The Real Good Food Company, Inc. (NASDAQ:RGF) Q1 2023 Earnings Call Transcript May 13, 2023

Operator: Greetings, and welcome to The Real Good Food Company First Quarter 2023 Earnings Conference 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, Shamari Benton, Vice President of FP&A and IR. Thank you, Shamari. You may begin.

Shamari Benton: Good morning, and welcome to The Real Good Food Company’s First Quarter 2023 Earnings Conference Call. On the call today are Bryan Freeman, Executive Chairman; Jerry Law, Chief Executive Officer; and Akshay Jagdale, Chief Financial Officer. Our first quarter earnings release crossed the wire at approximately 8 A.M. Eastern Time today. If you’ve not had a chance to review the release, it’s available on the Investor portion of our website at www.realgoodfoods.com. Before we begin, I’d like to remind everyone that certain statements made on this call are forward-looking statements within the meaning of federal securities law and are subject to considerable risks and uncertainties. These forward-looking statements are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995.

All statements made on this call today, other than the statements of historical fact are forward-looking statements and include statements regarding our projected financial results, including net sales, gross profit, gross margin, adjusted gross profit, adjusted gross margin, and adjusted EBITDA as well as our ability to increase our net sales from existing customers and acquire new customers, introduce new products compete successfully in our industry, implement our growth strategy and effectively expand our manufacturing and production capacity. Forward-looking statements made on this call represent management’s current expectations and are based on information available at the time such statements are made. Such statements involve a number of known and unknown uncertainties, many of which are outside the company’s control and can cause future results, performance, or achievements to differ significantly from the results, performance, or achievements expressed or implied by such forward-looking statements.

Important factors and risks that can cause or contribute to such differences are detailed in the company’s filings with the Securities and Exchange Commission. Except as required by law, the company undertakes no obligation to update any forward-looking or other statements herein, whether as a result of new information, future events or otherwise. In addition, throughout this discussion, we refer to non-GAAP financial measures, which refer to results before taking into account certain onetime or nonrecurring charges that are not core to our ongoing operating results and which we believe better reflects the performance of our business on an ongoing basis. Our non-GAAP financial measures include adjusted gross margin and adjusted EBITDA are referenced.

A reconciliation of each non-GAAP financial measure to its most directly comparable GAAP financial measure is included in our first quarter earnings release, which is available on our website under our Investors Tab. With that, it is my pleasure to turn the call over to The Real Good Food Company’s Executive Chairman, Bryan Freeman.

Bryan Freeman: Thanks, Shamari. Good morning to everyone, and thank you for joining us today on our first quarter earnings call. I will briefly review our first quarter highlights and discuss the reasons we believe we’re well positioned for long-term growth. Jerry will cover operations and Akshay will then review our financial results and outlook in more detail. After that, we’ll open the call for questions. Starting with our financial highlights for the first quarter. Net sales were $29.8 million, an increase of 78% on a two-year stacked basis. Growth on a year-over-year basis was negatively impacted by the timing of promotional events that boosted sales in the first quarter of last year, but are scheduled to repeat in the second half of 2023.

Excluding these transitory timing issues, sales would have been up double digits on a year-over-year basis, driven by strong baseline velocities and continued distribution gains. Baseline velocities, which exclude the impact of promotions, grew approximately 8% sequentially in the first quarter when compared to the fourth quarter and the trailing nine-month average. We’re able to leverage this velocity growth with our retail partners to grow our distribution and extend our brand into new categories of eating occasions. Gross margins were 16.7% this quarter, which is 300 basis points improvement sequentially in the best margin in the last eight quarters. What is particularly noteworthy about this performance is the fact that we achieved this while our plans were less than 40% utilized.

Adjusted gross margins, which account for the capacity utilization impact were 33.5%, a 580-basis point improvement sequentially in the best quarterly adjusted margin in the company’s history. Margins in the first quarter reflect improved operational performance and seasonally low commodity costs. Our operating performance should continue to improve even more sequentially, and we expect commodity costs to remain at or below historical norms, albeit following normal seasonality. We now have greater conviction in meeting our 2023 revenue target of at least $200 million due to the incremental wins we have secured over the last few weeks and months. In the measured channel, we have secured approximately 57,000 new distribution points for our products to ship in 2023, which represents an approximate 43% year-over-year increase in our distribution footprint.

