The Real Good Food Company, Inc. (NASDAQ:RGF) Q4 2022 Earnings Call Transcript March 27, 2023
Operator: Greetings, and welcome to The Real Good Food Company Fourth Quarter 2022 Earnings Conference Call. At this all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. . As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, , Vice President of FP&A and Investor Relations. Thank you, . You may begin.
Unidentified Company Speaker: Good morning, and welcome to The Real Good Food Company’s Fourth Quarter 2022 Earnings Conference Call. On the call today are Bryan Freeman, Executive Chairman; Jerry Law, Chief Executive Officer; and Akshay Jagdale, Chief Financial Officer. Our fourth 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 our Investor portion of our website at www.realgoodfoods.com. Before we begin, I’d like to remind everyone that certain statements made on this call are forward-looking statements within the meaning of federal securities laws and are subject to considerable risk and uncertainties. These forward-looking statements are intended to qualify for the Safe Harbor from liability established by the Private Securities Litigation Reform Act of 1995.
All statements made on this call today other than the 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 can 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 can 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 non-GAAP financial measures, which refer to results before taking into account certain onetime or nonrecurring charges that are not core to our ongoing operating results and which we believe better reflects the performance of our business on an ongoing basis. Our non-GAAP financial measures include adjusted gross margin and adjusted EBITDA are referenced.
A reconciliation of each non-GAAP financial measure to its most directly comparable GAAP financial measure is included in our fourth quarter earnings release, which is available on our website under our Investors 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, . Good morning, everyone, and thank you for joining us today on our fourth quarter earnings call. I will briefly review our fourth quarter highlights and discuss the reasons we believe we’re well positioned for long-term growth. Jerry 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 fourth quarter, net sales increased 39% to $35.7 million as compared to $25.6 million in the fourth quarter last year. Sales in the fourth quarter were below our original expectations driven by our decision intra-quarter to dial back on a certain promotional event that was a onetime LTO for non-core items in the unmeasured channel that would have ultimately been margin dilutive.
This action demonstrates our commitment to profitable growth. And despite pulling back on trade, unmeasured channel sales grew by 81% this quarter and were up 385% on a 2-year basis. Sales in the retail or measured channel increased 107% on a 2-year basis, which is an acceleration compared to approximately 15%, 2-year growth on average over the preceding 3 quarters. Our baseline velocities continue to outperform our expectations and have been the primary driver of growth in 2022. We’re able to leverage this velocity growth with our retail partners to activate new TPDs. For 2023, our growth will be driven by distribution gains of our high-velocity items. We’ve secured approximately 50,000 new distribution points for our products to ship in 2023, which represents an approximate 38% year-over-year increase in our distribution footprint.
These distribution wins include 11,000 incremental distribution points since last quarter, including further expansion at two large national retailers and several regional retailers. Moreover, this new distribution is for items that have significantly higher velocities than our base business, implying that sales growth will likely outpace distribution growth in 2023 as this new distribution comes online. As we’ve said in the past, due to the new item reset schedules in the measured channel, this new distribution will come online late in 2Q and into the back half of 2023. As such, the shape of our growth this year is back half-weighted. Now turning to the unmeasured channel. We are on track to meet or exceed our 2023 plan. There are two important things going on in the unmeasured channel that I would like to highlight.
First, our entry into the refrigerated section is a success. This is a new temperature state for us and gives us entry into the multibillion-dollar refrigerated category. The first item we launched this year is our Flautas, which can be found in approximately half of the U.S. and one of our customers in the unmeasured channel. We’re experiencing velocities that exceed $2,000 per point of distribution per week, which is 2x the threshold for the category. This success has led us to the authorization on the second item that will launch in April. The second item is our low-carb, high-protein chicken and pepper jack burrito. We will launch in approximately 1/3 of the country. We view the refrigerated area’s providing significant long-term growth and plan to expand these items and also introduce protein-based entrees in the coming months and years.
The second important topic I want to mention regarding the unmeasured channel relates to our frozen food business. We are currently transitioning our original enchilada into our new Creamy Poblano Enchilada using our new proprietary tortilla. This new version, which we call 2.0, is just now getting on shelf, and we are pleased with the velocities. The transition caused the short-term sales decline for the quarter, but we see this as a smart investment in our future and for achieving our 2023 plan. Our Breaded Poultry business continues to perform with expanded distribution coming in on time and on plan. So to summarize the unmeasured channel and provide additional perspective, in 2021, we had 2 items that on a combined and annualized basis achieved 65% ACV.
