Q3 2023 Real Good Food Company Inc Earnings Call

Participants

Shamari Benton; VP of FP&A & IR; The Real Good Food Company, Inc.

Bryan Freeman; Executive Chairman, President & Secretary; The Real Good Food Company, Inc.

Gerry Law; CEO & Director; The Real Good Food Company, Inc.

Akshay Jagdale; CFO; The Real Good Food Company, Inc.

Jeff Van Sinderen; Analyst; B Riley Securities

Presentation

Operator

Greetings and welcome to the Real Good Food third quarter 2023 earnings call. (Operator instructions) As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Mr. Shamari Benton, Vice President of FP&A. Thank you, Mr. Benton, you may begin.

Shamari Benton

Good morning and welcome to the real good Food Company's third quarter 2023 earnings conference call. On the call today are Bryan Freeman, Executive Chairman; Gerry Law, Chief Executive Officer; and Akshay Jagdale, Chief Financial Officer.
Our third quarter earnings release crossed the wire at approximately 8 AM Eastern time today. If you have not had a chance to review the release, it's available on the investor portion of our website at www.realgoodfoods.com.
Before we begin, I would like to remind everyone that certain statements made on this call are forward-looking statements within the meaning of Federal Security laws and are subject to considerable risks and uncertainties.
These forward-looking statements are intended to qualify for Safe Harbor from liability established by the Private Securities Litigation Reform Act of 1995. All statements made on this call today, other than statements of historical fact are forward-looking statements and include statements regarding our projected financial results, including net sales, gross profit, gross margin, adjusted gross profit, adjusted gross margin and adjusted EBITDA, as well as our ability to increase our net sales from existing customers and acquire new customers, introduce new products compete successfully in our industry, implement our growth strategy and effectively expand our manufacturing and production capacity.
Forward-looking statements made on this call represent management's current expectations and are based on information available at the time such statements are made. Such statements involve a number of known and unknown uncertainties, many of which are outside the company's control and could cause future results, performance or achievements to differ significantly from the results, performance or achievements expressed or implied by such forward-looking statements.
Important factors and risks that could cause or contribute to such differences are detailed in the company's filings with the Securities and Exchange Commission. Except as required by law, the company undertakes no obligation to update any forward-looking or other statements herein. Whether as a result of new information, future events or otherwise.
In addition, throughout this discussion, we refer to certain non-GAAP financial measures, which refer to results before taking into account certain one-time or non-reoccurring charges that are not core to our ongoing operating results and which we believe better reflect the performance of our business on an ongoing basis.
Our non-GAAP financial measures, including adjusted gross margin and adjusted EBITDA, are reference. A reconciliation of each non-GAAP financial measure to its most directly comparable GAAP financial measure is included in our third quarter earnings release, which is available on our website under our Investor tab.
With that, it is my pleasure to turn the call over to the Real Good Food Company's Executive Chairman, Bryan Freeman.

