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

Good morning, everyone. My name is Rupesh Parikh, I'm the senior analyst covering the food, grocery and consumer products sector at Oppenheimer. I'm very pleased to introduce the next presenting company, Vital Farms. We're excited to have joining us today, President and CEO, Russell Diez-Canseco; and CFO, Bo Meissner. For those of you who are not familiar with the company, Vital Farms is a food company that has a leading U.S. brand of pasture-raised eggs and pasture-raised butter. Its products are sold in both conventional and natural grocery stores as well as foodservice outlets nationwide. The format of today's session will be a fireside discussion following questions from the audience. If you have questions, please post in the interface at the bottom of the screen, and we'll get to the audience questions once we are through with mine. So let's get started.

So you have stated that you have benefited from the stay-at-home trend. How should investors think about that heading into the post-vaccine environment?

Thanks, Rupesh. Well, let me start by offering some important context on pre-pandemic growth and trends. I'll talk primarily about egg since that's the biggest part of our business. The roughly $6.7 billion retail egg category has grown 18.7% in 2020 versus prior year. And within the broader egg category, the specialty egg segment has grown 25.5% versus prior year. The entire category benefited from the increased eat-at-home trends during the onset of the COVID-19 pandemic, growing about 41% in the second quarter versus prior year. Despite the pandemic persisting throughout the year, that total category growth has decelerated to about 10% in Q4. Specialty eggs grew about 37% in the second quarter compared to 21% in Q4 of '20. We believe this is indicative of a shift in consumer preferences brought forward during the COVID-19 pandemic and position Vital Farms well as we head into 2021. Now turning to the increased at-home consumption we saw last year due to the pandemic, we did see an increase in the number of households buying our products since late March. But we view this as pulling forward an acceleration of households that we were going to get later. What was particularly gratifying to see, though, was that the initial repeat and multiple repeat rates. We saw a lot of new households join us, about 440,000 of them in that stock up period of sort of early March through April. And yet, what we saw when we looked at the buying patterns of those consumers in the 20 weeks after that stock-up period, presumably, when their original preferred brands showed up on the shelf again or perhaps came down from pandemic pricing. What we saw was that about 20% of them bought us multiple times after that initial trial. And we see that as a really powerful tailwind for us as we head into '21. We didn't spend a lot of marketing or trade dollars to attract them, but we managed to retain a big chunk of them.

And then just -- this is obviously -- this may be a difficult question to answer, but how much of your growth in 2020 do you attribute to COVID? And how do you expect that trend to be similar or different in 2021?

Well, as Russell said, I mean, we certainly saw an increase in the number of households buying our products since COVID began. Q2, which is really the peak of COVID pantry stocking and when stay-at-home trends really began, we estimate that about 50% of our 84% growth was related to COVID. Q3, we estimate that about 25% of the 57% growth we had attributable to the continued stay-at-home trends and increase in baking trends. In 2020, we took some steps to ensure that we could meet the increased base demand by pulling back on some promotions, particularly in Q4, and sign up additional farms to meet the growth. And with the new farms that we're going to be adding in 2021, we'll have over 200 small family farms in our network. As we think about 2021, we believe there are several trends that will continue but the most relevant to us being an increased interest in at-home cooking and with trusted food products. As Russell mentioned, another thing to note is the repeat rates of the new consumers that we saw in Q2 and Q3. They were driven with very little marketing support. So in 2021, as we renew our marketing investments, it really gives us the confidence in our ability to continue to retain many of the consumers who tried our products during the pandemic. We continue to grow trial and build loyalty. And finally, in 2021, we'll just continue to progress on our growth strategy, which is really focused on increasing household penetration, increasing our retail presence, expanding our foodservice footprint and identifying new product innovation.

Okay. Great. And earlier this year, you launched Egg Bites, your first multi-ingredient breakfast product. Can you talk about its performance so far? And any learnings you had since it's your first innovation product?

