Vital Farms, Inc. Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by and welcome to Vital Farms Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. It is now my pleasure to introduce Investor Relations, ICR, Ashley DeSimone.

Thank you. Good afternoon and welcome to Vital Farms second quarter 2020 earnings conference call and webcast. On today's call are Russell Diez-Canseco, President and Chief Executive Officer; and Jason Dale, Chief Financial Officer and Chief Operating Officer. By now everyone should have access to the Company's second quarter earnings press release filed today after market close. This is available on the Investor Relations section of the Company's website at www.vitalfarms.com. Before we begin, please note that all of the financial information presented on today's call is unaudited. 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 cause actual results to differ materially from those described in these forward-looking statements. Please refer to today's press release, the company's quarterly report on Form 10-Q for the quarter ended June 28, 2020, filed with the SEC and other filings with the SEC for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Note that management will refer to adjusted EBITDA, which is a non-GAAP financial measure. While the company believes this non-GAAP financial measure provides 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 GAAP. Please refer to today's press release for a reconciliation of adjusted EBITDA to its most comparable measure prepared in accordance with GAAP. I'd also like to note that we are conducting our call today from our respective remote locations. As such, there may be brief delays, crosstalk or other minor technical issues during the call. So thank you in advance for your patience and understanding. I'd now like to turn the call over to Russell Diez-Canseco, President and Chief Executive Officer of Vital Farms. Russell?

Thank you, Ashley, and good afternoon, everyone. It's great to speak with all of you on our first earnings call as a public company. On today's call, I will briefly review our second quarter financial highlights, provide an overview of our business model, and discuss the reasons we believe our brand is well positioned for long-term growth. Jason Dale, our Chief Operating Officer and Chief Financial Officer will then review our second quarter financial results in more detail and discuss our fiscal 2020 outlook. We then look forward to taking your questions. First, our second quarter financial highlights. We're pleased to report a strong second quarter. Net revenue increased 84% to $59.3 million compared to the second quarter last year. We also saw positive trends in our key profit metrics. Gross profit margin increased over 400 basis points year-over-year. Adjusted EBITDA improved 111% from the second quarter of 2019 to $9.3 million, demonstrating our continued increasing profitability. Because many of you are new to our story, I would like to provide an overview of our business model and our growth strategy. Vital Farms is on a mission to bring ethical food to the table by coordinating a network of approximately 200 small family farms and bringing their products to a national network of approximately 14,000 stores. Our values are rooted in conscious capitalism, exemplified by our belief that to build a sustainable enterprise, we must prioritize the long-term benefits for each of our stakeholders: our customers and consumers, our employees, whom we call crew members, our farmers and suppliers, our communities, the environment, and our stockholders. We are a Certified B Corporation as well as a Public Benefit Corporation. Our premium and values-driven positioning engenders trust with consumers and makes Vital Farms a strategic and valuable brand for retailers. As we continue to build a trusted brand in eggs and butter, I am optimistic about the categories we could potentially disrupt to offer consumers and other stakeholders better options. Since our founding in 2007, we have focused on delivering growth and profitability. For example, we delivered a net sales growth of 64% and a gross profit growth of 71% in the first half of 2020. In the last 52 weeks ending June 14, 2020, we were the number one pasture-raised egg brand with 78% dollar share of the U.S. pasture-raised egg market and the number two overall egg brand based on retail dollar sales. Next, I'll turn to our growth strategy. Our growth strategy consists of four key elements. First, expand household penetration through greater consumer awareness. Second, grow within the retail channel. Third, expand our footprint across food service. Fourth, extend our product offerings through innovation. Now we'll walk through our highlights from quarter two along each of these four dimensions. First, household penetration. In the second quarter, household penetration increased to 2.7%, up from 1.9% at the end of 2019 and up 70 basis points on a sequential basis from the first quarter. We recognize that some of these gains are driven by trends toward more eating at home due to COVID-19. We see some early signs that consumers who are trying our products for the first time are making repeat purchases. For example, during the COVID stock-up period, the eight weeks ending April 19, approximately 450,000 new buying households purchased Vital Farms eggs. In the following eight-week period ending June 14, 20% have already become repeat purchasers, and 45% of those purchased Vital Farms eggs multiple times during those eight weeks. Second, grow within the retail channel. During the second quarter, Vital Farms store count increased by over 700 doors, driven primarily by the grocery or food class of trade. Our velocities in that class of trade remained robust despite the extended distribution. In the natural channel, including Whole Foods, sales increased by double digits. Third, expand our footprint across food service. While we see growth opportunities in food service, the headwinds in that sector in quarter two limited our ability to attract new customers. This remains a small segment of our business, and we look forward to bringing additional focus to it as the sector rebounds. Fourth, extend our product offerings through innovation. Our focus in quarter two was on the successful ramp-up of production of our new Egg Bites, which we launched in August. Egg Bites are a new line of single-serve, refrigerated bites made with high-quality ingredients, including Vital Farms pasture-raised liquid whole eggs, pasture-raised cheese, humanely raised meats, and vegetables. Consumers are staying at home more than usual right now, and for many, their days are busier than ever. We created Egg Bites to address the growing number of consumers who crave a protein-packed breakfast made with fresh ingredients but who don't always have the time to cook. As our first multi-ingredient product, this launch has given us valuable experience in the entire innovation process from ideation to procurement to co-manufacturer management. Our successful launch involved many crew members from across the company, and we thank them for their tireless efforts to bring this product to market. Now, I'll discuss the impact of COVID on our business. As we mentioned earlier, we believe COVID-related shifts in consumption toward in-home have created tailwinds for our retail products. Since late February, we have focused on the health and well-being of our crew members and other stakeholders. As a result, we have seen limited impact on our supply chain with just two confirmed cases among our operations team at Egg Central Station in Springfield, Missouri. Their continued health and commitment have allowed us to deliver increased production above pre-COVID levels to help supply the increased demand we are experiencing from our retail partners. In summary, we believe Vital Farms is incredibly well-positioned for growth as we remain focused on increasing penetration in both retail and food service channels, increasing brand awareness, ongoing product innovation, and continuing to support family farms as we serve a robust market for food produced from humanely raised animals. I'd like to now turn the call over to Jason, who will walk you through our second quarter financials.