Bryan Freeman

Thanks. Thanks, Shamari, and good morning, everyone, and thank you for joining us today on our third quarter earnings call. I will briefly review our third quarter highlights and discuss the reasons we believe we're well positioned for long-term profitable growth. Gerry will cover operations and Akshay will then review our financial results and outlook in more detail. After that, we'll open the call for questions.
Starting with our financial highlights for the third quarter net sales were $55.6 million, an increase of 48% year over year and an increase of 141% on a two year stack basis, both of which represent a significant acceleration sequentially. Growth would have been even higher if we had been able to fill orders on time as consumption was up 90%, far exceeding shipment growth.
For perspective, our consumption growth 90% in the third quarter accelerated 80 points sequentially, and this momentum has carried into the fourth quarter. Acceleration of sales growth this quarter was driven by the unmeasured channel. Branded sales in non-measured channel were up 90% on a year-over-year basis and up 200% on a two-year stack basis, both of which represent nice acceleration.
Growth was driven primarily by distribution growth, which doubled sequentially. We're particularly encouraged by the breadth of our offerings and the unmeasured channel, which stands seven categories, two temperature states and three eating occasions. As we exited the quarter and began the third quarter, we had approximately eight items in distribution, over 50% of the store base in this channel, which is more than double compared to a year ago.
As a result, we expect unmeasured channel sales growth momentum to continue into the fourth quarter of 2023 and beyond. This includes national distribution of branded poultry appetizers and on trays as well as further expansion of our handheld, which include our cloud house and burrito platforms in the refrigerated section.
To summarize the unmeasured channel and provide additional perspective in 2021, we had two items that on a combined annualized basis achieved 65% ACV and 2022 figure to three items with a combined and annualized ACV of 68%. Currently have eight items in distribution and participate in seven categories in two temperature states. For perspective, we've never had more than four items operate simultaneously in our history. All of this is to say that our strategy to expand into new categories across two temperature state is working and creates a strong foundation for durable, predictable growth business going forward.
Now turning to the retail channel performance. Sales growth was 56% on a two year stack basis and up 12% year over year. The year-over-year growth would have been even better if we were able to fill customer orders on time. Our perspective consumption grew 30% far outpacing double digit shipment.
Both shipment and consumption growth significantly accelerated sequentially, driven by distribution growth from the June shelf reset, combined with higher [volumes]. The new products that we introduced recently have significantly higher velocities than our base products, which we expect will continue to drive significant overall brand velocity growth for the remainder of 2023.
We expect strong double digit growth in the channel for the remainder of the year. As of the third quarter end, our total distribution points for 187,000, which is an increase of roughly 58,000 total distribution points from the beginning of this year. In addition, we have roughly another 17,000 new distribution points confirmed for the fourth quarter of 2023, which if achieved, would represent 58% growth from the beginning of this year.
The products gaining distribution include our global MultiServ on-trade and bread and poultry, which has significantly higher velocities than our base, which we expect will continue to drive significant overall brand velocity growth for the remainder of 2023. We continue to expect strong double digit growth in this channel for the remaining of the year.
Aforementioned new distribution gains, combined with strong base business velocity gives us confidence that we will grow sales in 2024 to at least $245 million, representing growth of approximately 30%. Jagdale Akshay will speak to this in more detail, but I wanted to touch on our margins this quarter. Once again and provide a high-level view of how we see the remainder of the year shaping up.
Gross margins were 20.9% this quarter, which is a 1614 fifth improvement year over year and the second highest margin in our history. Year over year improvement in our margin being driven by our productivity initiatives and overall favorable commodity cost environment, as well as better plant utilization.
On a sequential basis, our reported gross margins improved 725 bps, owing to the increase of sales and corresponding better fixed cost leverage in the plants, which we expect will continue into the fourth quarter of 2023 and 2024, given the strong momentum.