For 2022, we grew to three items with the combined and annualized ACV of approximately 68%. Currently, we have eight items authorized that participate in three different categories in frozen and one category in refrigerated. For perspective, we’ve never had more than four items authorized simultaneously. We see our breaded poultry, enchiladas, bacon-wrapped items and refrigerated flautas easily achieving our plan for 2023 with an additional four authorized items providing opportunities for upside to the plan and 2024 future growth. All of this is to say that we are confident in meeting our 2023 full year plan. Finally, I want to highlight our product velocities across all channels. Baseline velocities continue to exceed our expectations with velocities for many of our new products trending significantly higher than our base products.
Specifically, our breaded poultry items are performing in the top quartile of all conventional SKUs with velocities that are 8x our base business. In fact, at one large national retailer, our low-carb, high-protein chicken nuggets were the number one health and wellness item in the category last week. And even more impressively, they’re in the top 12% of all frozen poultry meat items, this includes conventional producers such as Tyson and Perdue. The aforementioned new distribution gains, combined with strong base business velocities and another solid slate of new product innovation, gives us confidence that we will grow sales in 2023 to at least $200 million, representing growth of approximately 30%. Jerry and Akshay will speak to this in more detail, but I wanted to touch on our margins this quarter.
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Gross margins were 13.7% this quarter which is a 9-point improvement sequentially and the best margin in the last six quarters. What is particularly noteworthy about this performance is the fact that we achieved this while our plants were less than 50% utilized. Adjusted gross margins, which account for the capacity utilization impact, were 27.7%, a 13-point improvement sequentially compared to 15.8% in the third quarter of ’22 and the second best quarterly adjusted margin in the company’s history. Margins in the fourth quarter reflect a more normalized commodity cost environment and improved operational performance, both of which we believe are sustainable. Cost for chicken, cheese and bacon have come down from historical highs and are currently at or below their long-term historical averages.
We continue to expect commodity costs to have a 6 to 10-point positive impact on our margins in 2023, assuming current trends hold. Additionally, our operating performance improved sequentially as we gained efficiency in our new Bolingbrook facility. As we continue to ramp up production of meat demand, we expect these efficiency gains to be an even larger contributor to margins in 2023 and beyond. Adjusted EBITDA was a loss of $700,000, which was below our internal expectations, but improved significantly sequentially from a loss of $4.5 million in the third quarter of ’22 and was the lowest loss we have incurred at the EBITDA level in seven quarters. I want to touch on our decision to transition our distribution to a new strategic partner.
It’s the right move for our business as it reduces our costs in 2023 and beyond, but it did cost us 300 basis points of margin or close to $1 million of EBITDA. Barring this transition, we would have exceeded our internal expectations for adjusted EBITDA, but this decision will pay dividends in 2023. As for 2023, we expect adjusted EBITDA in the mid-to-high single-digit range driven by lower commodity costs, to a lesser extent, lower labor, improved plant utilization and better overhead cost leverage. Cash flow from operations is also expected to be positive in 2023. Next, let’s take a step back and look at the current state of the health and wellness market, our total addressable market and how our brand positioning is resonating with this broad consumer base.
Our total addressable market is the $242 billion health and wellness industry, which according to SPINS grew 6% year-over-year with an 8% 3-year CAGR. The frozen health and wellness subcategory continues to outpace overall health and wellness, growing at a 9% 3-year compound annual growth rate and about 6.5% year-over-year. It’s important to note that the frozen food category has historically performed well during recessions as it tends to benefit from consumers trading down from eating out to eating more at home. Also private label penetration in the frozen category is relatively low at about 9% to 10% as compared to 20% to 22% on average across all food categories. And private label penetration in health and wellness frozen is even lower than in the overall frozen food category.
As such, trade down risk within the category to lower-priced private label options is also limited. Additionally, our distribution footprint is focused on retailers that deliver value to their consumers, and we have low concentration with luxury high-end retailers that typically lose foot traffic during economic downturns. As many of you probably know, our brand promise has three primary claims, low carb with little to no sugar, high protein and clean ingredients. Products with these attributes are growing well above the growth in our overall total addressable market. All things considered, the categories we compete in remain highly relevant as evidenced by their large size and strong growth profile. Moreover, there are no signs of a slowdown despite the lapping of the pandemic dump and/or an economic recession as frozen foods historically performed well in recessionary environments.