Thank you, Russell, and good afternoon, everyone. It's great to be speaking with you on our first earnings call as a public company. We're very pleased with our second quarter financial results and what we believe are significant opportunities for growth ahead. We've made meaningful investments to build a growing trusted business as we increase penetration in the retail channel. Net revenue in the quarter was $59.3 million, up 84% compared to the second quarter last year. Our strong quarter gives us confidence in our expectation to exceed total net revenue of $205 million for the full year of 2020, representing a growth rate in excess of 45% compared to 2019. Growth in net revenue for the second quarter of 2020 was driven primarily by an increase in gross egg and butter sales, which were mainly due to volume increases to distributors and a high turnover rate of sales to retail customers, some of which resulted from stay-at-home trends associated with COVID-19. The increase in net revenue was partially offset by sales incentives offered to customers in connection with egg and butter sales. Gross profit was $22.7 million or 38% of net revenue for the second quarter of 2020 compared to $11 million or 34% of net revenue for the second quarter last year. The $11.7 million increase in gross profit and the more than 400 basis points of gross margin increase was primarily due to the increase in net revenue with a portion of the increase in gross margin attributable to lower costs associated with warehousing and transportation of shell egg inventory. Total income from operations was $9.1 million in the quarter compared to $3.9 million in the second quarter last year. The $5.2 million year-over-year increase was primarily due to the increase in net revenue and expanded gross margin. Net income was $5.9 million or $0.16 per diluted share compared to $2.8 million or $0.08 per diluted share in the second quarter of 2019. Total operating expenses were $13.4 million or 23% of net revenue compared to $7.1 million or 22% of net revenue in Q2 last year. This primarily includes SG&A expenses of $10 million, a $5.2 million increase compared to Q2 of last year, and shipping and distribution expenses of $3.4 million, an increase of $1.3 million year-over-year. The increase in SG&A was primarily due to an increase in employee-related costs due to an increased overall headcount to support our growth, increased spending on marketing programs, and an increase in corporate development expenses associated with our IPO. The increase in shipping and distribution expenses was primarily due to an increase in sales volume, which resulted in increased costs related to third-party freight associated with the distribution of our products. Our adjusted EBITDA was $9.3 million for the second quarter of 2020 compared to $4.4 million in the second quarter of 2019, which represents an 111% increase. The improvement in adjusted EBITDA was primarily due to expanded gross margin as well as leverage over our fixed operating costs. Looking ahead, we expect adjusted EBITDA to be in the range of $14 million to $16 million for the full year of 2020. Now shifting to our capital structure. Subsequent to the end of the second quarter on August 4, 2020, we completed our initial public offerings in which we issued and sold 5,040,323 shares of common stock and certain selling stockholders offered and sold 5,659,250 shares of common stock at a public offering price of $22 per share. This resulted in net proceeds to us of approximately $99.5 million after deducting underwriting discounts, commissions, and offering expenses. We did not receive any proceeds from the sale of shares by the selling stockholders. Total outstanding debt as of June 28, 2020 was $9.8 million. Of note, the company's $17.1 million cash balance as of June 28, 2020 does not include the proceeds from our IPO or reflect our payment in full of $1.9 million in outstanding borrowings under our equipment loan with PNC Bank. Capital expenditures totaled $4.7 million for the second quarter of 2020. We plan to use the proceeds from our IPO for general corporate purposes, including working capital, operating expenses, and capital expenditures, including further funding our expansion of Egg Central Station or shell egg processing facility in Springfield, Missouri, to increase our capacity for the distribution of pasture-raised shell eggs. As of September 4, 2020, there were 39,432,161 shares of common stock outstanding. Looking ahead at the robust market for food produced from humanely raised animals, we believe we have a unique opportunity at Vital Farms to achieve strong growth today and for many years to come. With that, now I'll turn the call back over to Russell.

