Sovos Brands, Inc. (NASDAQ:SOVO) Q1 2023 Earnings Call Transcript May 12, 2023

Operator: Greetings, and welcome to Sovos Brands’ First Quarter 2023 Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Josh Levine, VP, Investor Relations. Please go ahead.

Josh Levine: Good afternoon and thank you for joining us on Sovos Brands first quarter 2023 earnings conference call. On the call today are Todd Lachman, President and Chief Executive Officer; and Chris Hall, Chief Financial Officer. By now, everyone should have access to the earnings release for the period ended April 1, 2023, that went out this afternoon at approximately 4:00 p.m. Eastern Time. The press release as well as supplemental slides can be found on the company’s website at ir.sovosbrands.com and shortly after the conclusion of today’s call, a webcast will also be archived and available for replay. Before we begin, let me remind everyone that today’s discussion contains forward-looking statements based on the environment as we currently see it and as such does include risks and uncertainties.

If you refer to the company’s earnings release as well as its most recent SEC filings you will see a discussion of factors that could cause Sovos Brand’s actual results to differ materially from these forward-looking statements. Please remember the company undertakes no obligation to update or revise these forward-looking statements in the future. We will make a number of references to non-GAAP financial measures. We believe that these measures provide investors with useful perspective on the underlying growth trends of the business and have included in our earnings release a full reconciliation of non-GAAP financial measures to the most comparable GAAP measures. Please note that all consumption data cited on today’s call refers to dollar consumption on a total MULO basis as of the 13-week period ended April 2, 2023 and growth versus the prior year comparable period unless otherwise noted.

And lastly to avoid any confusion for discussions pertaining to first quarter results and full fiscal 2023 guidance and growth expectations, organic net sales growth is calculated as net sales growth adjusted for acquisitions, divestitures in the 53rd week in 2022. With that, I will now pass it to Todd.

Todd Lachman: Thanks, Josh. I will begin with a discussion of the exceptional performance we delivered this quarter and that we continue to expect in future quarters, before turning it over to Chris to provide greater detail on our results and updated 2023 outlook. When we spoke to you in our last earnings call we said that Q1 was off to a strong start building on the robust fourth quarter. Today’s results reflect sector-leading volume-driven net sales and profit growth with meaningful margin expansion as a result of excellent operational execution. We have generated a very strong momentum in the Rao’s mega brand, which we expect to continue through the second quarter and balance of the year. Given our robust Q1 results and the continued momentum in our business, we are raising our guidance for net sales and adjusted EBITDA.

Robust trends for the Rao’s brand continued in Q1. Rao’s grew net sales 38% surpassing $600 million on an LTM basis and for the first time ever achieved the number one dollar share in the food channel. The primary driver of this growth was the substantial gain in household penetration up 120 basis points versus Q4 for the total franchise and up nearly 100 basis points for SaaS. These gains represented the largest quarterly increase in household penetration in the last three years benefiting from robust distribution growth, which was up 22% for Sovos in the quarter as well as higher brand awareness that was driven by a substantial increase in marketing. Recall that awareness grew 10 full percentage points to 58% in 2022. As a result dollar consumption for the Rao’s franchise grew 26% in the quarter.

In SaaS, we grew dollar consumption 22% with units up 16% both well ahead of the category. We also delivered sustained growth in frozen entrees, soup and pasta with combined retail dollars up 46% in the quarter with each of these Rao’s businesses growing distribution, household penetration and dollars well ahead of their respective categories resulting in market share gains. As we show on slide 8 we have made considerable progress over the last few years developing these highly incremental businesses. With our non-sauce Rao’s branded products now accounting for nearly 20% of trailing 52-week measured retail sales. And our most recent non-safe launch into frozen pizza although still in the early stages is delivering in line with our expectations and we are excited about the retailer and consumer interest we have received thus far.

Importantly, we continue to see massive white space for the Rao’s franchise and Rao’s sauce in particular. While we did experience the largest quarterly household penetration gains in three years on Rao’s sauce our household penetration is still less than half the level of several competitors, unit share is below 7% and awareness of 58% is well below the greater than 90% levels for peers. And the brand remains highly underpenetrated and undershared in each of its non-sauce businesses. With many more at-home eating occasions today, than prior to COVID and traffic trends at restaurants remaining under pressure from cautious consumers. We see a long runway to provide many more consumers the opportunity to enjoy a restaurant-quality meal at home with their family.

