Earnings Call Transcript - STKL Q3 2020

Operator, Operator

Good morning and welcome to SunOpta Third Quarter Fiscal 2014 earnings conference call. By now, everyone should have access to the earnings press release that was issued this morning and is available on the Investor Relations page of Synopsize website. This call is being webcast and this transcription will also be available on the company's website. As a reminder, please note that the prepared remarks, which will follow, contain forward-looking statements and management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance and therefore undue reliance should not be placed upon them. We refer you to all of the content in the press release issued this morning, the company's annual report filed on Form 10-K, and other filings with the Securities and Exchange Commission for more detailed discussions of the factors that could cause actual results to differ materially from those projections and any forward-looking statements. The company undertakes no obligation to publicly correct or update forward-looking statements made during the presentation to reflect future events or circumstances, except as may be required under applicable securities laws. Finally, we would like to remind listeners that the company may refer to certain non-cash financial measures during this teleconference. A reconciliation of these non-cash financial measures was included with the company's press release issued earlier today. Also, please note that unless otherwise stated, all figures discussed today are in U.S. dollars. And now I'd like to turn the call over to Joseph Ennen. Good morning.

Joseph Ennen, CEO

Thank you for joining us today. With me on the call is Scott Hawkins, our Chief Financial Officer. Before we begin unpacking the Q3 results, there are three key takeaways that I would like to offer. First, our execution of our core strategy continues to deliver consistent, strong performance across all three business segments. Second, our prioritized investments in plant-based foods and beverages are paying dividends. We are playing offense, we are winning, and we expect to continue to win as our expansion projects come online in the fourth quarter, further strengthening an already strong position. Third, we are optimistic about our future ability to deliver consistent, sustainable, above-average growth. As anticipated, the third quarter results were strong, delivering our fourth consecutive quarter of more than doubling year-over-year adjusted EPS, and the third consecutive quarter in which each of our segments generated both revenue and margin growth. Trailing 12-month adjusted EBITDA at the end of Q3 2019 was $40 million; today, it is $84 million. With four consecutive quarters of more than doubling adjusted EBITDA combined with the momentum and plans we have, it is safe to say that SunOpta is no longer a turnaround story. We are simply a well-positioned, sustainability-minded growth company with a clear vision to fuel the future of food. Our performance reflects strong execution of our core strategy, along with investment and focus on our core strengths. We have now fully transitioned from our turnaround successes to driving profitability and growth across each of our business segments. I'm pleased with our positioning and the performance across our entire organization. For the third quarter, we delivered 5.4% revenue growth, adjusted for changes in commodity-related pricing. This growth was fueled by very strong consumer demand in all three of our core segments, led by robust growth in our global ingredients and plant-based business segment. I'd like to share some syndicated data to help conceptualize the consumer feel the momentum in our core businesses. Consumption in the last 13 weeks shows both refrigerated and shelf-stable plant-based milks growing 18% and 16%, respectively. We are excited to see continued tremendous growth in milk, with triple-digit growth rates. Oat milk is now the second largest plant-based milk behind only almond milk. This momentum in oat will certainly provide a tailwind for our plant-based business unit as our own extraction facility is in the final stages of commissioning, which gives us a fourfold increase in extraction volume. Frozen fruit also continues to see very strong consumer demand, and while our supply constraints have somewhat limited our upside, we are encouraged by the consumer's enthusiasm for this category. Lastly, we continue to see strong growth in organic food sales in many of our core markets around the world, fueling growth in our global ingredients segment. It is encouraging that we are so well positioned in such strong growth categories, and we fully intend to capitalize on consumer demand for our sustainable products. Since I joined SunOpta, I have talked about improving execution as a top priority. Nowhere is the improvement in execution more evident than in our gross margin performance. Total company gross profit margin in Q3 was 13.3%, the best gross margin since Q1 of 2012. Total gross profit margin improved 440 basis points, with our fruit business contributing the most to this improvement. Our productivity initiatives with a focus on automation, reducing line downtime, and more disciplined operations management are paying off around the world. Manufacturing plants from our cocoa facility in Holland to our plant-based aseptic beverage facility in Pennsylvania to our frozen fruit bagging operation in Canada are setting production records and doing so with fewer people. While these records are impressive in their own right, it's important to recognize that these results come at a time when we are also managing all of the challenges related to COVID-19 prevention in our plants. Today, we continue to have zero confirmed cases of community-transmitted COVID-19. This accomplishment is something we are all very proud of as employee safety is our top priority. While the challenges of managing around COVID-19 are significant, the overall impact