Thanks, Jason. Reflecting on the Vital Farms story that we just shared with you, this company more so than any I have been a part of, does a fantastic job of living its values every day. The multi-stakeholder model forms the framework within which we make our strategic decisions, and it is no coincidence that our commitment to the values of conscious capitalism and of meeting the needs of all of our stakeholders has resulted in profitable growth. Thank you for joining the call today and for your interest in Vital Farms.

And our first question comes from the line of Rob Dickerson with Jefferies.

Great. Thank you. So welcome. First off, done a great job. I guess this is kind of my first question, to keep it short, is just on household penetration. We're seeing obviously a lift across the board for a lot of food companies. You spoke to the 2.7% in total penetration, which is a nice step up from where you are just earlier this year. So maybe just some kind of brief commentary on kind of probability of retaining as much of that step up and kind of tracing as you can, and maybe, kind of, if there are any shifts or pivots kind of around the strategy of the near-term to maybe not only retain it, but to maybe accelerate your goals in a longer term basis now given a high trial repeat.

Thanks, Rob, and thanks for the warm welcome and thanks for being here. So a few thoughts. First is, we do get the question a lot internally and externally: Are we going to be able to hold on to the gains? We have some early signs that I referenced in the call about our ability to convert trial into repeat, which is an early stage of the loyalty we hope to have over time. We have some percentage of people who bought us for the first time in the peak pantry loading period of COVID have come back and bought us a second time in the subsequent eight-week period. Some portion of those shoppers have bought us more than once. We had the specifics in the intro. It's early days, but there is some evidence that new shoppers have kept buying even when their usual brand showed back up on the shelves. We're focused on the entire shopper journey from awareness all the way through loyalty. We certainly recognize that we've had an uptick or an acceleration of new trial. We're maintaining our strong commitment to the loyalty part, which includes community management on our social media platforms, for example, in the way that we interact with our fans and looking for other ways in which people interact with our brand beyond simply receiving a broadcast message from us. That's top of mind for us. The good news is we did not make an aggressive assumption about the retention of this new trial in order to deliver on the guidance for the year. It's too early for us to predict the extent to which we'll retain that business, but we are making a conservative assumption, both in terms of how much longer the COVID-related lift remains and in terms of how much of the new trial we retain. There may be an upside opportunity there beyond our expectations as we continue to see how consumers behave in the coming months.

All right. Great. And then just -- I guess, kind of follow-up to what you just said, just in terms of that, the implied back half revenue guidance, right, and it looks like it's about 30% to 35% year-over-year. Obviously, you did better than that in Q2 for all the obvious reasons. You're now kind of two-thirds of the way through Q3. There might not be as much visibility, right, as you get into Q4. So I guess just kind of, as you speak, I don't want to say too conservative guide, but just in terms of how you get to that guide. Do you have decent visibility and a feel for where Q3 might come in, and are you just doing your best to guess what Q4 is, or given the 700 new doors coming through the quarter, do you feel like your visibility is actually pretty good for the second half?

