SunOpta, Inc.

Good morning, and welcome to SunOpta's fourth quarter fiscal and full fiscal year 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 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 all to risk, all risk factors contained in SunOpto's press release issued this morning. the company's annual report filed from Form 10-K, and other filings with the Securities and Exchange Commission for more detailed discussion 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 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 in 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 occasionally rounded to the nearest million. And now, I'd like to turn the conference call over to SunOpta CEO, John Ennin. John Ennin.

Good morning, and thank you for joining us today. With me on the call is Scott Huckins, our Chief Financial Officer. I want to start by saying, while we are disappointed in the fourth quarter results, we are confident these results are a point in time and do not reflect the current or future earnings potential of the company. The causes are clear and are not unique to Synopta. The supply chain issues and labor market shortages are broadly felt and well publicized. Now let me share some key takeaways from the fourth quarter. First, Q4 consolidated gross margin was impacted by three headwinds. The most significant was higher costs in our plants without a corresponding increase in output. We were also impacted to a lesser extent by unrecovered inflation and yield-related issues in fruit. Let me share a bit more perspective on the Q4 challenges in our production facilities and provide an update on progress in Q1. First, 70% of the decline in plant-based gross margin was due to increased plant expense and lower utilization. Higher expenses were driven by hiring and training approximately 90 new employees, fueled by the great resignation over the summer. However, this infusion of new employees did not immediately produce a step change in production output, partially as a result of significant Omicron-related absences across the network. Additionally, our plant-based facilities are sophisticated and complex plants, and employees require weeks and even months of training to become proficient. Additionally, we incurred costs to improve overall equipment effectiveness, which disproportionately hit us in Q4. In total, these Q4 investments are paying dividends in Q1. We have staffed our plants and ended the year up 73 employees. We are deep into training our new employees, and retention of these new hires is consistent with our expectations. We have seen material improvement in our manufacturing output in the first seven weeks of Q1. We are currently forecasting Q1 production to be approximately 15% above Q4 levels and are tracking to this level of improvement halfway through the quarter. Beyond labor, let me comment on what is happening in the macro environment, which you are all very familiar with as these factors are impacting nearly every CPG company. Raw material availability in Q4 was tight, but we saw sequential improvement. There were a couple exceptions in the fastest-growing segments of our business, one being fruit purees from South America for our fruit snacks business and oats for our plant-based business. We still grew our oat business 120% in Q4, but we could have grown even more, and the same goes for our fruit snacks business. In an effort to support growth, we have added incremental suppliers, have improved safety stock on both ingredients, and we are working to secure additional volume for anticipated growth in 2022. As it relates to raw material inflation, all the currently known raw material cost inflation has been presented to customers, accepted, and implemented. There is always a delay between cost increases and price increases. It is typically a 90-day process from realized cost inflation to the new price being on an invoice to the customer. Lastly, let me comment on freight. The back half of Q4 saw even more inflation than the run rate, and this impacted Q4 by approximately $2 million. Additionally, the availability of trucks was very tight. In our plant-based business unit, almost every customer, and remember, these are some of the biggest CPG companies in the world, had difficulty lining up trucks to pick up their product, which impacted our revenue. In fruit, where we are generally responsible for the freight, we also saw availability issues and cost inflation. Pricing, reflecting the new freight costs, would be fully passed on to customers by the end of Q1. The revenue impact of the production shortfalls and transportation availability challenges was estimated to be at least $10 million in the quarter. While Q4 was a challenging quarter, it is important to recognize the long-term core earnings power of the plant-based business remains strong. Industry supply is still very tight, demand is very strong, and our manufacturing network remains strategic and will further improve with the new Texas plants. Despite our temporary production challenges, we continue to win in the fastest-growing segment of the market, which is oat. We are aggressively adding capacity, and we are aggressively passing on inflation through price increases. All of this leads me to the view that the future of the company has never been brighter. In 2022, we expect strong top-line growth with plant-based growing double digits. and we expect the fruit business to return to growth largely via pricing, as we have consistently stated during 2021. At a total company level, we expect at least double-digit revenue and adjusted EBITDA growth in 2022. Our plant-based capacity expansion, takeability