, and using the term dynamic makes sense given the current circumstances. However, analysts are anticipating significant sales exceeding $250 million next year. It's reasonable to expect that figure will decrease, but I'm curious about how much it might drop. I know your visibility is constrained, yet we are nearing the end of 2022. My specific question is whether you believe it is wise for investors to project sales below $200 million for the first quarter of next year, especially since many of these challenges may not ease until closer to the latter part of the year. I'm looking for clarity on where that estimate needs to settle.
Toni Petersson, CEO
Thank you for your question, Ken. We cannot provide quarterly guidance. However, I want to express our optimism for 2022. Our focus is on what we can control: launching more products, improving our pace, and enhancing distribution. Overall, we feel good about our current position. Given the circumstances, we remain positive, but we are unable to give any quarterly guidance.
Christian Hanke, CFO
And I think the one thing that Peter I guess said, he said that we might have more milk drinks than we originally had communicated and that might have an impact on the top line for 2022. So I think that is out there.
Kenneth Goldman, Analyst
Okay. And some companies are electing even though it's their policy long-term not to give quarterly guidance to sort of make an exception or at least give some directional activity right now, just given the situation. But I respect that. And then my second question very quickly. I think you said you expect to increase prices in certain products and regions. I assume that means not all products and regions. So which products, which regions are you not taking pricing and why?
Christian Hanke, CFO
No, I think it's something that we have to evaluate strategically across EMEA and U.S by the regional finance teams. With the purpose of offsetting the inflationary headwinds that we're seeing on the COGS level to neutralize that impact for 2022.
Kenneth Goldman, Analyst
Thank you.
Toni Petersson, CEO
Thanks, Ken.
Operator, Operator
Thank you. Our next question is coming from the line of Michael Lavery with Piper Sandler. Please proceed with your questions.
Michael Lavery, Analyst
Good morning. Thank you. I just want to come back to this shelf resets in EMEA, and understand that a little bit better. And I know you're clearly saying that, that you had ones you thought would have happened by now or in the fourth quarter that are getting pushed out. But are those now specifically set? Do you have confirmation in timing? Or is it just indefinitely sometime to be determined so?
Toni Petersson, CEO
Hi, Michael. Hope you're doing well. Well, we have ongoing discussions with our retailers across Europe for resets in between January and May. But what you can see, I mean, all these performance data is available for everybody to see. And we're drawing significant growth from disproportionate less shelf space in all our key markets in Europe, for instance. And definitely, you're going to see some changes there on the shelf in the beginning of next year. So it's an ongoing discussion. It's in nobody's favor that we have less shelf space than what we deserve, given how much growth we are driving across these regions.
Michael Lavery, Analyst
Okay, that's helpful. And then just one on the foodservice side. You called out the Blue Bottle partnership as well and highlighted that on the slide. It's only America's page and so I understand that's certainly where it's focused. But could that expand outside of the United States and at least also work in Hong Kong or potentially springboard, given the entry for you into Korea or Japan?
Toni Petersson, CEO
Do you mean Blue Bottle specifically?
Michael Lavery, Analyst
Yes, because that's obviously a partner that you have in one geography at least.
Toni Petersson, CEO
Yes. We are collaborating regionally with larger accounts, which often have different organizations across various regions. Blue Bottle is a premium chain, and we have a strong partnership with them. While there are no specific plans for 2022 with Blue Bottle, we are engaged in ongoing discussions with all our partners. Given our lengthy supply chain challenges, we are now increasing our capacity, which will enable us to broaden these discussions across different regions. For example, in Europe, we haven't been able to effectively engage with quick service restaurants due to supply constraints. However, the situation is changing, allowing us to pursue these discussions. The same applies to Asia, where our two factories will provide us with greater volumes, enabling us to take a more proactive approach moving forward.
Michael Lavery, Analyst
Okay, great. That's helpful.
Operator, Operator
Thank you. Our next question is coming from the line of Laurent Grandet with Guggenheim. Please proceed with your questions.
Laurent Grandet, Analyst
Good morning, everyone. I hope you’re all doing well. I’d like to return to the EMEA region and ask two questions. First, despite entering new countries, it seems our revenue dropped by around $31 million last quarter, which is about 30% lower than expected. Can you break down this gap in terms of factors like the shelf set resets, packaging supply issues, or the quality concerns you mentioned? Additionally, regarding the shelf space reset, are we losing in terms of fewer SKU expansions than anticipated, or is the issue more about increased out-of-stocks at the velocity you referred to? I’d like to understand the implications of not having as much natural shelf space as we expected.
