Utz Brands, Inc. (NYSE:UTZ) Q3 2023 Earnings Call Transcript

Utz Brands, Inc. (NYSE:UTZ) Q3 2023 Earnings Call Transcript November 9, 2023

Utz Brands, Inc. beats earnings expectations. Reported EPS is $0.17, expectations were $0.16.

Operator: Thank you for standing by, my name is Adam and I’ll be your conference operator today. At this time, I would like to welcome you to the Utz Brands, Inc. Third Quarter 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and- answer session. [Operator Instructions]. I would now like to turn the call over to Kevin Powers, Senior Vice President of Investor Relations. Please go ahead.

Kevin Powers: Good morning and thank you for joining us today. On the call today are Howard Friedman, CEO; Ajay Kataria, CFO; and Cary Devore, COO. 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 website. Finally, the company has also prepared presentation slides and additional supplemental financial information, which are posted on our Investor Relations website. And now, I’d like to turn the call over to Howard.

Howard Friedman: Thank you, Kevin, and good morning, everyone. I’m pleased to be speaking with you today, and I look forward to seeing many of you at our Investor Day next month, where we will discuss our opportunities for growth and value creation over the next few years. Given that, I’m going to keep my remarks this morning focused and make sure to allow enough time for your questions, and on that point, I’d like to welcome our new covering analysts to Utz, and I look forward to working with you. In the third quarter, we delivered solid results on both the top and bottom line, with organic net sales growth of 3% and adjusted EBITDA and adjusted EPS growth of 9%. Retail sales increased 3%, led by Power Brand growth of 5%, driven by continued momentum for Utz Potato Chips, On the Border, Zapp’s, and Boulder Canyon.

Power Brand growth was most pronounced in our expansion geographies fueled by distribution gains with growth of 8%, which exceeded category growth of 6%. While expansion was a bright spot in the quarter, our growth in our core of 1.6% lagged the category. This was primarily due to lapping very strong prior-year Utz brand growth of 20% in the core and challenges with our foundation brands. Our foundation brands declined faster than we anticipated due to our supply chain and portfolio optimization efforts. The impact can be seen most acutely in the Golden Flake brands. That said, on a positive note, we have seen service levels steadily increasing over the past five weeks, and we are in a much better position moving ahead, and these collective efforts have accelerated our productivity savings in the current year.

Of note, in recent quarters, our consumption growth has been tracking well ahead of shipments due to performance in non-tracked channels and our SKU rationalization actions, which have been focused on private label and partner brands, neither of which are in our retail sales results. This quarter, shipments were in line with our consumption due to better performance in non-tracked channels to include dollar, discount, and natural, and also from earlier-than-expected holiday shipments. This timing change benefited third-quarter net sales more than we originally expected and will impact our fourth quarter. In the second half of the year, a combination of timing elements, consumer demand trends, and Utz specific transitions have impacted our growth and led us to lower our near-term sales outlook.

As Salty Snack category growth is normalizing as we lap price increases from the past couple of years, we are seeing consistent trends indicating that consumers are increasingly looking for value as wallets are being stretched by well-known macro factors. We are seeing this manifested in a few ways to include shopping for absolute price points, trading to private label, and channel shifting. Today, consumers can find Utz across all classes of trade to include value channels, and we are focused on how we can deliver more value regardless of the shopper’s definition. This includes being laser-focused on our price-back architecture strategies up and down the ladder, evaluating smaller pack sizes at key pricing thresholds, introducing more value options, increasing use education, and better leveraging the breadth of our product assortment to meet retailers’ needs.

Importantly, our hybrid model and DSD capabilities enable us to implement these strategies across channels with flexibility around merchandising, product placement, and timing of events. Beyond consumer trends, as we have been discussing for the past few quarters, we have been taking aggressive actions to optimize our supply chain and portfolio to be better positioned for the future and capture our full potential. These actions include reducing our plant network size to 13 plants, reducing our SKU count, insourcing volume from co-mans and transitioning production across the network, and most recently moving from flex multipack and variety pack bags to boxes. Changes like this at speed doesn’t come without challenges, and these collective actions impacted our second half volumes more than we anticipated, with a disproportionate impact to our foundation brands, for which retail sales declined about 9%.