Sure. So Egg Bites is our newest convenient breakfast product, and it adheres to all the same values of our other products. Pasture-raised eggs and cheese, humanely-raised meat and vegetables and the ethically sourced ingredients that our consumers know and expect from us. Since we launched in August, we successfully ramped up distribution to over 850 stores, and we're really pleased with the initial response we received from retail customers and consumers, who we believe are interested in convenient, protein packed and ethically sourced breakfast or snacking solutions. It's important -- while we continue to make substantial investments in our innovation portfolio, growing the innovation team from 2 at the beginning of 2020 to at least 5 positions by the end of 2020, I think it's important to note that innovation was not a substantial driver of our kind of 5-year growth targets. And we're excited about the potential for innovation to provide meaningful growth for Vital Farms, but you don't have to believe in a big sort of new category launch to believe in our growth story.

Okay. Great. And then just going up that last question. How should we be thinking about innovation heading into 2021? What categories or areas are you looking into?

Yes. So innovation is a pillar of our long-term growth strategy, as I mentioned, and we're interested in serving consumers more convenient solutions like Egg Bites. We also will continue to explore opportunities to play in products in that adjacent value-added dairy category. It's the part of the store we know the best. It's the supply chain, the cold chain and the farmers that we know the best. And so I think, as we have done historically, new innovation will continue to be focused on things we think we have a right to win in that are on brand that we can execute well and that help us fulfill our mission to improve the lives of people, animals and planet [indiscernible].

And then switching gears to another topic. Can you talk about your expanding network of farmers and will you continue to add farmers to your network to support growth? And did COVID accelerate your network growth?

Yes. Well, Rupesh, I mean, one of the things that we do is every month, we're doing a detailed dive into supply and demand, looking at it for 12 to 18 months to ensure that we're always adding enough supply to meet the projected demand. In the past 12 months, we've also invested resources to bolster analytics in both areas. And as we've talked, I mean, COVID did accelerate consumer acquisition from 2021 into 2020, and we planned our future supply accordingly. The business that we've built prioritizes the long-term benefits of all of our stakeholders. And we lead with our values and stakeholder model, prioritize taking care of and partnering with everyone across the supply chain. Net result is we have a list of over 100 small family farms who have reached out to us because they want to do business with Vital Farms, because they've heard, by word of mouth, how we treat our partners. If we were to onboard all of these farms, we could more than double our current egg supply to allow for the future growth.

Is it fair to say at this point that you are comfortable with your capacity levels and utilization rates heading into 2021?

Yes. Absolutely. Like I just mentioned, we have 100 farms where we can add supply. And in 2020, we had to be thoughtful in partnering with our retailers in managing our promotional programs where we may not have promoted as heavily as we had in prior years during the same time frame. But we're confident that our shell egg supply is really set up to support and deliver our growth plans in 2021 and beyond. As we lined out in the models we built for the sell-side analysts during our roadshow back in 2020. Again, it's something we continue to measure and manage every month, and we'll look into planning for longer-term growth targets beyond 2021. On the packing side, we have processing capacity, what we call ECS, or egg packing facility. It's currently at close to 70% capacity. But it has the ability to support $300 million egg business. We're currently doing an expansion of this facility that will allow us to double the capacity in that facility, and that will be operational sometime in the first half of 2022.

Okay. Great. So switching to another topic. How resilient do you think your pricing power is? And do you think you can sustain your premium price point? And have you considered adjusting your price point?

