Utz Brands, Inc. (NYSE:UTZ) Q2 2023 Earnings Call Transcript

Utz Brands, Inc. (NYSE:UTZ) Q2 2023 Earnings Call Transcript August 10, 2023

Utz Brands, Inc. reports earnings inline with expectations. Reported EPS is $0.13 EPS, expectations were $0.13.

Operator: Ladies and gentlemen, thank you for standing by, and welcome to the Utz Brands, Inc. Second Quarter 2023 Earnings Call. I would now like to turn the call over to Kevin Powers, Senior Vice President, Investor Relations. Please go ahead.

Kevin Powers: Good morning and thank you for joining us today. On the call today are Howard Friedman, Chief Executive Officer; Ajay Kataria, Chief Financial Officer; and Cary Devore, Chief Operating Officer. Howard and Ajay will make prepared comments this morning, and all three will be available to answer questions during our live Q&A session. Please note that some of our comments today will contain forward-looking statements based on our current view of our business and actual future results may differ materially. Please see our recent SEC filings, which identify the principal risks and uncertainties that could affect future performance. Before I turn the call over to Howard, I have just a few housekeeping items to review.

Today, we will review certain adjusted or non-GAAP financial measures, which are described in more detail in this morning’s earnings materials. Reconciliations of non-GAAP financial measures and other associated disclosures are contained in our earnings materials and posted on our Web site. Finally, the company has also prepared presentation slides and additional supplemental financial information, which are posted on our Investor Relations Web site. And now, I’d like to turn the call over to Howard.

Howard Friedman: Thank you, Kevin, and good morning, everyone. It’s great to be here today. I’ll begin our discussion this morning with an overview of our second quarter results and consumption trends, and then Ajay will discuss our financial performance in more detail. Following our prepared remarks, we will open the call for questions. Starting with our second quarter results, we delivered another quarter of strong organic net sales growth, as we execute against our growth strategies and as our salty snack category trends remain resilient. In addition, our margins continue to recover through our pricing actions and productivity programs, which enable us to again raise our full year adjusted EBITDA outlook. In the quarter, our organic net sales increased 4.3% even as we lapped 13.6% comparable growth in the prior year.

As we expected, our sales growth was led by pricing with our volume trends improving relative to the first quarter, led by our branded volumes which increased in the second quarter. As a reminder, our non-branded volumes this year are being proactively impacted by our aggressive actions to better optimize our product mix into non-core and lower margin private label and partner brands. As we move throughout the second half of the year, through a combination of distribution gains, new product innovation, increased marketing spending, and lapping prior year SKU rationalization, we expect our total sales volume momentum to build each quarter. From a consumption perspective, in the quarter, our power brand momentum continued and increased 10% on top of 18% growth last year, which was our seventh consecutive quarter of double digit growth leading to share gains for Boulder Canyon, Zapp’s and On the Border.

Our adjusted EBITDA margin recovery continued with our second consecutive quarter of year-over-year expansion, led by prior year pricing execution, higher levels of productivity and portfolio optimization. In addition, during the quarter, we made progress against our network optimization program to support more profitable growth and better balanced capacity across our network as we closed our manufacturing operations in Birmingham, Alabama, and we continued to in-source production into our Utz plans from co-manufacturers. Briefly touching on our second quarter financial results, total net sales increased 3.6%, adjusted gross profit increased 1% and adjusted EBITDA increased 7%. While adjusted EBITDA margins expanded, led by accelerating productivity benefits across logistics and lower delivery costs, our adjusted gross margins declined more than we expected.

This was largely due to transitory, higher inbound freight and potato costs to support growth in the West, and a transitory volume deleverage due to our network optimization program. These headwinds are behind us and we can continue to expect for gross margins to improve in the second half of the year, and Ajay will provide more color during his comments. Looking at our retail consumption trends in the quarter our retail sales increased 9% versus the salty snack category growth of 12%. Our three largest brands, Utz, On The Border and Zapp’s, which combined represent about three quarters of our retail sales again delivered double digit growth. Our flagship Utz brand grew 7% even as we lapped 25% growth in the prior year, driven by potato chip growth of 15%, marking the eighth consecutive quarter of double digit growth for Utz potato chips.

