Sovos Brands, Inc. (NASDAQ:SOVO) Q4 2022 Earnings Call Transcript

Sovos Brands, Inc. (NASDAQ:SOVO) Q4 2022 Earnings Call Transcript March 8, 2023

Operator: Thank you for standing by, and welcome to the Sovos Brands Fourth Quarter and Fiscal Year 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers’ presentation, there’ll be a question-and-answer session. As a reminder, today’s call is being recorded. I will now turn the conference to your host, Mr. Josh Levine, Vice President of Investor Relations. Please go ahead, sir.

Josh Levine: Good afternoon and thank you for joining us on Sovos Brands fourth quarter and fiscal year 2022 earnings conference call. On the call today are Todd Lachman, President and Chief Executive Officer; and Chris Hall, Chief Financial Officer. By now, everyone should have access to the earnings release for the period ended December 31, 2022, that went out this afternoon at approximately 4:00 p.m. Eastern Time. The press release as well as supplemental slides can be found on the company’s website at ir.sovosbrands.com and shortly after the conclusion of today’s call, a webcast will also be archived and available for replay. Before we begin, let me remind everyone that today’s discussion contains forward-looking statements based on the environment as we currently see it, and as such, does include risks and uncertainties.

If you refer to the company’s earnings release as well as its most recent SEC filings, you will see a discussion of factors that could cause Sovos Brands’ actual results to differ materially from these forward-looking statements. Please remember the company undertakes no obligation to update or revise these forward-looking statements in the future. We will make a number of references to non-GAAP financial measures. We believe that these measures provide investors with useful perspective on the underlying growth trends of the business and have included in our earnings release a full reconciliation of non-GAAP financial measures to the most comparable GAAP measures. Please note that all consumption data cited on today’s call will refer to dollar consumption as of the 13 week period ended December 25, 2022 and growth versus the prior year comparable period unless otherwise noted.

And lastly, to avoid any confusion, organic net sales growth for the fourth quarter and fiscal year 2022 represents growth on a 13 and 52 week comparable basis that excludes the extra week. For discussions pertaining to fiscal 2023, including our guidance and growth expectations, organic net sales growth is calculated as net sales growth adjusted for Birch Benders and the 53rd week in 2022. With that, I would now like to turn the call over to Todd.

Todd Lachman: Thanks, Josh. I’m very excited today to share with you our outstanding results for 2022, highlighted by double-digit volume growth. Rao’s continued rapid March to $1 billion of net sales and our strong fourth quarter performance that is carried into 2023. I will then hand it over to Chris Hall to provide greater detail on our fourth quarter and full year as well as our initial 2023 outlook. Sovos Brands delivered another year of sector leading growth in 2022 with organic net sales up 19.5%, accelerating to 28.4% in the fourth quarter. In fact, organic net sales growth in the quarter was the highest for Sovos Brands and Rao’s since the first quarter of 2021. Importantly, our top line performance was driven primarily by volume as opposed to price, which highly differentiates us from the majority of our packaged food peers.

Specifically, volume contributed 10.8% and 16% to full year and fourth quarter growth respectively. And by the way, this momentum has carried into the start of the year with net sales in January and February coming in strong. The strength of our fourth quarter top line translated into equally impressive bottom line results with adjusted gross profit and adjusted EBITDA dollars of 29% and 40% respectively versus prior year. It’s important to highlight that we delivered our results against a very challenging operating environment. Our teams responded tenaciously to overcome supply chain challenges during a year of global supply constraints and rapid inflation. Our customer service levels for sauce and yogurt are now at or above target levels.

Our robust slate of automation and productivity projects are delivering on cost savings objectives and our inventories are in a healthier position than at any time since the beginning of the pandemic. We also divested Birch Benders at the end of fiscal 2022, allowing us to focus our resources on driving Rao’s towards $1 billion of net sales and beyond. Excluding Birch Benders, our full year organic net sales growth would’ve been 23.5% versus prior year. And as Chris will talk more about the continued momentum we are seeing in our business and a much simpler portfolio will help us achieve our guidance of double-digit growth for organic net sales and adjusted EBITDA in 2023. The volume led growth of Sovos Brands underscores the strength of the Rao’s franchise and the long runway of opportunity still ahead.