Adjusted EBITDA was $1.2 million, which was in the middle of the range we provided when we preannounced a few weeks ago, again, for the fourth quarter of 2023 and 2024, we see our plant utilization rates continuing to increase, which leverages our overhead and SG&A and is how we expect to see positive cash earnings in the fourth quarter of 2023 and 2024.
Gerry will expand on this later, but I want to talk about how we plan on accelerating our production growth to meet surges in demand on a couple of fast-growing odds. The primary change we are making is to add incremental capacity that creates redundancy in areas where we are seeing the most demand. Capital required to do this is made possible in part from our recent equity raise, and we expect the improved uptime and incremental capacity for certain products to come online this month.
Next let's take a look at the current state of the health and wellness market and how our brand positioning is resonating with a broad consumer base. According to [scan] for the 52 weeks ending September 10, 2023, for $206 billion, health and wellness industry grew 7% year over year, in line with the 7% three-year CAGR.
Over the same period, the $75 billion total frozen food category grew 5%. Several industry observers have called out the fact that category consumption trends have weakened in recent months as industry cycling for price increases during a relatively tough economic backdrop for consumers. We did not take significant pricing actions like our competitors and as such are not dealing with volume declines related to [velocity].
Another headwind, we believe frozen food brands are facing is their high glycaemic volume. According to NPD, the number one attribute consumers are looking for is to get away from sugar. In fact, according to spend, there was a $4 billion switch away from higher sugar food to low sugar Foods in the last 52 weeks as of June 18. This trend is durable and it is accelerating.
A further catalyst this is the significant consumer interest in adoption of GLP-1 drugs. A recent Morgan Stanley alpha Y study showed that 45% of the US adult population has interest in these drugs. The study also showed that those are taking GLP-1 drugs shift away from sugary foods and begin eating more poultry and protein-based foods. Yet when you walk the frozen food aisle, it is difficult to find meal solutions that are not high in carbohydrates and sugar. We believe this is why our growth continues to accelerate while others are declining.
For the latest 12 weeks ending October eighth, 2023, RGF measured channel grew by 31%. On a dollar per store per week basis, our branded poultry items are the highest velocity health and wellness item in the US. Our single-serve on-trade platform continues to post total points of distribution and velocity gains as we lap one and two year trends.
At our multi-serve on trees continue to grow in both velocity and points of distribution. We have the right item at the right time, and we plan to lean in even further in 2024. For that, and I'd like to spend a few minutes on our near term innovation agenda. I'm pleased to report that our new bread, especially in fish sticks, have been accepted in approximately 1,700 stores with the first ship this December. It is our initial entrance into the 7 billion frozen fish category, and we are pleased with the relatively fast acceptance of this new item with our retailer partners.
I believe this is further evidence of our brand position that is leading to low glycaemic consumer movement is resonating with retailers and consumers. Second, our low carbohydrates, high protein powders and burritos can now be found in the refrigerated section in mass retail. This is an example of taking success in the unmeasured channel and bring that to the measured flash retail channel. We believe this can be a significant growth accelerator in the coming quarters.
Third, we are launching our new low sugar, low carbohydrate barbecue, pulled pork and pulled chicken on trays and approximately 1900 stores in a national retailer in January with a first ship in December. As a reminder, conventional barbecue sauce proteins are loaded with sugar, while ours has only two grams of sugar per serving and it's delicious. Further, we recently gained a new large customer on the unmeasured channel that will be launching our frozen bacon wrapped stuffed chicken on trades in approximately 2000 stores in the first quarter.
In summary, we have a lot of momentum going into 2024, and we continue to believe we have permission to achieve our stated goal of achieving at least $500 million in sales over the long term.
I'd like to now turn the call over to our CEO, Gerry Law, to provide an update on Bolingbrook and our operations more broadly.