additions such as 330 ml, and new business development efforts in plant-based indicate adjusted EBITDA will increase significantly in 2023 and 2024 as our new Texas plant comes online. Based on our success to date pre-selling Texas capacity, we have line of sight to $100 million of adjusted EBITDA in 2023. Now let me share some of the top line results for the total company. Total company revenues, as reported in Q4, were nearly flat the prior year. Adjusted for the extra week in the year earlier period, our top line growth would have been 2.5% in the fourth quarter of 2021. Full-year revenue was $813 million, with full-year plant-based revenue growing 13% on an as-reported basis, or 14% excluding last year's 53rd week. Gross profit declined 650 basis points on a consolidated basis during the fourth quarter, with both plant-based and fruit-based segments down materially. For the full year, gross profit was $98 million, down 10% versus prior year. We managed SG&A aggressively to offset a portion of the corresponding decline in gross profit, but the net result was still a 48% decline in adjusted EBITDA in the fourth quarter to $11 million. Full-year adjusted EBITDA was $61 million, growing 3.4% versus 2020, with three times 2019's adjusted EBITDA. Now we'll turn to our segments, starting with plant-based. I would like to remind listeners that we have three strategic priorities in plant-based. One, strengthening and fortifying our competitive advantages. Two, building a strong ingredient business focused on oat to drive growth in refrigerated beverages. And third, building a multi-pronged go-to-market business that includes co-manufacturing, private label, and owned brands. Plant-based revenues, adjusted for the extra week last year, increased 9.2% versus prior year to $125 million in the fourth quarter, another record for Sinopta. This represents our 13th consecutive quarter of revenue growth, and this was up 18% versus two years ago. Plant-based beverages were the primary driver, reflecting strong demand for oat-based offerings, which increased over 120% versus prior year period. Oat now accounts for 22% of our plant-based milk portfolio, up from 10% a year ago. We also saw strong gains in tea stemming from growth at our two biggest tea customers. Production capacity challenges negatively impacted our broad business and partially offset growth in other plant-based beverages. However, as I mentioned, we have seen a solid improvement in output so far this year. As it relates to product categories, we continue to focus on oat. Our oat sales were 80 million in 2021, and we expect continued strong acceleration of this business. Plant-based milks continue to see solid overall category growth, with the latest 13 weeks showing 5% growth, and oat continues to be the driver with 55% growth. In 2022, we expect to continue to see strong oat segment growth. The national brands we support continue to lead the market and grow faster than the oat segment in total, which in part explains why Sonopta grew two times the rate of the oat category. In addition, we see significant upside in oat at our largest customer for 2022. Based on all of these exciting developments, we expect to continue to have strong double-digit growth in oat milk sales in 2022. In addition, as previously communicated, we are expanding oat extraction production to keep pace with demand. This added capacity will likely come online at the end of Q2 2023. From a go-to-market standpoint, the brands we acquired in 2021, Dream and West Soy, contributed to growth. We will be relaunching these brands in Q2, Q3 with new packaging, new products, and a push to rebuild distribution that had been lost over the last several years. Several of the people on this call have seen Dream Oat Milk at Starbucks, so I thought it would be worth confirming the go-forward approach with oat milk at Starbucks is via the Dream brand. We also launched a brand, the organic oat coffee creamer last year called Sunn. Our focus has been the natural channel, and we are seeing great success with this effort. As the leading natural channel retailer, Zone is now the number two brand in terms of sales velocity for the plant-based creamers after less than 15 months in market. Moving on to our fruit-based segment, our three strategic priorities are, one, de-risking the business through geographic diversification, customer pricing programs, and better grower relations. Two, becoming the low-cost operator in frozen fruit through automation, footprint reengineering, and aggressive cost takeouts. And three, evolving the portfolio via innovation towards more value-added offerings. Fruit-based revenue decreased 9.4% to $79 million in the fourth quarter, reflecting ongoing efforts to rationalize cues in customers, along with the impact of supply constraints in certain fruit varieties, partially offset by pass-through pricing actions. Fruit snacks had another strong quarter, with growth accelerating to 23.5%. As we communicated all last year, we expect a sharp return to revenue growth in 2022 on the frozen fruit side of the business, fueled by aggressive pricing moves and confirmed distribution gains beginning in mid-Q2 at our largest frozen fruit customer. As it relates to de-risking the business through geographic diversification, we are largely complete on this strategic initiative with Mexico now representing the largest source of fruit. More geographies, more fruit types, fewer customers for less complexity, all equal less risk. As we discussed last quarter, all pricing and support of the higher cost fruit has been passed on and reflects the strength of our customer relationships