Vital Farms, Inc. (NASDAQ:VITL) Q2 2023 Earnings Call Transcript

Vital Farms, Inc. (NASDAQ:VITL) Q2 2023 Earnings Call Transcript August 5, 2023

Operator: Good day, and thank you for standing by. Welcome to the Vital Farms Conference Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the call over to your speaker today.

Matthew Siler: Thank you. Good morning, and welcome to Vital Farms Second Quarter 2023 Earnings Conference Call and Webcast. I’m joined on today’s call by Russell Diez-Canseco, President and Chief Executive Officer; Thilo Wrede, Chief Financial Officer; and I’m happy to introduce Pete Pappas, our Chief Sales Officer. By now, everyone should have access to the company’s second quarter 2023 earnings press release issued this morning. This is available on the Investor Relations section of the Vital Farms website at investors.vitalfarms.com. Through the course of this call, management may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management’s current expectations and beliefs and involve risks and uncertainties that could cause actual results to differ materially from those described in these forward-looking statements.

Photo by Sebastian Gómez on Unsplash

Please refer to today’s press release under the company’s quarterly report on Form 10-Q for the fiscal quarter ended June 25, 2023, filed with the SEC today and other filings with the SEC for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Please note that on today’s call, management will refer to adjusted EBITDA and adjusted EBITDA margin, which are non-GAAP financial measures. While the company believes these non-GAAP financial measures provide useful information for investors, the presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP.

Please refer to our earnings release for a reconciliation of adjusted EBITDA and adjusted EBITDA margin to their respective most comparable measures prepared in accordance with GAAP. And now I’d like to turn the call over to Russell Diez-Canseco, President, Chief Executive Officer of Vital Farms.

Russell Diez-Canseco: Thanks, Matt. Good morning, and thanks, everyone, for your time today. I’ll start by sharing updates on how we delivered on all of our commitments to our stakeholders during the second quarter. Pete will then provide some insight into how our brand continues to expand its footprint with our retail partners. Finally, Thilo will provide more in-depth information on our quarterly results and our annual guidance before we take your questions. It was another strong quarter at Vital Farms. We achieved $106.4 million in net revenue, which reflects a 28.4% increase from the prior year period. The growth was driven by price/mix of about 21% and volume growth of about 6%. Our retail footprint has expanded by almost 2,500 stores since last year, and our products are now available in approximately 24,000 locations across the U.S. Our gross margin expanded by over 500 basis points to 35.5%, and we posted another strong quarter of adjusted EBITDA performance at over $11 million, achieving an adjusted EBITDA margin of 10.7%.

We delivered these strong results even though during the second quarter or the 13 weeks ended June 25, 2023, the egg category saw retail dollar growth of only 1% compared to average growth of over 60% over each of the past three quarters. As you might recall, we anticipated this dynamic at the beginning of the year. In this environment, Vital Farms grew our dollar share significantly by about 150 basis points relative to the same period last year. We are now about 7% of the total egg category in tracked retail channels. Our overall volume in tracked retail channels grew at about 2% during the same period, ahead of the category, which declined again down over 2%. Vital Farms also gained about 15 basis points of volume share, maintaining positive momentum while many other premium brands have suffered declines in unit growth during the same time frame.

We believe our performance offers proof that we have built a strong brand that resonates with consumers despite what may be happening across the category at any given time. This is an impressive performance against a volatile industry backdrop. And I think it makes sense to review what has transpired in recent months across the egg industry and how we believe it may evolve. The industry experienced a period of prolonged price inflation over the last year, primarily within conventional eggs. Much of this inflation was driven by a supply shock caused by avian influenza, which you have heard us discuss before. As birds were impacted by the virus, the size of the U.S. land block declined and fewer eggs were produced, driving higher prices. As you’ll recall, we built these dynamics into our guidance for the 2023 fiscal year.

As we look at the industry today, the U.S. land block has largely recovered and the supply of eggs has improved dramatically from earlier in the year. As inventory has returned, prices on conventional eggs have moved below historic averages, which is similar to what occurred after the last avian influenza outbreak. We are seeing short-term promotional activity as retail partners and producers are getting back to a normal cadence. We expected promotions to increase given the return of supply at this point of the calendar year and the deals you may see from some retailers on eggs are not a surprise to us. We have purposely avoided promotions in the first half of 2023, given the industry dynamics, knowing these issues would eventually reverse.

We are prepared to resume some level of promotional activity in the back half of the year as business returns to normal. With that said, Vital Farms will not be chasing consumers to drive quick unsustainable volume gains with discount deals that dilute our premium brand. We will continue to methodically build our brand and work with our retail partners to grow the category. While the current supply situation is likely behind us, there are issues that will continue to impact the industry. We’re still focused on the thoughtful development of our unique supply chain and our relationships with our farmers, and we believe we are well positioned to withstand changes in the operating environment and continue to propel our rapid growth. Let me conclude by reiterating that we will remain focused on driving long-term positive outcomes for each of our stakeholders, including our stockholders.