Rao’s had another impressive year, surpassing $0.5 billion of net sales, up 35% organically for the full year and accelerating to 45% in the fourth quarter. While we have quintupled household penetration for Rao’s since we acquired the brand in 2017, household penetration is still just 15% today with awareness at only 58%. With plans to grow our marketing and R&D spend double-digits in 2023, we are confident that we can continue to drive years of sustainable volume led growth into the future. Total Rao’s franchise dollar consumption for the fourth quarter grew 24.8% led by 16.6% unit growth driven by broad base gains and distribution and velocities. Total Rao’s household penetration increased to 15.2%, up 210 basis points versus prior year, as a result of adding new households across all categories.

Rao’s sauce achieved notable milestones during the year. Measured retail sales surpassed $0.5 billion, up 26.9% versus 2021. The fastest rate of growth for any scaled brand in the category. And for the first time, Rao’s was the number two ranked pasta and pizza sauce brand reaching a 14.7% dollar share for the year, up 150 basis points versus 2021. A remarkable improvement from the number seven position when we acquired the brand. While unit share, household penetration and awareness are all well below our peers, Rao’s soft dollar velocities are double the category average, while providing superior penny profits for the retailer, highlighting the massive opportunity ahead. For the fourth quarter, Rao’s dollar and unit consumption and sauce increased by 20.3% and 8% respectively with high single-digit unit growth coming in ahead of flattish category growth.

To build on our momentum, I’m also excited to share that we will be launching some new flavor innovations within the Rao’s sauce portfolio. Seeking to meet consumer demands for elevated culinary experiences at home, specifically caramelized onion, vodka arrabbiata and four cheese Alfredo pasta sauces, as well as arrabbiata pizza sauce will be hitting retail shelves later this year. And if you happen to be at the Natural Products Expo this week, feel free to stop by to try them out. Our newer Rao’s beachhead categories of soup, pasta and frozen, all continued to grow well ahead of their categories in the quarter, generating combined dollar and unit consumption growth of 45.5% and 41.1% respectively. With our business in each category growing dollars and units at least 30%, household penetration and dollar shares are at or below 2% for the Rao’s brand in each of these categories, reflecting material runway ahead.

In the second half of 2022, we conducted a test of Rao’s frozen pizza across select retailers. Due to successful test market results, we’ll be expanding nationally in 2023. A range of brick oven crust frozen pizzas made with Rao’s authentic pizza sauce and whole milk mozzarella cheese are a differentiated case-led premium offering in a large and fragmented category right for disruption. This is a natural extension of the Rao’s brand and an exciting opportunity to continue to offer the consumer restaurant quality food across the store. Turning to noosa, our yogurt business crew consumption low single-digits on a dollar basis in the quarter with pricing and mix driving the growth. We continue to fine tune our promotional strategy and have seen our consumption data improve in recent periods, bolstering our momentum towards a fourth straight year of growth for the brand.

We’re also delighted to announce some exciting news for the Michael Angelo’s brand. We recently launched the brand’s first innovation outside of the freezer, introducing four new mid-price skews into the pasta sauce category exclusively with a select retailer. This new line of delicious sauces uses 100 year old recipes inspired by Michael Angelo’s Sicilian matriarch, Nonna Foti and leverages the brand’s authentically Italian heritage. This allows Sovos Brands to capture more eating occasions by offering great tasting foods made with high quality ingredients at multiple price points. We see this as a highly incremental growth opportunity for the company and our retail partners. In January, as you likely saw, we disclosed that we divested the Birch Benders brand to Hometown Food Company, which resulted in a reduction in the categories in which we compete by nearly 50%.

Our ongoing efforts to create a more focused portfolio allow us to direct more resources and investment towards our most meaningful value creation opportunities, notably accelerating Rao’s to $1 billion of net sales and beyond. In summary, we are very pleased with our fiscal 2022 performance and momentum as we enter 2023. We are excited by what the future holds for our portfolio of brands led by Rao’s. Our growth trajectory and focus brand portfolio will enable another year of double-digit organic net sales, and importantly, robust adjusted EBITDA growth. This outlook notably includes continued increases in growth-oriented investments to support brand building, innovation and capabilities, helping us sustain our sector leading growth. I will now hand it over to Chris for more details on the quarter and year as well as our guidance for 2023.