and our expertise in the industry. With regard to becoming the low-cost producer, the automation we have installed, combined with the simpler business and the cost advantages we have in Mexico, along with the 2021 cost takeouts, point to improved performance in 2022. I'll recap the totality of the actions taken in fruit in 2021 to give you a sense of the breadth and depth of work completed. First, we passed on about $40 million of pricing. Second, we took out an additional 10 million of manufacturing costs, including the closure of two of our six plants in the network in 2021. Third, we took out several million dollars of people costs, creating a leaner, simpler business model. Please note that a significant amount of pricing actions will be absorbed by higher fruit costs and other forms of inflation. So these numbers are not designed to simply be added to 2021 profitability. Instead, I share these numbers to give you a sense of what we have undertaken to transform the results in this business. Lastly, on the innovation front in fruit, we've had great success in the launch of our Smoothie Bowls platform, which is part of our fruit snacks business unit. We have partnered with three major retailers who are launching product brand versions of Smoothie Bowls and a CPG leader in frozen foods who will be launching our Smoothie Bowls under one of their globally recognized brands. Lastly, we will continue to use our own brand, Sunrise Growers, to lead the innovation and push the edges of what we can develop. While fruit has certainly been a challenging business for SunOcto over the last five years, the transformation of the business against our three priorities gives me hope that 2022 will be the year where you are hearing about positive surprises on fruit. Let me end by updating on the progress we are making in Texas with our new Greenfield plant-based manufacturing facility. If you want to follow our progress, please follow us on LinkedIn where we share periodic updates. We posted an updated photo on Tuesday so you can see the scale of the plant and the tremendous progress we are making. As I shared on the last call, one of the capabilities we are putting in Texas is 330 milliliter production equipment. For those not familiar with the term 330 M.O., this is the Tetra Pak carton most associated with on-the-go protein shakes. This is a $3 billion segment and is an industry that is short in capacity, and we currently have a zero share of this market. Based on preliminary awards to date, we are confident we will sell out the capacity on this asset in the first year. In addition to 330ML, we are putting in three other capabilities all in phase one. We are installing T-extraction, which has seen huge growth in the last two years, along with two processing packaging lines to support our core business. We are similarly confident that we will have strong utilization of this T-extraction capability and one of the two processing and packaging lines in year one. Progress selling the incremental capacity created by this plant is ahead of our internal expectations, and the project is on track to be operational by the end of the year, generating saleable product no later than 12-31-2022. In summary, our strategic growth priorities around portfolio transformation, innovation, and doubling the plant-based business have not changed. We continue emphasizing growth in our plant-based business and improving profitability in fruit-based. We remain committed to our long-term growth algorithm of annual double-digit plant-based revenue and profit increases and continue to focus on improving return on invested capital. 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. Fourth quarter revenues of $204.2 million were down basis, reflecting continued demand growth in plant-based, where revenues increased 5.8%, offset by a 9.4% decline in fruit-based revenues due to planned skew rationalization, along with constraints in certain fruit varieties. Adjusting for the 53rd week in 2020's fourth quarter, revenue grew 2.5%, with plant-based delivering 9.2% growth. Gross profit was $18.4 million for the fourth quarter of 2021, a decrease of $13.4 million compared to the fourth quarter of 2020, and consolidated gross margin declined at 650 basis points to 9%. The factors that negatively impacted consolidated gross margin during the fourth quarter were, one, plant operations, including higher plant spend and lower than planned production and lost absorption of 340 basis points. Two, yield-related issues on raw materials of 210 basis points. And three, net unrecovered inflation of 100 basis points. In plant-based, segment-level gross profit decreased 8.4 million, and gross margin was down 770 basis points to 11.7%. Let me take you through the major drivers. First, plant spend was up 380 basis points as we hired and trained the 90 positions Joe spoke about earlier. Second, unrecovered inflation was 160 basis points, primarily comprised of freight. And third, underutilization of our plants was 140 basis points. Let me provide further detail on the 380 basis point plant spend drivers. This is comprised of 150 basis points of labor costs, 130 basis points of overhead, and 100 basis points of depreciation. We expect to recover roughly 40% of the margin rate decline in Q1 and expect the business to return to a high team's margin rate on existing capacity in the second half of the year. In fruit-based, segment-level gross profit declined to $5 million and gross margin decreased 530 basis points to 4.8%. The decline in fruit-based gross margin reflected poor raw material yields as a result of excess spoilage of 350 basis points, with