Whole Earth Brands, Inc. (NASDAQ:FREE) Q4 2022 Earnings Call Transcript

Whole Earth Brands, Inc. (NASDAQ:FREE) Q4 2022 Earnings Call Transcript March 13, 2023

Operator: Good morning and welcome to the Whole Earth Brands Fourth Quarter and Full Year Fiscal 2022 Results Conference Call. At this time all participants will be in listen-only mode. After today’s presentation there will be an opportunity to ask questions. Please also note today’s event is being recorded. At this time I would like to turn the conference over to Jeff Sonnek, Investor Relations from ICR. Sir, please go ahead.

Jeff Sonnek: Thank you and good morning. Today’s presentation will be hosted by Irwin Simon, Executive Chairman; Michael Franklin, Interim Chief Executive Officer; and Duane Portwood, Chief Financial Officer. The comments during today’s call and the accompanying presentation contain forward-looking statements within the meaning of the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. All statements other than statements of historical facts are considered forward-looking statements. These statements are based on management’s current expectations and beliefs as well as a number of assumptions concerning future events. Such forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results to differ materially from the results discussed in the forward-looking statements.

Some of these risks and uncertainties are identified and discussed in the company’s filings with the SEC. We’ll also refer to certain non-GAAP financial measures today. Please refer to the tables included in the earnings release, which can be found on the Investor Relations website, investor.wholeearthbrands.com, for reconciliations of non-GAAP financial measures to their most directly comparable GAAP measures. Additionally, we have provided a supplemental earnings presentation on the Investor Relations website that may be useful in your analysis of the company’s performance. With that, I’d now like to turn the call over to Irwin Simon, Executive Chairman. Irwin.

Irwin Simon: Good morning everyone and thank you, Jeff. And thanks to everyone for joining the call. I’m happy to be here today to introduce our Interim CEO, Michael Franklin. On December 12th, we announced a CEO transition plan where Michael took on the Interim CEO role in addition to a seat on our Board of Directors. Since Michael’s appointment to the Board, he has immersed himself in the business and has made excellent contributions. Already, Michael has demonstrated to the team why he’s the right guy for the job. The Board and the team has been impressed by his early contributions, and we continue to be excited for what is to come. His objective approach and experience working with organizations to enhance operational efficiencies and focus on long-term value creation makes him the ideal candidate for the CEO position.

Michael has been extremely busy over the last 90 days, and I look forward to our continued partnership in the coming years. We feel great about the opportunities that lie ahead for Whole Earth with our leading portfolio of better-for-you brands and the innovation that we are bringing to the market. With that, I’d like to turn the call over to Michael for his remarks. Michael.

Michael Franklin: Thank you for that introduction Irwin. Good morning, everyone and thank you for taking the time to join the call. As you know, in August 2022, I joined the Whole Earth Brand’s Board of Directors. I joined the Board because of my belief in the business and my desire to add value and help the team achieve its full potential. Since becoming Interim CEO, my belief in the long-term opportunity for the business has only been reinforced. This is a business with great people, great brands, and immense potential to create significant value for shareholders. With that said, 2022 was a challenging year, a year where the company fell short of its forecasts and expectations, hence the need for positive change. Improvements are being made, strategies updated, and action plans are being implemented.

Our plan is to provide the investment community with a detailed presentation on our strategic action plan and long-term financial goals in the third quarter of this year. Our CFO, Duane Portwood, will review the fourth quarter full year 2022 results and introduce our 2023 guidance. Before passing the call to Dwayne, I’d like to briefly share some of my initial observations, as well as some areas of immediate focus that we are uniting around to maximize our competitive strengths while optimizing our operations to achieve our goal of generating stable and sustainable long-term profitable growth. Since joining the board and assuming my leadership position, I have traveled extensively, meeting with our teams across the world in locations including Alabama, Chicago, Czech Republic, Dubai, Houston, London, Mexico, and Paris.

