Sow Good Inc. (PNK:SOWG) Q3 2024 Earnings Call Transcript

Sow Good Inc. (PNK:SOWG) Q3 2024 Earnings Call Transcript November 14, 2024

Operator: Good morning, everyone, and thank you for participating in today’s conference call to discuss Sow Good’s Financial Results for the Third Quarter Ended September 30, 2024. Joining us today are Sow Good’s Co-Founder and CEO, Claudia Goldfarb; and Interim Chief Financial Officer, Brendon Fischer. Following their remarks, we will open the call for analyst questions. Before we go further, I would like to turn the call over to Mr. Slach as he reads the company’s safe harbor statement within the meaning of the Private Securities Litigation Reform Act of 1995 that provides important cautions regarding forward-looking statements. Cody, please go ahead.

Cody Slach: Good morning, everyone, and thank you for joining us in today’s conference call to discuss Sow Good’s financial results for the third quarter ended September 30, 2024. Certain statements made during this call are forward-looking statements, including those concerning our financial outlook, our competitive landscape, market opportunities and the impact of the global economic environment on our business. These statements are based on currently available information and assumptions, and we undertake no duty to update this information except as required by law. These statements are also subject to a number of risks and uncertainties including those highlighted in today’s earnings release and our filings with the SEC.

Additional information concerning these statements and the risks and uncertainties associated with them is highlighted in today’s earnings release and in our filings with the SEC. Copies are available on the SEC’s website or on our Investor Relations website. Furthermore, we will discuss adjusted EBITDA, a non-GAAP financial measure on today’s call. A reconciliation of adjusted EBITDA to net income or loss, the nearest comparable non-GAAP financial measure discussed on today’s call is available in our earnings press release at our Investor Relations website. With that, I will turn the call over to Claudia.

Claudia Goldfarb: Thank you, Cody, and good morning, everyone. We appreciate you joining us today. In the first nine months ending September 30, 2024, we achieved $30.6 million in revenue, a substantial increase from $6.5 million in the same period last year. This growth is a testament to our bold approach in bringing innovative and differentiated products to a previously stagnant category, pioneering the new segment in an industry dominated by some of the world’s biggest CPG companies is no small feat, and it comes with significant risks and challenges. It’s not for the faint of heart with few undertaking such an endeavor, often deterred by the complexities, uncertainties and the daunting prospect of competing with companies that have far deeper pockets and well-established distribution channels.

At Sow Good, we are driven by an entrepreneurial spirit and are steadfast in our mission to leverage our powerful innovative technology to disrupt the status quo. We are committed to creating exceptional new products and bringing fresh experiences to consumers, unrepentantly pushing the boundaries of what existed before our entrants into the candy category. As we navigate the second half of the year, we have encountered unique challenges, largely stemming from our careful decision to pause shipments during the third quarter and early October to protect product quality amid extreme summer heat. While shipments resumed in October, some melted products did reach retail shelves, which has temporarily affected sales velocity. We are working closely with our retail partners to remove these affected items and restore regular sales momentum.

Moving forward, we are implementing temperature-controlled distribution to prevent similar issues next year, reinforcing our commitment to consistently delivering high-quality products to our customers. Looking ahead, we recognize that we’re in the early innings of a long game, navigating both challenges and exciting opportunities as we continue to pioneer this rapidly growing and evolving freeze-dried candy category. The entry of some of the world’s largest CPG companies into the space we helped create underscores the legitimacy and the consumer demand for freeze-dried candy as an everyday indulgence. While these giants leverage substantial market power and budgets to secure shelf space at their competitors’ expense, their efforts only highlight the strength of our brand and the exceptional quality of our products, which are already recognized as formidable players in this competitive landscape.

Despite these challenges, we remain dedicated to our long-term growth strategy. We now have six freeze dryers operating at our Union Bower facility. And at Rock Quarry, we received our seventh freeze drier along with our two candy making machine. Freeze driers 8 through 12 are set to arrive within the next eight weeks with our automated packaging machine arriving in 8 to 12 weeks. I will have more to say about this and our strategic growth plan in my closing remarks, but first, I’ll pass the call over to Brendon to give you more detail on our quarterly performance. Brendon?