This includes approximately 14,000 new distribution points that were recently authorized at a large national grocery retailer for entrees, burritos, and chicken bites with 7,000 of the aforementioned distribution points set to increase in the second half of 2023 and the remaining in January of 2024. These gains also included the previously discussed national rollout of two of our breaded poultry items at a large mass retailer in June with placement in a section of the store that had 6x the velocity as compared to our current placement as well as the national rollout of our multi-serve Asian entrees. As we’ve said in the past, due to new item reset schedules in the measured channel, this new distribution will come online late in the second quarter and into the back half of 2023.

As such, the shape of our growth this year remains back half weighted. These wins have the potential to double our measured channel business on a run rate basis starting in the second half of 2023. Now turning to the unmeasured channel. We have strong conviction in our ability to meet or exceed our 2023 plan owing to three factors. First, I am pleased to report that our breaded poultry will be available nationally and in full distribution in the unmeasured channel late in the third quarter. This is a big milestone that we have strived to achieve since launching the item in early 2022. Our breaded poultry velocity and incrementality to the category have earned this expansion and is helping grow category sales for our customers. Our other items such as our Creamy Poblano Enchiladas and Bacon-Wrapped Jalapenos have also earned full distribution in the back half of this year due to their strong performance in the current and prior periods.

Second, our recently launched Flautas and Low Carb Refrigerated Burritos have performed well, resulting in expanded distribution of these items. And third, the breadth of our offerings is unprecedented for a brand in our stage of growth and points to the momentum we have. We have a total of eight items authorized in this channel across seven categories and two temperature states. Summarized unmeasured channels provide additional perspective. In 2021, we had two items that on a combined and annualized basis achieved 65% ACV. For 2022, we grew to three items with a combined and annualized ACV of 68%. Currently, we have eights items authorized to participate in seven categories and two temperature states. For perspective, we’ve never had more than four items authorized simultaneously.

All of this is to say that our strategy to expand into new categories across two temperature states is working and creates a strong foundation for durable, predictable growth going forward. The aforementioned new distribution gains, combined with strong base business velocity give us confidence that we will grow sales in 2023 to at least $200 million, representing growth of approximately 41%. Jerry and Akshay actually will speak to this in more detail, but I wanted to touch on our margins this quarter once again and provide a high-level view of how we see the rest of the year shaping up. Costs for chicken, cheese, and bacon has come down from historical highs and are currently at or below their long-term historical averages. We continue to expect commodity costs to have a 6-to-10-point positive impact on our margins in 2023, assuming current trends hold.

Additionally, as we continue to ramp up production at our Bolingbrook facility to meet demand, we expect these efficiency gains to be a significant contributor to margins in 2023 and beyond. And of course, with greater plant utilization, our margins on a reported basis will continue to improve over the coming quarters. Adjusted EBITDA was a loss of $1.2 million, which was in line with our expectations and includes the impact of significantly higher-than-normal R&D costs in support of our strong second half growth agenda. As for 2023, we expect adjusted EBITDA in the mid- to high single-digit range, driven by lower commodity costs to a lesser extent; lower labor, improve plant utilization, and better overhead cost leverage. Cash flow from operations is also expected to be positive in 2023.

Next, let’s take a step back and look at the current state of the health and wellness market and how our brand positioning is resonating with a broad consumer base. According to SPINS for the 52 weeks ending April 30, $200 billion total health and wellness industry grew 7% year-over-year, in line with the 7% two-year CAGR. Over the same period, the $65 billion total frozen food category grew 10%, an acceleration compared to the 7% two-year CAGR. It’s important to note that the frozen food category has historically performed well during recession as it tends to benefit for consumers trading down from eating out to eating more at home. Also private label penetration of frozen category is relatively low and at about 9% to 10% as compared to 20% to 22% on average across all food categories and private label penetration, health and wellness frozen is even lower than that of overall frozen food category.

As such, trade down risk within the category to lower-priced private label options is limited. Additionally, our distribution footprint is focused on retailers that deliver value to their consumers, and we have low concentration with luxury, high-end retailers that typically lose foot traffic during the economic downturn. Our brand promises three primary claims: low carb with little to no sugar, high protein, and clean ingredients. Products with these attributes are growing well above the growth in our overall total addressable market. All things considered, the categories we compete and remain highly relevant as evidenced by their large size and strong growth profile. Moreover, there are no signs of a slowdown despite the lapping of the pandemic bump and/or an economic recession, given frozen foods historically performed well in a recessionary environment.