As for our brand health, we track ourselves against 4 indicators: household penetration, repeat rates, social community growth and engagement and velocities. Starting with household penetration, according to numerator data as of January 1st, The Real Good Foods brand household penetration is 8.4%. That’s up from 7.6% in January of 2022. This means approximately one in every 12 households in the United States has purchased our products in the last 12 months. Our household penetration continues to rank second amongst all health and wellness frozen brands behind only Amy’s, a brand with over $500 million in retail sales. Increasing household penetration demonstrates how well our brand position resonates and how quickly we have connected with a broad consumer base.
We view this as a leading indicator of future growth. Turning to repeat rates. They continue to be in line with industry averages at 32% in the most recent trailing 52-week data as of November 1, 2022. Regarding social community growth, we continue to grow The Real Good Foods online community. In the fourth quarter, our social and digital teams continue to outperform. We generated over 8 million organic impressions and 94 million total brand impressions. We also acquired 22,000 new SMS text subscribers and added 38,000 followers on Instagram, bringing our total to over 460,000 IG followers. We continue to believe using micro and nano content creators to spark authentic peer-to-peer conversations is a better use of marketing dollars than traditional advertising.
Based on a number of followers and subscribers, I can say it’s working and it’s efficient. This is reflected in the strong returns we get on our ad spending, which averaged 4x to 6x as measured by third parties. That’s far higher than our peers on average. Our retailer partners appreciate how we drive new consumers to the categories we participate in, allowing Real Good Foods to truly grow the frozen category with consumers new to frozen foods rather than taking share from others. Our close connection to our consumers enables us to efficiently test demand for new products before they launch on shelf. This leads to greater household penetration and incremental category growth, not only for us but for our retail partners as well. These strong brand health indicators underpin our confidence in achieving over $500 million in sales over the long-term.
Now moving to innovation. Our strategy can be characterized as fewer, bigger, better and faster. This means we’re interested in innovation that is additive to growth, meaningful to the consumer and profitable. With that in mind, in 2023, we built new plant capabilities that enabled us to enter the refrigerated section. Our flautas are now on shelf and our low-carb, high-protein burritos will be on shelf in the second quarter of 2023. Additionally, we plan on introducing a new set of refrigerated protein-centric meal solutions in the second half of 2023. You will continue to see us expand in the frozen category as we enter the handheld category this year with low-carb burritos, quesadillas and taquitos. These are large incremental platforms capable of delivering and accelerating long-term sustainable growth.
We also spend time and continual improvement in refurbishment of our existing items. We know today’s consumer is always looking for what is new. To that end, we have recently introduced a new Creamy Poblano Chicken Enchilada that uses an innovative new low-carb tortilla. Additionally, as we mentioned on our last earnings call, we are rolling out our new breakfast sandwiches, which feature a newly formulated fluffier bun. Similarly, our bacon-wrapped stuffed chicken platform innovation will feature new flavor combinations, including cheese with caramelized onions and for the holiday, bacon-wrapped cranberry and Brie-stuffed turkey breast. All of this is to highlight the talented, highly focused team of food developers that work tirelessly to create craveable nutrient in foods.
We know if we do that, we will have a massive positive impact on society while growing a large and profitable business. I’d now like to turn the call over to our CEO, Jerry Law, to provide an update on Bolingbrook and our operations more broadly.
Jerry Law: Thank you, Bryan. Good morning, everyone, and thank you for joining us on today’s call. I’m pleased to report that our Bolingbrook, Illinois facility is continuing to ramp up its phased start of production. And I’m very proud of the team and how far we’ve come since opening the new facility. Bolingbrook enables our entry into exciting new categories and gives us much needed capacity to meet the growing demand for our new and existing products. I was pleased with our margin performance in the fourth quarter, which came in above our expectations. Lower raw material costs contributed to the improvement, but the margin performance also reflects the fact that the start-up blues that we experienced in the third quarter of 2022 are behind us.
I am encouraged by the sequential improvement in efficiencies at Bolingbrook and continued performance at our City of Industry facility. Moreover, we expect operating performance to improve further throughout 2023 driven by better efficiencies, lower labor costs, improved plant utilization and better overhead cost leverage. Today, we have 8 production lines up and running in the Bolingbrook facility with capacity for approximately $200 million in sales with the ability to add another $50 million to $70 million of capacity in short order with limited CapEx investment. We are in a good position capacity-wise to be able to meet incremental demand driven by distribution wins we have already secured. We will view the first quarter of 2023 as a transitory period with two-noteworthy events.