Gerry Law

Thank you, Bryan, and good morning, everyone, and thank you for joining us on today's call. Our Bolingbrook, Illinois facility is continuing to ramp up production, and we expect acceleration in the fourth quarter of 2023, driven by better attainment levels and a new fryer coming online.
We under shipped demand in the third quarter, and this drove shortfall relative to our guidance. To expand on what Bryan said, we have taken measures to address this issue. First, I'm spending a considerable amount of my time in the facility to ensure the team has the support and resources it needs to execute the production plan.
Our operational performance has improved and production growth has accelerated as a result. Additionally, we are installing additional capacity for certain products, so that we can handle surges in demand. Our 20.9% gross margin is particularly encouraging as we continued to be in the early stages of achieving our long-term efficiency targets.
Our sales guidance calls for capacity utilization, rates to increase to 70% to 80% in the second half of 2023. Higher utilization rates should drive significant fixed cost leverage in the plants and enable our transition to positive cash earnings in the fourth quarter of 2023.
Adjusted gross margins, which assume full utilization were 27.8% and point to the underlying margin profile of the business, when the plants are fully utilized. We have been deliberate about building capacity ahead of demand, reflecting all the hard work and investments made to get to this capacity up and running over the past 18 months.
Although we had some trouble filling orders in September, we are confident that the issues that led to the shortfall were transitory. The addition of new frac capacity combined with continuing improvements in attainment levels and uptime due to machinery redundancy on existing product lines should help us catch up on orders in the fourth quarter of 2023.
Further formula optimization, in addition to raw material costs contributed to solid margin performance this quarter. I continue to be encouraged by the sequential improvement in efficiencies at Bolingbrook and City of Industry continues to perform well. Moreover, we expect our operating performance to continue improve in 4Q '23 and beyond, driven by better efficiencies resulting in lower labor costs, improved plant utilization and better overhead cost leverage.
Before I turn it over to Akshay, I would like to discuss the biggest catalyst for 2024. We continue to expect our labor costs to come down sequentially is Bolingbrook, which has structurally lower costs as compared to our City of Industry facility, becomes a larger portion of our production mix and achieves our targeted efficiencies.
Every incremental pound coming out of Bolingbrook is accretive to our labor costs. In addition, overall labor costs are further aided by continued efficiency gains at our City of Industry facility. We are confident in our ability to bring labor cost in line with industry standards of about 5% to 10% of sales over time.
Additionally, higher sales will drive a step change in plant utilization rates and allow us leverage lower overhead costs. We expect this overhead leverage to drive approximately five points and further improvement over margin profile in 2024 as compared to the first half.
Lastly, our investments in Bolingbrook have enabled significant productivity savings. These include the shelf manufacturing of our chicken tortillas, cooked chicken that is used in our product fillings and our proprietary breading blends, which on a combined basis, are likely to drive approximately 200 to 400 basis points of margin improvement.
As for direct materials inflation, the good news is that commodity costs are expected to remain favorable for the remainder of 2023. In summary, the sequentially higher sales levels that we are now guiding to in the fourth quarter, driven by distribution points already secured, mark an important inflection point for the business from a capacity utilization perspective and will enable us to meet our goal of transitioning to positive cash earnings in the fourth quarter of 2023.
We are pleased by our margin performance this quarter, which showed significant improvement sequentially and year over year. We expect 2024 adjusted EBITDA be in the positive mid-teens, billions of dollars range and expect to generate positive cash earnings.
We have strong visibility into the drivers of our continued margin turnaround and feel confident in achieving our outlook. It's an exciting time at real good foods. We continue to provide focused support for the growing demand of our sales group has locked in by investing in talent, capabilities and supply chain. I feel confident in our ability to effectively navigate the environment we are in to deliver results and build sustainable long-term value for our shareholders.
Now I'd like to turn the call over to Akshay, our Chief Financial Officer, who will walk you through our third quarter financials.