Turning to noosa, the brand grew net sales 8% in the quarter, driven by strong performance in non-measured channels. Our core eight-ounce offering grew dollar consumption 9%, outperforming the category on a unit basis and benefiting from distribution and velocity. We continue to invest meaningfully in the brand, highlighting its taste leadership and strengthening our assortment to drive higher trial and consumption. And we’re building a pipeline of delicious innovation, most notably in course noosa yogurt to capitalize on the brand’s leadership and indulgence and appeal across all dayparts. Michael Angelo’s net sales were down 6% in the quarter with the launch of sauce, partially offsetting the proactive decision, to exit certain lower-margin frozen SKUs. We continue to drive growth in frozen with key grocery retail partners and are gaining distribution in new channels.

Our total frozen entrées business inclusive of Michael Angelo’s and Rao’s, grew net sales 10% in the quarter with consumption up 11%, which was ahead of the category. With healthy inventories, significantly better service and increased brand investments we are growing distribution and velocity in our Sovos Brands frozen business and remain confident there is a long runway ahead for growth. Broadly speaking, our increased investments in marketing, R&D, selling and supply chain, are driving robust sales and profit results for our company. In marketing and R&D, we increased our growth investments of combined 27% in the quarter following a high single-digit increase last year. For example, our new advertising campaign for Rao’s, called, The Deliciousness of Slow highlights key points of what makes Rao’s sauce, so unique, including high-quality fresh ingredients and the slow simmer open kettle cooking process that results in our thick, delicious, one-of-a-kind sauce.

We’re leveraging a roster of celebrity fans and influencers, who showcase the many ways they use Rao’s products in their kitchens to their millions of followers. In R&D, we’re leveraging our new Innovation Center of Excellence in Austin Texas to continue delivering delicious innovation and new products across the portfolio. In sales, we’re adding more resources and customer-facing roles, we’re strengthening our net revenue management capabilities and we’re investing in data to enable better decisions. And in our supply chain, our investments in talent and capabilities are really paying off. I want to commend the team, on their performance in the quarter helping to deliver over 200 basis points of gross margin expansion and 30% adjusted EBITDA growth.

Our inventories are healthy with service for sauce and yogurt consistently above target and service for Frozen is in a significantly better position than this time a year ago. In addition our team is doing an excellent job proactively managing our input costs and we are successfully delivering on a wide range of productivity initiatives within the four walls of our factories. We see our supply chain capabilities as an important enabler in sustaining our volume led growth. In summary we are very proud of our first quarter performance. We are executing well across the organization and investing in the business to drive continued household penetration gains. In fact with household penetration for Sovos brands now in excess of 25% over 1/4 of all households in the U.S. have a Sovos brands product in their kitchen.

And to reiterate given the strong momentum in our business we are raising our full year guidance. We will continue to invest in brand building talent and capabilities to support our sector-leading volume-led growth and we’ll take the right actions to support profitable growth for our business in the quarters and years ahead. Chris Hall will now discuss the details of our first quarter and our updated guidance for 2023.

Chris Hall: Thank you Todd and good afternoon everyone. First quarter total net sales $252.8 million a $42.9 million or 20.4% increase over the prior year period. On an organic basis growth of 26.7% was driven by 15.6% volume and 11.1% price. For the quarter Rao’s increased total net sales of 37.7%, exceeding our expectations with continued robust growth across all categories and channels. We are adding distribution and driving improved velocities across nearly all of our categories. Our soft business in particular led our growth with performance in market accelerating across the quarter as a result of the big distribution and household penetration gains Todd spoke about earlier. Noosa had a good quarter up 8.2% year-over-year with growth driven primarily by non-measured channels.

We also successfully implemented a list price increase in February which will provide a tailwind to the balance of the year. And Michael Angelo’s declined 5.6%, primarily as a result of exiting certain channel-specific lower-margin SKUs. Total frozen entrée including rates in Michael Angelo’s grew net sales 10.1%. Adjusted gross profit of $71.1 million increased $16.6 million or 30.4% year-over-year, driven primarily by double-digit growth from volume and pricing. Adjusted gross margins were 28.1% for the quarter, up 210 basis points versus the prior year period. Margin expansion was a result of pricing and productivity as well as favorable mix driven by higher soft growth. We also began to see favorability for certain key items in our raw material and packaging costs, as prices moderated more quickly than we had previously expected.