Yes. Thanks, Rob. I’ll chime in at a macro level, and then Jason may want to contribute. We are humbled by the fact that there’s a lot of macro uncertainty in the future. What the economy, what the election brings, unemployment rates, and the potential for a fall resurgence, are factors to consider. On the one hand, more eating at home creates a tailwind for our product portfolio primarily at retail, yet the potential headwind of higher unemployment and lower incomes exists. We are comfortable with our annual guidance in light of that uncertainty in the fourth quarter.

Okay, great.

The only thing I'd add is to your point, Rob, I think if we see things continue, the reason why we have a range of guidance would be that it could pull us towards the higher end of that guidance. If we see what we've kind of been observing continue—not at the peaks of COVID, but with what we're seeing day in and day out—we would likely end up towards the higher end of that range.

Thank you. And our next question comes from the line of Pamela Kaufman with Morgan Stanley.

Hi. Congratulations on the IPO. I wanted to ask about your outlook for the promotional environment for the back half of the year. I think initially you had talked about potentially stepping up promotions and reinvesting some of the strength from this quarter. So just was curious to get an update on your plans there.

Thanks, Pamela, and thanks for being here and for that question. Our approach in the first half of the year was to avoid a lot of promotional activity during the peak pantry loading weeks of late February through mid-April while we were just trying to stay afloat and keep the shelves stocked. We planned to go back to a more typical promotional cadence and depth in the back half of the year, recognizing that if we saw a resumption of strong demand and the challenge of staying in stock, we might agree with retailers to pull back on this as well. Because we are continuing to see a lift above pre-COVID levels, we are trying to be judicious and purposeful with investments in promotion. We want to be great partners to retailers, but we are not relying on extensive promotional plans at this point to deliver the year.

Okay. That makes sense. Thanks. If you can provide some more color on Egg Bites and how its initial performance has been just in terms of the reception with retailers and consumers and your outlook for further distribution growth for that product.

Thanks. Yes, so it's still really early days. I mean, we just started hitting shelves a few weeks ago. We had relatively modest expectations for this year for Egg Bites, as we were just getting that up and running and things are working out about as well as we expected them to. We'll have lots more insights into that in our next release, but today it's pretty early.

Thank you.

Thank you.

Thank you. And our next question comes from the line of Chris Growe with Stifel.

Hi, good afternoon. I'll add my congratulations as well. Yes, good quarter and congrats on the IPO. I just had a question, if I could, first on just the gross margin, which was obviously a very strong performance in the quarter. Obviously not looking for quarterly guidance here, but just to understand the factors we should consider on the second half of the year. You have some great fixed cost leverage coming through. I guess I'd be curious as well to what degree or kind of where your capacity utilization stands today, maybe your peak. You were, I'm sure, running kind of full out. What sort of level are you down to, and maybe give some ideas around the fixed cost leveraging of the business.

I think that’s going to be for Jason.

Yes. Thanks, Chris. I think first to highlight your point about the gross margin performance in Q2. You could attribute about 280 basis points related to the peak of COVID. Some of that was related to our selling every egg we had because retailers were really trying to get any product they could. Relative to where we are versus that peak, we're down from that, but still getting leverage as we look forward. The guidance we're giving for the year and adjusted EBITDA range assumes a slightly higher margin than what we had originally modeled out for the back half of the year. It's less of a leverage play and more just about things starting to align relative to the warehousing and transportation costs that were mentioned in the Q2 that will continue, which we planned on and put in place.

Any comments Jason about capacity utilization, just rough levels, or just give a sense of kind of where you are today and how you can accommodate this elevated demand?

Yes. We are probably at somewhere between 50% and 60% utilization. So we have plenty of capacity at Egg Central Station today. We are diligent on the expansion process and expect that to be up and running in the second quarter of '22, which will support our growth plans.

Okay. And then just another quick question around the stickiness of some of these new sales. To understand like how many new doors are getting opened—we have household penetration that was up a lot, which was great. But just to understand in terms of new distribution or new shelf space, to what degree you're seeing more doors, more shelf space accrued to the company here?