Chris Hall: Thank you, Todd, and good afternoon, everyone. For the full year total net sales of $878.4 million increased 22.1% or 19.5% on an organic basis, driven by 10.8% volume and 8.7% price, excluding Birch Benders, our full year organic growth would have been 23.5%. Fourth quarter total net sales of $262.1 million, a $72.9 million or 38.5% increase over the prior year period, excluding the extra week organic growth of 28.4% was driven by 16% volume and 12.4% price. The extra week added $19.1 million or 10.1% to our quarterly growth excluding Birch Benders, our consolidated fourth quarter organic growth would’ve been 30.1%. Looking at our portfolio, we grew across nearly all categories and from a brand perspective, Rao’s remained the key driver.

As a reminder, Rao’s is our largest brand now accounting for nearly 70% of our annual net sales. Rao’s is also our fastest growing brand up 34.9% on an organic basis in 2022. And our Dinner and Sauces segment account for the majority of our EBITDA. For the quarter, Rao’s increased total net sales 56% or 44.6% on a comparable 13-week organic basis. This performance was driven first by approximately 25% net sales growth and measured channels that was generally in line with our consumption growth. Second, we saw particularly strong non-measured channel growth behind new events and distribution wins. And third, we benefited from some pipeline sale ahead of early 2023 distribution gains that will benefit us during the New Year. Beyond Rao’s, total net sales growth in the fourth quarter was up 12.5%, for noosa down 0.3% for Michael Angelo’s, and up 6.7% for Birch Benders.

On an organic basis, noosa grew 4.3%, Michael Angelo’s was down 7.1% and Birch Benders was down 1.2%. Adjusted gross profit of $76.5 million increased $17 million or 28.6% year-over-year. Double-digit volume and pricing growth as well as productivity savings more than offset the impact of low-double digit inflation. Adjusted gross margins were 29.2% for the quarter slightly ahead of our expectations, reflecting a 220 basis point decline versus a prior year period. We made meaningful improvements on gross margin during the year with our second half gross margin of 29.5% well above to 26.9% we generated in the first half, reflecting our commitment to improve margins while still growing the top line. Our CapEx enabled automation projects in our Austin manufacturing plant are now up and running, delivering cost savings and improved service levels.

Finally, note that the combination of our pricing and productivity efforts in 2022 will provide a tailwind as we enter the first half of 2023. $42.4 million of adjusted operating expenses inclusive of marketing and selling increased by $6.7 million or 18.8% over the prior year period, driven by growth enabling investments primarily to support our talent and capabilities. Adjusted EBITDA of $37 million, increased $10.5 million or 39.7% versus Q4 2021, while adjusted EBITDA margin was 14.1%, up 10 basis points versus the prior year period. Net loss for the quarter was $28.7 million, or negative $0.28 per diluted share compared to a loss of $3.8 million or negative $0.04 per diluted share in the prior year period. The loss in this year’s fourth quarter was largely due to the loss on asset sale related to the Birch Benders divestiture.

Adjusted net income was $19.6 million and adjusted EPS was $0.19 per diluted share, compared to adjusted net income of $13 million and $0.13 per diluted share in Q4 2021. On a full year basis, adjusted net income was $60.4 million or $0.60 per diluted share. At the end of the fourth quarter, cash and cash equivalents were $138.7 million and total debt was $482.4 million. We’re very pleased with our progress on leverage, which finished the year at 2.9 times. Better than expected year-end net leverage was driven by strong cash generation and EBITDA in the quarter, as well as the proceeds from the Birch Benders divestiture. Our strong cash position gives us enormous flexibility to invest further in our brands. I would now like to provide some detail on fiscal year 2022 results for Birch Benders.

