SunOpta, Inc.

Good morning and welcome to SunOpta's third quarter fiscal 2021 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 on SunOpta's website at www.sunopta.com. This call is being webcast and its transcription will also be available on the company's website. As a reminder, please note that the prepared remarks which will follow contains 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 SONOPTA's 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 discussion on 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 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 NANGAP financial measures during this teleconference. A reconciliation of these NANGAP 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 are occasionally rounded to the nearest million. And now, I'd like to turn the conference call over to SunOpta CEO, Joe Ennen, Please go ahead.

Good morning, and thank you for joining us today. With me on the call is Scott Huckins, our Chief Financial Officer. Before I begin unpacking the Q3 results, let me offer three key takeaways from the quarter. First, given everything going on in the macro environment, it is worth starting out by stating that nothing has fundamentally or structurally changed within our business. Our strategies, priorities, deployment of capital, and expansion plans are all on point. Demand was exceptionally strong, especially in areas like oat base, oat milk, and fruit snacks. Again, underlying the alignment of our priorities and investments with the market dynamics. Second, we saw very strong demand in plant-based, especially in oat, as oat revenue tripled versus prior year. Revenue was plus 16% versus prior year, achieving our highest ever Q3 in plant-based, and were it not for the raw material and labor challenges, we would have had growth in the low 20%. Sourcing incremental raw materials and incremental labor above plan proved challenging and disruptive to our operations. It would have been a much smoother quarter if we were just trying to deliver plus 5% plant-based growth. However, our aspirations are much larger than this. From a margin standpoint, gross margin in plant-based declined 360 basis points, of which 100 basis points was incremental depreciation. And the remaining 260 basis points was the result of the current supply chain and labor challenges. Given some of the challenges reported by our peers, only realizing a 260 basis point supply chain hit solidly represents the efforts of a passionate team hustling for every case, and every dollar of productivity. Third, while there was some timing impact in the quarter related to cost inflation, our co-manufacturing cost pass-through business model and our other pricing strategies have us in a solid position. Based on confirmed customer pricing adjustments, 100% of the current raw material price inflation will be passed on. These pricing adjustments will be fully implemented by the end of this month. Now, I'm sure everybody on this call is keenly aware of the unprecedented challenges impacting the global supply chain. Like many companies, we were challenged by labor availability, raw material availability, and inflation, along with the corresponding push to pass it on. It is important to note that these same issues are hitting our customers, and that is creating fluctuating order patterns, which is also disruptive to our operations. The three pillars that underlie our strategic growth priorities, portfolio transformation, accelerating customer-centric innovation, and doubling the plant-based business have not changed. We continue emphasizing top-line growth in our plant-based business and improving profitability in fruit-based. Our multi-pronged approach to solidify our leadership position by expanding capacity in the plant-based business while optimizing our fruit-based margins remains firmly on track. Our Allentown project will be coming online by year end. The Modesto expansion, along with the initial phase of the mega plant in Texas we announced in August, are all on target to be operational by late 2022. Collectively, these initiatives, combined with our investments in 2020, provide a doubling of our plant-based capacity, enabling significant growth as well as de-risking the supply chain through geographic diversification, improved redundancy, and network optimization. We continue to see strong consumer and customer demand for plant-based products, where we remain focused on strengthening our competitive advantages. In fruit, we are driving supply chain and cost efficiencies to improve the gross profit, which we are increasingly optimistic about. Our strategies are starting to pay dividends, and we expect to return to growth in 2022 based on the new business awards we have received. As it relates to the shortages in raw materials and labor, I want to recognize the Herculean efforts of the team in responding and tempering the impact. From adding backup suppliers to the backup suppliers, finding new sources of raw materials, hosting job fairs, working double shifts, adjusting production schedules on the fly to match the raw materials, our team has risen to the challenges. We also have a stepped-up focus on retention in our plant-based facilities. These are highly automated, sophisticated plants with highly skilled workers, and training new employees can take months. As I assess where we are through the first six weeks of Q4, I can share that