Earnings Call Transcript - STKL Q1 2024

Operator, Operator

Greetings, and welcome to the SunOpta's First Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the prepared remarks. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Reed Anderson for ICR. Thank you, you may begin.

Reed Anderson, Host

Good afternoon, and thank you for joining us on SunOpta's First Quarter Fiscal 2024 Earnings Conference Call. On the call today are Brian Kocher, Chief Executive Officer and Greg Gaba, Chief Financial Officer. By now, everyone should have access to the earnings press release that was issued earlier this afternoon and is available on the Investor Relations page of SunOpta's website. This call is being webcast, and its transcription will be available on the company's website. As a reminder, please note that the prepared remarks which will follow contain forward-looking statements, and management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance, and therefore, undue reliance should not be placed upon them. We refer you to all risk factors contained in SunOpta's press release issued this afternoon, the company's annual report filed on Form 10-K and other filings with the Securities and Exchange Commission for a more detailed discussion of the factors that could cause actual results to differ materially from those projections. The company undertakes no obligation to publicly correct or update the forward-looking statements made during the presentation to reflect future events or circumstances, except as may be required under applicable securities laws. Finally, we would like to remind listeners that the company may refer to certain non-GAAP financial measures during this teleconference. A reconciliation of these non-GAAP financial measures was included with the company's press release issued earlier today. Also, please note in the prepared remarks that follow, unless otherwise stated, the company will be referring to continuing operations portion of the business, and all figures are in U.S. dollars occasionally rounded to the nearest million. Now I'll turn the call over to Brian to begin. Brian?

