Yahoo Finance SunOpta Inc. (NASDAQ:STKL) Q3 2023 Earnings Call Transcript
SunOpta Inc. (NASDAQ:STKL) Q3 2023 Earnings Call Transcript November 8, 2023
Operator: Greetings, and welcome to SunOpta's Third Quarter 2023 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 call is being recorded. I would now like to turn the conference over to your host and that is Reed Anderson with ICR. Thank you. And you may begin.
Reed Anderson: Good afternoon, and thank you for joining us on SunOpta's third quarter fiscal 2023 earnings conference call. On the call today are Joe Ennen, 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 on SunOpta's website at www.sunopta.com. This call is being webcast, and this transcription will also be available on the company's website. As a reminder, please note that the prepared remarks which will follow contain forward-looking statements, and management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance, and therefore, undue reliance should not be placed upon them.
We refer you to all 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 detailed discussion of the factors that could cause actual results to differ materially from those projections in 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 with the company's press release issued earlier today.
Given the divestiture of a frozen fruit business in the third quarter of 2023, the company has changed reporting structures and is now reporting as a single operating segment. Also, please note in the prepared remarks that follow, unless otherwise stated, the company will be referring to the continuing operations portion of the business and all figures are in U.S. dollars occasionally rounded to the nearest million. I'd like to now turn the call over to Joe.
Joseph Ennen: Good afternoon and thank you for joining us today. First, let me say welcome to the new SunOpta. With the divestiture of the frozen fruit business, we have completed the heavy lifting around our portfolio transformation that began in 2020 with the divestiture of our global ingredients business, the Sunflower business in 2022, and finally, frozen fruit last month. Over the last several years, we've been very focused on aggressively investing in our plant-based and snacks businesses. And the results of these investments are now more obvious. The new SunOpta [ph] is a focused, high growth, competitively-advantaged business operating in very attractive categories. Let me give you a few facts about the new SunOpta. On a pro forma basis, factoring in our Q4 outlook, in the last 36 months, the new SunOpta has grown revenue approximately 40% and EBITDA has grown 45%.
Over this time, our EBITDA margins have consistently been in the 10% to 12% range. We have achieved this impressive growth in revenue and EBITDA in a highly efficient manner, with SG&A only up 5% in those 36 months, and SG&A has declined as a percentage of revenue every year for the last three years. Additionally, going forward, the divestiture has reduced the working capital needs of the business by over $100 million. The capital investments we made in 2021 and 2022 have been fueling this revenue and EBITDA growth, and we are excited about the future growth prospects for the new SunOpta as we further optimize the investments we have made. It is worth noting that Texas was half the investment quantum and has not yet contributed to EBITDA, thereby supporting continued EBITDA growth as Texas pivots from startup mode to delivering cash flow.
I will now share our strategic priorities going forward. First, operational excellence. We are focused on sweating our assets to gain maximum value from the investments we have made to fuel growth organically. We believe there is significant opportunity to do this over the next several years. Second, capital allocation. We have come out of a large investment cycle and we are focused on demonstrating and creating strong returns for shareholders. And third, growth. We are a growth company and our focus is on share gains with existing customers, adding new customers and TAM expansion. Now let me offer some key takeaways on the Q3 results. We have solid volume growth. We have 5.5% volume growth in Q3 and importantly, Q4 is looking even stronger as momentum builds.
Our growth was fueled by three things. Share gains with existing customers, new customers and TAM expansion. Fruit snacks had another strong quarter of volume field growth. And with our capacity expansion that came online at the end of Q3, we expect continued strong growth. Adjusted EBITDA increased 8% to $19 million as volume flowed through to EBITDA. At this point, all 2023 new business customers are in production and will positively impact growth in Q4 and 2024. Additionally, we have a strong pipeline of new business opportunities for the second half of '24 that we are aggressively working to close. We are reaffirming 2023 guidance, adjusting for the sale of frozen fruit, and projecting high single to double-digit volume and revenue growth in 2024.
In terms of details around the Q3 results. In beverages and broth, which is all of our packaged plant-based milks, teas, broths, and protein drinks, revenue increased 9% to $123 million. This product group represents 80% of our Q3 revenue. The 9% revenue growth came from a 6% increase in volume, resulting from share gains with existing customers, new customers, and TAM expansion. We saw growth in oat milk, creamers, teas, and of course protein shakes. Our fruit snacks business continued to deliver very strong growth, with revenues up 16% to $24 million, driven completely by increases in volume and led by private label growth. Q3 marks the 13th consecutive quarter of double-digit growth for our fruit snacks business. For the total company from a go-to-market standpoint, we saw very balanced growth with positive gains in co-manufacturing, gains in private label and the fastest growing part of the business continues to be our own brands.