Yes. I appreciate that. And that's a question that is not uncommon for us to get asked. The first thing I'd say is, one question -- another version of that question is, "Hey, we recognize that you've successfully maybe premiumized what historically has been a commodity category, how long before competitors come in and kind of compete away your right to win or your profits?" And what I'd say upfront is, we've had competitors in specialty eggs since we got into business, and we've had competitors even within the very special pasture-raised segments for years, both branded and private label. And it hasn't created a headwind to our ability to continue to expand household penetration, continue to expand distribution and maintain our premium prices. The reality is that we've created a premium brand, and it does command a higher price for ethically produced foods that consumers are willing to pay for. And what we do cost more, we think, even than what other producers of a commodity called pasture-raised eggs might cost. We provide meaningful economic opportunities for small family farmers in this country who usually lose at the end of the movie. We really, really treat animals in a fundamentally better way than some other types of production. And those are just a couple of small examples that, frankly, are costly to do and that consumers are willing to pay for. And so as a proof point, then I think that consumers are willing to pay for ethically produced foods like ours. As of September 2020, we're the #1 or #2 egg brand by retail dollar sales for branded eggs with key customers like Whole Foods, Kroger, Sprouts, Albertsons and Target. So it's resonating. People are proving that they're willing to vote with their dollars.

Okay. Great. So I'm going to switch into an audience question on the same topic. So did Vital Farms price aggressively during the pantry build to just like some other players?

Not at all. We haven't taken a list price change in at least 4 years as far as I know. And we certainly -- it would not be consistent with our bias towards building this company to be sustainable for the long haul, including sustainable long-term relationships with consumers and customers, to take advantage of a short-term spike in demand and try to profit economically in the short run. We're playing this for the long run, and it never occurred to us to take price action during that time.

Okay. So as you guys look at your, I guess, typical annual algorithm, pricing right now is just not as is an important driver, I guess, going forward in terms of the top line?

Look, we are not -- so we absolutely keep our eye on pricing in retailers and pricing in geographies across the entire category. We have a right -- I think we've earned the right and we've built a brand that commands a premium price. At the same time, we're not going to ignore what's going on in the marketplace. It's a competitive marketplace for sure. The fact is that we have not reached the point at which we feel like there's any kind of headwind created by our pricing. I think we're proud of our pricing. We're not embarrassed by it. And as long as people -- we continue to attract new households and new consumers to our flock who really identify with what we're doing and who want to vote with their dollars for what we're doing, we're going to keep doing it.

Okay. So switching to another topic. So you clearly have -- your company has quite a few avenues for top line growth. You have the opportunity to increase breadth through distribution. You can still add more SKUs at existing customers. There's new innovation opportunities as we covered before. How do you think about balancing your growth opportunities and really prioritizing the efforts going forward?

Well, again, our growth strategy, as we talked, is really increasing household penetration; expanding our national retail presence, both in terms of number of stores and number of SKUs in stores; expanding the foodservice footprint; and looking at product innovation. Now today, I mean, we have a broad portfolio of products, but we're still primarily an egg business, and eggs will drive most of the growth in the near term. So it's fair to say that the first 2 pillars of our growth strategy, increasing household penetration and expanding distribution, are going to be the substantial drivers of our growth and be prioritized accordingly.

And as you look at just on the distribution front, like what are the bigger opportunities you guys see on from a distribution perspective?

Well, I think they're in both areas. I mean, today, if we look at our best-in-class retailers in the natural channel, they have on average 9 or 11 SKUs on shelf. The balance of retail has somewhere between 3 and 4 SKUs on shelf. So there's an opportunity for us to expand the number of SKUs in the existing stores. And although we're in the majority of retail chains across the U.S., there's still opportunities to get into divisions or sections of the channels that we're not in today. So I think both present opportunities for us.

And you also mentioned foodservice. So clearly, a challenge area this past year, and it's likely going to be challenge to start this calendar year as well. How do you -- what are the opportunities you see on the foodservice side? And how do you prioritize foodservice growth right now?