As Todd noted earlier, we are very pleased with the progress we’ve made in operations and supply chain following the successful implementation of automation projects, particularly in our frozen entrée plant, value engineering on our packaging, and other processing cost initiatives including greatly improved operating systems. Along with these projects we are confident that our pipeline has yet to be implemented initiatives such as optimizing our logistics network, enhancing partnerships with key suppliers, and leveraging our creased scale will help us take costs out improve our margins and free up capacity for further volume-led growth. Adjusted operating expenses of $38 million increased $8.4 million or 28.3% over the prior year period. This included a 26.9% increase in growth-oriented investments such as marketing and R&D as well as increased support for our talent and capabilities.

Adjusted EBITDA of $36 million increased $8.3 million or 30.2% year-over-year. Adjusted EBITDA margins were 14.2%, up 100 basis points versus the prior year period. Net income for the quarter was $7.8 million or $0.08 per diluted share compared to net income of $4.1 million or $0.04 per diluted share in the prior year period. Adjusted net income was $18.1 million and adjusted EPS was $0.18 per diluted share compared to adjusted net income of $13.8 million or $0.14 per diluted share in Q1 2022. At the end of the first quarter, cash and cash equivalents were $153.6 million and total debt was $482.7 million. Our net leverage finished the quarter at 2.6 times trailing 12-month adjusted EBITDA compared to nearly four times post-IPO, which was just 18 months ago.

We continue to believe that a strong cash position gives us a lot of flexibility to invest in our business. Turning to our 2023 outlook. We are increasing our guidance for net sales and adjusted EBITDA. This primarily reflects our expectation for stronger performance from Rao’s than we previously assumed given the robust Q1 performance and our increased visibility to the balance of the year. For net sales, we are now guiding to a range of $935 million to $955 million, which implies full year organic net sales growth of 14% to 17%. We expect volume to continue to be the primary driver of growth led by higher household penetration as a result of Rao’s distribution gains and continued velocity performance. We also continue to expect that elasticities will normalize albeit at a slower pace than we previously anticipated.

For adjusted EBITDA, we are now guiding to a range of $136 million to $141 million or 13% to 18% growth. The increase to our guidance largely reflects the flow-through from higher expected net sales. We continue to expect moderate gross margin expansion for the full year with the benefit of pricing and productivity fully offsetting mid single-digit inflation. We remain committed to investing to support our long-term growth plan and our updated outlook incorporates high-teen growth for combined marketing and R&D as we seek to capitalize on the massive white space opportunity ahead of us. From a phasing perspective, we continue to expect volume led double-digit organic net sales growth in both halves of the year with growth in the remaining quarters expected to be consistently in the low double-digit to mid-teens range.

We expect Q1 gross margin to be the lowest of the year with an improved level over the balance of 2023 as we move out of the heaviest promotional quarter for this year. For adjusted EBITDA, we continue to assume growth and margin expansion will be stronger in the first half. And finally, given the strong Q1 performance, we now expect the first half to account for a slightly higher percentage of full year adjusted EBITDA than we previously assumed. For a summary of these and other annual guidance items, please see Slide 14 in our earnings slide deck posted on our Investor Relations website. I will now hand it back to Todd for some final remarks.

Todd Lachman: Thanks, Chris. We are excited by how the year has begun. We have a tenacious highly talented and energetic team that is executing well. The Rao’s brand is firing on all cylinders adding households through distribution and awareness gains and rapidly progressing on its path to $1 billion of annual net sales and beyond. And with strong operational performance, we are expanding our margins and driving bottom line growth helping to maximize shareholder value. With that, Chris and I are now available to take your questions. Operator?

Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Ken Goldman with JPMorgan. Please go ahead.

Operator: Next question comes from Peter Galbo with Bank of America. Please go ahead.

Operator: Next question comes from Jon Anderson with Librium Blair. Please go ahead.

Operator: Next question comes from Matt Smith with Stifel. Please go ahead.

Operator: Next question comes from Cody Ross with UBS.

Operator: [Operator Instructions] Next question comes from Michael Lavery with Piper Sandler. Please go ahead.

Operator: There are no further questions at this time. I would like to turn the floor back over to Todd Lachman, for closing comments.

Todd Lachman: Awesome. So thanks again, for joining us and showing, an interest in our story. We look forward to engaging with many of you in the coming weeks. Please feel to reach out to Josh, for follow-up discussions. Until then, have a great evening and take care.

Operator: This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation and have a great day.