My approach has been to be an active listener, understand both the positive and negative influences of our corporate culture, and to challenge the status quo. I want to make sure that as we evolve our strategy to drive top line growth, improve operational effectiveness, and increase margins and cash flow I understand the specific challenges and opportunities faced by our operating management teams. I believe that this investment in meeting people face to face was an important first step in developing our plan for the future. In my travels, I was incredibly impressed by the depth and quality of our team, as well as the great deal of enthusiasm from our people at the operating level. The Board and I have high expectations for the future of this business.

Building the strategy together is essential to making sure the company meets or exceeds expectations in the future. As you will see in our guidance, while we believe the path forward is full of opportunities, 2023 will be a building year for our longer-term financial goals. Accordingly, we anticipate 2023 will be similar to 2022 in terms of financial results. This year, we will be focusing on improving our operations and creating a foundation from which we can deliver sustained, profitable growth. Today, our business has unnecessary complexities that we are starting to simplify. While we have both short and long-term opportunities, we anticipate it will take 24 months to capture the full benefit of many of our initiatives. As I said at the beginning of my remark, I believe Whole Earth has significant opportunities for success.

To demonstrate my beliefs and commitment, I have asked that until the business has stabilized, I receive no cash salary for my role and that I only receive equity incentive compensation as I deeply believe in the value creation opportunities for all stakeholders. Globally, our CPG product assortment is well positioned in the current environment with a host of brands that support and drive unique consumer preferences, while also offering entry level price points for consumers that are feeling the effects of high inflation. The branded portfolio is supported by our private label and ingredients businesses, which helps us to develop stronger and broader customer relationships as well as significant purchasing scale. Our diversification extends to channel presence, product assortment, and geographical reach.

This is a strength that continues to drive the underlying growth of our entire branded CPG segment. Our flavors and ingredients segment is a dominant market leader with high barriers to entry, a strong free cash flow generator, and a global leadership position that will support our broader growth initiatives as we further diversify and grow Whole Earth Brands. This diversification in both revenue and cash flow is particularly valuable in a public company environment. Strategically improving our operational execution is an area of the business that we can continue to push forward. As has been discussed over the past several quarters, our manufacturing inconsistency at the Alabama facility cost us dearly in 2022. We still have important work to complete in 2023 with respect to optimizing our network and returning the business to an asset light state.

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This will assist us in controlling costs, delivering margin, managing working capital, and ensuring that we are delivering on our commitments with customers. Further reflecting on 2022 as I alluded to earlier, it was a year of challenges. Some of these were brought about by the pandemic and macroeconomic forces. Variables such as shifting consumer spending and preferences, labor complexities, rampant inflation, interest rates, and foreign exchange movements. It must be said some of our challenges were operational footfalls that are far along in being resolved. Taken together, our margins were under pressure despite our pricing, de-rationalization, and productivity strategies. We see 2023 as a year of stability and evolution. Our manufacturing footprint optimization will play a critical role in our strategy to right size our cost base, and we will continue to thoughtfully execute our SKU rationalization efforts.

We also intend to start reinvesting in our strong portfolio of brands. This was an area that was negatively impacted by the operating environment over the past couple of years, but as a core tenet of effective brand building and growing household penetration, you can expect us to commit more dollars to areas such as trade spend and marketing in the year ahead. Our near-term focus is to draw the best out of our culture while making sure that corporate function is there to serve the business rather than the other way around. We are already in the process to reframe our structure to be more efficient. We carry too many costs for a business this size, and this is being addressed in real time. Our leverage is also higher than our long-term goal of net debt-to-EBITDA of three times, which will be one of our financial targets we outlined at our Investor Day.

We will achieve this through free cash flow generation for debt reduction and EBITDA growth. In summary, I am confident that our outlook is positive, but I also believe that it’s necessary to make some select reinvestments in our organization including our greatest asset, our people. We will take our strong foundation and reinforce it for the long term. It is imperative that we repair our margin profile as it is the primary means by which we will generate higher growth of operating cash flows. In turn, this will allow us to delever the business and position the company to take advantage of the multitude of consolidation opportunities that we see in the marketplace today. Before passing the call over to Duane, I wanted to address the recent press that many of you may have seen regarding Erythritol.

