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

Great. Hello, everyone. Thank you for joining us today. My name is Brian Holland, senior research analyst at D.A. Davidson. I'm pleased to have CEO, Russell Diez-Canseco; and CFO, Thilo Wrede from Vital Farms with us to discuss their business. A Certified B Corporation, the company is driven to improve the lives of people, animals and the planet by bringing ethically produced food to the table. Today, Vital Farms is the second largest egg brand in the U.S., underpinned by its lordly share of the fast-growing pasture-raised segment. From 2018 through 2023, the company grew net revenue at a 35% CAGR and adjusted EBITDA in excess of 40% over that same period. 2024 year-to-date revenues and EBITDA are up 31% and 96%, respectively. I look forward to diving into the drivers behind this outsized growth this morning. Russell, Thilo, good morning. Thank you both for being here. For those who may be getting introduced to the story for the first time today, Russell, perhaps we could just start with a brief background on the company, who is Vital Farms and what's your mission?

Sure. Thanks, Brian. Great to be here. Many of you may have enjoyed our eggs, maybe you are already consumers. But it's important for you to also know that we went public in 2020. We've grown to on the order of $600 million in revenue. And we've done it all with a strong balance sheet and with the ability to self-fund our growth, the capital required to fuel our growth. A recent announcement that we made yesterday was that we continue to fuel our growth in advance of the need with the expansion of our own egg packing plant in Springfield, Missouri, and we continue to add farms at pace to ensure that we can continue meeting the needs of our loyal fans. As you mentioned, we were founded in '07 with a mission to improve the lives of people, animals and the planet through food. And we started that with the eggs for which we're known. Our founder, Matt O'Hayer, believes really strongly in improving animal welfare. And at the time, more than 95% of the laying hens in the country were confined to cages. And he felt like that was something that needed to be disrupted, and that's where it got started.

If we kind of continue down that path, Vital Farms has a unique supply chain that I know we'll be digging into during this discussion. So just high level, can you walk us through how that works?

Sure. So we work with a network of now over 425 small family farms, and they're spread across several states in an area of the country we call the pasture belt because we feel like you can't really do great outdoor access conditions for raising laying hens in any part of the country. It doesn't work well where it snows a lot in the winter, it doesn't work well where there's a lot of rainfall in the summer. So the pasture belt is where we're focused, which is sort of in the near south. And we work with those farmers as the consummate entrepreneurs. We buy eggs from each of those farmers. They own their farm, they own the chickens, they own the means of production. What we brought to them was an opportunity, a very clear set of standards for quality and animal welfare, and an awful lot of support to help make sure they're successful. That's in contrast to the way some other brands might work with their farmers where there's a bit more of a power imbalance in the relationship. If I own the chickens, if I own the feed, maybe you don't have as much of an ability to walk from our relationship if I'm not treating you the way I committed to. So we believe in mutual accountability. And in that respect, we've got a really unique relationship with our farmers.

And maybe if we stay on that because I think there's some lack of understanding with respect to the farmer network, how you attract and retain it. So maybe you could talk briefly about that, but also dig into, is recruitment and retention of these farmers getting easier or harder? Obviously, there was a change in working capital to support new family farms, which you attributed to higher construction costs and interest rates. And I think there's some question about whether that's a defensive move or maybe you can point to because obviously, you've been around much longer than you've been public, other instances where the company has a history of supporting your partners through challenging or dynamic periods in the category.

