TreeHouse Foods, Inc. (NYSE:THS) Q4 2022 Earnings Call Transcript

TreeHouse Foods, Inc. (NYSE:THS) Q4 2022 Earnings Call Transcript February 13, 2023

Operator: Welcome to the TreeHouse Foods’ Fourth Quarter 2022 Conference Call. All participants will be in listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note that this event is being recorded. At this time, I would like to turn the call over to TreeHouse Foods for the reading of the Safe Harbor statements.

P.I. Aquino: Good morning and thank you for joining us today. Earlier this morning, we issued our earnings release and posted our earnings deck, those of which are available within the Investor Relations section of our website at treehousefoods.com. Before we begin, we would like to advise you that all forward-looking statements made on today’s call are intended to fall within the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on current expectations and projections and involve risks and uncertainties that may cause actual results to differ materially from our forward-looking statements. Information concerning those risks is contained in the company’s filings with the SEC.

On October 3, 2022 we completed the divestiture of a significant portion of our Meal Preparation business. As such, we’ll be discussing our results on an adjusted continuing operations basis. A reconciliation of non-GAAP measures to their most direct comparable GAAP measures can be found in the release and the appendix of today’s earnings deck. With that, let me now turn the call over to our CEO and President, Mr. Steve Oakland.

Steve Oakland: Thank you, P.I. and thank you all for joining us today. I’m pleased to be here to report our progress on the strategic transformation of TreeHouse. Starting with our strong fourth quarter and continuing in our outlook for 2023 and beyond. On Slide 3, we’ve shared the key messages that I’d like you to take away from today’s call. First, we’ve accomplished a great deal in 2022, reaching a major strategic milestone in early October, by divesting a significant portion of our Meal Prep business at a compelling valuation. We reshaped our portfolio, sharpening our focus as a higher growth, higher margin private label snacking and beverage business. This will enable us to improve the consistency of our execution and our results.

Second, our fourth quarter results are evidence of this improved execution, as we outperformed the broader private label market in terms of unit growth across our core retail business. Third, our guidance for 2023 reflects the compelling opportunity we expect to capture as a new TreeHouse, including top line growth of 6% to 8% and significant profit improvement, with adjusted EBITDA expected to be in the range of $345 million to $365 million. This represents a year-over-year growth rate of approximately 24% at the midpoint. Fourth, we have a clear purpose and strategic ambition to drive long-term growth across private label snacking and beverages. We believe that beginning in 2024, we can grow revenue 3% to 5% and adjusted EBITDA 8% to 10% on an annual basis based on the portfolio as its constructed today.

And deliver free cash flow of at least $200 million for the next three plus years. We have the right team in place and our portfolio has never been better positioned to win and drive sustainable growth and shareholder value. Let me now turn to Slide 4, which summarizes our fourth quarter results. Sales in the fourth quarter grew 22% to $996 million, driven by pricing to recover inflation. Adjusted EBITDA of $120 million was at the top end of our guidance range. Importantly, EBITDA margin of 12% represents a 320 basis point improvement on a sequential basis. I’m very proud of our strong finish to the year and I want to thank the entire TreeHouse organization, for their hard work and dedication in making all of this happen. Before I turn it over to Pat to give you more color on the quarter, I want to spend a few minutes putting our fourth quarter performance in context with the rest of the retail landscape.

As we all know, over the past two years, we’ve seen unprecedented input cost escalation and pricing to recover that inflation. During the fourth quarter, pricing was up about 17% across the entire retail landscape, as everyone has had to recover higher input costs. On Slide 5, we’ve provided a look at how volumes are faring across the industry. We use measured channel data to give you an apples-to-apples comparison. You can see total edible consumption on a unit basis declined over 3% as a result of high prices. When you move to the right, we’ve narrowed the data set to capture just those categories in which we operate. Units for national brands shown by the wine colored bar declined 5%, while private label in total indicated in gold, outperformed and was slightly positive.