Since 1991, in the U.S. the FDA has approved Erythritol for use in foods and drinks and has certified it as generally recognized as safe. Similarly, Erythritol has been approved for use in more than 50 countries, including the European Union, Canada, Argentina, Australia, Japan among others. The recently released report is contrary to decades of proven scientific research. Like any through product we sell, we will continue to monitor and work with local authorities and industry experts to ensure that we are delivering the highest quality products to our loyal customers. With that, I’ll pass the call over to Duane to go over Q4 results and 2023 guidance. Duane?

Duane Portwood: Thank you and good morning to everyone. As a reminder, please refer to our non-GAAP reconciliations at the end of the press release for additional detail, and I encourage you to view the supplemental earnings presentation on our Investor Relations website. For the fourth quarter ended December 31, 2022 consolidated product revenue grew 4.7% to $138.9 million versus the prior year quarter. On a constant currency basis, product revenues increased 7.0% versus the prior year fourth quarter. The increase was driven by increased pricing. Reported gross profit was $28.3 million compared to $38.7 million in the prior year fourth quarter. The decrease was largely driven by cost inflation, costs associated with the supply chain reinvention project, and $2.5 million of headwinds from favorable noncash amortization of purchase accounting adjustments related to inventory revaluations in the prior year period that did not recur this year.

These were only partially offset by the benefits of our pricing actions. Adjusted gross profit was $40.1 million compared to $45.2 million in the prior year period. Reported gross profit margin was 20.4% in the fourth quarter of 2022 compared to 29.2% in the prior year period. Adjusted gross profit margin was 28.9% compared to 34.0% in the prior year. The majority of this decline was primarily a function of higher cost of goods sold due to cost inflation and increased prices. This resulted in higher sales to protect year-over-year gross profit dollars, but on a percentage basis, results in a lower gross profit margin. In addition, the decrease was due to cost inflation above these price increases including increased sugar tariffs as demand for our organic sugar continues to be strong.

During the quarter, we recorded a noncash goodwill impairment charge of $46.5 million. Most of this charge related to our North America branded CPG reporting unit and was driven by a number of factors, including rising costs, supply chain investments and increased discount rates. Consolidated operating loss was $46.2 million, including the $46.5 million noncash goodwill impairment charge compared to operating income of $6.4 million in the prior year fourth quarter. Consolidated net loss similarly reflects the impact of the impairment charge and was $60.3 million compared to a net loss of $0.4 million in the prior year period. Consolidated adjusted EBITDA was $20.2 million compared to $20.6 million in the prior year fourth quarter. The decrease was primarily due to unfavorable foreign currency impact of $0.9 million due to the strengthening U.S. dollar.

Excluding the foreign currency impact, consolidated adjusted EBITDA increased 2.4%. Now shifting to the segment results for Q4. Branded CPG segment product revenue increased $3.8 million or 3.6% to $109.4 million for the fourth quarter of 2022 compared to $105.6 million for the same period in the prior year. On a constant currency basis, segment product revenue increased 6.0% compared to the prior year, driven primarily by pricing actions. Overall, volume was down 2.4% due to the discontinuance of certain private label SKUs at the beginning of 2022. Excluding the impact of the SKU rationalization, Branded CPG volume was essentially flat versus the prior year quarter. Operating loss for the Branded CPG segment was $47.7 million in the fourth quarter of 2022 compared to operating income of $4.4 million for the same period in the prior year.

The decrease was primarily driven by the aforementioned noncash goodwill impairment charge that falls within the Branded CPG segment. To a lesser extent, operating loss was also impacted by costs associated with our supply chain reinvention project, the impact of cost inflation, and an unfavorable impact from a stronger U.S. dollar, partially offset by pricing actions. Our Flavors & Ingredients segment continues to perform well with product revenue up 8.6% to $29.5 million for the fourth quarter of 2022 compared to $27.1 million for the same period in the prior year. On a constant currency basis, segment product revenue increased 11.0% primarily due to strong volume growth of 5.6%, driven by growth in liquid extracts and pure derivatives, resulting from the company’s commercial expansion and innovation efforts.

