Vital Farms, Inc. (VITL) Earnings Call Transcript & Summary

Welcome, everyone, to the Jefferies Virtual West Coast Consumer Conference. We'll kick it off in the food space. We're honored to have Vital Farms with us today. Vital Farms is an ethical food company that's leading -- or is a leading U.S. brand of pasture-raised eggs and butter and is the second largest egg brand in the U.S. by retail dollar share. Listed on the Nasdaq this past July. And thankfully, we do have President and CEO, Russell Diez-Canseco; and Chief Operating and Financial Officer, Jason Dale, with us today. And with that, Russell, I will turn it over to you for a couple opening remarks, and then we can jump into Q&A. Thanks.

Perfect. Thanks so much, Rob. Good morning, everybody. It's great to be here. This is our first of these as a public company, and we're excited to participate. As Rob mentioned, we are on a mission to improve the lives of animals, people on the planet through food. And we do that by coordinating a network of about 200 small family farms across the south in an area we call the pasture belt, which is warm enough for meaningful outdoor access for animals and wet enough for meaningful vegetative cover for them. Just one small example of how we try to live our values every day, and that those values then form a brand that's increasingly resonating with consumers in this country. In just 13 years, we've built the second biggest egg brand in America, the biggest egg brand of what we call pasture-raised eggs with 80% share of that market. It's the fastest-growing part of the egg market. And we have a dynamic portfolio of other products, including butter and things made from eggs and butter. So we've got a lot of runway in front of us in terms of household penetration, in terms of new doors, in terms of new items. We're having a lot of fun disrupting our little corner [ of the food chain ].

Great. Sounds fun. Russell, just to kick it off, yes, there's a lot to talk about around your company. I have, myself, a lot of questions over the past few days just on the secondary that was announced and completed last week. So I just thought maybe any color you can provide around kind of rationale for those investors to divest at least some of their holdings at all. And maybe the benefits, right? I mean it does provide increased liquidity, which I would think would be a positive long-run.

Sure. Well, so we were pretty clear, even in the IPO road show, that our motivation to become a public company was in part the desire to retain our independence even as we needed to create liquidity opportunities for early investors. We took on a handful of growth capital, VC and PE investors. None of them has a majority stake in our company, but all of whom, at some point, had to put the money back. And so our best path forward to maintain our independence, to be able to stay true to our mission but also create that liquidity opportunity, came from an IPO and joining the public markets. So I think there hasn't been a change in anyone's enthusiasm for the company, including management. This is -- we didn't participate in the follow-on. But I think these, frankly, just represented shares that would have come to the market early next year, at the end of the lockup period at the end of January. Instead, we got to bring those shares to market in a more orderly way as we did during the IPO. And to your point, Rob, we heard from some investors at the IPO who said, I love the story. I'd be interested in investing. But there aren't going to be enough shares available for me to build the kind of position that I would want to build to justify the work I have to do. So bring me some more shares, and then we'll take another look.

Makes complete sense. So I guess maybe to address on something a bit more interesting, at least. It's just you're a Class B corp., right? You speak to the following -- the greater stakeholder model, right, the benefit for all, including the humane welfare of the hens. So maybe just kind of give us a little background as to why maybe that was a priority from the start, how that kind of fit into the model and kind of just how you think holistically about that as overall organization?

Yes. So our founder, Matt O'Hayer, is the consummate serial entrepreneur. He started a bunch of companies over the course of his life, seize an opportunity right every corner. And I think he had -- when he started Vital Farms, he had recently read an essay by John Mackey of Whole Foods called Conscious Capitalism, and there's a book behind me, that is the book that came from that essay. And it describes a version of -- a better version of capitalism, which focuses on all stakeholders and not just on shareholders. It also says that business deserves a higher purpose than just profit. And it really resonated with me when I arrived at Vital Farms, but I can't take credit for infusing it in the ethos of the company. Animal welfare and the focus on pasture-raised hens in the early days with meaningful outdoor access to produce a better egg, that was a natural outcome of that kind of thinking. But it isn't the only expression of those values. It shows up in the fact that we pay a living wage plus 25% as our minimum wage anywhere in the country, which means in Springfield, Missouri is a starting wage of at least $14 an hour. It shows up in the way that we support our small family farmers to be successful and don't sort of pit them against each other in a tournament-style pay scheme that some integrators might have, et cetera. So we believe that for anything -- any company to be sustainable over the long haul, sustainable as in resilient, sustainable as in successful, it's got to be so for all of the stakeholders that helped it do its thing. And so that's really the basis for how we behave and how we make decisions.