The only go-to-market approach that was down was outside ingredients sales, resulting from the strategic shift we outlined in Q1 to prioritize internal use of oat base versus selling it externally as an ingredient. Here are a few comments on category performance for some of our major categories. From a category performance standpoint, we see a similar dynamic across plant-based milks, snacks, and broth which is track channel performance being flatter down in volume and non-track channels performing strongly. Since there have been a lot of questions about plant-based milk category performance, we have made an internal estimate of total category performance based on all the channels, and our aggregated estimate is that the total shelf-stable plant-based milk category is up low-single-digits in Q3, driven by foodservice and untracked club stores, despite track channel category volume being down.
It may be surprising to know that we estimate that the foodservice coffee shop channel consumes 3x to 4x as much shelf-stable plant-based milk as all of track channel retailers combined. One track channel bright spot last quarter was health and performance beverages, aka protein shakes. This category was up 18% in units, with performance nutrition up 38%. Our major capacity expansion projects continue to show steady progress, and we are tracking largely as expected. The new capacity at our snacks production facility in Omak, Washington, came online in the third quarter as planned. Once fully ramped, this expansion will create a 40% increase in our total fruit snacks capacity. Production continues to ramp at our Midlothian, Texas facility with output on the first two lines approximately 60% of the way to ideal state.
Texas production continues to meet customer expectations, and we feel good about the demand environment for utilizing the Texas capacity. The two lines we commissioned this year are now shifting to running $24.5 million and $24.7 million respectively, and the third line will come online in Q1. The focus continues to be on improving output and efficiency of these new lines to fully realize the volume potential in 2024 and 2025. Lastly, as we referenced on the Q1 2022 call, we have now completed construction of a new oat extraction capability in Modesto, and we will begin commissioning and production in the first of 2024. With the divestiture of our frozen fruit business, we are at an inflection point and think it is a good time to outline in more detail our capital allocation priorities.
Historically, our approach and target metrics were heavily influenced by the capital needs of our different lines of business, which did not allow for much flexibility. That changes with the divestiture of frozen fruit. Our working capital needs are significantly reduced. This fact, combined with anticipated growth and lower internal investment needs over the medium term will result an increased free cash flow, thereby giving us more optionality for returning value to shareholders. Greg will cover this in more detail in his section, but it is a very important point and truly an inflection for SunOpta that we feel is underappreciated today. Given the new more focused portfolio, let me share a preliminary view of our outlook for 2024. In 2024, we will see steady, strong growth across the year with both volume and revenue growth in the high single-digit to double-digit range, specifically 8% to 13% volume and revenue growth.
EBITDA will grow faster than revenue with adjusted EBITDA growth expected to be in the 14% to 21% range. This is our core business forecast, and in addition to this, we have a very strong pipeline of new business development opportunities for the second half of 2024, which we will be able to update during the Q4 call. I will end by commenting on previously communicated forecasts. We have previously communicated a midterm target of $150 million of adjusted EBITDA. This number would have included approximately $25 million for frozen fruit, as you can infer from the bridges presented in both 2022 and earlier this year. The $125 million for plant-based plus snacks represented full utilization of the network, and this number is still valid. As to when we see the network being fully utilized again, that is something that is informed by new business, but likely by 2025 or 2026.
In summary, we continue to execute well against our strategic priorities and are well positioned to deliver significant growth and improved profitability as we leverage our flexible model and expanding capacity to fuel the future of food. In a moment, I'll turn the call over to Greg Gaba, who was appointed CFO in mid-October. Many of you know Greg and have interacted with him previously in his prior capacity as Deputy CFO. Greg has been with SunOpta for over six years and has consistently provided critical financial insights and played a pivotal role in achieving our business goals. He has a strong background and extensive knowledge of our business and I'm thrilled to have him lead our finance organization. Greg?
Greg Gaba: Thank you very much, Joe, and good afternoon everyone. It's a privilege to speak with you today. I'm excited about my new role and look forward to regular dialog with all of you in the future. Before discussing the quarterly results, let me start with the divestiture of our frozen fruit business on October 12th. Frozen fruit at the health for sale criteria and together with sunflower qualifies for reporting as discontinued operations beginning in the third quarter of 2023. As a result, the assets and liabilities of the frozen fruit disposal group have been reclassified and reported as held for sale on the balance sheet. The estimated aggregate purchase price of $141 million comprised cash consideration of $95 million.