on our financial performance for the quarter was not significant on a year-over-year basis. When we net the headwinds and tailwinds, the impact on revenue offset each other. Turning to the Nevada segment, as mentioned, we more than doubled EBITDA on a year-over-year basis for the third quarter, with an increase of 129% to $22.8 million on 5.4% adjusted revenue growth. Adjusted EBITDA as a percentage of revenue was 7.2% and showed solid progress against our long-term stated goal of 10%. Turning to our segment results, let me begin with our plant-based segment. Sales momentum continued, overcoming the impact of softer food service sales as COVID-19 continues to impact the channel, as one would anticipate. Sales increased 6.6% on an adjusted basis, despite our largest customer not contributing to the growth given their food service focus. Sunflower, which is reported within this segment, saw revenue decline in Q3, which dampened overall segment performance. If we remove the sunflower head, the remainder of the segment grew revenue 10.8%. Gross margins improved to 19.9%, reflecting improved utilization and execution of our productivity initiatives with significant growth in consumer demand, which I mentioned earlier. You will not be surprised to hear that in Q4, we will be operating as close to capacity as possible. As a result, we expect a strong Q4 in our plant-based business unit, and our three expansion projects, which we have discussed several times, are on time and on budget. Combined, they will further expand our leadership position in aseptic plant-based beverage production through new capabilities in plant extraction and added aseptic production. These projects, when fully utilized, have the potential to add approximately $100 million to our annual sales. I continue to be pleased with our sales development efforts, and we are in advanced discussions with several large customers who will consume a sizable portion of the incremental volume. I would like to remind listeners that adding this amount of new business does not happen overnight. In many cases, these are large new customers with complex needs; it is not as simple as flipping a switch. However, we continue to believe that we can have this incremental capacity fully utilized by the end of 2022. Our new capacity additions in the fourth quarter position us for a strong 2021 and 2022. Our leadership in plant-based beverages, our broad capabilities, along with our strong positioning, are the key drivers of these significant new business opportunities and are the foundation of our plans to double our plant-based business unit over the coming years. In global ingredients, sales growth accelerated to an impressive 8.3% on an adjusted basis, reflecting very strong performance in cocoa oils and juice. To highlight just a few categories, we generated another quarter of improved gross margin as a result of top-line growth along with executing our productivity plan; our cocoa and cocoa processing facility generated record production levels with higher efficiency. Further, our efforts in driving return on investment yielded a roughly 10% reduction in year-over-year inventories, while our revenue growth accelerated gross margin in this segment to 12.2%, reflecting strong execution of our plan. While this business has had some historical volatility, it is encouraging to see a heightened level of discipline and execution at this time. Within our fruit platform, our focus on driving improved margins yielded significant year-over-year gains, with gross margin improving to 7.7%, up 990 basis points from the prior year on approximately 1% adjusted revenue growth. Our investments in automation are driving significant improvements in productivity, partially offsetting a challenging fruit procurement environment. We have wrapped up the California strawberry season, and despite the lower than expected Fraser crop, our renewed focus on grower relations helped us procure a significantly larger share of the available fruit compared to 2019. We maintained our plant throughput for the whole season, utilizing roughly 40% less seasonal labor compared to 2018 due to our automation initiatives. We remain confident in our ability to meet our expectation for further sequential margin improvement in the fourth quarter. While there were many questions last quarter on the impact of the California strawberry season, I will share that this business is different now than in the past. For context, conventional strawberries grown in California represent less than 5% of our total company gross profit. Do I wish the season had been better? Of course. But some headwinds on 5% of the business do not define us. Our fruit business has had a history of negative Q3/Q4 surprises, but this is not historical; in our view, 2021 has actually improved compared to last quarter, and we are now incrementally more optimistic about next year. We have more clarity into customer commitments and we are seeing success in passing through pricing to offset more costly fruit. Therefore, while there are still some unknowns, we can now communicate a more optimistic view that we expect profit growth in fruit in 2021. In conclusion, we delivered yet another doubling of year-over-year adjusted EBITDA, drove the third consecutive quarter of growth and gross margin improvement in all three of our segments, and produced the best consolidated gross margin percentage performance in eight years. Further, we are seeing significantly increased consistency across each of our segments, which is reflected in our quarterly results. Our positioning in key, healthy, natural, and organic categories, along with our leadership in plant-based foods, position us exceptionally well with consumers. We have successfully executed and completed our turnaround efforts, reduced leverage, invested in promising opportunities, and are now focused on driving growth across our core platform. Now, I will turn the call over to Scott to take us through the rest of the financials.