As for our brand health, we track ourselves against four indicators: household penetration, repeat rate, social community growth, and engagement and velocity. Starting with household penetration, according to numerator data as of March 2023, The Real Good Foods brand household penetration is 8.3%, approximately flat from 8.4% in December of 2022. This means approximately one in every 12 households in the United States has purchased our products in the past 12 months. Our household penetration continues to rank second amongst all health and wellness frozen food brands behind only Amy’s, a brand with over $500 million in retail sales. And for a perspective, according to a research report recently published by Jeffrey. The entire plant-based food category had a household penetration of 5%, down from a peak of 9% a couple of years ago.

Increasing household penetration demonstrates how well our brand position resonates and how quickly we can connect with a broad consumer base. We view this as a leading indicator of future growth. And as our distribution footprint grows in the back half of this year, we expect to see our household penetration grow significantly. Turning to repeat rates, they continue to be in line with industry averages at 32% in the most recent trailing 52-week data as of March 2023. Regarding social community growth, we continue to grow Real Good Foods online community. In the first quarter, our social and digital teams continue to outperform. We generated over 3 million organic impressions and 108 million total brand impressions. We also acquired 5,000 new SMS text subscribers and added 31,000 followers on Instagram, bringing our total to over 466,000 Instagram followers.

We continue to believe that using micro and nano content creators to spark authentic peer-to-peer conversations is a better use of marketing dollars than traditional advertising. Based on our number of followers and subscribers, I could say it’s working and it’s efficient. This is reflected in the strong returns we get on our ad spending, which averages 4x to 6x as measured by third parties, far higher than our peers on average. Our retailer partners appreciate how we drive new consumers to the categories we participate in also, allowing Real Good Food to truly grow the frozen category with consumers new to frozen foods rather than simply taking share from others. In fact, a recent study from SPINS showed that only 3.5% of households have purchased our breaded poultry items were from households that purchase breaded poultry from the nation’s largest brand in the prior 52 weeks.

This generates incremental category growth I’ve not seen before in my career. It means our growth is not only good for us, but it is good for our retail partners as well. These strong brand health indicators underpin our confidence in achieving over $500 million in sales over the long-term. I’d now like to turn the call over to our CEO, Jerry Law, to provide an update on Bolingbrook and our operations more broadly.

Gerard Law: Thank you, Brian. Good morning, everyone, and thank you for joining us on today’s call. Our Bolingbrook, Illinois facility is continuing to ramp up production, and we are on track to achieve targeted efficiencies in the second quarter. I am very proud of the team and how far we’ve come since opening a new facility. Bolingbrook enables our entry into exciting new categories and gives us much needed capacity to meet the growing demand for our new and existing products. I was pleased with our gross margin performance in the first quarter, which was above our expectations. Our 16.7% gross margin is particularly encouraging, given that our plants were significantly underutilized owing to the cadence of our sales plan, which points to the first quarter being the trough for utilization.

For perspective, our sales plan calls for a doubling of our capacity utilization rates by the end of the year relative to the first quarter. Adjusted gross margins, which assume full utilization were 33.5% and point to the underlying margin profile of the business when the plants are fully utilized. We have been deliberate about building capacity ahead of demand. All the hard work and investments made to get this capacity up and running over the past 12 months has put us in a position where we are confident that we can scale production to meet our significant growth our sales team has locked in for the rest of the year. Not only are we in a good position to meet our demand needs, we expect to do so at targeted efficiencies. In other words, our growth should be highly incremental to the margin structure for the remainder of the year, especially in the second half of 2023.

Lower raw material costs contributed to our solid margin performance in the quarter, but it also reflects improved efficiencies in our formulations, which we had planned for and are durable. This was a tough quarter to judge plant efficiencies given the sub-40% utilization levels as well as the amount of new product activity, both of which have a negative impact on efficiencies. However, I am encouraged by the sequential improvement in efficiencies at Bolingbrook and City of Industry continues to perform well. Moreover, we expect our operating performance to improve significantly as the year progresses, driven by better efficiencies, lower labor costs, improved plant utilization, and better overhead cost leverage. Before I turn it over to Akshay, I would like to discuss the biggest catalyst for the remainder of 2023.