Brian Kocher, CEO

Good afternoon, and thank you for joining us today. We are eager to announce our results for Q1 and look forward to providing you more insight into our plan for sustainable revenue and EBITDA growth. In short, we are thrilled by our continued and accelerating revenue growth in line with our first quarter performance and yet still see the opportunity for future growth and improvement. For today's call, I'll start with the highlights from Q1, along with an update on business trends and key priorities. Greg will follow with a review of the financials and our outlook. Then we'll take your questions. Quarter 1's headlines include 18% revenue growth, supported by improvements in throughput at our plants that translated to 21% EBITDA growth and adjusted EBITDA of $22.6 million. For the second quarter in a row, we are growing at a rate of approximately 3 times faster than the categories in which we serve, and that growth drove the increase in the bottom line. Greg will have more financial details in his section. However, I'm proud of the quarter we delivered and even more proud of the manner in which we delivered. On the Q4 call at the end of February, we told you we were focused on three key areas: top line growth, supply chain efficiency, and spending capital wisely. We made progress across every one of our initiatives as we again delivered top and bottom line results that exceeded guidance. Let me offer some insights on our key levers for revenue growth. First, the revenue growth you see today is a reflection of our business development activities from 2023 and early 2024, and remains broad-based as we expand with existing customers, reap the benefits of new customer launches and leverage our TAM expansion capacity in the rapidly growing protein shake category. Volume drove our excellent revenue growth of 18% to $183 million, a further sequential acceleration from the 14% increase we delivered in Q4 and a 6% increase in Q3 of last year. The revenue growth was also a testament to our broad and diverse portfolio across channels, customers, and products. In fact, our food service channel grew by 11% year-over-year. Every product category in which we operate grew in the quarter. And in fact, our top three customers all grew double digits in the quarter. Secondly, the addressable market we serve is growing. For shelf-stable plant-based milks in tracked and untracked channels based on the latest publicly available data and our own proprietary sales order data, we estimate that category volume will grow mid-single digits for calendar year 2024. Recall that much of our volume is derived from untracked channels, and we continue to see growth in foodservice and club channels. Also, protein shakes continue to show a very robust growth in tracked channels, up roughly 20% in volume over the last 13 weeks versus the prior year. Finally, fruit snacks revenue grew 31% from the prior year's quarter, a 15th straight quarter of double-digit growth. Fruit snacks continue to deliver the highest growth rates among our product categories as we leverage our expanded capacity, while underlying demand remains very strong. In short, we grew in almost every way you can analyze our revenue. Switching to operations, I spent a significant amount of my personal leadership time just starting our supply chain excellence initiatives. As I mentioned previously, improving the effectiveness and efficiency of our supply chain is a journey of 1,000 steps. We made progress in the quarter, increasing our output by over 20% from the prior year despite some modest margin leakage in inventory reserves as we continue harmonizing processes across an integrated supply chain. We have a continuous improvement structure in place, and we see a lot of opportunity for significant margin improvement in the back half of the year. As it relates to our capacity expansion projects, production continues to ramp on our first two lines at our Midlothian facility. We feel really good about the demand environment for utilizing the Texas capacity. Our third line commercially launched at the end of the first quarter, and we expect to see meaningful contribution from this line in the back half of the year. The focus in Texas continues to be on improving output and efficiency of these lines to fully realize the volume potential in 2024 and 2025. Finally, our oat extraction expansion in Modesto is now up and running, and we will continue ramping up production volumes throughout the remainder of the year. As for spending capital wisely, we continue to evaluate capital projects in a disciplined way and are on track for our 2024 CapEx guidance of $25 million to $30 million. Additionally, we fully expect to achieve a leverage ratio under 3 times adjusted EBITDA by the end of the year. I'd like to take a minute to highlight a SunOpta strength. We have a fantastic culture at SunOpta. Our people care. They care about the planet, about each other, and about making a positive impact in the communities in which we work and live. The passion and values of our employees and company culture drive our ESG initiatives, whether our employees are pushing energy reduction in our Midlothian facility, achieving 0 waste status at our beverage plants, or planting trees in Niagara, Canada during a designated volunteer time off day, our employees live ESG, and we are better for it. I am thrilled that in our model, we make sound business decisions and investments that are also great for ESG considerations, all while managing our capital allocation. I'm excited to share that we just published our latest annual comprehensive ESG report, highlighting progress across the business. This report is available on our website and does a terrific job of articulating our intertwined goals of fueling the future of food and living our ESG values each and every day. Now that we've talked about the highlights of the quarter, let's discuss specifically how all this information impacts our outlook for the balance of the year. As a reminder, we provided an updated guidance for 2024 financial results based upon what we see versus what we hope, and we are sticking to that communication philosophy. In determining our guidance for the year, we consider our performance to date and all publicly available trends in the food service, club store and retail channels. In addition, we collaborate with our customers regularly in supporting their innovation efforts to ensure we are co-developing products to address changing consumer needs and wants and incorporate changing business demands. Most importantly and certainly most relevant to how we guide our future performance, on a weekly and sometimes daily basis, we work with our customers reviewing actual purchase order volumes on a rolling eight-week period as well as order forecast for the balance of the year. As a result, we feel it is appropriate and have confidence in raising the guidance for 2024 by the amount of our overperformance in Q1, again, by what we see, not what we hope. Greg will cover the specific details in his section. Before turning it over to Greg, I want to review our priorities for next quarter. In short, our areas of focus will not change, and we remain steadfast in executing across the three following areas: number one, top line growth. We are a growth company in growing categories with a competitively advantaged model that provides multiple ways to win. Remember, our revenue stream has the advantage of diversity. We operate in categories that are growing, and we have a great customer base that continues to win in the marketplace. We are thrilled to be able to support their growth. We expect the trajectory of our growth to continue to be driven by growth of our existing customers, share gains with our existing customers, and the acquisition of new customers in TAM expansion. I'm excited about our new business development efforts and the opportunities on the horizon. Number two, increasing the efficiency and effectiveness of our supply chain. As mentioned, we made progress in increasing the output of our manufacturing facilities. We are simultaneously working on numerous initiatives to improve labor cost, waste, inventory management, conversion costs, and a host of other key operating metrics. Importantly, this is a journey integrating multiple people, processes, and technology platforms, and my highest leadership priority is ensuring we are taking a step forward in operational excellence every day. To continue delivering strong volume gains, it is essential that we optimize our production to support the demand side momentum in our business and expand our gross margin. Number three, manage our capital wisely. We remain disciplined in executing our capital allocation priorities and continue to be focused on deleveraging over the near term. In summary, we're off to a great start in 2024, and our team is executing well across our strategic priorities. While we are encouraged with our results, we expect to continue getting better. We have a great opportunity to continue delivering strong revenue and EBITDA growth to drive significant shareholder value, and we are relentlessly focused on accomplishing this goal. We know that SunOpta's true potential is so much greater, and we are still very early in the operational excellence phase of our transformation. As we continue to sweat our assets to drive volume and revenue growth, the efficiencies we realize should propel even greater improvements in profitability and increasing rates of return. I'm confident in our outlook and the direction of our business, and we are on track for delivering our 2024 guidance and midterm financial goals. I am looking forward to updating you on our strategic initiatives throughout the year. Now I'll turn the call over to Greg to cover the first quarter and full year outlook in more detail.