So as you -- as some of the folks in the audience may know, foodservice is a very small part of our business. It was pre-COVID and it continues to be. The reality is we've built the brand at retail primarily. And where we've had success in foodservice, it's really been gratifying to see it happen when we're able to co-brand and co-market with a foodservice concept and bring our flock of raving fans to their concept. So a great example in Austin, in my hometown here is Tacodeli kind of the hometown hero taco concept. And we co-brand and co-market their breakfast tacos. They exclusively use our eggs in them, and you can find us on the window cling, you can find us on the menu, you can find our logo on the taco itself. As we have looked, and by the way, foodservice, as Bo mentioned, is not a substantial portion of the future growth in the model we offered, but we believe there is upside opportunity there. When we talk to potential customers. And we think there's a big opportunity with, for example, corporate and university commissaries that may have an ESG focus to their procurement practices. One of the things we hear loud and clear is they don't just want shell eggs from us, which is what we offer them today. They want bulk liquid eggs. And so we're working on bringing that to them in 2021 so that we can really better understand their appetite to partner, not just with a producer of a commodity called pasture-raised eggs, but with a conscious company called Vital Farms that brings them things like that. So I'm excited about that opportunity. There are 2 things that we've done to substantially invest in that opportunity. One is bringing on our new sales leader, Pete Pappas, who joined us a few months ago. He raises our game across all channels in terms of our go-to-market and our sales strategy. He's just got -- he's been there, done that sales leader across multiple companies over a lot of years. And I think he'll help us further explore foodservice. And then partnering with, I think, the premier national broker to help us continue to refine that strategy and go-to-market in 2021 aggressively.

Okay. Great. I'm going to switch to another audience question. How long does it take to certify a farmer? And can you elaborate -- I guess, the question is, and can you elaborate on how you track farmers?

Sure. So a couple of thoughts there. We have enjoyed an amazing network of what we think are the best farmers in America, maybe in the world. And we have managed to attract them and retain them without any outbound marketing efforts at all. It's a little bit of the flywheel effect that we've created. We treat our farmers with respect. We pay them on time. We partner with them to help them become more successful financially. We're really in this together in ways that I think some companies and some farmers don't try to partner. And the net result is that farmers want to work with us. They see what we're doing. They want to be a little inspired and feel like they're really fulfilling their own values, especially around animal welfare when they work with the brand. So the first thing I'd say is no outbound marketing to attract them. That said, and certification is one part, perhaps of a total onboarding process. It can take us 8 to 12 months, to onboard new production from a new farm. Generally, our farmers are building a new part of their farms, specifically to work with us. We're not generally attracting existing egg farmers from other companies, for example, and that -- and there's a time frame in that. We start by -- we're pretty picky and so we vet them, we vet those farmers. We only want the best, and we want ones that are aligned with our mission. We spend a lot of time training them because many of them are experienced farmers, but maybe not specifically with eggs, with chickens. And then there's a build-out process, a training process, and as you mentioned, a certification process. But the certification process is just a portion of that 8 to 12 months.

Okay. Great. Switching to a financial question. So clearly, you guys have a lot of potential for top line growth as we just discuss distribution and innovation. But how do you think about margin expansion? And what are the main drivers you see going forward on the margin side?

Well, Rupesh, I mean our long-term gross margin targets in the mid-30s and with EBITDA in the low double digits. I think our actual 2020 year-to-date results have demonstrated that the gross margin targets are achievable. But as we look forward, I think the primary drivers of continued margin expansion are working with our small family farms to achieve better outcomes, which will result in cost benefits for the farms and for us. Better monetization of all sizes of eggs that get produced and greater throughput at ECS. I think another area is continue to improve in innovation margins, which we expect will increase over time as we scale those products. We start with them in co-manufacturing facilities, and we'll look at opportunities as they scale to either bring them in-house or find other opportunities to take -- leverage that scale. I think the final piece is, we're clearly a growth company. And in 2020 and 2021, we're investing significant resources and people, systems, infrastructure to allow the business to scale. And we've incurred a high carrying cost to become a public company, and we'll see continued leverage on those areas as we continue to grow over time.

Okay. And I'm not sure if you can even comment on this. But as you look at 2021, any cost headwinds or anything that you guys are seeing right now out there that we should be focused on?

I'm sorry, I didn't hear the question.

As you look at 2021, are there any cost headwinds that we should be focused on or anything out there that you guys are focused on for this upcoming year?