On a full year basis, total net sales were $41.2 million, an adjusted EBITDA with negligible, reflecting elevated reinvestment into the brand with bottom line performance relatively consistent by quarter. I will now turn to our fiscal 2023 outlook in some of the underlying assumptions that support it. Specifically for net sales, we are guiding to a range of $900 million to $925 million. This reflects organic net sales growth of 10% to 13%, which adjusts for Birch Benders and the 53rd week in 2022. We expect our growth to be balanced across volume and price with price moderating during the year as we last year’s actions. We also assume that elasticities will normalize given the potential that macroeconomic challenges could materialize. Lastly, we are pleased with our overall promotional strategy and anticipate our cadence in 2023 to be similar to 2022.

For adjusted EBITDA, we are guiding to a range of $130 million to $135 million reflecting growth of 9% to 13%. Embedded in this guidance is moderate gross margin improvement for the full year, driven by pricing and productivity that we expect will fully offset mid-single digit inflation. We also will increase our growth investments, specifically supporting our brands, people, and capabilities to help us capitalize on the multi-year opportunity ahead. This includes a strong double-digit increase in marketing and R&D. Below the line, we are guiding net interest expense to be in the range of $36 million to $40 million. As a reminder, half our debt is floating while we have cap the other half at an effective 7.5% interest rate. We expect our adjusted effective tax rate to be in the range of 25% to 27%.

For a summary of these and other annual guidance items, please see Slide 16 in our earning slide deck posted on our Investor Relations website. Finally, I would like to provide some color on our expectations for the phasing of the year. Overall, we expect double-digit organic net sales growth in both the first and second half of the year. For adjusted EBITDA, we expect growth and margin expansion to be higher in the first half, and as a result, EBITDA dollars should be more balanced between the first and second half of the year than in 2022. Let me now turn the call back over to Todd for some final remarks.

Todd Lachman: Thanks, Chris. We are very proud of what we achieved in 2022. We generated volume led 22% sales growth, year-on-year bottom line growth and catapulted forward on our March to $1 billion of net sales for Rao’s. None of this would’ve been possible without our great team and the incredible frontline employees that come to work every day to support our business and deliver these strong results. As we look forward, we are confident in executing against the comprehensive plans we discussed to deliver double-digit growth for the top and bottom line in 2023. With that, Chris and I are now available to take your questions. Operator?

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Q&A Session

Operator: Thank you. Our first question comes from Ken Goldman of JPMorgan. Your line is open.

Ken Goldman: Hi, thank you. Good afternoon.

Todd Lachman: Hey, Ken.

Ken Goldman: Just curious Chris, how big was the ship in that you mentioned in the quarter for pipeline fills and some new distribution? And as we think about modeling the first quarter, I know you gave some cadence items there, but should we essentially just pull that amount out of the quarter or there are some offsets that we should think about too?

Chris Hall: Hey, thank you, Ken. We did get some very nice distribution gains here as we kickoff the year. We’re seeing that in our consumption results ramping up week after week after week. What we shipped out at the end of 2022 for that pipeline, had a €“ did I call it a immaterial impact on our Q4 results? It did account for some of our beat to our guidance, but it won’t have an impact on Q1 because we’re seeing that consumption growth that we would want from that space. So I wouldn’t reflect anything of a reduction to Q1 based on a small pipeline fill.

Ken Goldman: Got it. Okay. Thank you. And then my second question, we’ve seen, you and I have talked about this some of these sort of entry level premium brands and sauce, for lack of a better phrase, sort of coming in, not taking a ton of share, but doing reasonably well on a small level. I’m just curious how they’re performing now against your expectations. And if you’re doing anything in particular to combat them and I guess where I’m going with that is this sort of where the Michael Angelo’s introduction into sauce is going to kind of be that entry level premium? Or is that more truly mid-tier?

Todd Lachman: No, I mean, I think €“ hey Ken, how are you doing? It’s Todd. You can call it kind of mid-tier or entry level premium. I actually think they’re a bit one and the same. So yes, I mean, honestly, there have been some competitive entrance in that area that that’s a growing space and we see that as an opportunity. I mean, look, we’re a sauce company through and through. Clearly Rao’s is on fire and I’ll talk about that subsequently. But we’ve been looking at this for a while and felt that there was a distinct opportunity to leverage another equity. Michael Angelo’s, which we have, we’ve tested this conceptually, we’ve tested product wise and it keeps hitting out of the park, but the price €“ that price range of like $4 to $5-ish, which is about 50% premium to mainstream for perspective, that’s about 30% less average to average-ish to Rao’s.