Akshay Jagdale

Thank you, Gerry, and good morning, everyone. Turning to our financial results, net sales in the third quarter were $55.6 million, an increase of 48% as compared to the third quarter of last year. Branded sales in the unmeasured channel increased by approximately 90% year over year in the third quarter, primarily driven by distribution growth.
Consumption in dollar terms or was at an all-time high, more than doubling both sequentially and year over year and far outpaced shipment growth. As a reminder, consumption data is scanned sales at the cash register as measured by IRI. It is worth noting again that our consumption growth is highly incremental to the category and the incrementality is higher than we had expected.
Expanding upon Bryan's remarks in the measured channel, our brand's overlap with the leading brand and breaded poultry was only 3.5%. The same is true in the unmeasured channel, where our growth has been almost 100% incremental to incumbent brands. Growth in the unmeasured channel is tracking ahead of our expectation, and we have strong momentum heading into 2024.
In the retail channel, growth was 56% on a two-year stack basis and up 12% year over year. Year-over-year growth would have been even better if we were able to fill customer orders on time. Our perspective consumption grew 31%, far outpacing shipments. Both shipment and consumption growth saw a significant acceleration sequentially driven by distribution growth from the June shelf reset, combined with higher velocity.
And new products that we introduced recently have significantly higher velocity than our base products, which we expect will continue to drive significant overall brand velocity growth for the remainder of 2023. We expect strong double-digit growth in this channel for the remainder of the year.
Although we have a strong innovation agenda for 2024 and are entering a few new adjacent categories like Breaded Fish, our focus is on growing distribution of existing products that are already performing well on show. At third quarter gross profit was $11.6 million, reflecting a gross margin of 20.9% of net sales. As compared to a gross profit of $1.8 million or a gross margin of 4.7% of net sales in the third quarter of last year.
The increase in gross margin was due to improved product contribution margins in part driven by lower commodity costs as well as productivity initiatives. Lower plant costs also contributed to margin expansion, driven by better utilization rates. Gross margin should continue to improve sequentially as the higher revenue leads to better fixed cost absorption in the plan.
Adjusted gross profit during the quarter was $15.5 million, reflecting an adjusted gross margin of 27.8% of net sales as compared to $5.9 million or 15.8% of net sales in the third quarter of last year. Productivity initiatives and lower commodity prices contributed to the year-over-year increase in margin.
Total operating expenses were $20.5 million in the third quarter as compared to $12.4 million in the third quarter of last year. Adjusted operating expenses increased by approximately $5.2 million to $15.9 million in the third quarter. As compared to $10.7 million in the third quarter of last year.
The increase in operating expenses was driven primarily by the increase in research and development costs and to a lesser extent, higher distribution costs. The increase in R&D expense is to support the strong new product pipeline and commercialization efforts. R&D costs tend to be lumpy on a quarterly basis depending on the level of new product activity as well as the timing and scale of commercialization.
As for the increase in distribution costs, we transitioned a few large customers to our new distribution relationship in the quarter, which proved to be inefficient. This trend should reverse in the fourth quarter as we transition these customers back to more efficient distribution arrangements.
Adjusted EBITDA totaled $1.2 million in the third quarter as compared to a loss of $3.8 million in the third quarter of last year. Cash burn pre debt service of $2.2 million was the lowest in the Company's history, improving $9 million sequentially in the third quarter. Several one-off factors negatively impacted our results and cash flow in the third quarter, including but not limited to the temporary spike of certain key commodities as well as our inability to fill orders on time.
Following the end of the third quarter we completed a public offering of Class-A stock, generating $15 million of net proceeds. We intend to use the proceeds for general corporate purposes, including but not limited to investing in working capital to support the significant acceleration and growth. Acceleration in our sales growth starting in the third quarter is driving significant fixed cost leverage across our plant network and G&A propelling us to positive cash earnings.
Now turning to our outlook for the remainder of 2023 and 2024. For the three months ending December 31, 2023, we expect net sales to be $65 million to $72 million, approximately 83% to 102% growth as compared to the corresponding quarter in 2022.
Adjusted EBITDA is expected to be between $4 million and $6 million. For the full year ending December 31, 2023. We expect net sales to be in the $185 million to $92 million range, or approximately 31% to 36% growth as compared to 2022.
Adjusted gross margins are expected to be at least 24%, and adjusted EBITDA is expected to be in the low to mid-single digit million range. For the full year 2024, we expect net sales of at least $245 million, adjusted gross margin increasing one-percentage-point to two-percentage point as compared to 2023 and adjusted EBITDA of at least $15 million.
Long term, we continue to expect net sales of approximately $500 million, adjusted gross margin of 35% and adjusted EBITDA margin of 15%. In addition, we currently expect to reach positive cash earnings beginning in the fourth quarter of 2023 and to carry that trend forward into 2024.
This concludes our prepared remarks. I would now like to hand the call back over to the operator to begin the Q&A session. Operator?

Question and Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator instructions) Thank you.
Jeff Van Sinderen, B Riley Securities.

Jeff Van Sinderen

Good morning, everyone. And congratulations on your progress in Q3 and into Q4. Realized you touched on some of this in your prepared comments, but maybe we can drill down a little bit more, if you can give us a little more detail about the ramp in production at Bolingbrook so far in Q4, I guess where you are with the new fryer and any other equipment that may be are needed. And then just sort of general efficiencies you're experiencing there so far in Q4 and where you are in terms of utilization and target run rate trend of Q4?

Bryan Freeman

Yeah. You bet. Hey, Jeff. You know what we saw late, very late in Q3 is pretty significant order flow and we have the capacity to fill those orders. However, when we really push the plant to get it done, we fell down and you know, so what the way to solve for that is to create redundancy and frankly, excess capacity. And we've gone about doing that. And I think that it doesn't happen in the future.
And to that end, I'll flip it over to Gerry because each one has really been hands-on on that piece.