Yes, I appreciate that, Brian. We're very much -- first of all, we follow the tenets of conscious capitalism, which is a fancy way of saying, like, we're playing for the long run, and we want to make sure that what we're doing is sustainable for all of the stakeholders, including the farmers. And that means that the decisions we make have an eye toward that long term. In the early days, when we were small and didn't have a well-known reputation in the farming community, we had to pay a premium essentially for the risk the farmer took on working with an upstart. Bankers saw us as less of a well-known quantity. And if for some reason, we ran into trouble in those early days, the farmer potentially had a stranded asset, and that wasn't a positive outcome. As we've grown and as we've consistently delivered on our commitments to our farmers and to their bankers, we've enjoyed a very strong relationship in both communities. And I think the example that really cemented that relationship was in 2016. 2015, '16 was the prior example of when the industry experienced avian influenza as we're experiencing now. And like any agricultural commodity, there's inevitably in the broader egg market, a boom and then a bust. The boom attracts a lot of new entry. And then at some point, there's a fallout as supply catches up once again. And that inevitably happened in 2016. We were still very small. Our revenue was well under $100 million. We were EBITDA positive, but in single-digit millions of dollars. We had too many eggs. We didn't yet have a brand that differentiated what we were doing, and we weren't the only source for pasture-raised eggs even back then. We had more eggs coming off of the farms than we needed. I think in those circumstances, a lot of brands were walking away from their farmers. We had contracts with them. The contracts said we needed to keep buying the eggs, but there are a lot of brands for which that didn't matter as much. Our farmers are often Mennonites and Amish and for religious reasons, they don't turn to the courts to sue in the case of nonperformance. Back then, we went to our private company Board and said, we need to raise some money. I need money to pay farmers to not produce eggs for a while to keep them whole with the agreement we made, but not to produce eggs because I don't need them right now. And our private investor Board took dilution, did an equity raise, so I could spend at the time about $6 million, paying farmers not to produce. We kept them whole. Then when growth resumed and we needed more farmers, there was a line out the door because we were the ones that stuck by them and did what we said we'd do. Nothing has changed about that today. So we have no challenge attracting new farmers as evidenced by the incredible growth we continue to bring to that network as evidenced by our press release yesterday. Adding $200,000 as essentially a construction bonus upfront is nothing more than what we need to do to keep the economics whole for the farmer. They're paying more to build their farms and they're paying more to finance the loan. And we have to pay more in order for them to be fairly compensated for those increased investments. We had an option to just pay all of our farmers more for their eggs, but it was only the new ones that were facing this increased construction cost. So we chose to do it in a way that focus that investment on them alone. We amortize it over the course of the contract. And it's simply -- it's not defensive, it's simply about recognizing that we have to clear the market for what we're doing.

And I think that's important context for thinking about the long-term nature of these relationships that the farmers don't necessarily view this as an arbitrage opportunity, but really a sustainable long-term partnership. And I think that builds into my next question, which is, folks have asked certainly me and I know you a ton about these accelerator farms that you're building. Those are in your -- around your second ECS facility in Indiana, scheduled to break ground later this year. Can you just clarify or kind of reiterate the purpose of this initiative? And I guess, why this isn't the first step towards what some presume to be a step towards a vertically integrated model. And maybe, why a vertically integrated model doesn't or couldn't work for you guys?

Sure. So a lot to unpack there. So there's no change in our business model, which is to partner with a large network of small family farms. That's an important part of our purpose because it's harder and harder for them to get the right economic opportunity and maintain the rural lifestyle that they want to maintain. And we see that as an important part of kind of why we exist. When you get to a certain scale in terms of the number of those farmers, suddenly, the value of improving their outcomes can have a significant impact across the network. And we finally hit a point at over 300 farms where having a few farms in which we could do some innovation, do some R&D, try some new technology that we're seeing in, frankly, in Europe, where what we do is much more common, started to make sense where we could allocate some capital to that and bring best practices back to that network of farmers and see them all benefit from it. So these accelerator farms are not a change in our approach. They're actually a way to make it work even better. If we decide it makes sense in the future to potentially sell those farms as a turnkey operation, that's certainly something we'd be open to. But it's not something we plan to expand or replace our existing network.

I appreciate all that color. And so now let's maybe take a step back. Just level set us on the segment in which you play. What is pasture-raised share of total eggs today? And what is Vital Farms share pasture-raised? How do you think about the size of the prize? And what are the barriers to entry?

So it's funny. Yes, we're the largest brand of pasture-raised eggs in the United States, and we're the second largest brand of eggs, period of any kind. But it's funny, when we do a lot of consumer research and very consistently over a lot of years, we have found that there's a ton of confusion for consumers about eggs. There are all kinds of claims, all kinds of types of eggs, free-range eggs and pasture-raised eggs. There's cage-free, which is being mandated in some states, organic non-GMO, you name it, those cartons are full of words. Surprisingly, more than half of the people that buy our eggs don't know that they're called pasture-raised. And in fact, more than half of our consumers attribute more value to a term free range than they do to this thing called pasture-raised. Our takeaway is people are looking to us because they trust us in the way that we operate. They trust us to be transparent. They trust the brand. And if you've noticed over a number of years, the word pasture-raised in our carton are getting smaller and smaller and the logo Vital Farms are getting bigger and bigger. The industry looks at scan data and they look at terms assigned to the product and they say, "Gosh, pasture-raised, that's where all the growth is. We should all offer a pasture-raised egg", and they have been for years. Cal-Maine has had a pasture-raised eggs since at least 2016. Their brand, Eggland's Best brought it out as a control brand, and now they've branded it Eggland's Best. Every one of our top 10 customers has at least one private label pasture-raised egg offering and multiple branded offerings. Yet we've got the highest price of all of them, and we're growing faster than all of them. I think that speaks to the fact that it's not about the term or the claim, it's about the brand. And maybe there's a little bit of hubris when I say it, but I think if we had decided to call it something else 15 years ago, then that something else would be the fastest-growing part of the egg system and everybody would be racing to offer a something else egg. It's incidental that we called it pasture-raised.