We expect our labor cost to continue to come down sequentially as Bolingbrook becomes a bigger portion of our production mix and achieve targeted efficiencies, further aided by continued efficiency gains at our City of Industry facility. We are confident in our ability to bring labor costs in line with industry standards of about 5% to 10% of sales. To reiterate, we expect a major portion of this opportunity to flow through this year as efficiencies are optimized at both plants and Bolingbrook becomes a bigger portion of our production mix. Additionally, higher sales will drive plant utilization rates higher and allow us to leverage lower overhead costs. We expect this overhead leverage to drive approximately 10 points on our further improvement in our margin profile in the second half of 2023 as compared to the first half.

Lastly, Bolingbrook has enabled significant productivity savings that have already started to accrue as we move into 2023. These include the self-manufacturing of our chicken tortillas, cooked chicken that is used in our product fillings, and our proprietary breading blends, which on a combined basis are likely to drive approximately 200 to 400 basis points of margin improvement. As for direct material inflation, the good news of the commodity costs remains favorable and point to roughly a 600 to 1,000 basis point tailwind for 2023. In summary, although we walked away from some promotions in the first quarter that negatively impact sales, it was all done with a keen eye on margin targets. We are pleased by our margin performance this quarter, which showed significant sequential improvement to the highest margin in our company’s history.

We continue to expect 2023 adjusted EBITDA to be in the positive to mid-high single-digit millions of dollar range. We have strong visibility into the drivers of our continued margin turnaround and feel confident in achieving our outlook. It’s an exciting time at Real Good Foods, and I am thrilled to report the tremendous progress of our supply chain and operations teams have made all in order to support our growing demand. I still believe we are in the very early innings of growth and are well positioned to capture market share in the categories in which we compete. Now I’d like to turn the call over to Akshay, our Chief Financial Officer, who will walk you through the first quarter financials.

Akshay Jagdale: Thank you, Jerry, and good morning, everyone. Turning to our financial results. Net sales in the first quarter were $29.8 million, a decrease of 21% as compared to the first quarter of last year. The year-over-year decline in sales this quarter was driven primarily by the timing of certain promotional events that drove sales growth in the first quarter of last year, which now fall in the second half of this year. Excluding these promotional timing issues, sales would have been up double digits this quarter, driven by continued distribution gains in the measured channel, new product, and strong baseline velocity. Underlying velocities remained strong and were up sequentially in the first quarter. Sales in the unmeasured channel declined by approximately 35% year-over-year in the first quarter, owing to the aforementioned promotional timing issue.

Excluding the impact of promotions, sales would have been up in the mid-teens on a year-over-year basis. On a two-year stack basis, growth remained strong at 77%. We expect growth to accelerate both on a year-over-year and two-year basis for the remainder of the year. As you may recall, eight items were authorized for distribution in March, which is a two-fold increase in the number of items we have ever previously had authorized at any one time. Several of the new items authorized are in categories that have 50% higher velocity than our base business, and as such, will be additive to our brand level velocities in this channel. Points of distribution in the unmeasured channel, which are a good proxy for volume growth trough in March as we were transitioning into newer versions of our legacy product and had yet to gain distribution for our new products.

Distribution has increased substantially in the second quarter, and we expect this trend to continue as the year progresses on the back of the significant new distribution wins already secured, growth in legacy item distribution as well as commitments to certain planned promotional events. Since we reported 4Q earnings in late March, we have gained greater visibility on the outlook for growth in this channel. Specifically, we now have commitments for nationwide distribution of our breaded poultry as well as our 2.0 enchiladas in the second half of 2023. These commitments, combined with our new product wins, gave us greater confidence in achieving our 2023 sales target for the unmeasured channel. In the retail channel, growth was flat in the quarter as we lapped 76% growth in the first quarter of 2022.

Including the impact of promotional timing, sales growth would have been in the mid-single digits on a year-over-year basis. Shipment growth outpaced consumption this quarter, which we attribute to the new product activity that is yet to be captured by syndicated data and usually takes 90 days to integrate. We expect both shipments and consumption to accelerate for the remainder of the year, starting in the second quarter, driven by the aforementioned 40% increase in distribution points already secured and strong owing baseline velocity. Underlying velocities on average across our portfolio remained strong and improved by approximately 8% sequentially in the first quarter. We expect velocity to continue to improve sequentially and show year-over-year growth starting in the second quarter as the comps normalize and we gain further distribution on new items that have higher velocity.