First, the timing of large customer promotion moved to the fourth quarter of 2023 from the first quarter. Second, we took the opportunity to reorganize our distribution footprint to enable further cost savings by simplifying our network and to better serve our customers. Although this move cost us 300 basis points or $1 million in incremental costs in the fourth quarter, it’s the right strategic move as it structurally lowers our costs and creates further flexibility in our manufacturing network. We now have a large strategic partner servicing a majority of our customer base, simplifying our supply chain and significantly reducing touch points for the company. This transition will significantly lower our overall logistics costs and enable us to achieve our long-term target.
Products made in the new Bolingbrook facility will have structurally lower costs as compared to those made in our City of Industry facility driven by lower labor costs, higher throughput and Bolingbrook’s proximity to lower cost raw materials, supplies and a major distribution hub. Overall, we believe this new facility brings us closer to meeting our long-term goal of achieving $500 million in revenue while concurrently accelerating our margin improvement efforts. We have already seen the impact Bolingbrook has had in terms of successfully relieving pressure on our City of Industry plant, which is operating above 100% capacity utilization throughout most of 2022. With the City of Industry plant running at more normalized operational levels, it has allowed us to focus on continuous improvement.
And in turn, we expect to further improve yields and drive new efficiencies. Specifically, conversion costs in our City of Industry plant for the fourth quarter were relatively flat sequentially but down approximately 700 bps of net sales, which is an acceleration from Q3 as compared to the average of preceding four quarters. This improvement was driven primarily by improvement in labor costs. Before I turn it over to Akshay, I’d like to discuss our biggest catalyst as we exit the fourth quarter and move into 2023. We expect our labor cost to continue to come down sequentially as Bolingbrook becomes a bigger portion of our production mix, further aided by continued efficiency gains at our City of Industry facility. We are confident in our ability to bring labor costs in line with industry standards of approximately 5%, 10% of sales.
To reiterate, we expect a major portion of this opportunity to flow through within the next 12 months as efficiencies are optimizing both plants and Bolingbrook becomes a bigger portion of our production mix. Additionally, higher sales will drive plant utilization rates higher and allow us to leverage lower overhead costs. We expect these overhead leverage to drive a further 200 to 300 bps improvement in our 2023 margin profile. Lastly, Bolingbrook has enabled significant productivity savings that have already started to accrue as we move into 2023. This includes the self-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 bps of margin improvement.
As for direct materials inflation, the good news is that commodity costs remain favorable and point to a roughly 600 to 1,000 bps tailwind for 2023. In summary, although we walked away from some promotions in the fourth quarter that negatively impacted sales, it was all done with a keen eye on our margin targets. We are pleased by our margin performance in the fourth quarter, which showed significant sequential improvement to the second highest margin in our company’s history. We continue to expect 2023 adjusted EBITDA to be in positive mid-to-high single-digit millions of dollar range. 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 and I am thrilled to report the tremendous progress our supply chain and operations teams have made, all in order to support our growing demand.
I still believe we are in the very early innings of growth and are well positioned to capture market share in the categories in which we compete. Now I’d like to turn the call over to Akshay, our Chief Financial Officer, who will walk you through our fourth quarter financials.
Akshay Jagdale: Thank you, Jerry, and good morning, everyone. Turning to our financial results, net sales in the fourth quarter were $35.7 million, an increase of 39% as compared to the fourth quarter of last year. Sales growth in the fourth quarter was primarily due to strong growth in our core products and the unmeasured channel. In the unmeasured channel, growth accelerated in the fourth quarter to approximately 81% as compared to 77% growth in the third quarter. Sales growth in the unmeasured channel would have been significantly higher if it weren’t for our decision to dial back promotions on certain non-core products to prioritize margins. The strong 81% growth in this channel was driven by distribution gains and to a lesser extent, velocity increases.
As for 2023, we expect another stronger growth in this channel driven by expansion of our breaded poultry items starting in the first quarter of 2023, significant new distribution wins already secured as well as commitments to certain planned promotional events. It is important to point out that our growth plan has always been significantly back half-weighted, but it is more so now due to the timing of certain promotional events moving from the first quarter to the fourth quarter of 2023. Despite this change in promotional timing, we remain on track to achieve our 2023 sales target for the unmeasured channel. In the retail channel, growth slowed sequentially to 1% in the fourth quarter as we lapped 105% growth in the fourth quarter of 2021.