This has been the goal of our business from the start, and we have been intentional about the choices we made over the past several years to drive towards this goal. We believe the decisions we make every day fully consider each of our stakeholders, which contributes to our enduring success and provides a competitive advantage. Our 2023 operating plan has always built in flexibility to drive success regardless of the external environment in the latter half of the year. We have great confidence in the trajectory of our business and are raising our fiscal year 2023 outlook for net revenue and adjusted EBITDA. Thilo will provide further details around our financial outlook later in the call. And now I’m happy to introduce our Chief Sales Officer, Pete Pappas, who will provide some context around the long-term focus of our sales strategy here at Vital Farms.

Peter Pappas: Thank you, Russell, and good morning, everyone. Our brand is an extension of Vital Farms purpose and our customers choose us because they know we are committed to improving the lives of people, animals and the planet through food. In my experience, one way to gauge the health of a brand is the ability to expand distribution on a sustained basis. In other words, getting to more doors and have more SKUs on the shelf in existing doors. With that in mind, I want to talk a bit about what we’re doing in this regard through long-term deliberate efforts, we have driven substantial growth in our market presence. As Russell mentioned earlier, we continue to successfully expand our footprint with new retail partners. We’ve added almost 2,500 stores over the last 12 months.

And as a result, our products are now available in approximately 24,000 retail locations across the United States. I’m also extremely bullish about the opportunity to place additional items on shelves with our current retail partners and the incremental net revenue it can drive for Vital Farms. We currently have an average of 2.5 SKUs per store across the food channel, which is well below our largest branded competitor who currently offers approximately six egg SKUs. Most of our SKUs have a higher velocity than the category average. In fact, we have core SKUs that are high performers relative to legacy SKUs in some of our retailers’ current sense. As we continue to demonstrate to our retail partners that adding incremental Vital Farms SKUs to their assortment lead to better category performance, we’re confident that they will add more SKUs to existing shelves in the coming years.

This strategy provides the opportunity to drive growth at both newer and legacy retail partners where innovations like True Blues or Restorative also add to our depth on the shelf. Our success in building and maintaining strong relationships with our customers has been a cornerstone of our growth. I’m proud to share that we’ve emerged as the category leader for many of our retailers, a testament to our commitment to quality, consistency and customer satisfaction. We recognize that retailers are crucial partners in both our journey and our mission, and we’ve invested heavily in fostering mutually beneficial collaborations. Through communication and tailored support, we have been able to understand and address the unique challenges faced by retailers, providing exceptional service and going above and beyond expectations.

This progress would not have been possible without the talent and tenacity of our dedicated crew across the organization and the trust our retailers place in our brand and sales leaders. We’ve worked hard to identify and onboard new retailers, strategically positioning our products for maximum visibility and accessibility. I’d also like to express my sincere gratitude to our valued retail partners and food service operators for their unwavering support. Thank you for your continued trust and confidence in Vital Farms and for your time today. With that, I’ll pass it over to Thilo.

Thilo Wrede: Thank you, Pete. Hello, everyone, and thank you for joining us today. I will review our financial results for the second quarter ended June 25, 2023. I will then provide more details about our increased guidance for the fiscal year 2023. As Russell mentioned earlier, we had another strong quarter with net revenue of $106.4 million, an increase of 28.4% compared to the prior year period. This was driven by price/mix of about 21% and volume growth of 6%. The volume growth was driven by increases at both new and existing retail customers. Let me put the volume growth in a bit of context. In Q1, we achieved 26% volume growth over the prior year period, which included a onetime benefit due to avian influenza. Last quarter, we said this was a high single-digit benefit.

Excluding this benefit, our underlying volume growth in Q1 was in the high teens. In Q2, supply returned to the market, but customer order patterns became much more volatile as retailers manage through the return of normal supply and order algorithms had to adjust for noisy baseline data. As a result, even though supply was normalizing, one could still experience empty retail egg shelves throughout Q2. We estimate that these irregular order patterns reduced customer demand for us by mid-single-digit percentage. Now that we have had more than one fourth of a normal supply, our order books have returned to more expected levels. Gross profit for the second quarter of 2023 was $37.8 million or 35.5% of net revenue compared to $24.9 million or 30.1% of net revenue for the second quarter of 2022.

Gross profit dollars benefited primarily from higher sales and the 540 basis point gross margin expansion was a result of increased pricing across our portfolio, more than offsetting a few headwinds, including higher input costs and higher packaging costs. SG&A expenses for the second quarter were $23.9 million or 22.5% of net revenue compared to $17.0 million or 20.5% of net revenue in the second quarter last year. The increase in SG&A was primarily driven by higher marketing expenses and some increased employee-related costs as we grew headcount to support our continued growth. Excluding marketing expenses, SG&A declined year-over-year as a percent of net revenue. Shipping and distribution expenses in the second quarter were $5.9 million or 5.5% of net revenue relative to $7.2 million or 8.7% of net revenue in the second quarter of 2022.