we are in a better spot as far as staffing in the plants. There are still open positions, but fewer than this summer, and there is still work to be done around training to improve our overall efficiency. Similarly, the raw material situation is sequentially better than this summer. As I mentioned, for the most part, we have been successful in sourcing our planned level of raw materials. It is sourcing materials for the growth over and above our planned growth that has been challenging and disruptive. So, with all of this as backdrop, our total company revenues in Q3 increased 3.6% to $198.5 million. which, as I mentioned, was somewhat suppressed due to our inability to keep up with demand. This had a disproportionately negative impact on gross margin due to underutilization and plant disruptions, resulting in a 220 basis point decline to 11.8%. Despite these factors, we delivered 8.4% growth in adjusted EBITDA to 15.6 million by mitigating headwinds through proactively managing SGMA. Now let me turn to our segment results, starting with our plant-based segment. As a reminder, we have three strategic priorities in our plant-based business unit. First is strengthening and fortifying our competitive advantages already present in our Synopta value proposition. Second, compete in refrigerated plant-based beverages by building a strong ingredient business focused on oats. Third, build a multi-pronged go-to-market business that includes co-manufacturing, private label, and owned brands. The reason we are so bullish about the growth in this business is that we have multiple layers of competitive advantage that comprise our SunAfta value proposition. This model has five dimensions. First, capacity, having available capacity for our customers to grow. Second, quality, consistent product quality that comes from new state-of-the-art plants. Third, cost, delivering advantage supply chain costs that are derived from our national manufacturing footprint. Fourth, service, with professional support and strong order fill rate. And last but not least is innovation that is enabled by world-class R&D to accelerate customer innovation. We've made a significant investment in R&D, in talent, and a brand new R&D innovation center in Minneapolis, which includes a full-scale pilot plan. We start moving into this new facility in the next six weeks. We reported plant-based revenue of $114.9 million in the third quarter, up $15.8 million, or 16% over prior year, which is the highest plant-based Q3 in our history. This 16% growth is 23.9% on a two-year stack basis. Had we not faced challenges around labor and raw material availability, our plant-based growth would have been notably higher, likely five points or so, as I mentioned earlier. Retail scan data for the plant-based milks category shows 6% growth over the last 13 weeks, and compared with 2019, the 13-week growth was 24%. Looking at the trends by ingredient type for the last 13 weeks, almond has a 63% market share, and revenue is down slightly. Oat has an 18% share, and revenue is up 65%. And soy has an 8% share and is flat. New customers slash new business accounted for an impressive 34% of our plant-based growth, with a significant portion attributable to our own brands. Dream, West Soy, and Soan. Beyond our brands, we also signed a new two-year contract with a major food service customer to supply chai tea, and we extended our manufacturing agreement for another two years with an existing oat milk customer, which is one of the leading brands in retail oat milk. Revenue from our top five plant-based customers increased 14% during the third quarter, more than 2x the pace of category growth. The majority of this gain was driven by oat-based offerings, which more than tripled. As I mentioned on our last call, the success of our brand partners is a strong marketplace testimony to the quality of the product that is produced by our proprietary oat extraction process, as evidenced by consumers' purchasing behavior and validated in quantitative consumer testing. Being innovation-led is one of our three strategic priorities, and this is a great example of the power of proprietary innovation combined with great brand partners. We have secured long-term commitments from our three largest existing oat customers. When you combine this with strong interest from other major new customers, it is highly likely that we will soon begin construction on another oat extraction facility in the very near future. From a go-to-market standpoint, our owned brands were a key growth driver in the third quarter. Dream and Westsoy, which we acquired in Q2, contributed to growth and performed slightly ahead of our expectations, as did Soan, our organic oatmeal creamer. Soan was named a 2021 Best New Product by Progressive Grocer Magazine, and we are seeing strong velocities and expanding retail distribution. We expect to be in over 3,500 stores by the end of the year. Brands accounted for only 6% of Q3 plant-based revenues, but we are excited by the long-term prospects of our branded portfolio. As an aggregate, it has a more than 1,000 basis point gross margin advantage compared to our core business. As we have communicated for the past two years, our plan is to double the size of our plant-based business. As such, business development is a critical component to realizing this goal. We have several promising opportunities we are working on with