TreeHouse specifically did better than that. In the fourth quarter, our units grew almost 3.5% within retail measured channels. I’d like to point out that our unit growth for our core retail business was more than 3% in both measured and unmeasured channels. Pat will take you through the sales walk in his comments. The pressure on today’s consumer is significant. Shoppers are seeking value and the private label value proposition continues to gain momentum, supporting unit share gains, which we’ve now seen for the last 54 consecutive weeks. We continue to invest in our business to support our customers in capturing that demand. With that, let me turn it over to Pat to take you through our fourth quarter and guidance. You’ll find that the rest of our typical macro slides on shelf prices, price gaps and shopper basket are in the appendix of our deck today.

I’ll come back at the end to share with you how we’re going to build on the progress we’ve made and how that translates into the long-term outlook for the business. Then we’ll open the call up to your questions. Pat?

Pat O’Donnell: Thanks, Steve, and good morning, everyone. I want to first echo my appreciation to the TreeHouse team this past year. We went through a great deal of change and I’m proud of the company we are today. I’ll start on Slide 6 and as Steve noted earlier, fourth quarter revenue grew 22%. Pricing to recover inflation accelerated further in Q4 and was up 24.6% reflecting our cumulative efforts to recover inflation. Volume and mix declined 2.2% in the quarter. On Slide 7, we provided a look at our case volume by channel. As Steve noted earlier, across our core retail grocery business in both measured and unmeasured channels, we delivered 3% volume growth. As a reminder, the retail grocery business represents approximately 80% of our annual revenue.

It’s also worth noting, our volume growth would have been higher had we not faced lingering supply chain and service constraints in about half of our categories. Additionally, our retail growth was offset primarily by the exit of certain co-pack and food-away-from-home volumes, including the Pickle business that we discussed last quarter. Turning to Slide 8 and our profit drivers. Fourth quarter adjusted EBITDA totaled $120 million, which was at the top of our guidance range. Adjusted EBITDA margin was 12% representing a sequential improvement of 320 basis points. Volume and mix including absorption declined $5 million in the quarter. Pricing net of commodities was positive once again, contributing $90 million versus last year, which demonstrates that our efforts to recover inflation continue to be realized.

We have seen a number of the traded commodities begin to come down, but I want to highlight two things. First, most commodities remain at historically elevated up; and second, only about half of our basket of inputs are considered tradable. Our non-tradable cost basket is comprised of hundreds of inputs, everything from labels and specialty packaging, to food chemicals and foil lids. We continue to see meaningful inflation in this area. Some of the inflation we are seeing in our non-traded inputs is offsetting deflation in the traded commodity. As a result, we are still taking some pricing currently, but it’s much more surgical in nature. The last bar represents operations, which declined $35 million in the fourth quarter, as we continue to mitigate supply chain disruption and invest in employee retention.

Our focus on TMOS, our TreeHouse Management Operating System is ongoing, as well as our efforts around labor stability and line reliability. In the fourth quarter, we continue to make progress on our service levels across the network and delivered more than 100 basis point improvement sequentially with about half of our categories near target service level. Slide 9 demonstrates both the progress we’ve made in paying down debt over the last three years, including a significant reduction in Q4, when we used the divestiture proceeds to pay down $500 million in October. We ended the year with covenant leverage of 3.2 times, in line with our range of 3 times to 3.5 times and liquidity of more than $500 million. Turning now to our 2023 guidance on Slide 10.

We expect to grow sales by 6% to 8% in 2023, driven by pricing, as we lap the actions we took to recover inflation last year. The impact of the pricing ramp will be most prominent in the first half of the year. You’ll recall that pricing to recover inflation was affected in late March, July, and late September of 2022. Our guidance assumes that volumes will be flat this year. As I mentioned, about half of our categories are back to target levels of service. We continue to face constraints in certain categories like cookies, creamer and single serve beverages. We’re working diligently to resolve our supply chain challenges and by the end of this year, we expect most of our categories to be very close to our target service level of 98%. Adjusted EBITDA is projected to be between $345 million to $365 million, which at the midpoint represents a year-over-year increase of 24%.

The key drivers are pricing and supply chain initiatives, as we continue to drive TMOS and continuous improvement. We expect net interest to be between $20 million and $25 million in 2023, reflecting the benefit of approximately $45 million in income, primarily related to interest on the note receivable. Interest expense will be very similar to 2022, between $65 million and $70 million. Recall that the financial statements we provided back in November were recast to remove the impact of the divested business and factor in the use of cash proceeds to reduce debt. CapEx is estimated to be about $130 million in 2023. This year, approximately half of our spending will be focused on growth and supply chain initiatives in areas such as capacity expansion and innovation capabilities.