plant variances representing, on a net basis, the remaining 180 basis points. The yield issues became known as we pulled work in process to produce finished goods. The vast majority of these costs are now behind us. Segment operating loss was $1.6 million in the fourth quarter compared to operating income of $6.8 million in the year-earlier period, reflecting lower gross profit, a $3.4 million adverse foreign exchange result, and $0.5 million of incremental amortization expense related to Dream and Westside. These factors were partially offset by a reduction in SG&A expense, which was down 8.8 million versus a year ago, largely due to lower variable compensation. Loss from continuing operations attributable to common shareholders for the fourth quarter was 2.6 million, or two cents per diluted share, compared to a loss of 37.2 million, or 41 cents per diluted share, during the fourth quarter of 2020. On an adjusted basis, fourth quarter 2021 loss was $1 million or $0.01 per diluted share versus an adjusted loss of $2.5 million or $0.03 per diluted share in the prior year period. In the fourth quarter, adjusted EBITDA was $10.7 million compared to $20.6 million in the prior year. In addition to the $8.4 million decline in segment operating income, Depreciation and amortization increased $1.4 million versus a year ago, reflecting our capacity expansion initiatives and plant-based. Partially offsetting this increase was a $4.7 million reduction in stock-based compensation expense. Finally, adjusted EBITDA included a net increase of $1.8 million in EBITDA adjustments related to business development and startup costs. 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 January 1, 2022, total debt was $225 million and reflects $165 million drawn on our asset-based credit facility, 53 million of capital leases with a balance representing smaller credit facilities. Leverage stood at 3.7 times at the end of the fourth quarter. From a cash flow perspective, cash provided by operating activities during the fourth quarter of 2021 was 19.7 million compared to 19.8 million of cash provided by operating activities during the fourth quarter of 2020. Cash used in investing activities was $23.3 million compared with $11.2 million in last year's fourth quarter, primarily reflecting investments in capacity expansion projects. Let me close by providing our outlook for 2022, recognizing the environment is very fluid as it relates to inflation, supply chain, labor, and raw materials. On the top line, we expect revenue in the range of 890 to 930 million, which translates into growth rates of approximately 10% to over 14% compared with 2021. Revenue growth will be led by plant-based, but we do expect fruit to return to growth in 2022 as we have been communicating. We generally expect the first half of 2022 to be more challenging than the second half of the year. As such, we would expect margins to be stronger in the second half of the year than the first on our existing capacity. I'd also like to offer commentary around the new plant-based facility in Midlothian, Texas, and how this is likely to affect 2022 gross margin. As we have previously stated, we expect commercial production to start at the very end of the year. In order to be ready for year-end production, we expect to incur approximately $10 million of startup costs, primarily in the second half of the year, roughly evenly distributed between Q3 and Q4. While these startup costs are added back to adjust the EBITDA, they will affect gross profit and gross margin rate as reported. From a profitability standpoint, we expect adjusted EBITDA in the 67 to 75 million range for 2022. This represents 10 to 25% growth over 2021. From a capital standpoint, we expect capital expenditures to be in the 110 to 115 million range, as reported on the cash flow statement, driven primarily by the new Greenfield plant in Texas. As we have previously communicated, these expenditures are largely financed through the company's credit and lease facilities. We have no reason to believe that we have the need for equity capital to support these investments. Finally, while we are a ways away from 2023, we are currently forecasting adjusted EBITDA of $100 million, benefiting from the capacity expansion projects we have across the network. Two final items to mention. First, we are planning to host an investor day during the second quarter, likely in the May-June timeframe. We intend for this to be both an in-person event and a webcast available to all investors. This event will be held at our new headquarters and innovation center in Eden Prairie, Minnesota, where we can showcase our full range of products and our pilot plan, provide a deeper understanding of our business, introduce you to the broader management team and map out the financial impacts of the significant progress we've made over the last two years, increasing our capacity and capabilities as a plant-based milks manufacturer. More details will be provided as we get closer to this event, and we hope you can join us. The second item is really housekeeping. Beginning with the first quarter of fiscal 2022, we intend to move our earnings release time to after market close based on feedback we've received from several of you. Before opening the call for questions, just a reminder that for competitive reasons, we do not provide detailed commentary regarding customer or SKU level activity. And with that, operator, please open up the call for questions.

At this time, I would like to remind everyone in order to ask a question, press star and then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Brian Holland. Your line is open.