leading CPG customers who are significantly expanding their plant-based portfolios. Additionally, now that we have begun construction in Texas, we have initiated the first phase of business development for a brand new capability for us. This capability is one of the building blocks of our plan to double the business. We will be installing equipment to produce 330 milliliter Tetra Pak beverages. For those not familiar, 330 ml is the size commonly associated with protein drinks, which you see in club stores, gyms, and virtually every other food retail outlet in America. The retail sales for the nutrition beverage segment is approximately 3.5 billion, and we estimate the majority of this is co-manufactured. Clearly, this is a big opportunity for Sonopta, and we are actively engaging with multiple potential customers. We expect to be in production with this new capability in Q1 of 2023. Moving on to our fruit-based segment, where our three strategic priorities are, number one, de-risking the business, which we're doing through geographic diversification, customer pricing programs, and better grow relations. Two, becoming the low-cost operator in frozen fruit through automation, footprint re-engineering, and aggressive actions in right-sizing SG&A, and three, evolving the portfolio via innovation towards more value-added offerings. We reported fruit-based revenue of $83.6 million in the third quarter, down $9 million, or 9.7% over the prior year period. Similar to what you've heard all year, this reduction is reflective of SKU and customer rationalization, along with global shortages in certain fruit types such as blackberries and raspberries. Declines in frozen were partially offset by fruit snacks, which increased 21%, fueled by growth in both CPG Coman customers as well as retail private label customers. We are seeing very strong demand in fruit snacks across the board, and consider this a growth engine for the future. In addition, we have successfully launched smoothie bowl products, which will be marketed across co-manufacturing, private label, and our own branded platform. Based on Nielsen data, the frozen fruit category is basically flat over the last 13 weeks, with private label outpacing branded offerings rising 3%. The fruit snack category is up an impressive 16% over the same time period. Our business grew faster than the category, propelled by strong growth from our top retail customers, as well as our top CPG co-manufacturing customers. The focus of the last several months in fruit has been around pricing. To provide some perspective, we have executed significant pricing increases across the portfolio, including with our largest customer. These actions are expected to pass through the entirety of the fruit cost inflation. These pricing actions are material, representing low double digits as a percentage of a revenue. In summary, despite all the global supply chain issues, our plant-based segment produced another solid quarter of growth, delivering a record-setting third quarter, more than offsetting declines in our fruit-based business. We continue to work to mitigate the impact of supply chain issues, creating transitory headwinds, and our long-term outlook for double-digit plant-based revenue growth and continued improvement in return on invested capital remains unchanged. We've been winning business with new customers capturing additional business from existing customers, adding capacity, and expanding our portfolio of products. Coupled with our strong balance sheet, Synopter remains well positioned for substantial long-term growth in some of the fastest growing CPG categories, all of which supports my continued optimism as we continue to focus on fueling the future of food. Now I'll turn the call over to Scott to take us through the rest of the financials. Scott?

Thank you very much, Joe, and good morning, everyone. We're excited to report another quarter of plant-based revenue and adjusted EBITDA growth. As Joe mentioned, third quarter revenues of $198.5 million were up 3.6% year over year, reflecting strong demand in plant-based, where revenues increased 16%, partially offset by a 9.7% decline in fruit-based revenues due to both the rationalization of marginally profitable SKUs and ongoing shortages of certain fruit varieties. Adjusted EBITDA increased 8.4 percent to 15.6 million. Gross profit was 23.4 million for the third quarter of 2021, a decrease of 3.5 million compared to the third quarter of 2020. And consolidated gross margin declined 220 basis points to 11.8 percent. In plant-based, segment-level gross margin decreased 1 million, or 360 basis points, to 16.3%. Lower plant utilization was the primary factor due to supply chain disruptions and labor shortages. This adversely affected plant efficiencies during the third quarter, worth 260 basis points. In addition, depreciation expense increased 100 basis points over last year similar to the second quarter. In fruit-based, segment-level gross profit declined 2.5 million or 210 basis points to 5.6%. The decline in fruit-based gross margin reflected higher commodity prices for most berries, higher production costs, and higher cost of fruit inventory due to a stronger Mexican peso versus the prior year. Pass-through pricing, rationalization of marginally profitable business, and productivity gains were mitigating factors in fruit-based during the quarter. As we have previously