The other half will be focused on infrastructure and maintenance. In total, our 2023 spending is anticipated to be at the high-end of our long-term range of 3% to 3.5% of sales as we have a number of locations that require upgrades and investments in equipment that will ultimately improve line reliability and efficiency. Specific to the first quarter, we are guiding to growth of 9% to 12% on the top line and adjusted EBITDA margin improvement of 300 basis points to 450 basis points on a year-over-year basis. With that, I’ll turn it back to Steve for closing comments. Steve?

Steve Oakland: Thanks, Pat. As we begin 2023, we continue to see a macro environment that supports private label growth. That coupled with our improving service levels and our investments in capacity, support our guidance for growth, both short-term and long-term. I’m excited about the direction we’re heading and our journey as a more focused private label snacking and beverage company. Last fall, we shared with you our new purpose statement shown on Slide 11, to engage and delight one customer at a time. Our strategic ambition is profitable growth driven by leadership in consumer trending categories. Beyond the 2023 guidance, Pat discussed earlier, we believe that over the next three years plus, we can deliver annual growth of 3% to 5% in revenue; 8% to 10% in adjusted EBITDA; and free cash flow of at least $200 million.

We’re confident we can deliver that level of growth because we have a clear purpose, ambition and strategy attached to a solid portfolio of categories. Those of you who have followed the company for some time know that for the last several years, we’ve rallied around operational and commercial excellence, portfolio optimization and people and talent. These tenants continue to ring true to our priorities. And as new TreeHouse, we’ve sharpened and refined our strategic growth pillars to better reflect how we will engage and delight our stakeholders. As the supply chain for our retail partners, our resources support the nation’s biggest and best retailer brands. Leveraging our work and operational excellence, we are now building a world class supply chain.

This requires investments in talent and technology. It includes an ongoing commitment to TMOS and continuous improvement, applied to both manufacturing and to our distribution network with a greater customer centricity in mind. The sale of a significant portion of Meal Prep enabled us to better optimize our portfolio and strengthen our balance sheet. Today, we are a higher growth, higher margin business focused on private label snacking and beverages. We will drive profitable growth through category leadership and investment in capabilities. We’ve talked in the past about how we outperform in categories where we have competitive advantage, defined by a leadership position and having depth. Depth can mean different things in different categories, but it’s essentially having the right capabilities, capacity and geographical reach to drive mutually profitable growth for our customers and for TreeHouse.

We’re at a pivot point in our strategic journey rather than prioritize free cash flow to pay down debt as we have for the last several years. Today, our balance sheet is strong. We will generate healthy free cash flow to invest in our business and build our capabilities, which will be key to our success, which leads me to strategic customer partnerships. We’ve come a long way toward driving commercial excellence since I first arrived. Today, we are building on our collaborative efforts and taking it to the next level for key customers with whom we have strong alignment and growth prospects. We’re going beyond simply the fundamentals to create a more true partnership, joint business planning, innovation solutions, leadership engagement, and long-term agreements are all part of this journey.

Finally, people and talent continue to be the heart of our organization. We strive to be a talent leader and to be seen as the employer of choice in the markets in which we operate. We’re doing that by better defining career paths, harmonizing and modernizing targets and rewards and through employee engagement. I’m confident that we have the right team, priorities and investments in place and we’re in the right categories to drive sustainable revenue, and profitability growth and long-term value creation for our stakeholders. With that, let’s open the call up to your questions. Operator?

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Q&A Session

Operator: We will now begin the question-and-answer session. Your first question comes from the line of Andrew Lazar from Barclays. Your line is open.

Andrew Lazar: Great. Good morning, everybody.

Steve Oakland: Good morning, Andrew.