Scott Huckins, CFO

Thank you very much, Joe, and good morning, everyone. Let me walk through gross profit and the rest of the income statement given Joe's discussion of the commercial activities and revenue during the quarter. I will also cover our balance sheet and cash flow results. We're very pleased to report another strong quarter, as Joe discussed. We saw 6.4% revenue growth and more than doubled adjusted EBITDA for the fourth consecutive quarter. Gross profit was $41.9 million for the third quarter of 2020, an increase of $15.6 million, or 59%, compared to $26.3 million during the third quarter of 2019. The plant-based segment was responsible for $9.1 million of the gross profit improvement. For perspective, that brings year-to-date gross profit in 2020 to $119.8 million, or nearly five times the prior year results. The improvement in freight came from improved revenue pricing, a favorable mix of higher margin retail versus food service revenue, and the benefits from increased automation and productivity initiatives implemented in our plants. The plant-based segment accounted for $3.4 million of the increase in gross profit, mainly reflecting revenue growth of 10.8% in the plant-based beverage and extraction businesses, offset in part by a reduction in revenue in the sunflower business. In addition to revenue growth, increased production volumes, as well as strong execution of our productivity plan and higher capacity utilization drove improved margins, which was partially offset by lower revenue production volumes and utilization in the sunflower operation. Global ingredients contributed $3.1 million of improvement, primarily due to solid execution of our portfolio optimization efforts that resulted in increased pricing spreads and higher margin product mix, organic ingredients, and premium juice products. This was supplemented by manufacturing efficiencies and productivity improvements. These results were partially offset by an unfavorable cocoa commodity hedging result of $1 million versus the prior year and manufacturing inefficiencies related to organic avocado oil production. As Joe noted, we were quite pleased with the performance of our cocoa processing operations, which had record production volumes in the third quarter with improved efficiencies. As a percentage of revenues, third quarter gross margin was the highest since 2012 at 13.3%, compared to 8.9% last year, a 440 basis point increase. All segments contributed significantly to the gross margin expansion; the gross margin expanded 990 basis points in the food segment, 210 basis points in the plant-based segment, and 160 basis points in the global ingredients segment. Operating income was $9.4 million, or 3% of revenues, in the third quarter, compared to a loss of $3.5 million last year. Yesterday, increased $1.6 million to $29.3 million in the third quarter, with savings initiatives being offset primarily by variable compensation expenses. Loss attributable to common shareholders for the third quarter was $2.8 million, or $0.03 per diluted share, compared to a loss of $13.8 million, or $0.16 per diluted share during the third quarter of 2019. On an adjusted basis, the net loss was $1.3 million, or $0.01 per diluted share, compared to a loss of $9.9 million, or $0.11 per common share in the prior year. As Joe mentioned, earlier for the third quarter of 2020, adjusted EBITDA was $22.8 million, compared to $9.9 million in the prior year, bringing the trailing 12 months adjusted EBITDA to $84 million. I'd like to remind listeners that adjusted EBITDA and adjusted earnings are non-cash measures, and a reconciliation of these measures together can be found toward the back of the press release issued earlier this morning. Turning to the balance sheet and cash flow, Q3 total debt was $443.8 million, down approximately $47 million from Q4 of 2019. Total debt reflects $219.5 million net of issuance costs of our second lien notes due in October of 2022, and $199.7 million drawn on our global asset-based credit facility, with the balance representing smaller credit facilities, leases, and other financing arrangements. Leverage has improved to 5.3 times from 10.3 times as we entered 2020, and we are now nearing completion of refinancing our term loan, which matures in March of 2022. Following this, we will begin the process of refinancing our second lien notes, which are due in late 2022. Our significant improvements in EBITDA over the trailing 12 months is a significant asset in the refinancing process, and we are very confident in our refinancing prospects. From a cash flow perspective, during the quarter, cash generated from operating activities was $20 million compared to cash generated of $4.3 million during the third quarter of 2019. The improvement reflects improved operating performance and continued working capital management. It is worth pointing out that our Global Ingredients segment reduced nearly 10% of its inventory position versus Q3 of last year. Cash used in investing activities was $11.8 million, compared with $7.6 million in the third quarter of 2019. The increase in capital investments primarily relates to investments to expand capacity in our plant-based operations. As we look forward, we continue to expect that our executional excellence will generate strong P&L flow through in the fourth quarter. We will likely see high single-digit revenue growth, creating robust double-digit gross profit growth, which could approach a nearly 50% increase in EBITDA versus Q4 of 2019, which in turn was a doubling of EBITDA versus Q4 of 2018. With that, I’d like to ask the operator to please open up the call to questions.