Brendon Fischer: Thank you, Claudia. Jumping right into our financial performance. Revenue in the third quarter of 2024 was $3.6 million compared to $5 million in the prior year period. The decline was primarily driven by our decision to delay the majority of product shipments to customers as extreme heat during the quarter was negatively impacting the quality of the candy shipments. As Claudia mentioned, despite halting shipments, some retailers continue to distribute products to stores resulting in melted stock on shelves. This has impacted sell-through rates beyond our expectations, further contributing to the lower revenue. We’ve been in continuous discussions with our retail partners to remove melted stock, but has progressed slower than we would have anticipated.

As such, we expect this to affect sales velocities for at least the next one to two months. Gross profit in the third quarter of 2024 was $0.6 million compared to $1.3 million for the same period in 2023. Gross margin was 16% in the third quarter of 2024 compared to 27% in the year ago period. The decrease in margin was largely due to higher cost of goods sold as a percentage of sales. Operating expenses in the third quarter of 2024 were $3.8 million compared to $0.3 million for the same period in 2023. The increase was primarily driven by higher compensation and other general and administrative expenses as we scaled our business. In addition, we experienced an increase in bad debt expense due in part to a customer bankruptcy in the period.

Net loss in the third quarter of 2024 was $3.4 million, or $0.33 per diluted share, compared to net income of $0.3 million, or $0.04 per diluted share, for the same period in 2023. Adjusted EBITDA in the third quarter of 2024 was negative $1.9 million compared to $0.6 million for the same period in 2023. Moving to the balance sheet. We ended the third quarter of 2024 with cash and cash equivalents of $6.9 million compared to $2.4 million as of December 31, 2023. This increase was primarily driven by the public offering we completed in the second quarter when we raised $12.8 million in proceeds, net of underwriting fees. Inventory at the close of Q3 was $19.4 million, marking a $9.1 million sequential increase. This rise is largely attributed to our decision to hold shipments during the quarter.

Given the extended shelf life of our products, we anticipate working this inventory down to more typical levels over time as we address short-term sales challenges. Converting this inventory to cash will not only reinforce our cash position, but also enable us to continue implementing our long-term strategic initiatives. This concludes my prepared remarks. I’ll now turn the call back to Claudia. Claudia?

Claudia Goldfarb: Thank you, Brendon. I’d like to share the decisive actions we’re taking to address current revenue pressures while remaining fully committed to our long-term growth strategy. A strategy we believe continues to hold tremendous untapped potential. First, on resolving melted products and restoring sell-through. We expect to see a full resolution on shelves within the coming weeks. The impact on sell-through has been significant. So we’re launching targeted promotions to drive strong reengagement and boost momentum. This November and December, we will run focused campaigns with Five Below, HEB and other retailers to reignite sales momentum. At Cracker Barrel, we’re replacing 2 SKUs to spark trial and are excited about the recent launch of our minty Mint to Be SKU, a fresh addition we believe will enhance their assortment.

Despite competitive pressures, we remain relentless in our strategy to innovate and secure shelf space. We’ve strengthened our sales team with two top-tier salespeople to rapidly open new retail doors aiming to increase our market share from our current approximate 10% penetration. We are also launching a bold marketing campaign that highlights our dedication to innovation, entrepreneurship and disruption. We are here to change the game, not nearly to play by its established rules. Bringing two candy production in-house excites us. It allows us to innovate flavors, textures and improve ingredients, an important competitive advantage that further differentiates us from our competitors. Despite short-term headwinds, we believe we are only beginning to tap into the broader potential within the candy category.