Pricing was also a significant contributor, increasing 5.4% versus prior year. This was the fifth consecutive quarter of double-digit top line constant currency growth for the Flavors & Ingredients segment. Operating income for the Flavors & Ingredients segment was $8.4 million in the fourth quarter of 2022 compared to operating income of $7.6 million in the prior year period. The increase was primarily driven by revenue gains, partially offset by $2.5 million of headwind that I noted previously associated with the favorable amortization of purchase accounting adjustments in the prior year period related to inventory revaluations that did not reoccur in the current quarter. Operating expenses for corporate for the fourth quarter of 2022 were $6.9 million compared to $5.7 million in the prior year period.

Now I will briefly cover our full year results. As a reminder, we acquired Wholesome on February 5, 2021. I will speak to reported results, which include Wholesome for the full year of 2022. Additionally, we will provide some select Pro Forma results as if we owned Wholesome for the entirety of 2021 to assist in your analysis of the organic growth of the combined portfolio. For the year ended December 31, 2022, consolidated product revenues grew 9.0% on a reported basis to $538.3 million versus the prior year. On a Pro Forma basis, organic constant currency product revenue increased 7.1% compared to the prior year. Consolidated operating loss was $24.6 million compared to operating income of $22.8 million in the prior year. Consolidated adjusted EBITDA decreased 3.7% to $79.2 million, which included $3.9 million of unfavorable foreign currency.

Excluding the impact of foreign currency, consolidated adjusted EBITDA increased 1.1% for the full year. Now moving to cash flow and the balance sheet. Cash used in operating activities was $5.8 million, and capital expenditures were $8.9 million for the year ended December 31, 2022. Although free cash flow in 2022 will be negative $14.7 million due to increased working capital investment and approximately $22 million in cash add-backs, primarily related to the supply chain reinvention, we did achieve our goal of generating positive free cash flow in the fourth quarter, generating approximately $9.5 million, driven by lower working capital, which reversed a portion of the build we had seen in the first three quarters. With respect to 2023, we anticipate free cash flow in the positive mid-single-digit millions as lower working capital requirements and significantly reduced cash add-backs will largely be offset by increased interest costs.

As of December 31, 2022 we had cash and cash equivalents of $28.7 million and $432.2 million of long-term debt, net of unamortized debt issuance costs. Our long-term debt increased from year-end 2021 by approximately $49 million, primarily due to $51 million of draws on the revolving credit facility. These proceeds were used to fund a portion of the Wholesome earn out payment in the first quarter and to fund increased net working capital levels, primarily related to higher levels of inventory, resulting from increased costs and to improve customer service as well as timing. At December 31, 2022, there was $76 million drawn on our $125 million revolving credit facility. Reducing leverage over the intermediate term is a top corporate priority.

For 2023, however, we expect our leverage ratio to remain at current levels. Before I cover our outlook for 2023, I’d note that we’ve initiated actions to close our Decatur, Alabama production facility. We took control of the facility in the summer of 2021 as a result of financial difficulties that the co-packer was experiencing. Subsequently, we experienced supply difficulties resulting from labor force availability challenges due to the pandemic. During 2022, we worked hard to improve manufacturing production and restore customer service levels as separate as a result of the supply difficulties. While I’m pleased to say that we were successful in that regard, it is clear that the costs associated with that facility are structurally too high which was the basis for the decision to shut down this operation.

Our team is already shifting this production to other co-packers across our network who have the advantage of greater scale so that we can lower our per unit cost to levels that are more appropriate. As a result, you can expect some onetime expenses associated with these actions in 2023. Now shifting to our full year 2023 outlook. As a reminder, our outlook is presented on a reported basis which includes the impact of foreign currency translation and our expectations for growth are presented on an organic basis. For 2023, we expect consolidated product revenue to be in the range of $550 million to $565 million, representing growth of 2% to 5%. We expect consolidated adjusted EBITDA to be in the range of $76 million to $78 million. While we are not providing quarterly guidance, we do expect the first quarter to be the lowest quarter in terms of overall adjusted EBITDA and adjusted EBITDA margin.

Finally, we expect total capital expenditures to be approximately $9 million. That concludes our prepared remarks. Operator, now back to you. Please open the call for questions and answers.