The foundation brand most impacted was Golden Flake, which until June was made in our which, until June, was made in our Birmingham, Alabama plan. In summary, we underappreciated the complexity of integrating Golden Flake into our Hanover facilities and deploying finished goods to local southern markets. As a result, we fell behind meeting our caseload requirements until October. As we continue to explore opportunities to optimize our supply chain network, there are several key learnings we will apply from this experience. First, recent plant closings have provided us with insight and best practices that will inform our approach to future network optimization decisions. Second, we will be more conservative with respective inventory safety stock levels.

And third, we will look to trusted co-man partners to provide redundancy. Over the years, our team has acquired and integrated several manufacturing facilities without incident, while closing a plant requires a modified approach. We are now much better prepared for future network optimization. For example, I would point you to the recent sale of our Bluffton facility, where our transition has gone very smoothly. While these activities impacted second-hand volume, the stepped-up pace of supply chain and portfolio optimization has already delivered increased productivity and other cost savings which enable us to maintain our adjusted EBITDA guidance. Moreover, despite navigating dynamic consumer trends and the beginnings of our own transformation, our consumer panel trends have been very positive on an absolute basis and relative to the category.

In the quarter, we increased our household penetration ahead of the category while we maintained consumer trips despite declines for the category. As we all know, driving household penetration is a key indicator of long-term business success, and we continue to have significant white space opportunities in our expansion geographies. We look forward to discussing this more at our Investor Day in December. Now I’d like to turn the call over to Ajay, and then I’ll make a few final remarks before we open the call for questions. Ajay?

Ajay Kataria: Thank you, Howard, and good morning, everyone. In the third quarter, we delivered organic net sales growth of 3.1% and adjusted EBITDA growth of 9.2% as our productivity programs and actions to optimize our network and portfolio are delivering stronger profitability. Of note, our organic net sales growth combined with these actions resulted in our third consecutive quarter of adjusted EBITDA margin expansion. I’m proud of our team’s efforts during a dynamic consumer environment to deliver these results while we continue to make structural changes to access a higher level of productivity. These collective efforts helped us deliver 14% adjusted EBITDA margins in the quarter, which I will note, was our highest level in two years.

During the quarter, our organic net sales growth was led by price realization of 3.7%, partially offset by lower volume mix of 0.6%. Volume was impacted by 3.3% due to SKU reductions, which was slightly more than what we expected due to earlier than planned transition of certain SKUs. When we adjust for SKU rationalization, we estimate that our volume mix grew 2.7%, which is an acceleration from 1.8% last quarter. Our broad-based SKU rationalization actions are complete, and looking ahead to 2024, we don’t expect these impacts to be material to our results. Finally, our total net sales growth was impacted by two additional factors. First, our net sales continued to be impacted by the conversion of company-owned RSP routes to independent operators, which reduced growth by 60 basis points.

Similar to SKU rationalization, this will be largely complete by the end of the year and will not have a material impact on our fiscal 2024 sales growth. And second, our third quarter net sales benefited from some earlier than expected holiday shipments that were originally forecasted to occur in the fourth quarter. This timing factor, along with the strong performance in unmeasured channels, resulted in shipments that were more in line with consumption than recent quarters. Moving down the P&L, adjusted gross margin declined in the second quarter primarily from our conversion to IO routes, which had an adverse impact of 60 basis points. Excluding this impact, adjusted gross margins expanded year-over-year by 40 basis points led by our pricing and productivity programs, which more than offset commodity and labor inflation.

In addition, our SKU rationalization programs are improving our margin mix as we reduce lower-margin private-label and partner-brand SKUs. That said, the margin performance in the quarter was slightly less than our expectations primarily due to lower fixed-cost leverage from softer-than-expected volumes, as Howard described earlier. Adjusted SD&A expense declined 1.8%, an improvement of 97 basis points as a percent of sales, as a result of our productivity initiatives focused on logistics and lower administrative spend. As our sales growth normalizes, we have been able to manage spend through cost-control measures in addition to driving productivity within our selling and logistics costs. Partially offsetting these factors were continued investments in e-commerce, people, selling infrastructure and supply chain capabilities to support our growth.