Right. Great. It's actually focused on the team, right? I mean that's what gets you going. And then, I guess, just to kind of speak to the brand that people ask me all the time, why do you think Vital Farms could do better just as a brand relative to other competitors, or other brands even in adjacencies with the bandwidth of the brand, how do you personally view the brand, which is a complete subjective answer. So maybe just kind of discuss how you and the company develop the brand, and then why do you think the brand itself should resonate with consumers over the long term.

Yes. And it's funny, there's a lot of parallel between the way that brand has evolved and the way we became a B corp., actually. In that, I think a brand is -- and I'll mangle the quote, but it's sort of the sum of all the decisions you make and all the touch points you have with the outside world every day, right, whether you realize it or not. And in the same way, becoming a B corp. was essentially being evaluated on a bunch of criteria around the practices and the change you're trying to make in the world. In both cases, the things we were doing predated our thinking about getting credit for those things. So the -- when we went -- when we applied to become a B corp., we actually passed on the first go without changing anything that we did. It wasn't a goal that we had, and we slowly adapted our practices to meet that goal. We were already there. And in the same way, in the early days of Vital Farms, we just started operating in a certain way. We didn't have a lot of purposeful brand building because in those early days, frankly, first-mover advantage was enough. If we could educate you about how pasture-raising was different and maybe better, chances are we got a new consumer who didn't rely on us rolling that up to a brand. And in fact, in those early days, we had a whole portfolio of brands because many retailers said, well, we want something that's proprietary to us. And when we hired our first true marketing professional, our CMO, Scott Marcus, in 2016, he is the one who first said, "Guys, you think you've got a brand, but what you really have is first-mover advantage in something that's catching on. But there are a bunch of other guys who are going to come and try to eat your lunch. And so you better start talking about the Vital Farms brand and not just having a bunch of products on shelves that have a certain set of criteria." He was absolutely right. And so over time, what we found is that the brand is about the set of behaviors and values throughout our company that resonate with a certain group of consumers. And we used to think it was all about animal welfare, and animal welfare is a critical component of what we do, but it's far from the only thing. And it can be some of those other things I mentioned earlier, whether it's the way we treat our people, the way we treat our farmers. It can be the transparency that we bring to all of that. Ultimately, that rolls up to this thing called Vital Farms, which is all about, over time, building, earning and retaining trust with consumers so that no matter what they care about, they know that if we check that box for them, they can trust that we're going to do it that way consistently. I had just one small story example of that. We were doing consumer ethnography work, where we pay shoppers to let us shop with them so we can understand how they make their decisions and what they choose in the store and why. And the facilitator would ask this particular shopper about each choice she made. She pick up a carton of eggs, and she'd asked her why she picked that one or carton of milk, and what does she think about this organic claim or that non-GMO claim, et cetera. And after about the eighth or ninth item in the basket, the women kind of threw up her hands and said, "Look, it seems like every other day, I'm reading or hearing about an example of someone who cheated on that standard. They were -- they -- asserted that they were upholding, whether it's regular grain that leaves Eastern Europe and shows up in America with a USDA paperwork attached to it or cows that are marketed as pasture-raised, but whose milk doesn't have any CLA in it. I don't trust a lot of folks out there. The key is for me to trust you. And when you trust -- when I trust you, I'm not quite so focused on exactly which claims you're making. It's sort of more binary. And so that's really what we're about. It's building that brand that says, look, if it says Vital Farms, you can trust it for your family.