Internationally, we’re enthusiastic about expansion opportunities in Europe and the Middle East. We are on the cusp of final regulatory approval for our 2025 launch, positioning us to enter these markets before any significant competitors. Domestically, we’re intensifying our footprint expansion across regional grocers, convenience stores, travel hubs and non-traditional retail outlets. We’re also mindful of the tremendous growth within U.S. ethnic markets. As a Latina, I’m personally inspired by this wave of emerging growth. We recently launched our Chamoy products at Five Below with the launch of HEB planned by year’s end. These items are a natural fit for the expanding ethnic market, and we’re working closely with broker partnerships to target these channels effectively.

Given recent results, we’re also taking proactive steps to strengthen our operational resilience and flexibility. First, operating expense optimization. We’re carefully evaluating our operating expenses to achieve savings that enhance efficiency without impacting production, innovation or quality. Second, the launch of our proprietary candy. In collaboration with our retail partners and key brokers, we’re seizing the opportunity to introduce our unique rock candy in the first quarter of 2025. The enthusiasm around our Chamoy gummy in its non-freeze-dried natural format has been encouraging and reaffirming our commitment to growing the candy category with products that stand out both in form and flavor. While initially modest in revenue, fast-tracking this candy format enhances our retail presence, build brand recognition and it broadens access for those budget conscious consumers.

Third, our private label expansion. With increased production capacity, we are reengaging customers who only operate in the private label space. This creates a new revenue stream and supports our margins by reaching markets otherwise inaccessible under our brand. This positions us uniquely among our competitors as we are not only a brand, but expert manufactures. Our U.S. based manufacturing capabilities enable us to gain additional market share, producing high-quality products across brands and formats regardless of who enters the market. These actions underscore our unyielding commitment to sustainable, scalable growth and our focus on cost efficiency within a fast-paced market. Sow Good is committed to expanding our offerings thoughtfully to meet a range of consumer needs at various price points.

Accelerating our entry into traditional candy formats positions us strategically enhancing our competitive advantage. We’re not just participating in this industry, we are defining its future. Backed by our advanced technology and manufacturing expertise, we’re delivering best-in-class products with pricing and quality that distinguishes us. Aware of the challenges that come with pioneering in a traditionally stagnant category ruled by corporate giants, we’re energized by what lies ahead, confident in our ability to serve a broader market. We’re prepared to meet the evolving needs of consumers with unmatched creativity, quality and care. Operator, we’ll now open the call for Q&A.

Q&A Session

Operator: Thank you, madam. [Operator Instructions] Our first question comes from the line of Eric Des Lauriers of Craig-Hallum Capital Group. Please go ahead, Eric.

Eric Des Lauriers: Great. Thanks for taking my questions. I guess, first, just on the impact of the melted products, you said that some of your customers pushed them to shelves and obviously impacted sales velocity. Should we think of this as kind of a broad-based dynamic or perhaps targeted to just a few customers? I’m just kind of wondering if this is sort of across the customer base or this was more limited in its impact?

Claudia Goldfarb: Hi, Eric. Yes, no, great question. I think that we’re primarily seeing it in three customers, which would be Five Below, Cracker Barrel and HEB. As we mentioned in the comments, we thought we would be able to move through these melted issues much quicker than we have been able to and hindsight’s 2020, right? We felt like we made the correct decision in pausing shipments in the third quarter. And in retrospect, what we probably should have done is taken products back from the retailers, so that they weren’t pushing out to the stores, but they chose to push it out to the stores and because of that there is melted products on the shelves. We’re seeing that in very specific items. So if we look at quarter-over-quarter performance on a SKU basis, we’re seeing it really impact the crunchy worms, the sweet worms, the sour worms.

We were down 30% on the crunchy worms from Q2 to Q3 on Pfizer [ph] IRI, same thing with the sweet worm. So we’re seeing the impact on those melted items. At the same time, we’re seeing increases in our sweet bites, our sour spheres. So short-term impact on some of our top sellers that are more susceptible to heat, but from a sell-through data at the retail level, those items that aren’t impacted by heat are continuing to do well. Now I understand, I looked at the stock this morning. I thought you guys had already priced in the third quarter issues. We created this category. It’s brand new. We’re 16 months into doing it. There’s going to be fits and starts. There’s going to be stumbles. There is going to be headwinds. And one of the things that I want to make really clear to everyone on this call, we are going to do what is in the best long-term interest for this company.