Bringing it together, adjusted EBITDA increased by 9.2% to $52.1 million and margins expanded 87 basis points to 14% of sales. The margin expansion was driven by 370 basis points of price, 280 basis points of productivity, partially offset by 530 basis points of inflation, and 40 basis points of impact from our continued investments to support our growth. In addition, adjusted net income increased 9.5% and adjusted EPS increased by 9.2% to $0.17 per share. Stronger operating earnings and a more favorable tax rate were partially offset by higher interest expense primarily due to higher rates on our floating rate debt. Turning to cash flow and the balance sheet, consistent with normal seasonality and from our cross-functional efforts to improve our cash conversion cycle, we generated strong cash in the third quarter of $53.4 million.

I am happy to report that our transformation efforts in this important area are working and we are now seeing the benefits in our results. This now brings cash flow from operations year-to-date to $49.1 million and we remain on track to reduce leverage below 4.5 times by the end of the year. We also remain committed to our capital priorities and year-to-date capital expenditures were $45.7 million primarily related to supporting our productivity programs and our investment in our Kings Mountain manufacturing plant. In addition, we have paid $24.1 million in dividend and distribution to shareholders. Finishing with the balance sheet, cash on hand was $60.1 million and our liquidity remained strong at over $209 million, giving us ample financial flexibility.

Net debt at quarter-end was $875.9 million or 4.8 times trailing 12 months normalized adjusted EBITDA of $181.8 million. While leverage remains above our target range, I will remind you that roughly 70% of our long-term debt is fixed at approximately 4.7%. We have no significant maturities until 2028 and our credit structure is comprised of covenant light instruments. Now turning to our full year outlook for fiscal 2023.As Howard mentioned earlier, today we revised our organic net sales outlook to 3% to 4% growth to reflect normalizing category trends and greater than expected volume impact from our aggressive supply chain and portfolio optimization actions to better position our company for the future. This results in volume mix now to be modestly lower than fiscal 2022 with modest growth in the fourth quarter.

But I’ll remind you that our fourth quarter assumes about a 2.5% impact to volume from SKU rationalization and adjusted for that impact, we expect to grow brand volumes by nearly 3%. That said, our stepped up pace of supply chain and portfolio optimization is already delivering increased productivity benefits and these savings combined with disciplined spend management has enabled us to maintain our adjusted EBITDA outlook of 8% to 11% growth. For additional items, we now expect our full year 2023 adjusted effective tax rate to be approximately 17% to 18% versus 20% to 22% previously due to our state tax optimization efforts. Interest expense of approximately $55 million, capital investments of between $50 million and $55 million are both unchanged.

Now I’d like to turn the call back over to Howard for some final remarks. Howard?

Howard Friedman : Thanks, Ajay. Before I open the call up for questions, I want to tell you why I’m confident about the future of our company and category over both the short and long term. First, when you look across the store, Salty Snacks is an attractive and growing category with relative resilience and strength versus other food categories, with consumption growing nearly 6% in the latest quarter. I have few doubts as we lap several years of price increases that the category will normalize and continue to grow at levels that existed prior to the unique environment we’ve been in over the last three years. Second, we have an advantage portfolio of brands that are resonating with retailers and consumers highlighted by our 5% growth of our Power Brands with significant white space distribution opportunities.

Third, while our supply chain and portfolio optimization actions this year temporarily impacted volume more than we expected, we learned important lessons that better position us for stronger execution. And in doing so, we were able to deliver productivity and other cost savings that enabled us to maintain our earnings outlook for the year. And we are building a stronger foundation that positions us for growth and margin expansion. Fourth, we continue to develop our existing talent through embracing new ways of working and continuous improvement while augmenting the team externally when appropriate. Lastly, our cash performance in the quarter was strong through cross-functional efforts to improve our cash conversion cycle and keeps us on track to hit our full year leverage goal, which will position us well for continued improvements in fiscal 2024.

And now, operator, we’d like to open the call for questions.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Johnny Shamir. Your line is open.

Andrew Lazar : Great, thanks. It’s actually Andrew Lazar, Barclays. Good morning, everybody.

Howard Friedman : Good morning, Andrew.

Ajay Kataria : Good morning, Andrew.

Andrew Lazar : I guess first question, Howard, is you mentioned some of the continued weakness that you’re seeing in the core markets. I realize some of this, as you mentioned, is a tough year ago comparison and some weaker foundation brand performance. But I was hoping maybe you could dig in a bit deeper on that and just go through some of the drivers and maybe more importantly, how you’re thinking about sort of that metric as we go forward?