Operator, Operator

Thank you. This time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. Our first question comes from Brian Holland of D.A. Davidson. Your line is open.

Brian Holland, Analyst

Maybe first question, they're just kind of near term focused on the ramp of the new plant-based capacity. I know we've talked about $100 million over two years. We just think about maybe the next couple of quarters, though, as you ramp that up, the impact to the sales and also gross margin, if there's anything we should be mindful of as we're forecasting out.

Joseph Ennen, CEO

Yeah, good morning, Brian. So first of all, just in terms of our expectations on ramping that production utilization, we put a marker out there that we expect it to be fully utilized by the end of Q4 2022. At this juncture, we don't have perfect insight into how that's going to flow. We are making good progress in terms of working with significant new customers in adding business to that capacity. As it relates to gross margin impact, there are three components. Certainly, the added capacity would be a bit of a headwind to gross margin. However, as we look forward to 2021, we think both customer mix and our productivity efforts will both be tailwinds, and that those two tailwinds should mitigate any negative impact from the added capacity. So we would expect 2021 gross profit margin to look broadly like 2020.

Brian Holland, Analyst

Appreciate the color there, and it's not another question of. You know, you've been asked several times since your expansion announcement about whether you had the demand to fill that capacity, and you know it. Mindful specifically of the significant growth within the GOP segment, you know, as well as the potential harm given the value proposition of the almond. I'm curious whether you think you've added enough capacity and if not, and given the lead time required to stand up that incremental capacity. Are there plans in place for further investment?

Joseph Ennen, CEO

You know, on some levels, I hope we didn't have enough capacity, but that would be a good problem to have. We are certainly encouraged by the consumer — excuse me, the customer outreach that we had on that and customers' interest in space. You know, at this juncture, our focus is on, you know, getting that new facility fully up and running and utilized. And if we find that, you know, in kind of at some point in 2021 that we feel like, you know, we've got a 12-month view out of the business where we think we're going to sell that out, we're certainly willing and able to make further investments in that space.