The decrease in shipping and distribution expenses was driven by a decline in line haul rates and better truckload utilization. Adjusted EBITDA for the second quarter was $11.3 million or 10.7% of net revenue compared to $3.7 million or 4.4% of net revenue for the second quarter of 2022. That marks the second consecutive quarter of double-digit adjusted EBITDA margin and was achieved despite the previously mentioned increase in planned marketing spend for the year. And lastly, an update on our capital structure. As of June 25, 2023, we had total cash, cash equivalents and marketable securities of $93.5 million, an increase of $10 million compared to the first quarter due to the strong business results. We have no debt outstanding. Before concluding the call, I want to update you on our raised fiscal year 2023 guidance.

We now expect net revenue of more than $465 million, up from our prior expectation of more than $450 million. Furthermore, we now expect adjusted EBITDA of more than $35 million, up from our prior expectation of more than $30 million. We still continue to expect that gross margin in the second half of the year will be below what we have posted in the first half of the year, primarily due to the return of a more normal promotional cadence in the back half of 2023. In SG&A, we continue to anticipate higher marketing spending in the second half of the year compared to the first half. Lastly, we are now planning for fiscal year 2023 capital expenditures in the range of $16 million to $21 million, below our prior forecast of $25 million to $30 million.

Before we open the line for questions, I would like to reiterate a few points. First, we have successfully navigated several anticipated challenging dynamics across the egg category and continue to grow our volume in the category that declined this quarter. Second, we are taking a different approach to pricing than many of our competitors to protect the retailer and consumer value equation of our brand. Third, we continue to expand our distribution at new and existing retail partners as can be seen in the growing dollar and volume share for Vital Farms. Thank you for your time and interest in Vital Farms today and for the confidence that you have placed in us with your investment. With that, we will now be happy to take your questions.

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Q&A Session

Operator: [Operator Instructions] The first call comes from the line of Pamela Kaufman of Morgan Stanley. Pamela, please go ahead.

Pamela Kaufman: Good morning. It’s good to see a guidance raise given the performance in the second quarter. But your increased EBITDA guidance implies about $10 million in EBITDA in the second half versus $25 million in the first half and a much lower EBITDA margin. So how much of this is conservatism and what’s driving your outlook for the moderation in profitability?

Thilo Wrede: Pam, thanks for the question. I think there are a few things at play. One is, we talked for the second quarter that there were a few dislocations and order patterns was a good reminder for us that while the quarter — the underlying performance in the quarter was exactly, as we expected, there’s variances from quarter-to-quarter and how this plays out. And so we just want to make sure that we are not getting ahead of our skis, if you want. So there is some conservatism in there. The other part that plays into the EBITDA guidance is we — as we mentioned, we are planning to get into a bit more regular promotional cadence, and we are planning to take up our marketing spend in the second half. And all those obviously weigh on our margin outlook. And with that, between conservatism and some planned increases in spending, we want to make sure that we don’t get ahead of our skis.

Pamela Kaufman: Okay. And then maybe can you just elaborate a bit more on what you observed from customer order patterns in the second quarter? And what you’re seeing in the third quarter so far?

Peter Pappas: Pam, this is Pete. One of the things that we saw in Q1 was a dramatic spike in orders as a result of AI. As a result of that spike. What we saw was retailer algorithms, which typically drive a lot of the order patterns kind of got a little bit — took a little bit of time for those to adjust to moderate as supplies now have come back into balance. So as those supplies — the orders have come into balance. What we’re seeing now is a much more normal — a return to normal order patterns. And as we start to promote, we’re starting to see an increase in those orders as well. So we’re very bullish about the way that we have planned the year, particularly in the back half now that these algorithms have come up with the supply imbalance. And I think we’re really well poised with the plans that we have in place.

Thilo Wrede: Everybody, please standby for a sec. We’re trying to figure out the technical issue bring up here.

Operator: The next question comes from the line of Cody Ross of UBS. Cody, your line is now open.

Cody Ross: Great. Thank you for taking our questions and good morning, everyone. A couple of questions for me. Can you just help us understand and dig into more in your prepared remarks, your decision to pull back on promotions in 2Q? And how you’re thinking about increasing your promotional intensity going forward, especially in light of what your competitors are doing.

Russell Diez-Canseco: Cody, it’s Russell. Good to be with you. So the first thing is, as Pete was describing and as we foretold when we gave our guidance at the beginning of the year, the return to normal supply throughout the industry predictably led to some sort of dislocation, I would say, in the way that retailers and distributors ordered as they had to switch from a time of scarcity to a return to a time of plenty. The short-term impact of that, and this occurred in Q2, and I believe we’re largely tested now, was that they went from having built up some inventory to drawing it down but maybe underordering and then having some sort of stock outs in their warehouses and on shelves and then they kind of bounced around over ordering and underordering for a bit.