Toni Petersson, CEO
The shelf space is a significant factor. We have a disproportionate amount of shelf space across our key regions. For instance, in one extreme case, we drove 27% of our sales from just 7% of shelf space. This pattern is also evident in Germany and other countries, having a considerable impact. We anticipate no significant changes in Q4, but we expect developments during the first half of 2022. We have the supply to bolster our sales efforts and increase velocity, which has shown a solid performance since the lows of summer in all our key markets, reflecting a positive trend from summer to now. We also plan to enhance our branding, a previously untapped opportunity. There are delays in reopening markets that we had closed in 2020, primarily due to the challenges retailers face in the current COVID-19 environment. On multiple levels, we are exploring ways to drive higher sales. Additionally, increasing distribution with our existing partners is crucial for our growth.
Laurent Grandet, Analyst
Thanks, Toni. And one more thing. You said in your prepared remarks, I mean you're investigating a quality issue in one of your precious facility in Europe, and you will destroy some inventory. So how big it is and what it is? And is this something that is we should expect I mean time to time?
Toni Petersson, CEO
Yes, we operate a food company, and situations like this are often encountered, though not too frequently. They are part of the business. During a maintenance stop at our Landskrona facility this weekend, we found a potential quality issue. As always, we prioritize safety and product quality, so we promptly began a quality assessment and activated the necessary procedures. We have complete traceability for all our products and, as a precaution, conducted the assessment. There is a possibility that this assessment could lead to the destruction of inventory and associated losses, especially in the EMEA region. However, we do not anticipate that this will hinder our ability to meet our 2021 outlook.
Laurent Grandet, Analyst
Thank you.
Toni Petersson, CEO
We will provide more information when we have it.
Operator, Operator
Thank you. Our next question is coming from the line of Dara Mohsenian with Morgan Stanley. Please proceed with your questions.
Dara Mohsenian, Analyst
Hey, guys. So first, just that quality issue in EMEA, is it a significant portion of revenues? Obviously, it's early to sort of specifically quantify it, but just trying to understand, is it across product categories? Is it more of an isolated issue? And are you comfortable that it's related to that one plant and not something that could be an issue elsewhere? And then the broader question is more just as we look at the implied Q4 guidance, it does seem like the disappointments sort of versus what you originally expected is much larger than what we saw in Q3. But conceptually, Ogden is in better shape. Perhaps there's not as much foodservice pressure in Asia, as they're not as many closures. It seems like some of these issues should be getting better relative to Q3. So just sort of trying to understand why the magnitude of impact seems greater in Q4 relative to Q3, as you run through these various issues where it seems like there might be some progress conceptually.
Toni Petersson, CEO
Yes. Hi, Dara. So just on the quality thing here, yes, it's the same, it's one facility. So that is clearly identified and we are still assessing the situation. And we will provide more information as soon as possible, if necessary. So we're still in assessing the situation.
Christian Hanke, CFO
Dara, I mean, I think currently we can say that we do not expect that this will limit our ability to achieve our '21 outlook.
Toni Petersson, CEO
Yes, correct. That is correct. In terms of …
Dara Mohsenian, Analyst
Okay.
Toni Petersson, CEO
In the fourth quarter, there are three key components to consider. Europe is a significant factor as it represents 51% of our sales. In the U.S., the Ogden production output has been impacted by delays in manufacturing equipment due to COVID. For Q4, we are adopting a conservative approach to ensure we meet the updates provided today. We are looking for more consistent output from Ogden over several months to achieve stability. In China, we recognized the COVID challenges during the summer, but we did not anticipate the extent and duration of those issues. This has surfaced again and, importantly, foodservice is a substantial part of our business there. We have limited offerings in the China business-to-consumer market due to supply constraints, with only one SKU, the Barista addition. Last year, we quickly redirected sales to e-commerce during the peak of the pandemic, which was less developed at that time. Now, we are rapidly working to expand our offerings with new SKUs and formats to enhance both our e-commerce and retail businesses, which hold significant growth potential beginning in 2022. Regarding Europe, the retail environment remains dynamic and challenging as we adapt to changes in out-of-home consumption, resets, and planogram rebuilding. We are focusing on our performance and aligning our growth with market share gains, which are contributing to substantial growth across our key markets, although this progress is expected to begin in early 2022.
Christian Hanke, CFO
Dara, navigating the pandemic environment, we see shutdowns in Germany again, the closing down societies and that's kind of what we're navigating through as well as a company. But fundamentally, we have high beliefs in our business.
Toni Petersson, CEO
You're correct, Christian. We believe that the majority, if not all, of our key markets in EMEA will continue to experience some level of lockdown, with the Netherlands recently re-entering lockdown. We know that Germany is significantly affected by COVID-19, and we can observe the situation in the Nordics as well. This leads us to understand that the adjustment on the retail shelf is unlikely to occur until the first half of 2022.
Dara Mohsenian, Analyst
Okay, thanks.
Toni Petersson, CEO
Thanks, Dara.
Operator, Operator
Thank you. Our next question is coming from the line of Brian Holland with Cowen. Please proceed with your questions.