Yes, that means a lot. I guess that's -- kind of to your comments, it's nice to kind of transition into just -- like you had mentioned that competitive dynamic, right? So obviously, you helped to create, right, this one of the fastest sort of -- or the fastest-growing subcategory, at least within the egg market. You also pulled most of the share. It's what, close to 80% at this point. So usually, growth, for better or worse, begets increased competition. People like, they sell, they're doing it. So why aren't we doing it. So I guess just kind of that direct question is, you have the brand, right? You build that trust with the consumer. How do you view the competitive dynamic, right? And let's just say, could the subcategory itself become sizable enough, let's say, that maybe there is room for more than one player to succeed.

Yes. So first of all, I'd say that given that there's still a lot of confusion about food claims, especially in eggs, around animal welfare claims and other claims that are made on packages. I would assert that the competitive set or the landscape is broader than just pasture-raised. Yes, we dominate pasture-raised. The reality is that starting back in 2015, we attracted fast followers, both branded and private label, and several of our largest retail customers have a private label pasture-raised egg. So that kind of competitive pressure started showing about 5 years ago. And it doesn't seem to have created much of a headwind for our growth. And none of those competitors seem to have achieved anywhere near the size or growth trajectory as we are in the categories in which we play. So I don't want to be overly precise in my assessment of why it is. But I think part of it has to do with the notion that we're a brand that brings some products to market that look a lot like commodities. The people that bring those commodities to market without the brand don't seem to be getting the kind of traction we are.

Fair. Okay. And then just, I guess, touch on the food at home by consumption lift, right? It's kind of the shift in consumer behavior. We all talk about now every day. A lot of food companies have experienced a nice little lift. A little bit more complicated to probably separate out your true growth currently relative to what that lift might be providing, given you're already growing so quickly before the pandemic. So maybe if you could just touch on, as we go into next year, right, I guess one is how could some of that demand, let's say, soften, I guess, number one? But then maybe number two is, maybe as your supply becomes a little bit more rightsized, are there offsets such that you can almost push a little bit more on your business and the distribution potential going forward?

Yes. So one thing maybe to clarify just a little bit for the group that are in the audience, the cause -- so one aspect of what we do that, frankly, we think it makes us more resilient but has its pros and cons, is our eggs, for example, come from our own network of small family farms, and we buy all of their supply. And we don't buy supply on the open market because our standards are higher than any commodity that we might be able to buy in the open market. So that means that we have pretty long lead times for projecting our supply requirements, right? Generally, 8 to 12 months is the kind of the time frame. So in terms of the ability to lean in to growth, for example, that -- we're making educated bets 8 to 12 months out, and we've got to live with that. We have the ability to flex supply by single-digit percentage points within a given month or given year but not double digits within a month or a quarter. That said, there's so much room ahead of us in terms of growing households, in terms of educating more consumers about what we do and how it's different and in terms of getting even more doors. We're excited to lean into that growth. And we just hired a really terrific new sales leader, Pete Pappas, most recently from Califia. And we're excited about kind of the more strategic channel strategy that he'll bring and really driving an even higher level of kind of sales culture in our company. So that's what I would suggest there. In terms of how much of what we saw in '20 is COVID-related and how much of it continues into '21, not unlike the way we think about long-term sustainability for our company. We have a through-cycle mentality when it comes to planning our business, meaning we didn't suddenly change our expectations or the slope of our growth in our own internal planning because COVID came along. The fact is we did, and it looks like early results are that we did manage to retain perhaps as much as 20% of the households that tried us for the first time during the stock, [ at least with ] COVID, as repeat buyers in the following months. And so we certainly have that front and center as we think about supply planning, but we think this has more of pulling forward a growth trajectory that was already there as opposed to a total step-change in our business.

Okay. Good answer. Jason, give you an opportunity to chime in. And Russell, obviously, if you can contribute, too. So look, I mean, part of the story here over the next few years is just the potential to expand the margin, right? You have -- there's -- there are scale benefits or efficiency benefits. But then I'd assume, over time, you also may increase the investment you put into the brand. So maybe if you could just -- really, for those who are unaware of the drivers of that margin upside going forward, maybe you can just kind of touch on what they are and potentially how quickly they could come, but then some offsets as well as you look into next year.