Well, I think right now, certainly, grain prices are going up and freight prices are going up. If you look at what's going on in the markets. But for us, those represent a smaller proportion of our sales than they do for some of our commodity peers. So I think as you think of the impact on us, it's less from a margin perspective than for them. And we're not really concerned about those in the long term.

Okay. Great. And then shifting to another topic. On the marketing front, what's your marketing strategy and how you think about marketing investment spend in 2021?

Yes. Marketing has been a critical part of helping tell our story and helping to help the -- helping to connect the right households, like-minded consumers to what we do. And we'll continue to invest heavily in our brand in '21 as we have over the past several years, focused on growing trial and household penetration as well as building the loyalty among our fans. So efforts will focus on efficiently reaching new consumers, educating people about our mission and products so that we can help continue to grow household penetration. We, I think, have developed a pretty well-oiled machine around using targeted digital advertising, and we plan to continue to do that in '21, supporting our product portfolio. And we're actually launching a new campaign that supports our brand's mission and product portfolio later this month. We also support retail efforts, online and in-store to help convert shoppers to purchase and to help, frankly, support the goals of the retailers who are critical partners to our long-term growth strategy. We're also very focused on caring for our existing fans, ensuring strong product quality and personal interactions and brand experiences that are felt across our fan base. And ultimately, those things help keep buyers loyal.

Okay. Great. As a reminder for the audience, if you do have any questions, please post them on the interface at the bottom of the screen. So another area I wanted to touch is just competition. So given consumer preferences for better-for-you as we source through, could we see a growth in more premium pasture-raised egg companies going forward? And in your view, what barriers to entries are there? And what is your competitive moat?

Yes. So that's a great question. We get that one a lot. And I think there are certainly examples in food over the years of companies like ours that kind of carve out a niche, find a way to differentiate and maybe even premiumize something that otherwise looks like a commodity. And then at some point in the future, larger competitors come in and maybe erode profits or the right to win. And we have actually faced competitors, not just in premium eggs, but even in pasture eggs, the very special thing that we do for years now, whether it's private label options from some of our largest retail partners or whether it's branded options. And so far, those haven't proven to be a headwind to our continued growth, even though our prices are generally higher than the competition. I think it's -- there's not a moat around any particular element of what we do. Other companies work with small family farms, other companies use Instagram to tell their story, et cetera. But it's sort of the mission and the values of our company lead us to do a lot of things differently. And that's the part that's hard to replicate. It creates a little bit of a flywheel effect. If you think about just as one example, the way we partner with our small family farms, the way we select them to help make sure that we're choosing the very best, the way that we partner with them to help them be as successful and profitable as they can be, the way that our people go visit those farms, not just to inspect and ensure compliance, but to partner in support of a mission, like -- and that results in 0 voluntary attrition of our farms, right? That results in, I think, a better product coming off those farms. And in turn, those things feed great consumer outcomes, great partnerships with retailers, et cetera. And so there's this sort of a flywheel effect from the way we work with all of our stakeholders that I think is very hard to replicate.

Great. So shifting to a few other topics. How's progress on shifting your mix of egg supply to lower cost contracts?

Yes, I mean, first, I want to be clear that we're not opening up existing contracts for renegotiation. The contract for every new small family farm that we sign up today represents a new cost structure that really represents efficiencies gained over time. And we've had no issues signing new farmers to these terms, which we believe indicates they're fair and competitive. As we renew contracts with farmers that we've worked with for several years, we're transitioning them to the new contracts, and again, we've had no issues resigning existing farmers to these new contracts. So again, we believe they're market competitive, and we really see no headwinds in signing up new farmers or in transitioning our existing farmers to the new cost structure.

Okay. Great. Is there any sensitivity or -- I guess one more cost question. Is there any sensitivity or step-up in the shipping and distribution costs that we should be mindful of moving forward?

Well, I mean, we're seeing the headlines about the increased freight costs, but aren't really seeing a material impact. Again, because it's not a significant piece of our cost structure related to sales but 80% of our freight is contracted and about 20% we buy on the spot market.