We are not going to play a quarterly game because if we do that, we lose. We’re really focused on continuing to innovate to not ship if there is a heat issue. We’ve resolved the heat issue for next year. We’re going to be in temperature-controlled environments. The candy making machine is coming in-house, so that we continue to innovate. And as these corporate pressures come in, try and get us off-shelf, they’re not going to be able to because we will have the most innovative product, which is what consumers are saying, they want. So that’s really what our focus is on with Five Below, Cracker Barrel, HEB. We’re working through promotional actions trying to get products pulled off shelves so that we can resolve this and get back to a regular sales cadence across all SKUs. And I probably gave you more info than you wanted, Eric.

Eric Des Lauriers: That’s all right. I appreciate the color there. I guess, on some of your other customers, 7/11, Target were sort of big, big wins earlier in the year. Could you maybe just comment on how we should think about these sort of dynamics impacting there? Should we think about these as kind of short-term as well? And I guess just more broadly speaking, besides those customers that you just called out, like how should we think about shelf space? Have you been able to sort of defend the shelf space that you won with them? Have you lost any accounts? Just kind of wondering how we should think about the sort of the customer base going forward, more broadly speaking.

Claudia Goldfarb: Yes. No. So we’re aggressively going after shelf space. Just yesterday, we got a PO for Toys R Us Canada. We’ve hired two top-tiered salespeople whose only mandate is boots on the ground get us shelf space because if we can get on-shelf space we feel like we win that battle. In regards to customers, Five Below, 7/11, Cracker Barrel, some of those key accounts that we’ve had for a long time are growing with us and growing with us through these challenges because they understand what we understand, right? They helped us pioneer this category. They understood that there weren’t — we weren’t going to have the answer to every single question. So they’ve been incredibly flexible and have partnered closely with us as we continue to innovate and grow this category.

In regards to Circle K and Target, I don’t have good answers for you on those. There are large CPG competitors that are entering the landscape. And our conversations have been that they may want to be the only freeze-dried product on-shelf at certain retailers. And the position that we’re taking is we have the best product, the best assortment, the best pricing. And if you choose to go in a different direction with some exclusivities or whatever relationships you’re going to, we’re just going to pick up other shelves elsewhere because across the board, what we’re hearing from retailers, is what their customers want is this broad assortment of freeze-dried candy. And that’s why our assortment is so important and continuing to innovate that assortment is going to be key for us to continue long-term growth.

I mean the growth right now, third quarter wasn’t fun, it wasn’t great, but it was still the right decision and how we continue to operate from here is really going to dictate our long-term success.

Eric Des Lauriers: I appreciate that color. Just two more for me. So obviously, inventory has been picking up, no surprise given these dynamics. But how should we think about your production plans going forward? I mean, are you still — should we think about these still in full production? Are you kind of pausing production to work through any of the inventory? How should we be thinking about that going forward…

Claudia Goldfarb: Yes. No. We are pausing production and we’re continuing production on certain items, like the Mint to Be is just coming out. And so that’s what we’re producing right now. Our everyday SKUs that we have sufficient inventory because the inventory that’s on the balance sheet, we had anticipated it being gone by the third quarter, right? So all of those items, we are not continuing to produce until we need it. The nice thing about that inventory, a, it’s already paid for. So the minute it’s sold, it’s just converting to cash. It has a long shelf life. It’s got a two-year shelf life. So it’s not like we’re in a time crunch to move it as quickly as possible. And we’re continuing to use the freeze driers on the items that we’re innovating and launching.

In my remarks, one of the things we mentioned is there are retailers out there that only live in the private label world, right? They don’t bring brands into their retailers. Since we now have the production capacity because of the slowdown in the third quarter, those are conversations that we are reentering because why not? It’s not a market we can access if we don’t go the private label route with them. So we’re going to take that approach of keeping the freeze driers full with branded and private labeled products, where appropriate, where it’s not going to affect our branded strategy.