As such, we remain bullish about our prospects for measured channel growth in 2023. As Bryan mentioned, we now have greater conviction in meeting our 2023 revenue target of at least $200 million in sales. The increase in our conviction is based on the following: one, continued strong momentum on distribution expansion in the measured channel, including approximately 14,000 new distribution points at a large national coastal retailer; two, commitments for national and full distribution of our breaded poultry and 2.0 enchiladas in the unmeasured channel; three, sequential improvement in baseline velocities; and four, strong new item velocities and incremental distribution growth. Our first quarter gross profit was $5 million, reflecting a gross margin of 16.7% of net sales as compared to a gross profit of $4.2 million or a gross margin of 11.3% of net sales in the first quarter of last year.

The increase in gross margin was primarily due to lower commodity costs and the positive impact of our productivity initiatives, which include reformulations and throughput increases. The 16.7% gross margin performance this quarter implies an approximate 300 basis point sequential improvement, which is particularly encouraging given the fact that our plant utilization remains below 40% and declined sequentially. Adjusted gross profit during the quarter was $10 million, reflecting an adjusted gross margin of 33.5% of net sales as compared to $6.5 million or 17.2% of net sales in the first quarter of last year. Productivity initiatives and lower commodity prices contributed to the year-over-year increase in margins. Would also note that certain key commodities like chicken, pork, and cheese were at seasonally low levels in the first quarter and contributed to our adjusted gross margin being the highest in the company’s history.

Although we exited 2022 with structurally lower costs given the cyclical nature of some of our key commodities, we expect our adjusted margins to moderate in the second quarter as we absorb the impact of seasonally higher costs for some of our key commodities. With that being said, we are maintaining our adjusted gross margin guidance for 2023 of at least 24%. Looking ahead to 2023 and beyond, we have a long runway of future productivity savings that will drive incremental margin expansion. Additionally, as Jerry mentioned, the cost of our key commodities are down significantly on a year-over-year basis and if you were to lock in our key commodities at current spot rates, our margins in 2023 would be 600 to 1,000 basis points higher. Total operating expenses were $15.7 million as compared to $12.9 million in the first quarter of 2022.

Adjusted operating expenses increased by approximately $2.5 million to $12.7 million in the first quarter of 2023 as compared to $10.2 million in the first quarter of 2022. The increase in operating expenses was driven entirely by the increase in research and development costs to support the strong new product pipeline in 2023. For perspective, R&D costs were $3.1 million or 10.3% of sales this quarter and are expected to moderate as a percent of sales for the remainder of the year. We continue to expect R&D costs to be roughly 3% to 4% of sales for the full-year. R&D costs tend to be lumpy on a quarterly basis, depending on the level of new product activity as well as the timing and scale of commercialization. Adjusted EBITDA totaled a loss of $1.1 million as compared to a loss of $3.3 million in the first quarter of 2022.

This was generally in line with our expectation. Cash burn was greater than expected this quarter, owing to our plants being significantly underutilized as a result of the shift in promotional timing we talked about earlier. We also invested in inventory to support the significant new product activity in the quarter as well as some opportunistic buys to take advantage of lower commodity costs. We have strong visibility into our distribution gains in the upcoming shelf retail cycle in May, which includes the national rollout of our breaded poultry items at a large mass retailer. This significant inflection in our sales growth starting in the end of May and early June should result in significant fixed cost leverage across our plant network and in G&A, propelling us to be closer to our goal of being operating cash flow positive starting in the second half of 2023 and for the full-year.

As such, we have sufficient liquidity to fund our current needs and execute the plan we have laid out. As a reminder, it is important to note the Bolingbrook facility and equipment is being leased with costs flowing through the P&L. Now turning to our outlook for 2023. In 2023, we continue to expect net sales of at least $200 million, adjusted gross margin of at least 24%, adjusted EBITDA in the mid to high single-digit range and positive cash flow from operations. Long-term, we continue to expect net sales of approximately $500 million, adjusted gross margins of 35%, and adjusted EBITDA margins of 15%. This concludes our prepared remarks. I would now like to hand the call over to the operator to begin our Q&A session. Operator?

Q&A Session

Operator: Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question is from Jon Andersen with William Blair. Please proceed with your question.

Operator: Thank you. Our next question is from JP Wollam with ROTH Capital Partners. Please proceed with your question.

Operator: Thank you. Our next question is from Rob Dickerson with Jefferies. Please proceed with your question.

Operator: Thank you. There are no further questions at this time. I’d like to hand the floor back over to Bryan Freeman, Executive Chairman, for any closing comments.

Bryan Freeman: Thank you for joining us on this call this morning, and we look forward to reporting our second quarter results in a few weeks. Have a good day.

Operator: This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.