Greg Gaba, CFO

Thank you, Brian, and good afternoon, everyone. As Brian said, we had a strong first quarter. Revenue of $183 million was up 18% compared to last year driven by volume growth. Gross profit increased $7.7 million or 32% to $31.7 million in the quarter. Gross margin for the quarter was 17.4%, a 190 basis point increase from 15.5% in the prior year period. Adjusted gross margin was 17.5%, down 180 basis points from the prior year period, mainly reflecting 90 basis points of incremental depreciation related to new production equipment, together with an increase in inventory reserves, partially offset by improved plant utilization stemming from strong volume growth. Operating income increased to $10.2 million from $0.5 million in the year ago period, driven by profitable volume growth and a gain on sale of the smoothie bowl product line of $1.8 million. Earnings from continuing operations was $3.8 million compared to a loss of $2.8 million in the prior year period. The increase was primarily driven by the flow-through of profitable volume growth. Adjusted EBITDA from continuing operations increased 21% to $22.6 million compared to $18.7 million last year. Turning to our balance sheet. At the end of the first quarter, debt was $259 million, resulting in leverage of 3.1 times, down from 3.4 times last quarter. Cash provided by operating activities of continuing operations during the first quarter was $7.4 million and cash used in investing activities of continuing operations was $4.2 million. Subsequent to the end of the quarter, we completed an amendment to the Series B preferred stock that eliminated dividend rights. While we could have forced conversion to common shares, doing so would have caused Oaktree to exceed the exchange caps. Therefore, we mutually agree to this amendment. Now turning to our full year outlook. We are raising our 2024 outlook to reflect the strong performance in Q1. We now expect revenue in the range of $685 million to $715 million, which represents growth of 9% to 13% versus our prior guidance of 6% to 11%. From a profit perspective, we now expect adjusted EBITDA of $88 million to $92 million, which represents growth of 12% to 17% versus our prior guidance of 11% to 17%. From a pacing standpoint, we continue to see the back half of the year to be slightly stronger than the first half with a revenue split of approximately 49% first half and 51% in second half and adjusted EBITDA split of approximately 47% first half and 53% second half, reflecting the expected benefits in the second half of the year from our supply chain excellence program that Brian discussed earlier. From a leverage standpoint, we expect to be under 3 times leveraged by the end of this year, recalling that in Q2, we expect an increase in debt as we will have roughly $25 million of debt from the capital lease related to the oat extraction expansion at Modesto coming online. Given current interest rates and expected debt levels, we expect interest expense of $24 million to $26 million for the year. We continue to expect capital expenditures on the cash flow statement of approximately $25 million to $30 million and free cash flow of $35 million to $45 million for 2024. In terms of cadence, we expect free cash flow generation to be largely back half weighted. Before opening the call for questions, just a reminder that for competitive reasons, we did not provide detailed commentary regarding customer or SKU level activity. And with that, operator, please open the call for questions.

Operator, Operator

(Operator Instructions.) Our first question is from the line of Jon Andersen with William Blair.

Jon Andersen, Analyst

Good afternoon, everybody. Thanks for the questions, and congrats on a strong start to the year. I guess I wanted to start by asking about your guidance. It sounds as though your outlook for category growth has not changed. I think you mentioned again mid-single digits, which is consistent with what you talked about last quarter. But again, you took the revenue up for the year. So, I kind of want to get a sense from you on where you saw stronger performance? Or what was the source of the upside relative to plan in Q1? And what gives you conviction kind of this early in the year given some of the noise out there around consumer trends and particularly in food service of late that, that outlook for the category and the business is supportive of a raise at this point?