Yes. Thanks, Chris. The household penetration had a nice lift. We added about 700 new doors during Q2. We keep effectively engaging with retail partners, both existing and new. Retailers are being open to their traditional reset approach, and we're not seeing any substantial changes from our plan and strategy on that note.

Okay. Thank you for your time today.

Thank you.

Thanks.

Thank you. And our next question comes from the line of Adam Samuelson with Goldman Sachs.

Yes. Thanks. Good afternoon, everyone.

Hey, Adam.

Hey, Adam.

Hi. Following up on the earlier question on capacity utilization from a different angle. Just, Jason, Russell, any comments you could have on the live supply chain? You’re seeing big sales up 80% in the second quarter and talking about a 30%+ increase in the back half, thinking about how far ahead you've got to plan with your grower network. How tight is the live inventory there, and are you seeing any issues in terms of fill rate?

Great. Thanks, Adam. Yes, the guidance that we gave, we're well within the supply to generate that range of what we're talking about. As we told you guys, there’s a lot of lead time to put down new farms to ensure we have a balanced supply and demand. We want to be thoughtful about growth without creating an imbalance.

That's really helpful color. And then the follow-up is thinking about distribution from a SKU count perspective and kind of new items per door. How has COVID impacted or benefited you from the category reviews that your retailer customers, particularly in the mainstream channel have done, as you think about distribution, that you might have a number of items on the shelf in '21 to convert some of those new households into recurring buyers?

I don't have an updated statistic on average items per door in front of me. Generally, we try to create proposals and strategies that are good for retailers and us and those tend to be very retailer-specific. In some retailers, where we're seeing high velocities but we have just one or two SKUs, we might propose several more items. There's always an element of negotiation with the retailer in determining what makes the most sense for them. I think generally retailers want to maintain a strong partnership with us, especially since we distinguished ourselves as good partners in March and April when it counted.

Okay. I really appreciate the color. I'll pass it on. Thanks very much.

Thank you.

Thank you. And our next question comes from the line of Robert Moskow with Credit Suisse.

Hi. Thank you. I wanted to perhaps clarify what's happened with the contracts you're negotiating with your farmers. Have you converted more of your farms to new contracts recently, and how are those discussions going?

Jason, you want to pick that?

Yes. Hey, Rob. We're not actively adding supply right now. Since the last time we talked, we haven't added any new contracts. So we're not actively converting the existing farms over yet. As contracts expire in the next year, we'll look to put down new supply onto the new forms of contracts.

Okay.

But to add some color, we are adding supply regularly to support our continued growth. The distinction is that we haven't signed new contracts recently. There's a lead time to sign a contract, and the supply comes online some months later.

In that case, how do you plan to expand gross margin over the next two years? What are the biggest drivers of that gross margin?

Yes, we still have the same playbook we discussed. As we continue to evolve and gain more farms on larger supply contracts, that will help positively impact our margin.

Okay. All right. Well, thank you.

You bet.

Thanks, Rob.

Thank you. And our next question comes from the line of Ken Zaslow with Bank of Montreal.

Hi. Good afternoon, everyone.

Hello.

Hi, Ken.

Just two questions. One is on the medium size eggs. Have you found your strategy there to stick? Do you feel like there's more permanency to them?

Great. Thanks for that, Ken. That's certainly an area of focus for us. There are two ways to think about medium eggs. One is to be able to sell them at retail as a shell egg. The other is to convert them into liquid eggs. Those mediums can be used to make our new Egg Bites, and they are also used to make hard boiled eggs. We are actively presenting the opportunity to retailers, and there is some interest. But I can't say we have solved for the entire projected supply next year—it continues to be a focus area for us.

My second question is, how much shelf space did you actually gain or expect to gain in the reset? How do you forecast that?

Each retailer is different. Generally, we create proposals that are good for the retail environment and us. In many cases where we see high velocities but only have one or two SKUs, we propose more items. Retailers tend to maintain a strong partnership with us. So I don't have an exact figure for the market as a whole, but we believe that the additional SKUs can still be very productive for the category and for retailers.

Great. Really appreciate it. Thanks, guys.

Thank you.

Thank you.

Thank you. I'll now turn the conference back over to Russell Diez-Canseco for closing remarks.

Thank you. Hey, thanks everybody for being here and for your great questions and engagement. It's new for us, and we're really excited to engage with you all as stakeholders in what we're doing. Thanks again. Have a great day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may now disconnect.