On The Border tortilla chip consumption rebounded nicely, increasing 16% as we lapped the prior year increased merchandizing support and large distribution gains in the mass channel. In addition, On The Border was particularly strong within the grocery channel in our core markets, with growth of over 40%. Zapp’s consumption remained robust and increased 35% in the quarter, primarily driven by sustained momentum of our new flavored pretzel innovation. Our seasoned pretzels continue to drive the overall pretzels subcategory, and we recently won the best pretzel award in PEOPLE Magazine’s Food Awards 2023 edition, earning a rare perfect rating from testers. This follows our SELF Magazine Pantry Award as the winner for best Pretzel Stix, which was announced on the NBC Today Show.

When you look across our consumption trends during the quarter, consistent with what I mentioned earlier, our volume trends continue to improve with each successive month as we work through our laps from last year. As a reminder, we were still lapping significant activity in the mass channel through April due to promotional activity that did not repeat in 2023. In addition, we secured new distribution gains primarily in the grocery and mass channels that began in May, which helped drive volume momentum in the quarter. And we expect for these trends to continue in the second half of the year. Moving to our key salty subcategories, we gained share across potato chips and pretzels and our tortilla chip growth improved significantly relative to our first quarter performance driven by On The Border.

Potato chip growth was led by Utz with growth across all major channels and over 50% growth for Boulder Canyon, led by distribution gains at key strategic retailers in the grocery channel. Pork Rinds and cheese remain focus areas. And while they are not a big portion of our sales, we are intent on turning these businesses back to growth. For Pork Rinds, our performance is improving as we make price pack architecture changes and introduce new packaging. In cheese snacks, our sales growth was primarily impacted by lapping incremental programming in the mass channel last year that did not repeat. From a geography perspective, we are making progress penetrating our whitespace opportunities as our double digit consumption momentum continued in our expansion regions driven by the Utz brand, Zapp’s and Boulder Canyon, all supported by distribution gains.

Our performance in the quarter was mixed, largely due to lapping very strong Utz brand growth in the prior year, Golden Flake softness, particularly in potato chips, and portfolio optimization actions within our RW Garcia brand. That said, we delivered growth across On The Border, Zapp’s and Boulder Canyon and we expect our core performance relative to the category to improve in the second half of the year. Shifting to our better-for-you segment in salty snacks, our consumption in Natural Channel increased by nearly 20% in the second quarter, significantly outpacing category growth of 10%. Our primary better-for-you brand in the Natural Channel is Boulder Canyon, and we maintained the number three ranking in the salty snack category as measured by SPINS, growing 28% in the quarter, which was triple the category growth rate.

Boulder Canyon has now delivered 22 consecutive periods of double digit growth in SPINS and is the number two potato chip brand in the Natural Channel, with our Avocado Oil chip now ranked number one in terms of dollar sales. Consistent with our growth strategies as we sustain strength across our power brands, in the second half of the year, we remain committed to thoughtfully increasing our brand marketing investments. Our initial primary areas of focus will be on enhancing our package design, with strategic design partners first focused on Utz, Zapp’s and On The Border, elevating our omni-channel and ecommerce strategy by investing in new capabilities, integrating deeper into the business and increasing retail media advertising and expanding our marketing capabilities with incremental investment and agency support to build brand awareness on our power brands.

In addition, we are capitalizing on-trend right innovation. As I mentioned earlier, we’ve had great success with our Zapp’s flavored pretzel launch, and this year we’ve added more on-trend flavors to our Utz brand portfolio. I’m especially pleased with the introduction of Utz Mike’s Hot Honey chips. Hot & Spicy is now the number one flavor in salty snacks and is growing nearly twice the rate of the category, and our Utz Mike’s Hot Honey sales are already 4x higher than our previously best Utz limited time offer. Our weekly velocities are well ahead of expectations and are already approaching one of our top selling items, Honey Barbecue chips as we’ve been supporting this launch with retail activation and marketing support, driving nearly 75 million earned media impressions.