Eric Des Lauriers: Got it. And then just last one for me. Can you comment, I guess, broadly on fixed cost leverage in the model, the overall impact of sales volumes on gross margins. We’ve seen some pretty significant volatility there, 58% last quarter, 16% this quarter. How should we think about appropriate gross margin levels going forward?

Brendon Fischer: Yes. So we’re going to continue to see variability in the gross margin just because of the changing dynamics we’re facing in the industry. This last quarter, we had a step down and that was primarily due to some production yield variances we experienced, and that’s driven by a multitude of things. But primarily, what we believe it was in the quarter was higher levels of product loss from breakage and that was just due to increased product handling as we move facilities. We had some unfavorable fulfill variances. So that’s kind of what impacted us on top of the deleverage on the sales impact as well. As far as the fixed cost leverage going forward, you look at what our — what makes up our COGS, the two big things are labor and our overhead, which is primarily rent. The labor, obviously, if we’re pulling back production, that will come down. But the rent, obviously, will be a deleverage there if there is a sales decline.

Eric Des Lauriers: All right, and thank you for taking my questions.

Brendon Fischer: You’re welcome.

Operator: Thank you. Our next question comes from the line of George Kelly of ROTH Capital Partners. Your question please, George.

George Kelly: Hi, everybody. Thanks for taking my questions. Maybe to start, I know you mentioned that you still have — there’s heat-affected product at retail. But I’m curious, even outside of that, what do your retail inventory levels look like? Do you have a good sense of that? And is there still a fair amount of kind of excess inventory at retail?

Claudia Goldfarb: So what we’re seeing, George, in regards to reorders at this point is the products that were not affected by heat. And so that’s why pulling the heat-affected product running those promotions is really important because it makes sense, right? If someone goes to a shelf and they see melted worms, they’re not going to want to buy them. And so that’s really our focus right now. Let’s get those off-shelf, let’s get fresh product in and kick start that sales momentum on those items again. But, for example, on the bites and all of the other items, that’s where we’re seeing strong reorders.

George Kelly: Okay, understood. And then do you have any data or what can you share just with respect to the broader category? I’m curious if you’re seeing any signs of, just in general, the whole freeze dried candy category showing signs of velocity sort of slowness or any data you can share there would be helpful.

Claudia Goldfarb: Yes. I think that we’re starting to see freeze dried candy enter a steady state. If we hadn’t had this heat issue, I think we would have a much better sense of what everyday velocities at retail were going to be like. But the frenzy of the fourth quarter of last year has definitely died down, and now we’re entering into how it’s going to perform every day. And I think that getting the melted product off the shelf getting back to a steady state with those items will give us a really good sense of on a go forward basis, what the category is going to do in a normal cadence.

George Kelly: Okay, understood. And then maybe last question for me. On private labeling, how big of an opportunity is that? And might you also consider — I don’t think this is what — in response to one of the questions earlier, you mentioned the opportunity that you’re currently assessing. But I’m wondering if you’re also considering becoming more of a manufacturing partner for other branded companies.

Claudia Goldfarb: Right now, we’re really focused on the private label opportunities in order to fully utilize our freeze driers right now. At the end of the day, what we’ve said from the beginning, what we are is manufacturers. We’re expert manufacturers. And so where those opportunities are that are going to help support our long-term growth is where we’re going to go. Co-manufacturing for other brands at this point, we feel would be detrimental to the Sow Good brand that has a really strong presence amongst retailers and customers. So focusing on those private label opportunities where we will not be able to access them in anything other than a private label format is where we’re going to start.

George Kelly: Okay, understood. Thank you.

Operator: At this time, this concludes our question-and-answer session. I would now like to turn the call back over to Claudia for closing remarks.

Claudia Goldfarb:

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Operator: Ladies and gentlemen, this does conclude today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.