That’s like a €“ that’s a nice area right now that we just felt was an opportunity to leverage our Michael Angelo’s equity. The products are very different except what Michael €“ we’re offering though is a slow simmered whole tomato based sauce with real ingredients. So at a premium to mainstream, albeit not as high as Rao’s, you’re getting something that is different than tomato paste plus water, plus sugar, plus canola oil, plus dehydrated onions, which that’s mainstream sauce. That’s the private label analog. But it’s very differentiated verse Rao’s both label, proposition, packaging, texture we’ve made sure of that. And in the end of the day, with only 6% of the units, Rao’s, your source of volume will come proportionally from all players.

So 95%-ish, 90%, 95% of the units that we will source from Michael Angelo’s in this entry, which is only starting off with one customer I’ll be the larger one. We’ll be coming from competitive, the competition versus Rao’s. So we see this as a really smart thing to do. We’ve had our eyes on this space for a while and we’re excited to see what’s to come.

Ken Goldman: Thank you.

Todd Lachman: Thank you, Ken.

Operator: Thank you. Our next question comes from the line of Andrew Lazar of Barclays. Your line is open.

Andrew Lazar: Good afternoon, everybody.

Todd Lachman: Hello, Andrew.

Andrew Lazar: One quick clarification first. With the pipeline fill that you were talking about earlier, did you say it was material to 4Q sales or immaterial to 4Q sales?

Todd Lachman: Yes. No, it was immaterial, not material to Q4, which as you’ve seen was a tremendous quarter for Rao’s and for the business in general.

Andrew Lazar: Got it. So was there much of a differential in between consumption and shipments for Rao’s or not so much in the fourth quarter?

Todd Lachman: Yes. No. So you’ll see for Q4 we’re seeing in our consumption reports, IR reports is lower than our shipments and there’s a few drivers for that. When you look at pure retail, which was up roughly 25% in consumption really mirrors our shipments as well. So we were right in line there both for Q4 and for the full year. We had a particularly strong quarter and non-measured channels. We had a very, very favorable event that a single customer and we also picked up distribution across a few other outlets that we had a good building up across the year that really took flight in Q4. And that’s true, not just in thought, but really across all the categories within Rao’s and the totality of our beat to our previous guidance as well as our uptick from consumption to shipments, really what’s seeing across the Rao’s business.

Andrew Lazar: Thanks for that.

Chris Hall: Yes. Let me just build up, because what is material is the distribution gain that we’re seeing now in market, and I think that is really important. I’ll give you perspective, we just using sauce as an example for the fourth quarter TDPs were up about 7% year-on-year in the fourth quarter. If I look at the last 13 weeks ended 226, fresh data up 22% versus prior year. So €“ and again, that is on a brand now that organically was $566 million of sales, that’s total franchise. But we have very meaningful distribution gains as I’ve been talking about a lot, Andrew, with you and others on these calls that there is still major win to chat, major opportunities for further distribution gains and I’ll talk more about that in a bit.

But in the end right now, 22%. And so what we’re seeing is, we increased penetration in total franchise almost between 200 basis points, over 200 basis points from 13.1% to 15.2%. And we increase 100 basis points year-on-year on sauce, and we see both of those up meaningfully in two months into the quarter, not going to quote exact number, we’ll talk about that on our next call, but those distribution gains are playing through right now in consumption and most importantly to us in household penetration gain.

Andrew Lazar: Got it. That’s great to hear. I appreciate that detail. And then just Chris, could you just briefly walk us through some of the puts and takes around gross margin for 2023. Obviously, you’ve got pricing and productivity that sounds like it’s going to take care of what the mid-single digit inflation that you’re looking for the coming year. What are the things should we think about? Because in theory, I would think that the potential for gross margin recovery, maybe I would’ve thought could even be greater than moderate, but I’m probably not taking into account some things.