Brian Holland, Analyst
Yes, thanks. Hello. I'll start by focusing on the U.S. There has been a lot of discussion about distribution dynamics at retail in EMEA, but the data points investors are monitoring every other week are primarily concentrated in the U.S. I understand that this is a relatively small part of your business. However, as you work through your channel initiatives, have you found yourself facing any challenges with retailers? I'm interested in whether you anticipate improving your in-stock situation in the U.S. during the first half of 2022, which could lead to some stabilization in market share within the conventional grocery channels, excluding SPINS data.
Toni Petersson, CEO
Yes, we have made significant improvements in our fill rate since the lows we experienced before summer, and we are continuously increasing our volume. The velocity of growth is also in a positive trend. We are optimistic about closing the fill rate gap as demand continues to rise, and we believe we can achieve this in 2022. Additionally, we are looking to enhance our presence in other channels. Our focus is on building a strong demand system while strategically balancing our efforts across various channels. Although we are not yet at a full fill rate anywhere, we have made considerable progress since summer.
Brian Holland, Analyst
Okay, appreciate the color. And then last question for me. I think you said last quarter, you expected to be back at 100% supply at Starbucks. Their commentary a few weeks back suggested they'll continue to call on secondary sources. So just curious, maybe if anything's changed in that relationship, is there now an expectation on your end, that they will call on secondary sources of supply to meet the full demand and just any update there would be appreciated? Thanks.
Toni Petersson, CEO
Yes. Again, the relationship with Starbucks is just excellent. And we're both excited and thrilled about the success of our opening launch there. We will serve 100% of the Starbucks network in December and January. And White Label will enter in February and stay through the end of calendar 2022. So during 2022, we will service around approximately 85% to 90% of the total Starbucks network after White Label returns. And that said, as we increase production, we're constantly thinking about our supply allocation and how we can balance our channel needs to drive our sales growth and profitability. But off to expand our reach and brand awareness, this is a very strategic topic for us internally since we also generate great unit economics from our retail and coffee channels. But we feel more confident as we bring more capacity in the U.S., for sure.
Brian Holland, Analyst
Thanks, Toni. Best of luck everyone.
Toni Petersson, CEO
Thank you.
Operator, Operator
Thank you. Our next question is coming from the line of Jon Andersen with William Blair. Please proceed with your questions.
Jon Andersen, Analyst
Oh, hi, everybody. Thanks for the question. I wanted to ask, I know, you're limited in what you're able to say about 2022. But there were pretty significant, or expectations of pretty significant gross margin improvement in 2022. And just hearing some of the commentary today around focusing the production capacity that you have on milk, more so maybe than other food, some manufacturing delays, perhaps the use of co-packers for a longer period of time, how should we think about that in the context of the margin improvement you originally anticipated in 2022? Does that get pushed out? Is the rate of improvement more moderate than the original plan?
Christian Hanke, CFO
Hi, Jon, it's Christian here. Yes, so I think, first of all, fundamentally, we do believe and this is sort of the case as well, that gross margin is expected to improve quarter-by-quarter in 2022, despite the inflationary headwinds, despite what we were experiencing in Ogden, and the ramp-up complications over there. And that improvement is driven by the new facilities, the localization of production in each of the region, making them self-sufficient on their own production volumes and sales volumes, increasing the share of self-manufacturing and a general improvement in freight and distribution costs coming from the localization of our production capacity in each of the region. Now, will the gross margin improvement in terms of what we might have indicated before be slightly less? I would say that's probably a fair assessment. But we will come back to that when we are doing our fourth quarter earnings call.
Jon Andersen, Analyst
Okay, thanks. One quick follow-up. This was I guess, kind of addressed earlier, but in the U.S., your ACV or distribution at retail, I guess, half maybe the number one brand at retail by market share. And I'm just wondering, if you have kind of a visibility or plan to try and narrow that gap and bring your ACV up from I think high 30s now to a much more broader distribution and what that timeframe might look like? One of the concerns I hear is that this window of time is giving competitors an opportunity to generate trial and perhaps brand preference, while you're working to kind of scale up. So your thoughts there would be helpful. Thanks.
Toni Petersson, CEO
Absolutely. You're right about that. Hi, Jon. The ACV in the U.S. is currently 34%, while the largest brand holds 89% ACV. If we look at total distribution points, we have ten times more than they do. Our top priority is to address the fill rate gaps and collaborate with our current retailers. This is crucial as demand continues to rise, which is a very positive sign for us. In retail, there's always room for leading brands, and our performance data significantly outperforms the competition. I believe we have the flexibility regarding timing and optimizing our distribution and ACV as we expand our capacity. This highlights the potential we have, especially due to our strong performance in the U.S.
Jon Andersen, Analyst
Thank you.
Toni Petersson, CEO
Thank you.
Operator, Operator
Thank you. There are no further questions at this time. I'd like to turn the call back over to management for closing remarks.
Toni Petersson, CEO
So thank you for your questions. We really appreciate it and appreciate our discussions with you today and look forward to continuing our dialogue here. So have a great day everybody.
Operator, Operator
This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Have a great day.