Andrew Lazar: To start off, I think on the third quarter call, Steve, you identified two sort of large buckets of impacts, right, between where you would end up this year, or where you would end up €˜22 EBITDA, and what you see as sort of your normalized EBITDA range going forward, right? One was PNOC and then one was some of the supply chain disruption. So PNOC has now been positive, right, for two quarters in a row, as pricing is catching up, obviously, making really good progress there. So I guess my question is, how much of the — I think it was $40 million in supply chain impacts. Do you think you can recover in ’23 specifically that kind of underpins your sort of guidance range? And then I just got a follow-up.

Steve Oakland: Sure. Well, I think you’ve seen PNOC be positive the last, like I say, two quarters. And I would expect that the first half of this year, right? I mean, most of the pricing we will start to lap it as get into the back half of the year. With regard to exactly how much of the supply chain recovery, I don’t think we’ve given that exact number, have we?

Pat O’Donnell: No. We’ve not — I think what we’re trying to suggest is, we’ve got about half of our plants that are operating at a normalized level of service. And we expect that, that remaining half will improve over the course of the year. We exited 2022 with about 93%, 94% service in the fourth quarter. We expect that to continue to move up as we start to do that, we’re still seeing some pockets of labor challenges, a little bit of material availability and some line things, which is why you’re seeing us invest in CapEx. But we’re pleased with the progress in service and we’re pleased with the progress in margin that we saw.

Steve Oakland: Yeah. I guess, we just haven’t given an exact number, but Andrew, we do expect to make progress and I think if you work through our guidance, you’ll see that we have to make progress on that line in order to make the numbers we’ve given you. So we feel good about.

Andrew Lazar: And then, I guess, how much — well, I guess, what’s the magnitude even directionally of sort of net inflation that you’re expecting in €˜23? And how much of the pricing that you need to sort of offset that is sort of incremental from here versus the benefit from carryover actions already taken?

Pat O’Donnell: Yeah. We’re sort of expecting mid-single digit inflation as we think about what we’ll experience in 2023. So nothing like what we saw over the last cycle. We have some pricing in place and I think as we’ve described it, there are pockets of some deflation and then some pockets of inflation and so we’ll continue to have those kind of very back based conversations with our customers to bring to them the total basket of goods so that they can understand what that looks like, and then take pricing accordingly that’s necessary.

Steve Oakland: Yeah. And I think your question is how much more do we have to take? A good piece of that was taken already in the month of January and so much of that is already in.

Andrew Lazar: Great. Thanks so much.

Operator: Your next question comes from the line of Rob Moskow from Credit Suisse. Your line is open.

Rob Moskow: Hi. Thanks. I was wondering, you’re going through capacity constraints at a time when the private label industry probably has a golden opportunity to grow volume. I’m sure a lot of retailers want to give it more shelf space and consumers want to trade down to it. Do you have a sense at retail what your volume growth could have been or could be this year, if you were fully up to speed. And is there a risk of losing shelf space to your competitors who might be a little farther along?

Steve Oakland: Rob, I think, if — Pat said a minute ago about half of our categories are operating at the right service levels. So if you thought a point or two on half of our business is probably out there to get, right, would be my guess. And my understanding and look, I have the benefit of top to tops with virtually all of our customers or our largest customers. And I think we’re performing as well or better. And I think, that if you take you back to Slide 5 in our deck, when you look at where private label is in macro, and how we’re doing, right? So I don’t think we’re at risk of losing business for that reason, right. So I think we’re performing and we’re leveraging our scale pretty well right now. So if anything, I think we’re grabbing maybe a little bit of that.

In some of the dual supply customers, they’re offering us an extra division or two, that kind of thing, because I think we are actually recovering faster than some of our peer set. I can tell you we have a full court press on. I can tell you that we’re doing everything we can to get ourselves in a position to take advantage of this opportunity. And I think you’re absolutely right. It’s a great time for private label, right. And we’re prioritizing everything. The little bit of business we lost, Pat touched on it in his comments, a little bit of business that, our national branded co-pack business that’s down. We’re trying to repurpose that capacity as fast as we can to private label.

Rob Moskow: Okay. And a follow-up would be, when you developed your long-term plan, 3% to 5% top line and then the 8% to 10% EBITDA margin. Your capital investments, like, how much capacity are you going to add to your existing footprint to deliver that 3% to 5%? And also, are there productivity targets like on a percent of COGS basis that are helping you get all that margin expansion, it’s a lot of margin expansion in that guide?