Brian Holland, Analyst

Got it. Fair enough to switching over to food service, you know, a bit of a headwind or an offset to the growth this quarter. Not surprising, but just curious if you could maybe kind of give us a little bit of incremental color on sort of the pace of recovery in that channel? I think high level, what we're seeing is obviously a trough first half of the year, you know, immediately following lockdowns. And then we saw some steady progression, moderating declines that seemed to have sort of peaked, you know, depending on what channel you're talking about, maybe in the high single-low double-digit range. So I'm curious if specific to your business that that's kind of mirrors what we're seeing high level. And then secondly, with the concerns about, you know, a second wave and new cases and maybe new measures being implemented, how you're kind of thinking about the plan going forward here and the pace of recovery in that channel as it pertains to your business.

Joseph Ennen, CEO

Yeah, so, you know, yes, we're seeing a consistent pattern to what you articulated in aggregate. Food service was neither a headwind nor a tailwind for the quarter. It looked broadly similar to 2019. As it relates to the impact of a second wave of COVID, we're all certainly concerned about that at multiple levels, you know, first and foremost for our associates and the operations of our facilities. But, you know, we're going to continue to monitor it and work with our customers and respond to their forecast. Today, we have not seen any significant adjustment in their forecast as they think about a potential second wave, but we'll certainly be ready to respond to that.

Brian Holland, Analyst

And last one for me. I really appreciate the color and the clarity provided with respect to the food segment this quarter. But just to confirm, you are lapping pricing that you took, I believe, this time last year. So just curious, have you taken or will you need to take more pricing this quarter? And if so, how those discussions progressed?

Joseph Ennen, CEO

So, yes, we are in a position where we have been able to pass through the majority of the impact of higher cost from this season, and many of those prices will go into effect here in the fourth quarter. You know, that's the result of a lot of great work by our sales team over the last 12 months to get better relations with our customers, as well as different pricing mechanisms in place, which certainly has aided our efforts in mitigating the impact of the higher costs.

Operator, Operator

Thanks for your next question comes from Ryan Meyers of Lake Street Capital. Your line is open.

Ryan Meyers, Analyst

Thanks for taking my questions. First, just a clarification. There's some commentary on the fourth quarter for revenue, gross profit adjusted, but I just want to make sure this is year-over-year growth, correct?

Joseph Ennen, CEO

Correct.

Ryan Meyers, Analyst

Okay, and then can you discuss potential headwinds that you guys might see in the plant-based beverage, including food service that you could potentially see going forward, that maybe slow the growth a little bit?

Joseph Ennen, CEO

Yeah, I mean, I certainly think a second wave of COVID could have an impact. I mean, all I will remind is that we now have several quarters of what a COVID environment looks like. And so I don't really have any material forward-looking insight that would suggest it would look different than our Q2 and Q3 results from this year. You know, I think there's obviously an offset with retail growth, and we see very, very strong growth in the retail segment. I would expect 2021 to look like 2020 if we were to kind of go back into a very deep COVID shutdown.

Ryan Meyers, Analyst

Okay, that's helpful. And then now that you're through sort of a transition phase, what's your outlook for gross margins on the plant-based business? You know, they're pretty strong this quarter. Just kind of how are you thinking about that going forward?

Joseph Ennen, CEO

Yeah, as I mentioned to Brian, we think that the 2021 gross margin will look broadly like 2020. You know, there is a bit of a headwind with just some added capacity, which will be a short-term headwind to our gross margin rate. But there are two strong tailwinds: our productivity initiatives certainly being one of them. So, and we also think mix, both product and customer mix will be a tailwind in 2021. So, you know, 2021 will look broadly similar to 2020.

Ryan Meyers, Analyst

Okay. And then last one for me. Any update on new product performance such as the hard rubab?

Joseph Ennen, CEO

Yeah, I mean, we continue to monitor and look for additional customers to roll it out. We're happy with the product and are actively engaged in putting promotional efforts against it to drive trial. We're encouraged by the repeat that we're seeing on the product, but we're looking for additional ways to drive trial.

Operator, Operator

Thanks. Your next question comes from Jon Anderson of William Blair. Your line is open.