Great. Happy to. Yes, so I think if you break this down kind of into the categories, if you look at butter, we're early days in our journey there. We created this product in 2015. And we use a co-man to actually produce the butter. And then we've historically relied on them to manage the relationships with the farm that were to -- where that milk is coming from. And so as we -- very similar to what we did with eggs, over time, as we start to get more directly involved in that supply chain, working more directly with farmers, either within that existing network or building out our own network and working through other co-ops, there's likely ability there for us to be able to do things that are more impactful and allow us to reduce the cost structure there. It will also likely come in innovation and as we look to expand in value-added dairy, and we're using more components of that raw milk stream, we would see there be some margin accretion from developing those items as well. In terms of other innovation, similar to the Egg Bites that we released earlier this year, in August of this year, as we just scale those products and get better at those products, we're likely to get some margin accretion over time there as well. And then for the biggest part of the business, the shell eggs side, as we continue to focus with our team on just meaningfully impacting outcomes for small family farms, a lot -- that -- initially, that value will accrete to the farmer. But over time, we fully believe the things we're doing on the farm are going to help us reduce the cost structure of the eggs we're pulling off those farms and ultimately allow us to accrete the gross margin there. I think walking that down the P&L to adjusted EBITDA, we're a growth company. We -- certainly, this year and next year, we continue to invest in infrastructure to support kind of our operational growth targets. And then just the carrying cost for us in being a public company, obviously, is pretty extreme. And so -- but I fully expect as we stay on target to get to that gross margin accretion and target in the future, that we'll start to get scale benefits of the adjusted EBITDA line in the out-years, for sure.

All right. Cool. I guess you had mentioned Egg Bites, so I'll mention it, too. And then just potential for go-forward innovation. Prior -- let's say, prior to Egg Bites, right, one could say, "Okay, well, you're a different kind of egg company, but you're an egg company. And eggs are a bit more commoditized in other products, right?" You have a brand, which is a positive, with a totally different mission statement and value system, let's say, that the consumer might buy into. But it's great when you have other products that consumer can almost bite into, let's say. And Egg Bites can -- it's value-based, as you said, which usually gives a bit more of a margin benefit, hopefully, over time. And then you also could sell the product in different locations, right? So I guess -- Russell, I guess, one is just kind of maybe touch on why the Egg Bites were the first real, call it, innovative product within the egg -- within your egg business? And then two is how quickly would you expect there to be ancillary innovation, so to speak, that would be forthcoming, that maybe might be more akin to what we're seeing with the Egg Bite product?

Sure. So I think the distinction for Egg bites is that it was our first foray into a multi-ingredient product. So historically, we had eggs, and then in 2015, we launched butter. And we've had different forms of eggs and butter; liquid eggs, whole eggs, ghee butter or clarified butter, for example. But you're right, Egg Bites feels like a different opportunity, different step in our journey. The impetus for it was really -- it starts with consumers. I mean that would be another way that might distinguish us from some other, especially food companies, that are based on direct agricultural commodities. We start with consumer insights and work backwards to develop the supply chain to bring those things to market. I think some companies have a group of farmers that are producing something, and their marketing and sales team's job is to get the highest price for that thing they're producing. So in that sense, we're really focused on the consumer, first and foremost. And we saw an unmet need that sort of on-the-go and time-starved, especially the parents, frankly, who are struggling to find no-compromise options to feed themselves and their kids. They wanted cleaner labels, they wanted higher standards of animal welfare. And frankly, they wanted great source of protein and maybe a little less carbs in the mix. And so that's really where the impetus came from. Then it was about coming up with great recipes and great ingredients to deliver a great eating experience. Because the stuff is going to taste great. It doesn't matter what our values are. Food is going to taste good, right? In terms of the sort of the opportunity for further growth outside of commodity eggs and butter and sort of the pace at which we do that, you've got a multiyear pipe -- innovation pipeline. And that's definitely something that we believe we have the right to do, and we're going to continue investing in it. But what I -- the emphasis I would give to you is you shouldn't have to bet on a big TAM, new product launch 5 years from now, to believe in our growth story. And as we have demonstrated over all of our years of profitable growth, we'll be focused on efficiently using our capital to grow. So we'll focus on things -- in areas that we know a little something about, which really looks like value-added dairy.