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Q&A Session

Operator: . And our first question comes from the line of Brian Holland with TD Cowen. Please proceed with your questions.

Brian Holland: Yeah, thanks, and good morning. If I could start with the Erythritol where Michael, you made comments towards the end of your prepared remarks. Maybe just a couple of questions there. One, can you give us a sense of how much exposure your portfolio has to that specific sugar replacement? And then appreciate your points about kind of the long-term research that’s been done around Erythritol. But obviously, that is going to — I don’t know how much of an impact that’s going to have with respect to whatever the consumer response will be to the Cleveland Clinic report. So any sense yet from retailers or customers or consumers, excuse me, how they feel about what’s coming out of the Cleveland Clinic and how they might respond?

Michael Franklin: Yup, thanks Brian. I’m happy to take that. So with regard to Erythritol, similar chart what I shared in our prepared remarks, we’ll continue to monitor the situation closely. And for us, like any ingredient, any product that we sell, we don’t disclose what amount of that product account for what percent of sales and we won’t be doing that on this call. With respect to customers, retailers, and partners that we have, look for us, we’re working with our customers. We’re working with our retailers. We’re making sure that, obviously, we want to deliver the best products to our loyal customer base. And so we continue to see, obviously, consumers continuing to purchase these products and for us making sure that we’re reacting on the forefront and adjusting accordingly, we’ll continue to monitor that over the coming months and the existing reaction.

Brian Holland: Okay. As we think about the 2023 outlook, I’m just curious if there’s any assumption for adverse impact to your products that do have exposure to Erythritol, if you made any assumptions for any decline in consumption as with respect to that?

Michael Franklin: Yes, I mean, we’ve obviously — we’re putting together our 2023 plan. We included that in terms of what we could see from a consumer perspective. But the truth is we continue to see demand for our products continue to be strong. We’re working through it now and that is reflected for our 2023.

Brian Holland: Yes. .

Irwin Simon: Mike, just let me say something about Erythritol. I think guys, again, I think every week, there’s a study that comes out in regards to the ingredient in the product. And I’ve been through it many, many times. And I think as we’re governed by the FDA and we’re governed by a lot of regulatory, we’re going to ensure for safety and health of our consumers. But I think ultimately out there, there’s a lot of products out there besides Whole Earth, and there’s a lot of products out there that contain Erythritol. And actually, Erythritol is one of the highest ingredients to increase because of corn and that coming from Ukraine. So I hear you on that, and I think we’re going to keep an eye on it. And if there’s an ingredient as substitute, we will do that.

But it’s not the whole thing that makes up our business. That’s not what — we’re not just in the Erythritol business. And so far, as Mike said, we’re not seeing a major impact from it and we’ll absolutely keep an eye on it. But I think we’re used to this, but with the Cleveland Clinic or the different associations come out with a finding, and this is something that’s been going on for seven years, and I’m not sure of all the signs behind it, too. So Mike.

Brian Holland: Last one for me. Michael, you talked about I think, providing a long-term outlook later this year. I think what the company has spoken to in the past as far as long-term targets are mid-single-digit organic growth, mid- to high single-digit adjusted EBITDA growth. Can you just — certainly, when there’s a CEO transition, obviously, by the time of this guidance was given, the environment has been very dynamic ever since then. Has anything from your perspective changed such that it should structurally alter the outlook that was out there prior to your arrival, are those goals generally still attainable, or is something structurally altered such that any of that wouldn’t be attainable down the road?

Michael Franklin: Yes, look, we’re excited to provide a more fulsome presentation of our long-term goals and how we plan on getting there in the third quarter of this year. We look forward to hosting an Investor Day to do that. But no, I think in terms of our long growth algorithm, I think that it’s relatively consistent, looking to grow our revenue base by mid to high single digit. And EBITDA concurrently, rather relentless focus on cash flow this year. But in the third quarter, we’ll share on that long growth in terms of our financial targets.

Brian Holland: I will leave it there. Thanks. Best of luck.

Michael Franklin: Thanks Brian.

Operator: Our next question is from the line of Rob Dickerson with Jefferies. Please proceed with your questions.