stated, we are confident we will pass on materially all of the fruit cost increases, but there is a time lag. Operating income was $3.9 million in the third quarter compared to $3.1 million in the year-earlier period. SG&A decreased $5.6 million, or 25.3%, to $16.5 million, primarily due to reductions in variable compensation and a headcount reduction in our fruit business, partially offset by transition and integration expenses related to the Dream and WestSoy acquisition. Loss from continuing operations attributable to common shareholders for the third quarter was $3.8 million, or $0.04 per diluted share, compared to a loss of $6.7 million, or $0.07 per diluted share, during the third quarter of 2020. Note that this quarter's loss is after giving effect to $2.8 million of expenses related to the transition and integration of the Dream and Westway acquisitions, business development costs, including our new plant-based beverage facility under construction in Midlothian, Texas, and costs related to the exit of our Southgate fruit processing facility. Loss from continuing operations also absorbed $2.9 million of income tax expense due to the lack of deductibility of certain expenses. On an adjusted basis, third quarter 2021 earnings were $1.1 million or one cent per diluted share versus an adjusted loss of $5.8 million or six cents per diluted share in the prior year period. Adjusted EBITDA was $15.6 million compared to $14.4 million in the prior year, an 8.4% increase. In addition to the $0.8 million improvement in segment operating income, depreciation and amortization was $1.3 million higher versus a year ago, reflecting our capacity expansion initiatives in plant-based. Partially offsetting these increases was a $2.2 million decrease in stock-based compensation expense. Finally, adjusted EBITDA included $1.6 million in add-backs for business development costs associated with the acquisition of Dream and WestSoy, as well as project costs for a new plant-based beverage facility being constructed in Texas. I'd like to remind listeners that adjusted EBITDA and adjusted earnings are non-GAAP measures, and a reconciliation of these measures to GAAP can be found toward the back of the press release issued earlier this morning. Turning to the balance sheet and cash flow, as of October 2, 2021, Total debt was $220 million, approximately 50% lower than a year ago, and up $14 million from the end of the second quarter. Total debt reflects $170 million drawn on our asset-based credit facility, with a balance representing smaller credit facilities, lease, and other financing arrangements. Leverage stood at 3.1 times at the end of the third quarter versus 5.3 times a year earlier. From a cash flow perspective, cash provided by operating activities during the third quarter of 2021 was 5.1 million compared to 8.7 million of cash provided by operating activities during the third quarter of 2020. The change in operating cash flow versus last year was primarily due to the year-over-year change in networking capital. Cash used in investing activities was 17.4 million compared with the $11.3 million in last year's third quarter, primarily reflecting investments in capacity expansion projects. I'd like to remind listeners that we expect to see our customary reduction in working capital and resulting cash flow benefit in Q4. Before we turn to the outlook, and given our investment in capital projects, I'd like to comment on our capital allocation priorities and perspectives on capital expenditure ROIs. As we have discussed previously, we prioritize our plant-based business from a capital allocation standpoint, while investments in fruit have been more modest and centered around cost reduction projects. In plant-based, to remind you, we have three projects in flight now, which are the expansion projects in Modesto, California, and Allentown, Pennsylvania, along with our greenfield plant in Midlothian, Texas. When we think about return profiles, it is important to understand that there are three broad categories of growth investments. One, building a specific capability, such as oat extraction. Two, general capacity expansions to an existing plant. And three, building a new plant. Looking across these investment types, taken in the aggregate, they provide somewhere between a three and four year payback period, which is attractive. Let me close by providing some commentary around the outlook for the fourth quarter, recognizing we are all operating in uncertain times with supply chain, labor, and ingredient challenges. Further, it is important to recall that Q4 2020 had an extra week, so we'll be talking about adjusted growth in light of last year's 53rd week. On the top line, we are assuming that we will continue to experience some disruptions, and as such, expect the total company to grow in the mid to high single digits versus Q4 2020, adjusted for the 53rd week. From a margin standpoint, we expect Q4 to show some sequential improvement. Finally, from an EBITDA standpoint, given the macro environment headwinds, Q4 will likely be similar to last year, recognizing Q4 2020 was a record quarter from continuing operations at 20.6 million. Before opening up the call for questions, just a reminder that for competitive reasons, we do not provide detailed commentary regarding customer or SKU-level activity. With that, I'd ask the operator to please open up the call to questions.