Brian Kocher, CEO

Jon, thanks a lot for joining the call and thanks for your question. Let me try to unpack a couple of different things. If I look at the quarter, we've kind of consistently said this shelf-stable category in the markets we're serving are growing in that mid-single digits. And I think our performance, which, again, for the second quarter in a row, is probably close to 3 times what we believe the category is growing. Our performance really is driven by expansion with existing customers, acquisition of new customers, and then TAM expansion. And if I look over the quarter, about each one of those was equal. We actually grew a little bit more with our existing customers either through share or innovation than maybe in some of the other categories. But it is relatively close to being even when you look at our revenue growth from Quarter 1 of 2023 to Quarter 1 of 2024. So that's kind of the revenue growth question. Let me talk to you specifically about our outlook because I think it's something really, really important. For the last three quarters, SunOpta has kind of stuck with the philosophy that said, we're going to take what we see, customers, products, timing of new business and current customer orders, we're going to take and communicate what we see, not what we hope, and I think that's a really important thing to remember as we talk about our guidance. Remember, we have a really diverse revenue stream. Channels are diverse, customers diverse, products are diverse. I mean our foodservice channel grew 11% in the quarter. Our top three customers, each of them grew over 10% plus in the quarter. So, we've got a lot of diversity. And I think that's one thing that we've gained confidence in. But I think even more importantly, when we look at the balance of the year guidance. Certainly, the public information and the category trends inform our guidance. I would say it informs our guidance. But remember, we're having daily and weekly calls with our customers on order volume on order forecast, on customer innovation, and on promotion activity. Those are what inspire and generate our guidance. So, the category data informs but what we really base our guidance on is what we can see versus what we hope happens. And I hope that's a little insight into the balance of the year and how we feel and think about the year shaping up for us.

Jon Andersen, Analyst

Yes, that's very helpful. Just focusing on the guidance for a moment, it seems you increased sales by about $15 million at the midpoint, with EBITDA slightly rising by $0.5 million. Is there anything to interpret from that? Are there any details regarding the nature of those additional sales and the associated costs?

Brian Kocher, CEO

Jon, our approach was straightforward. We increased our guidance due to the strong performance in the first quarter. It's as simple as that. I'm genuinely enthusiastic about our ongoing business development efforts. We're having weekly discussions with our customers about new opportunities, but we focused our guidance on what we can actually see with current customers, existing products, and realistic timelines, rather than our aspirations. Therefore, our guidance reflects the increase based on our first-quarter performance.

Jon Andersen, Analyst

Okay. And Brian, I know it's really important to you and a focus area on operational excellence and really getting the most out of the supply chain after a couple of years of really putting a lot of new capacity in place. Since you've been there for a few months now, how do you feel about both the progress and the plans on that front and your ability, I guess, to kind of sweat the capacity that you've recently put in place to kind of deliver on those midterm goals? What are some of the initial learnings? That would be helpful.

Brian Kocher, CEO

Jon, I think the way I would describe it overall is I'm pleased with the first quarter. We increased output over 20% to satisfy the demand we had on the sales side. That's good. I think simultaneously, I'm not satisfied. We have multiple simultaneous initiatives we're pushing on anywhere from labor to throughput to equipment maintenance to waste reduction, all of those we're pushing on. And I think we've got opportunities to reap improvement in each one of those metrics over the balance of the year. So, we've got a ways to go. Pleased but not satisfied is a phrase I would keep in your mind because it's certainly one in mine.

Operator, Operator

Your next question is from the line of Jim Salera with Stephens.

Jim Salera, Analyst

Congrats on the strong results.

Brian Kocher, CEO

Thanks, Jim, appreciate it.

Jim Salera, Analyst

I wanted to drill down on food service because I think, candidly, a lot of us are surprised at how robust the results were given some of the commentary and traffic softness at some of the publicly traded comps in that space? Can you maybe walk us through the difference between your strong results and maybe some of the softness we've seen in traffic trends? Is that just a function of you winning more share across food service? Or should we think about the plant-based beverages that you sell into that channel as being separate from the overall kind of traffic softness and they're gaining share while maybe traditional dairy base is losing?

Brian Kocher, CEO

Thank you for the question, Jim. We wanted to engage with the investment community on this topic. I would like to rephrase your question slightly; you noted you were pleasantly surprised by the strength of our growth. This really comes down to two key areas. First, we are closely connected with our customers, engaging in innovation discussions on a weekly basis, and at least monthly with our top 15 clients. Often, these discussions revolve around multiple projects together. If you were to visit a popular food service restaurant, you'd likely notice substantial promotion of plant-based products, with various categories promoting items featuring plant-based beverages. This may create some disconnect, as we possibly have a heightened focus on plant-based products at many food service venues compared to their overall revenue. Our plant-based offerings are definitely gaining traction in certain areas of food service. Secondly, we have indicated that we are increasing our share with existing customers, which definitely plays a role in our growth. More importantly, we are continuously innovating—whether it’s for promotions, limited-time offers, or aligning our innovations with present market needs rather than past trends. We are consistently working with our customers on research and development. Our efforts cover everything from taste and performance profiles to potential cost and efficiency improvements in stores. Hopefully, this clarifies why our growth may be distinctively positive compared to some broader trends you’ve observed.