No. I mean I think most folks would agree that the moat in branded CPG is the brand, generally speaking, with very few exceptions. And our analysis, which we've done multiple times, would point to the mix of distribution and velocity on your business, which I think is a really strong measure of the quality of the growth and the predictability of it going forward. And it's you guys, it's Freshpet and it's BellRing brand. So that's pretty heady company at the top of the heap there. Speaking of the distribution component of that, you've seen some material distribution gains over the past year. Importantly, your velocity has accelerated as you've gotten the distribution gain, so we can get into that. But maybe first, what is driving that increased shelf space? Second, how is the pipeline shaping up? And then just kind of looking forward, frame how long the runway you believe to be for increasing the shelf presence from here?

I keep going back to that conscious capitalism notion and this idea that we really think about long-term outcomes for all of our stakeholders. And those retail partners are no exception. We don't think about our retail partnerships as transactional. For example, we're not rushing to raise prices in this current environment in which there's an egg shortage because that's not how we want to make our money. We want to make our money in ways that benefit us and the retailer over time. So I mean, at the end of the day, the retailer has a strategy and has goals for the category. They want to grow the category. They want to grow it profitably. They want to attract and meet the needs of their consumers. And we've built a brand that drives really high performance from our items, from our products. And so we can have a very fact-based conversation with the retailer about how our items perform in the category, maybe in their competitors, how the ones they've already added to their stores are performing and how the next item or items might outperform some of the other items in their set. And as long as we're delivering on superior economics and as long as we continue to be transparent in our dealings with them, we don't overreach. We don't shoot for more distribution than we think we can supply. We don't promise promotions that we won't be able to support. They've come to trust us in the same way the consumers trust us, and that's what drives the next placement and the next placement. And in many cases, we've become their advisers on where the category is headed because we're where the growth is in the category.

It's funny how the world works, right? In September of 2023, you laid out 2027 financial targets. The market largely dismissed it's too ambitious at the time. Fast forward a year, the #1 question I get is whether you can keep up with demand. So I'd like to spend a few minutes here. In the most recent quarter, total net revenue grew an impressive 31%, led by volume growth of 22%. However, while the top line matched consensus forecast, it certainly lagged what the track sales data was telling us, and thus raised questions about where the ceiling might be on sales in the near to intermediate term. So for starters, just remind us what caused shipments to trail consumption? Was that bottleneck tied to supply, i.e., your network of family farms that we made reference to earlier or capacity, i.e., Egg Central Station?

Yes. So what we found in the back half of 2024 and as highlighted in the results we announced for Q3 was that we started to hit a constraint at Egg Central Station where we packed the vast majority of our eggs. We built that in '17. We expanded it in '21. And there's still untapped capacity there, but we're achieving it primarily through continuous improvement of the existing assets. And we announced that we're going to add a third line to that plant, which will be incremental on top of the $800 million capacity that we've talked about previously. There were a few things that kind of came together. One was there was a water main break in Springfield, Missouri that took us offline for a few days. And then as we started to hit the limits of expanding our capacity through more hours in the day. We started to run 24/7. Suddenly, we started to see the impact of running those machines nonstop, and we identified opportunities to invest in some incremental maintenance and configuration changes at the plant to unlock more capacity. That also took some days of production out of circulation as we made those investments in future growth. Long story short, we -- egg supply was not a constraint in Q3, but we started to hit the limits of what we could push through that building in Q3.

Okay. And per press release issued yesterday, which you made reference to, Vital Farms added -- has added 125 family farms to the network in 2024. I think that's a roughly 40% increase. Is it reasonable to assume that 2024's new farms equate to 2025's incremental supply? Also, what can you tell us about these farms relative to the company's legacy footprint and how that translates to your egg sourcing supply growth?