Given the success of the launch, I’m pleased to announce that Mike’s Hot Honey chips has secured placement in our long-term assortment and reflects the strength in our innovation approach. Wrapping up, I’m pleased with our progress this year as we’ve been building our capabilities, delivering sustained results in a dynamic environment, and are well positioned for a strong second half of 2023. I’m confident that we will drive continued organic net sales growth with sales volume momentum building throughout the year, and will be supported by increased brand investment focused on our power brands. Critically, these investments will be funded by our productivity and revenue management initiatives which remain on track and will also help to expand gross and adjusted EBITDA margins in the second half of the year.

Finally, we expect to deliver on our commitments and generate stronger cash flow to reduce balance sheet leverage to unlock further financial flexibility down the road. Now, I’d like to turn the call over to Ajay. Ajay?

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Ajay Kataria: Thank you, Howard, and good morning, everyone. Our second quarter results reflect the resilience of our salty snack category. Despite again lapping significant growth in the prior year, we delivered organic growth of 4.3% while proactively optimizing our portfolio. In addition, we expanded adjusted EBITDA margins as we are executing our margin-enhancing programs. I would like to thank the entire Utz team for their contributions, and we remain well positioned for a strong 2023. Turning to our second quarter results in more detail, net sales was in line with our expectations and increased 3.6% to $362.9 million. Adjusted gross margin declined 100 basis points to 35%. And this includes an approximate 70 basis points of negative impact from our IO conversions.

Excluding this impact, our adjusted gross margins contracted about 30 basis points versus last year. As Howard mentioned earlier, the gross margin decline in the quarter was larger than we expected primarily for two reasons. First, last year’s potato crop yields were lower than normal in the Western part of the country that supply our Washington and Arizona plants. Given the growth we are seeing in this region, we decided to source more potatoes from the Midwest to support production in these plants. This drove both inbound freight costs and potato cost higher, but was temporary in nature as we have now transitioned into a new crop harvest out West and are fully sourced. Second, during the second quarter, we experienced larger than expected transitory volume deleverage associated with our network optimization program.

As a reminder, we announced the closure of our Birmingham plant in April. We ramped down production in the facility quicker than we originally anticipated to shift production to more efficient plants in our network. As a result, we experienced higher than expected standard cost. The transition is now complete. Importantly, these transitory impacts are behind us and our network optimization efforts, combined with the in-sourcing of production from co-manufacturers and stepped up productivity benefit and sales volumes, will drive gross margin expansion in the second half of the year. For context, the month of April was the lowest gross margin month in the quarter, and our margins improved across each successive month in the quarter. Pulling this all together, our gross margin expectations in the second half of the year remain unchanged and we continue to expect year-over-year expansion.

Adjusted SD&A expense declined 2.6% to $81.7 million and improved by 144 basis points as a percent of sales. As a reminder, our outbound freight, which is the vast majority of our freight expense given our DSD operations resides within SD&A expense and not cost of goods sold. As a result, the benefits from improved freight market conditions, combined with our productivity initiatives, focused on logistics helped to drive strong expense leverage in the quarter. Finally, our adjusted EBITDA increased by 7.1% to $45.2 million or 12.5% as a percent of net sales. Adjusted net income of $18.8 million and adjusted EPS of $0.13 per share were both in line with last year, largely due to higher interest expense. Moving to the P&L for some additional details, starting with net sales.

Our net sales growth in the quarter was 3.6%, driven by organic growth of 4.3%. In addition, total net sales were impacted from the conversion of company-owned RSP routes to independent operators, which reduced the net sales growth by 0.7%. Our organic net sales growth was led by price realization of 6%, partially offset by lower volume mix of 1.7% as we expected. In addition, our SKU rationalization initiatives are ongoing as we aggressively optimize low margin SKUs to improve portfolio mix, and we unlock manufacturing capacity to focus on producing our branded business. This program began late into the first quarter of 2022 and through a wraparound impact from last year’s actions, combined with the new actions this year, our volume was proactively impacted by approximately 350 basis points in the second quarter.