Jim Salera, Analyst

Yes, that's very helpful.

Brian Kocher, CEO

Jim, sorry, just to hit this one more time. But just to be complete, our food service business grew 11% this quarter. And our top three customers were all double-digit growth. So again, it kind of shows up in our numbers.

Jim Salera, Analyst

Sure. Can you provide an update on the utilization rate of your shake line? This category has experienced significant demand, so I'm curious about the potential for increased throughput and how much you can boost sales by ramping up production on the shake line as the year progresses.

Brian Kocher, CEO

We don't typically share utilization rates on the lines, but I can provide some context. We are on track to meet our productivity and throughput goals, which I consider important for our investment strategy, by the middle of this year. This investment strategy is based on specific assumptions that guided our funding for the total addressable market expansion project, and we are meeting those goals. I believe that supply chain management is an ongoing process, and there is potential for increased throughput not just in our protein shake line but throughout our entire network. This increase has the advantage of reducing the overall cost per unit; the more units we produce within a fixed cost structure, the lower our cost per unit becomes. Additionally, it creates non-capital expenditure capacity that enables us to grow without committing additional capital assets.

Jim Salera, Analyst

Thanks, guys, I appreciate the color. I'll hop back in the queue.

Operator, Operator

Your next question is from the line of John Baumgartner from Mizuho Securities.

John Baumgartner, Analyst

I guess first question, Brian, you sound pretty bullish on the incremental efficiencies in the model for the back half from it sounds like a number of different sources. And I'm looking to tie it back to the minimal uptick in guidance for EBITDA for this year. Are there any offsets that are sort of contrary to your new efficiencies coming in the model? Are there any intermediate steps you have to take to get those efficiencies that maybe push the realization in the P&L into 2025? I guess how do you think about kind of the cadence of the realization of those efficiencies coming through?

Brian Kocher, CEO

Okay. There are no significant risks that are hindering efficiencies. More than anything, improving the supply chain is simply a matter of hard work. We're engaged in this effort every day, involving procurement and product sourcing, managing water usage, and optimizing production sequences to gain small efficiencies. I don't want anyone to misinterpret the guidance as a sign of a lack of growth; we're confident in our business development pipeline and our potential for supply chain growth. We're committed to transparently communicating our outlook based on the timing of customer products and the portfolio we have, not on what we wish for. As we continue to pursue business development and close new opportunities, the next time I discuss these specifically will be when they appear in the financials and we update our guidance.

John Baumgartner, Analyst

Okay. Greg, could you elaborate on the modest margin leakage and the inventory reserves from the quarter? How should we consider any potential impact this may have for the rest of the year?

Greg Gaba, CFO

Yes. No problem, John. So when you look at it, Brian mentioned that we increased our production 20% versus prior year, right? And it is a journey of supply chain efficiency and excellence. And with that, we did have a little bit of leakage. We do strive to get better every day, and we continue to get better every day. And we're putting things in place that would hopefully reduce that waste going forward. And, no, we don't consider it to be a long-term issue at all, John.

Brian Kocher, CEO

John, I think a good way to think about it and put it in perspective is we're trying to work on nine different things at once in improving our 10 or 12, whatever it is that we're doing to try to improve our supply chain operations. And we made progress for sure on output. But there are some others that we didn't make as much progress. And we've got initiatives. We're happy with our initiatives. We're happy with our opportunity to drive improvement. But as we said, there's a lot of complexity in doing this, and we believe this is something that we will continue to show progress with the balance of the year.

Operator, Operator

Your next question is from the line of Brian Holland with D.A. Davidson.

Brian Holland, Analyst

Yes. So, I just wanted to maybe start by asking about the upside in the quarter. I know the strength was broad-based. Was the source of upside versus your internal expectation on the top line broad-based as well? Or was it disproportionate towards new business development, etc.? Just because it doesn't sound like the category actually changed or it seems like it was relatively consistent. So, I just want to make sure I understand the source of the upside versus your own internal expectation.