On a 2-year basis, our growth accelerated to 107% in the fourth quarter as compared to 49% in the third quarter of ’22, 85% in the second quarter of ’22 and 70% in the first quarter of 2022. Our growth in this channel continues to be driven by strong baseline velocities, while distribution has been flat to slightly up. However, as Bryan mentioned, we have strong momentum on distribution wins and are bullish about our prospects for 2023. Three factors underpin our positive outlook for 2023 revenue growth. One, significant wins we have already secured. Two, strong baseline velocity growth, and three, exceptional new product velocities. We have recently secured approximately 50,000 distribution points for our new items introduced in 2022, which represents an approximate 38% increase year-over-year in distribution points.
Moreover, these new items have velocities that are already 3x to 8x our base business. As such, these new distribution wins are likely to be materially additive to our overall sales growth in this channel, and we expect another strong year of growth in this channel in 2023. Our fourth quarter gross profit was $4.9 million, reflecting a gross margin of 13.7% of net sales as compared to a gross profit of $1.3 million or a gross margin of 5% of net sales in the fourth quarter of last year. The increase in gross margin was primarily due to lower commodity costs, continued strong operating performance at our City of Industry, California facility and improved efficiencies in our new facility in Bolingbrook, Illinois. Adjusted gross profit during the quarter was $9.9 million, reflecting an adjusted gross margin of 27.7% of net sales as compared to $4.5 million or 17.5% of net sales in the fourth quarter of last year.
We had expected margins in the fourth quarter to be higher than the third quarter, owing to lower commodity costs and efficiencies related to the Bolingbrook ramp-up. However, margins came in above our expectations primarily owing to lower-than-expected direct material costs and to a lesser extent, greater than expected efficiencies related to the Bolingbrook ramp-up. As expected, we exited 2022 with structurally lower cost, particularly on the labor front. Looking ahead to 2023 and beyond, we have a long runway of future productivity savings that will drive incremental margin expansion. Additionally, as Jerry mentioned, the cost of our key commodities has come down significantly in recent months. And if you were to lock in our commodities at current spot rates, our margins in 2023 would be 600 to 1,000 basis points higher.
Total operating expenses were $13.6 million as compared to $42.3 million in the fourth quarter of 2021. Adjusted operating expenses increased by approximately $3.4 million to $12 million in the fourth quarter of 2022 as compared to $8.7 million in the fourth quarter of 2021. The increase in operating expenses was primarily driven by increased personnel expenses related to the build-out of our company’s operations, finance and leadership team as well as increased investments in research and development. Adjusted EBITDA totaled a loss of $700,000 as compared to a loss of $4.5 million in the fourth quarter of 2021. This was below our expectations driven by two factors. One, lower-than-expected sales due to us walking away from a promotion that would have negatively impacted margins.
And two, as Jerry and Bryan mentioned, our decision to transition our distribution network to a new strategic partner, which resulted in a $1 million increase in our distribution costs this quarter. Now shifting to our balance sheet and cash flow. As of December 31, 2022, we had cash and cash equivalents of $7.6 million and total debt of $73.2 million. Our total liquidity position was $37.6 million as of the end of the year. Cash burn in the fourth quarter was approximately $8 million, a significant decrease as compared to $19 million in the third quarter of 2022 and $24 million in the second quarter of 2022. Of the $8 million cash burn this quarter, $1 million was related to core working capital. We have strong visibility into our distribution gains in the upcoming shop reset cycle in May, which includes the national rollout of our breaded poultry items at a large mass retailer.
This significant inflection in our sales growth starting in May could result in a significant fixed cost leverage across our plant network and in G&A, propelling us to be closer to our goal of operating cash flow positive starting in the second half of 2023 and for the full year of 2023. As such, we have sufficient liquidity to fund our current needs and execute the plan we have laid out. As a reminder, it’s important note that the Bolingbrook facility and equipment is being leased with costs flowing through the P&L, and there’s no incremental CapEx spending associated with that plant. Now turning to our outlook for 2023. In 2023, we expect net sales of at least $200 million, adjusted gross margins of at least 24%, adjusted EBITDA in the mid-to-high single-digit range and positive cash flow from operations.
Long-term, we continue to expect net sales of approximately $500 million, adjusted gross margin of 35% and adjusted EBITDA margin of 15%. This concludes our prepared remarks. I would like to hand the call over to the operator to begin our Q&A session. Operator?
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