When we adjust for proactive SKU rationalization actions, we estimate that our volume mix grew 1.8% in the quarter led by our power brands. In the second quarter, adjusted EBITDA increased 7.1% and margins expanded 40 basis points to 12.5% of sales, which, as Howard mentioned, was our second consecutive quarter of margin expansion. Decomposing the change in the adjusted EBITDA margin for the quarter, positive drivers include a price benefit of 6%, productivity improvements of 2.7% and volume mix benefit of 70 basis points, largely driven by favorable sales mix from our SKU rationalization actions. Partially offsetting these positive drivers were the unfavorable margin impact of 7.8% driven by commodity and labor inflation and selling and administrative expense impact of 1% due to our continued investments in marketing, people, selling infrastructure and supply chain capabilities to support our growth.

Our second quarter adjusted EBITDA margin performance reflects good execution against our primary margin enhancing initiatives. Our pricing actions last year are countering inflation, while we continue to enhance our price pack architecture program and optimize our trade spend, leveraging improved capabilities. Our aggressive SKU rationalization actions are providing a mixed benefit to margins, while we free up capacity in our plants and distribution network to help us service our higher margin power brand business. Our productivity programs are on track, and we continue to expect to deliver productivity of approximately 4% in 2023 as a percent of COGS. For example, our integrated business management capabilities are starting to deliver a more balanced demand and supply plan, which is helping to drive higher levels of productivity.

Lastly, we are progressing our manufacturing network optimization program while also in-sourcing volume where we have capacity. As we first announced in April, we completed the closure of our manufacturing operation in Birmingham, Alabama. And we have been shifting production to our facilities in Kings Mountain, North Carolina and Hanover, Pennsylvania. Of note, in connection with the closure, we recorded an expense of $8.9 million in the second quarter, which includes $1.3 million in severance and related costs and $7.6 million of fixed asset impairments. Now turning to cash flow and balance sheet. Beginning with cash flow, consistent with normal seasonality, cash flow used in operations in the first half of the year was $4.3 million. The second quarter improvement reflects our cross functional efforts to improve our cash conversion cycle as we have made foundational improvements across our operations.

We continue to expect progress on our net leverage reduction in the back half of the fiscal year as we drive stronger free cash flow conversion, which remains a major priority for the company. Capital expenditures stepped up in the second quarter and were $30.2 million in the first half of fiscal 2023, primarily related to supporting our productivity programs and our manufacturing expansion in Kings Mountain. Finishing with the balance sheet, net debt at quarter end was $913.3 million or 5.1x trailing 12 months normalized adjusted EBITDA of $177.4 million. As I stated earlier, our first half is a heavier use of cash and we would expect progress on our net leverage reduction in the back half of the fiscal year. Now turning to our full year outlook for fiscal 2023.

Today, we reaffirmed our net sales growth outlook and increased our adjusted EBITDA growth outlook. As we consider our first half performance and look ahead to the remainder of the year, our outlook is unchanged for total net sales growth of 3% to 5% and organic net sales growth of 4% to 6%. Our shift to independent operators is expected to impact our total net sales growth by approximately 1%. And price is expected to be the largest contributor to growth, with volume mix consistent with last year, assuming a 3% impact to growth from our SKU rationalization actions. From a profitability perspective, we continue to expect to deliver gross margin expansion in 2023, although less than our previous expectations given the transitory impact in the second quarter.