Okay. Okay. So maybe just one last question to wrap up the discussion. And I've been asking all the companies I've been doing fireside chats with today. As you look at this business post pandemic, I mean, clearly, Vital Farms has benefited from consumers being at home. You guys have seen an increase, so maybe a pull forward in some of the household penetration out there. What are some other implications from the business that you see coming out of pandemic? Is there anything else that you could point to that, that could either benefit or hurt the business as you look post pandemic?

Yes. A few things come to mind. First of all, like we're thrilled that the vaccines are here and getting rolled out. There's a light at the end of the tunnel. We didn't build our business model on benefiting from a pandemic. Like many food companies, we saw increased demand, and we attracted some new households. And frankly, I think there was an acceleration of a shift to more conscious and better and healthier foods, which we certainly benefited from in terms of the categories in which we play and the approach we take to food production. In terms of implications for '21 and beyond, one, in the spirit of a tailwind is that I think we absolutely -- I know, we attracted new households at rates greater than we probably would have otherwise. And we did it much more effectively and efficiently without nearly as much marketing and trade spend. That was an acceleration of households we would have gotten in '21 and beyond. And so we -- I think that just helps give us an even bigger platform for growth in '21. I think beyond that, as foodservice comes back, we're excited to have that be a potentially larger part of our growth story going forward, and we're excited to partner with more foodservice concepts, who I think in many respects, have -- will look for a more compelling story for their customers around the ethics of their supply chain, around the purpose behind the ingredients they bring to their diners. And so those are 2 things that kind of stand out for me. I think one other thing to call out is around resilience. The word sustainability gets used a lot, and it means a lot of things to a lot of different people. For me, sustainability is about resilience. And I think we demonstrated in many ways the resilience of the Vital Farms model through the pandemic. Our ability to ramp up production, our ability to keep our people safe, our ability to deliver at high levels to retail partners without raising prices to them. And I think those stakeholders will remember that, right? I think we distinguish ourselves and companies that operate the way we do distinguish themselves over the last year that we can rise to the occasion and face challenges we couldn't imagine. And so I think it just -- it bodes well for our future.

Okay. We actually have another audience question that just came in. Any headwind from the growth of alternative eggs such as plant-based eggs?

Not that we've seen. My understanding, and I don't have scanned data on it, is that it's still tiny. It's a really big market. I mean, I think I mentioned earlier that retail shell eggs in the United States are about $6.7 billion. And we're just a few hundred million of that. So there's lots of room. I think, plant-based eggs and plant-based proteins in general are trying to solve a lot of the same issues that we're trying to solve. We're just approaching it differently, and we're not seeing any impact at this point.

Okay. And I'm just going to go back to one of your points before. We talked about foodservice early in the conversation. And you guys have clearly gained a lot of new customers eating your product at home. So as you look at the foodservice growth going forward, now that you have this bigger base, do you think that could help accelerate foodservice going forward because people are already aware of your product? And if you're co-branding the product, that presumably could lead to maybe more customers knowing the product and maybe doing better when you go into different foodservice outlets in the future?

Yes, that's a terrific question. It is not a coincidence, I believe, that we started to see success with that co-branding approach when we had developed a critical mass of raving fans. I mean, we -- I don't know what the current number is, but I believe we've had -- we've gotten up to almost 90,000 Instagram followers, for example. And we don't buy those likes, right? We earn them. And so I think coming to foodservice concepts earlier in our growth when we didn't have as many households, and we didn't have as many rating fans, it was a little bit of a harder conversation to have with foodservice partners, right? Why would they co-brand with a brand that didn't have a lot of awareness in the marketplace? And you're right, the more households we've got, the more powerful the brand is and the more powerful -- the more valuable it could be to foodservice partners. I think you're absolutely right.

Okay. Great. Well, thank you very much, Russell and Bo, for joining us today.

Thank you.

Thank you, Rupesh.