Gerry Law

Yeah. Thanks, Bryan, and good morning. Yeah, I think the way to think about it in that, you know, I like car, so I'm going to associated with the with the race car. But you know, we had a race car, let's call it a Ferrari in the garage, capable of doing 200 plus miles, an hour. We've had it out in the track, we've been doing late lapse. We've been front and paste core, then we hit the accelerator so hard that we melted with the tires. The plants had to start one and two times.
So to that point, you know, we're hardening the core, race time ready. Not only have we really stopped melting tires, we put spares on the shelf as well. The last five, six weeks I've been there, we've seen a 35% increase in credit, credit poultry, September over October. And just remember my background and my history, I come from a hard-core ops and manufacturing background, and that's my specialty.
I can get teams to make those machines dance. As Bryan mentioned, we've added redundancies to improve the uptime and schedule attainment. Additionally, we have more fryers coming in. We have a fryer that'll arrive sometime next week and be online. You don't short order, and we have a second fryer coming in before the end of the year.
And you know, I think I want to also remind everyone that the lines that we're adding are relatively low CapEx. We have the core of the plant built. I would think of it in terms that we've built the office out and we're adding a couple of more printers to the office in that sort of term or so, yes. So we're executing the plan. We're comfortable with our capacities, both before and after these changes and the future is in order for us. I hope that covers the question for you.

Jeff Van Sinderen

That's really helpful and great to hear. And then maybe we can just shift a little bit to kind of what your existing larger retail customers are telling you they want most in terms of additional skews and then plan for door expansion in those and then maybe if you could just touch on ramping distribution into new retailers or new doors?

Gerry Law

Yeah, you know, it's kind of straightforward and simple when you have skews with very high velocities and are also bringing in new consumers to the category. So you're helping retailers grow their category, then usually they want to just lean in with you. And so specifically, Jeff, what I see expanded distribution in the categories you currently participate in, there's obviously an opportunity to add skew count in the breaded poultry door and the same is true in the single-serve on-trade door as well as the MultiServ on-trade door.
Though, I think that as you see increased points of distribution next year, you'll really see us kind of build out, the skew selection because, you know we're helping them grow the category. The other thing that I wanted to call attention to is, we see a pretty nice opportunity on the refrigerated section of the store as well. And that's going to be a focus of ours going into 2024 to expand our handheld business and our soft meats business in the refrigerated category on the upcoming quarters.

Jeff Van Sinderen

Okay. And then you mentioned the fish launch, I think you said December or you're shipping, starting to ship in December and then that will start to actually hit shelves in January. Is that correct?

Gerry Law

Yes, that's correct. The same is true on our soft meat platform. So and I'll skip the store counts are significant. They're in the range of 1,700 to 1,900 stores nationally. And having a national footprint for that allows our social media folks to really lean in on the platforms as well, and we'll see how velocity shape up next year once drawn shelf.

Jeff Van Sinderen

And if the -- just to follow up on that, if the shelters are pretty good in the fish, for example, when would the next sort of reset date, would that be a June reset for that reset? Or how should we think about that?

Gerry Law

You know, I would be thinking back half of next year. It's when those resets would occur.

Jeff Van Sinderen

Okay. Fair enough. I'll take the rest offline. Thanks for taking my questions.

Gerry Law

Thank you, Jeff.

Operator

Thank you. We have reached the end of our question and answer session. And with that, thank you for participating. You may now disconnect.

Bryan Freeman

Before we disconnect, I wanted to make a few comments on recent deal that we have put in place. I wanted to just call attention to it and make a few comments. First of all, our overall strategy over the last several months has been really to strengthen our balance sheet, and we've done that in a couple of ways.
One was the recent equity raise and two putting in some debt instruments that do two things. One, reduce our cash interest cost into increased liquidity and so we're pleased to announce is that our long-term partner, PMC financial services has really been with us since the beginning, has made the decision to move forward with a new $45 million debt piece that will has the potential.
We see it as essentially reducing our cash interest cost of as much as $6 million annually, and it will also increase our liquidity by as much as $15 million. So we think that that's a really positive development. And we look forward to completing that deal in upcoming days, not weeks, and we'll get more into it when we pull that together.
I view that as very positive development for the business and look forward to supporting our fourth quarter results next year. And I hope everyone has a great Thanksgiving. So with that, have a great day and thanks for taking time today. Thanks.

Operator

Thank you. This concludes today's teleconference. You may now disconnect your lines at this time. Thank you for your participation.