Higher potato sourcing costs were offset by favorability in the outbound freight rates, which is recorded in SD&A expense. While this shifts P&L geography for inflation, our total gross input cost inflation outlook of high single digits is unchanged. Pulling it all together, we continue to expect adjusted EBITDA margin expansion this year, but the majority of it will now come from SD&A expense leverage. And given stronger than expected SD&A expense leverage and better productivity benefits in our delivery costs, we are raising our adjusted EBITDA growth outlook from 7% to 10% to 8% to 11%. Moving down the P&L, we continue to expect our full year 2023 adjusted effective tax rate to be approximately 20% to 22% and interest expense of approximately 55 million and capital investments of between 50 million to 55 million primarily to support manufacturing capacity expansion.

Finally, we expect stronger free cash flow generation in the second half of the year from higher profits, normal seasonality, and our working capital initiatives. Our capital priorities remain consistent, and we expect to reduce leverage in fiscal 2023 by half a turn and end the year below 4.5x normalized adjusted EBITDA. In closing, we are confident in delivering another year of strong operating performance in 2023, with continued top line momentum, optimization of our cost structure, and expansion in margins while we invest in our capabilities. And now, operator, we would like to open the call for questions.

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Q&A Session

Operator: The floor is now open for your questions. [Operator Instructions]. Our first question comes from the line of Andrew Lazar from Barclays. Please go ahead.

Andrew Lazar: Great. Thanks. Good morning, Howard and Ajay.

Howard Friedman: Good morning, Andrew.

Andrew Lazar: First off, you mentioned that you’re still looking for flat volumes on a year-over-year basis for the full year. And I guess this would suggest a pivot to a year-over-year volume growth in the back half. Just want to make sure I have that right. And if so, what are the key drivers I guess to delivering volume growth in the second half? And I guess what gives you that confidence also in light of a little bit of I guess a broader food industry malaise when it comes to sort of volume recovery?

Howard Friedman: Hi, Andrew. It’s Howard. I appreciate the question. First of all, I would point out that one of the nice things that we’ve been seeing across our second quarter is a sequential improvement in our volumes overall, which is largely what we had expected, as we were building through the quarter. I think if you turn to the back half, there are a couple of areas where I think that give us confidence. First, our drags actually become less impactful. We’re seeing that in the second quarter, and we’ll see that continue. Drags like our SKU rationalization gets less of a net taker on our trend as we go into Q3 and Q4. We are seeing some of our brands like Golden Flake that are actually the trends are improving. And we’re seeing better momentum, both in our mass channel, which we talked a lot about last year as being a challenge, and our club business also as we move through some of our prior year laps.

Second, we are experiencing incremental distribution gains, specifically in mass and grocery. They really kind of started in May of this year and we’re starting to see the benefits of those drives. Third is one of the areas that we’re continuing to work on is the multipack variety pack segment of the category, which is a piece where the consumer interest is high as is the retailer opportunity. We’ve improved our packaging structure. We’ve added incremental assortment and we’ve got our price points in a place where we would have expected them to remain competitive the rest of the year. And then the last thing is incremental sales activity, but also we’ll start to step up our marketing investment. I talked earlier in our journey together that being thoughtful about how we start to increase marketing year-on-year really starts to step up as we build confidence in both our capability to actually deliver the message but also the partnerships with some of our customers.

So all those things together I think roll up to a positive back half volume trend.

Andrew Lazar: Great. And then can you talk a bit about what you’re seeing I guess in the competitive environment in salty snacks at the moment? I guess some players have finally sort of solved some of their own capacity constraints from a year ago, and maybe are back to more normal levels of sort of merchandizing in in-market activity. So I’m just trying to get a sense for that and sort of where your merchandizing levels stand currently, and where you think they either need to be if that’s different from where they are sort of right now?

Howard Friedman: Yes. I would say, overall, really not a lot of surprises. One of the great things about our category obviously is the consumers’ resilience. The customer likes to sell it. And our competitors are all typically very rational even as they have cycled back into better supply chains. So from our perspective, it’s largely what we would have expected to see. You’re right that year-on-year, it is — the promotional environment’s higher. But I would just point to, if you went back to 2019, overall promotional activity in terms of both frequency and depth, so how often and how deep do we go on pricing, we’re still as a category well below those levels as we turn both currently and we would expect into the future.