A short-term note receivable of $10.5 million, secured seller promissory notes due in three years with a stated principal amount of $20 million in the aggregate, and the assumption by the purchasers of $16 million of accounts payable and accrued liabilities of frozen fruit. At the closing date, $21 million of the cash consideration was used to make required repayments of certain bank loans in other liabilities of frozen fruit not assumed by the purchasers. We utilized the remaining cash consideration of $75 million to repay a portion of the outstanding borrowings under our revolving credit facilities. Note that unless stated otherwise, my commentary regarding our third quarter performance will be in regard to results from continuing operations.
Third quarter revenues of $153 million were up 6% versus last year, driven mostly by a volume growth of 5.5%. Adjusted gross profit for moving startup costs was $25 million, or 16.4% of revenue, which includes 150 basis points impact of incremental depreciation from new production equipment. Adjusted earnings from continuing operations was $500,000 compared to $2.4 million in the prior year period. Adjusted EBITDA from continuing operations increased 8% to $19 million and was up 25 basis points as a percentage of consolidated revenue to 12.5%. Turning to the balance sheet and cash flow, at the end of Q3, debt was $315 million. Adjusting for the $75 million of immediate paydown of debt related to the divestiture of frozen fruit, debt is $240 million and corresponding leverage is 3.2x.
Cash used in our operating activities of continuing operations during the third quarter was $26 million, reflecting the impact of startup costs related to our Midlothian, Texas facility, higher cash interest expense, together with increases in working capital. Cash used in investing activities for continuing operations was $5 million, reflecting the wind down of CapEx associated with Midlothian. As Joe commented earlier, the divestiture of our frozen fruit business had a significant positive impact on our balance sheet with a paydown of debt and with a significant reduction to our working capital levels going from approximately 20% of annual revenue to half that amount at around 10%. Given the significant working capital reduction, our current ABL arrangement, which was supplemented with third-party extended payable facilities and finance leases, is suboptimal for our new operating company.
We are moving to a term loan and revolve structure with limited finance leases. We have great banking partners who have been very supportive and we anticipate completing the refinancing with a five year maturity by the end of the year. Over the next several years, we expect this refinancing to lower our cost of capital and provide greater flexibility around capital allocation. In recent years, our focus has been on internal investment opportunities to add new capabilities and capacity. As a reminder, we've invested $230 million, since 2020 to expand and improve existing facilities along with building our new Greenfield plant in Texas. These investments will continue to deliver significant growth in revenues, profits, and cash flow over the next several years simply by monetizing this incremental capacity as we have been doing since 2021.
As a result of this investment cycle, our CapEx needs will decrease significantly in the medium term, which will generate meaningful free cash flow. In 2024, we expect to generate free cash flow in the range of $35 million to $45 million. Given our expected soon to be significant cash flow, I feel it is an appropriate time to outline our capital allocation priorities. The first use of cash will be to further pay down debt until we are under 3x levered. Given current interest rates being sub 3x levered is our leverage goal. We expect to be there in the second half of 2024 as that will increase slightly in the first half of the year, resulting from the Modesto Extraction Project, Joe referenced coming online and the payment of other current liabilities.
Once we are under 3x levered, our priority is to use free cash flow to buy back shares, assuming the stock price is still undervalued. We have had preliminary discussions with our board and they are aligned. It is management's intention to formally propose a share buyback at our year-end Board meeting. While we believe there are many attractive organic investment options, none compare to the values SunOpta represents. As we believe our stock is significantly undervalued and trading at a material discount to other similarly positioned companies. While the specific quantum and boundaries of a buyback are yet to be agreed, we would expect to be roughly equivalent to one year's cash flow. After these priorities, we will either fund organic growth through attractive ROI projects or acquisition.
Let me close with comments on our outlook. From a guidance standpoint, we are maintaining our 2023 estimates that were provided on our previous call, adjusting for the sale of the frozen fruit business. The midpoint of the guidance for continuing operations would result in high single-digit revenue growth and single-digit adjusted EBITDA growth in the fourth quarter. For 2024, we expect revenue in the range of $670 million to $700 million, which represents growth of 8% to 13% from the midpoint of the range of our 2023 outlook. From a profit perspective, we expect adjusted EBITDA of $87 million to $92 million, which represents growth of 14% to 21% from the midpoint of the 2023 range. From a pacing standpoint, as you would expect, we see the back half of the year to be somewhat stronger than the first half.
From a balance sheet and cash flow standpoint, we continue to expect capital expenditures on a cash flow statement of approximately $45 million in 2023 and approximately $25 million to $30 million in 2024. 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 the call for questions.
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