Howard Friedman : Yeah, thanks for the question, Andrew. Look, I think the first thing I would say is we’re certainly not pleased with losing share in our core. Because as you know, our goal is to make sure that we maintain the core and then expand share in our expansion geographies. I mean, I think over the long term, that is what we expect, and I think that’s what others should expect from us. When you look at the current quarter, there are a couple of pieces. In the prior year, us brand was up about 20% in the core. And so we’re lapping that. And you really see it in the share in the consumption performance on that brand in the current period. Second, our foundation brands really are more heavily weighted to the core. And so when they tend to drag, they actually have an oversized impact and driven really by a lack of consumer and brand investment, as well as they’ve been a primary focus of our SKU rationalization programs over the last couple of quarters.

Third, we mentioned a little bit around Golden Flake weakness. That’s been about getting our pricing and packaging right in the stores, but also making sure that the supply chain recovers from our Birmingham transition, which, as we talked about, really did affect our Q3 and leaked a little bit into October as well. But that said, on the upside and the thing I think we’re most excited about is when you look at our Power Brands, they continue to perform nicely, both in our core and in expansion geographies. For example, On The Border grew over 30%, Zapp’s and Boulder Canyon are also growing really nicely. And then in our expansion markets, we actually outpaced the category, growing about 8%. So I think we roll it all up together and say, we’re not happy about where the core is.

We’re very clear and laser focused on improving those trends and remain really optimistic that from an expansion perspective that customers and consumers embrace and welcome these brands onto their shelves and into their pantries.

Andrew Lazar : Great. And you mentioned the Power Brand growth that you’re seeing in expansion markets, which seems to be going really well. I was hoping maybe you could put a little finer point on that, just kind of what you’re seeing. Is it new distribution, new accounts in new regions? Kind of where are you starting to see that? Is it using some of the metrics and performance from the launch in the Southeast that you’re able to communicate more fully to some new accounts, I guess, in some new areas? Is that helping?

Howard Friedman : Yeah, I mean, certainly a couple, I think it’s all of those things. Certainly what we learned in the Southeast about how to enter markets with anchor consumers and how we enter markets when we look at expansion through distribution buybacks and partnerships that we’ve been able to do. All of those things, I think, translate into better core performance. But I think as you look at, or I’m sorry, better expansion performance. But I think when you look at our Power Brands, Boulder Canyon is growing very quickly in the expansion markets. Zapp’s and Utz also continuing to improve. And probably the highest compliment that we get is when we enter into markets and we demonstrate that we can grow the category and that we’re incremental and helping build baskets, that we tend to get expanded distribution as we lap it, which we also continue to enjoy.

Andrew Lazar : Great, see you in December.

Howard Friedman : Look forward to it.

Ajay Kataria : Thanks, Andrew.

Operator: Next question comes from the line of Modi Nik. Your line is open.

Modi Nik : Thanks, good morning, everyone. I guess the question is, given the top line guide down, the implied margins for the fourth quarter are still pretty healthy. So Howard, Ajay, I was wondering if you guys could just opine and just give us more clarity, maybe a little more detail around those productivity efforts and kind of what’s driving the offset?

Howard Friedman : Yeah, thanks, Nik. First of all, welcome. We’re excited to have you on the call and look forward to working with you as we go forward. Look, ultimately, I think that our story has always been about continuing to be able to fund our growth by creating fuel in our productivity line. And if you look at the progression of this company over the last couple of years, a few years, short years ago, we were only at about 1%. We’re feeling very comfortable at 4% this year. And that’s really being driven by the aggressive supply chain actions we took on the quarter. So Birmingham, obviously, was a decision that we announced in June. Really, the benefit there is still mostly in front of us, but we’re starting to see some of that flow through.

We took actions on our private fleet, and we’re able to start to get some, see an uptick in our productivity as we go forward there. And we also are seeing benefits from the sale of our Bluffton, from our Bluffton plant. So when you put all of those things together, a lot of those things were not necessarily contemplated earlier in the year, but we’ve been able to be able to pull some of those things into our guide and into our confidence level as we move forward to offset some of the call down on our volume side.

Modi Nik: Excellent, thank you, I’ll pass it on.

Howard Friedman : Thanks, Nik.

Operator: Next question comes from the line of Rob Moscow with TD Cowen. Your line is open.

Rob Moscow: Hi, how you doing? Hi, Howard.

Howard Friedman: Hey, Rob.