Jon Anderson, Analyst

Morning, everybody. Thank you. Good morning, Jon. Nice to have some fellow questioners on the call. I want to ask you about the old extraction process. Can you talk about the quality of your process in producing the base, and is there, you know, the equivalent? You know, player in the market that does this? My understanding is there are some differences in the way oat milk is formulated, and it can have a difference on kind of the quality and the functionality of the products themselves.

Joseph Ennen, CEO

Yeah, without getting too technical here, I might need some diagrams and schematics. There are two ways of making oat milk. One is you start with oat flour and add water. The result of that process is you get a very gritty, better-tasting product. The other way to do it is you start with raw oats, you soak them, and you add enzymes that basically break the oat down into soluble and insoluble components. Obviously, the soluble components are turned into oatmeal. You get a much cleaner-tasting product, none of that gritty texture that consumers complain about. We think it's a superior process to the way many of the people are manufacturing it. I certainly don't have detailed information into how everyone does it, but what we are aware of is that one of the leading oat milk manufacturers that we don't make products for also does it in a similar process to the way that we do it.

Jon Anderson, Analyst

That's great. It's tough to go technical and do it in terms that layman like I can understand, so I appreciate that. Your plant-based beverage business is interesting. I thought it was great that you provided some of that consumption data, syndicated consumption data that showed both aseptic and refrigerated growing at very healthy rates. Which segment is more important to you, and I assume that that might be changing a little bit with your base capabilities, because that may allow you to serve the refrigerated market, perhaps making that assumption in the way you haven't in the past. But if you could just talk a little bit about your outlook for aseptic versus refrigerated growth and your exposure and ability to serve both of those markets.

Joseph Ennen, CEO

You're exactly right. Our added extraction capability opens us up to being a supplier on the refrigerated side where both of them are important to us. Obviously, we have significant aseptic manufacturing assets, and that is the core business for us. But the extraction project and capability certainly afford us the opportunity to start to work with customers in the refrigerated space who aren't current customers today on the shelf-stable, aseptic side.

Jon Anderson, Analyst

Ok, thanks. On that fruit, in terms of fruit, what led you to be willing to kind of upgrade your outlook for gross profit in 2021? Some of the specifics may be in your priorities, you know, form.

Joseph Ennen, CEO

Yeah, our success in working with customers to pass through the increased costs and our clarity around the customer commitments that we have for 2021 would be probably the two biggest ones that gave us confidence to suggest that 2021 is going to be better than previously forecasted.

Jon Anderson, Analyst

And given that you're through the season and the harvest this year, the 2020 harvest. Does that provide you foster visibility through the bulk of 2021 at this point?

Joseph Ennen, CEO

Typically, it would provide insight, certainly into Q1 and Q2. As it relates to our overall cost structure for the balance of 2021, while the fruit input cost is still a variable, we certainly understand the overall cost structure of our supply chain, network, labor, etc.

Jon Anderson, Analyst

Ok, that's helpful. Last one just on the debt, Scott's comments on the debt refinancing. So my understanding, the Abdelhalim process and the second lien is soon to come. And I think he expressed confidence around the second lien. Is your expectation on the second lien that there would be an ability to get better pricing?

Scott Huckins, CFO

Yes, good morning, Jon. So the comments I was offering were really focused around here in the home stretch, you know, and getting the bill done, recognizing it has the March 2022 maturity date and the second lien notes due about two years from now in October 2022. So we're working on them sequentially. I would expect that if all else were equal in the capital markets, you know, like our chances to have some rate reduction on the second lien notes, but that'll follow the work on the first lien.

Jon Anderson, Analyst

Ok, thanks so much, congrats on a great, great stretch here.

Operator, Operator

There are no further questions at this time. I will now return the call to our calls for closing remarks.

Joseph Ennen, CEO

Ok, thank you, operator, and thank you all for participating in our third quarter conference call. I look forward to speaking to you in the future and appreciate your interest and support. Have a great day.

Operator, Operator

This concludes today's conference call. Thank you for your participation, you may now disconnect.