Brian Kocher, CEO

Brian, I would say it was broad-based as well. I mean if you look at it, we did a little better than we thought almost whether it was new customer acquisition and the robustness and the timing of that or growth with our existing customers, we had some favorability across the spectrum. And again, it kind of showed up everywhere. It showed up in channels. It showed up in customers. Almost any way you could cut this data, we saw growth. And so, we're excited that a diverse revenue stream can help us in a quarter like this.

Brian Holland, Analyst

Okay, that's great. I appreciate the detail you provided about how you develop your forecasts for the investment community; it's very helpful. However, I want to ensure we clearly understand what specifically has changed compared to about a year ago. We started last year with strong optimism, and then things took a downturn midyear, a scenario we've experienced several times. I'm curious if there have been any adjustments in how you approach your modeling, at least in terms of what you've communicated to the Street.

Brian Kocher, CEO

Yes, I believe there has been a change that occurred before I arrived. SunOpta benefited from some business development efforts last year, but the timing was not right. As they shared their expectations, the timing shifted for various reasons, leading to disappointment. It was likely during the third quarter results when SunOpta communicated how they would forecast moving forward, which makes sense to me. We aim to guide based on what we know and can see regarding customers, products, and timing, rather than what we hope will happen. Timing with customers is always a variable, but we are striving for consistency and focusing on what we can see in terms of customers, products, and timings instead of relying on hopeful guidance. Are you still there?

Brian Holland, Analyst

Yes. Sorry. All good. I appreciate the color, Brian. Sorry, I figured they'd move on. Thank you very much.

Operator, Operator

Next question is from Ryan Meyers with Lake Street Capital Markets.

Ryan Meyers, Analyst

It sounds like the growth was broad-based, but I'm curious, as you communicated that prices have come down a little bit. I mean, have you seen any improvement in the tracked channels? And I know that's a smaller portion of revenue, but just kind of curious what the dynamic of that is.

Brian Kocher, CEO

Ryan, thank you for the question about tracked channels. While I wouldn't say we've seen a definite improvement in these areas, there is some volatility and a bit of promotion happening. One of SunOpta's strengths is our strong relationships with successful customers. By successful customers, I mean those who are innovating, co-developing solutions with us, investing in their brands, and ultimately growing faster than the overall category. If you examine all the brands we support in the tracked channels, they are performing 300 to 400 basis points better than the category, both in a 52-week and a 26-week perspective. This indicates a positive divergence in our performance compared to overall tracked channels.

Ryan Meyers, Analyst

Okay. No, that's helpful to understand. And then it didn't sound like there was a lot of this during the quarter, but I'm curious if there's any way that you guys can quantify new customers or any sort of impact of bringing new customers on board.

Brian Kocher, CEO

Yes. I think I mentioned at the beginning of Q&A, if we split revenue growth between TAM expansion, expansion or share of wallet gains with our existing customers, and new customers. The growth with existing customers was probably the largest of those three, but it was relatively broad-based.

Operator, Operator

Your next question is from the line of Andrew Strelzik with BMO.

Andrew Strelzik, Analyst

I wanted to maybe go back to some of the supply chain opportunities that you've talked about, which I know you've already addressed several times here, but I wanted to try again. And maybe thinking about the 2025 outlook that had been provided, obviously, well before you joined and started attacking a lot of the supply chain opportunities. And so, I guess what I'm curious about is, is it fair then to think that whatever that contributes or materializes into, whatever that bucket looks like, would be incremental to the guidance that was put out there for 2025? Or is that not a fair way to look at it?

Brian Kocher, CEO

Yes, Andrew, I think the guidance suggests that we anticipated reaching a $125 million EBITDA run rate by the end of 2025 or the beginning of 2026. This projection included some expected revenue growth and margin expansion. Historically, when SunOpta plants operated at full capacity, we achieved about a 20% gross margin, and we expect to be close to that figure when we are fully operational at the end of 2025 or early 2026. Thus, this expectation is incorporated into the $125 million guidance. In the long term, both Greg and I have publicly discussed the potential to exceed a 20% margin, as we continuously focus on supply chain initiatives, efficiency, and effectiveness. This is an area we are committed to improving. I hope this clarifies the midterm guidance of $125 million.

Andrew Strelzik, Analyst

Yes, it may seem more incremental than that, but it's definitely helpful context. Additionally, I have another question regarding capital allocation. I understand you've mentioned that levels will increase in the second quarter and that leverage will also rise. You're approaching a timeline where you'll reach your leverage targets, and you appear quite confident about this. You've mentioned some capital projects under consideration, and I'm interested in hearing more about your thoughts on these. Also, regarding opportunities like M&A or buybacks, how would you prioritize those once you achieve your leverage targets?

Greg Gaba, CFO

Yes, Andrew, thanks for the question. So, our capital allocation strategy remains the same, right? So once we get the 3 times levered, which we believe will be by the end of this year, we will look at three things: we'll look at attractive ROI projects, we'll look at potential share buybacks based on the stock price at that point in time or attractive M&A deals. So, those continue to be the options we continue to evaluate every day. And once we get there towards the end of the year, we'll give you a further update.

Operator, Operator

Your next question is from the line of Daniel Biolsi with Hedgeye.

Daniel Biolsi, Analyst

So, from your vantage point, what have you seen from price increases in the food service channel and what that has done to their demand? Can you follow that when they raise prices, has that impacted demand? Or do you see that in another way?

Brian Kocher, CEO

Thank you, Daniel, for the question. There are likely some effects in food service due to rising prices, particularly among less frequent or fringe consumers. However, we are seeing food service providers actively planning promotional events and limited-time offers, which is an area where we can significantly assist our customers. We can leverage our team of over 20 food scientists to develop new recipes and provide a comprehensive supply plan. So, the situation has two sides: while there are some price-sensitive fringe users, our customers are also focusing on promotional activities to drive growth throughout the network and the overall category.

Daniel Biolsi, Analyst

Thanks, Brian. So new contract wins were part of the upside in the quarter, but are you not including that continuing in the second half with the raised guidance you had today?

Brian Kocher, CEO

No, no, sorry, Daniel, thanks for the clarifying question. That's really good because we don't want to miscommunicate. I think what we're trying to say is, remember, we're still guiding for the year. I think midpoint is 11% revenue growth. So, we're still guiding for a pretty hefty revenue growth year-over-year. And I think what we were trying to articulate is the business development efforts that were announced in 2023 and the timing was maybe a little off, you're seeing the benefit of that in 2024, and you will continue to see the benefit of that in 2024 for us to achieve our midpoint 11% revenue growth.

Daniel Biolsi, Analyst

Okay. That makes sense. And then if I could ask one last question for Greg. What's behind the inventory reserves? Is that just spoilage?

Greg Gaba, CFO

Yes, great question, Daniel. As you know, we mentioned that our output has significantly increased in our plans compared to last year, 20% more than the previous year. However, there is an opportunity to improve the efficiency of that output. We did have a bit more waste than we desired, and we are working on improving that.

Operator, Operator

At this time, there are no further questions. I will now hand today's call over to Brian Kocher for any closing remarks.

Brian Kocher, CEO

Thank you very much. I'd just like to take a couple of minutes to summarize our key messages. If you only take three things away from this call, please think about these three. First and foremost, we are a growing company in growing categories. In addition to the growth that we naturally see from our customers, our blue-chip customer base, we're growing share with our existing customers, we're bringing on new customers, and we continue to grow via TAM expansion. Our revenue stream is diverse and resilient. Remember, in this quarter alone, our top three customers grew double digits. Each one of them grew double digits. Our food service channel revenue increased by 11% in the quarter. And almost every way you slice our revenue, we grew in Q1 of this year. And that's how you grow a quarter by 18%. So, one is revenue growth. Secondly, we will never stop working on supply chain excellence. We've talked about it in the Q&A. I'm proud of the increased plant production we've had in the quarter. Plus 20% is not easy. That's how much we've increased output in the quarter with our existing plants. We will continue to tighten and sharpen our other supply chain processes, and we expect to see that roll into our performance in the balance of the year in both margin improvement as well as supply for future growth. So that's the second thing. Finally, I would just like to remind people of our strategy on communicating guidance. We have visibility in the market trends, and that informs our guidance. However, visibility into actual order demand by customer, order forecast in the longer term by customer, customer innovation initiatives and activities, customer promotional activities, that's what inspires and generates our guidance. So, remember, our communication philosophy is to communicate what we have visibility to in terms of customers, products, and timing versus what we hope happens. With that, operator, we can adjourn. Thank you very much for joining us. And Greg and I look forward to updating you on our progress throughout the year.

Operator, Operator

This concludes today's call. Thank you for joining. You may now disconnect your lines.