Flow Beverage Corp

TSX:FLOW

Earnings Call Transcript 2022-Q2

[Operator]

Good morning, everyone. Welcome to Flow Beverage Corp.' Second Quarter 2022 Financial Results Conference Call. As a reminder, this call is being recorded on June 14, 2022. [Operator Instructions]

I will now turn the call over to Devan Pennell, Chief Financial Officer. Please go ahead, Devan.

[Devan Pennell, executive]

Thank you, operator. Good morning, everyone. And thank you for joining us today for Flow's second quarter 2022 financial results we released this morning. The press release, financial statements and MD&A are available on SEDAR as well as the company's website, investors.flowhydration.com.

Before we begin, I'll refer you to Slide 2 of our presentation, which contains our caution regarding forward-looking statements. I am joined on the call today by Nicholas Reichenbach, Flow's Founder and Chief Executive Officer. I will now pass the call over to Nicholas.

[Nicholas Reichenbach, executive]

Good morning, everybody, and thank you for joining us today. I'll begin the call by speaking about our financial targets. Then I'll speak about sustainability and how it is driving new milestones for the Flow brand. I will review some recent wins in our distribution capacity and then provide an update on Flow's market share gains. Devan will then provide a detailed review of our financial performance, and I will conclude our prepared remarks by reviewing our exciting business development pipeline.

We introduced financial targets in fiscal Q3 2021 last year for the Flow branded net revenue growth, EBITDA improvements and capital efficiencies. We are very pleased that our financial targets for improving in EBITDA losses of 45% to 50% is on track.

While we still expect to achieve the Flow branded net revenue growth of 45% to 55% in the second half of this year, given our financial performance in the first half of the fiscal period 2022, we believe it's prudent to adjust our targets accordingly. The primary driver behind the revision is the trade spend cost we incurred in Q2. We plan to leverage these investments in trade spend throughout our summer season activation programs, and we remain confident in our new contract wins, innovation pipelines and the trends of sustainability to continue to drive the growth moving forward.

Flow has been the beneficiary from the tailwinds created by the growth in the premium, sustainable and functional water segments. The sustainable water segment has been surging recently, up almost 80% in the last year. And Flow is at the epicenter of this segment. We attribute the growth of sustainable water segment to an evolving consumer preference in sustainable packaging and socially conscious brands. Furthermore, large organizations around the world are changing their focus from COVID to implementing ESG framework. This implementing these ESG frameworks usually means lowering their environmental footprint and aligning with like-minded organizations such as Flow with a proven culture of sustainability.

As most of you are aware, Flow has been sustainable from day one. Flow has carbon neutral operations. Our packaging is made from renewable plant-based material, and we are excellent stewards of our water sources, and we keep getting better. Last year we achieved one of the highest scores of a company in B Corp Certification of 126.5, which puts us at the upper echelon and best-in-the-world class. Most recently in a partnership with the Nasdaq OneReport, Flow began reporting under SASB investor disclosure framework. This will assist ESG rating services and impact investors in their ESG assessment on Flow.

Our market position is paying off. In January, we reported that Flow ended the calendar year of 2021 with almost 25,000 points of distribution across North America. Only 4 months later flow can now be found in 35,000 locations across North America. This increased store count is attributed to the success of our national DSD rollout and our U.S. retail penetration. In addition to these significant increases in store count, Flow has also won 2 important contracts in the food service sector with 2 globally recognized companies.

A critical aspect of these contracts were and are Flow's ESG credentials. The first contract one in the food service was with Accor, an international hospitality group ranked third for luxury hotels in the world. We began to roll out to over 70 of these hotels across North America and the Caribbean. And just yesterday, we announced that Flow became the official partner of the Norwegian Cruise Line, a leading global cruise company with a fleet of over 28 ships offering itinerary to over 490 destinations worldwide.

Turning to Slide 7. We present a breakdown of our store count by channel. We recently achieved significant gains in the U.S. food, drug and mass channel with Dollar General. And we added 4 new Costco locations in Canada in fiscal Q2. As compared to the prior year, our DSD partner in the U.S. have contributed significantly to the growth of our store count and secured hundreds of locations in the Canadian gas and convenience channel.

Flow continues to maintain very high growth rates in 2 large markets, growing 59% in the U.S. food, drug and mass channel and 63% in the Canadian food, drug and mass channel. We attribute the ongoing growth to our increased store count in both U.S. and Canada, certain product innovations that we have made in the last year, and of course our ESG positioning amongst a changing and evolving consumer preference.

We are pleased to announce and share a market update with you today. I am thrilled to say that our alignment with sustainability product innovation and our recent retail wins have combined to increase Flow's market share to 45% in Q2, which means that Flow is the leading market company in carton format water in food, drug, and mass in the natural channels within the United States. This means that Flow is officially #1 in our category.

I would like to take a moment to thank Flow's employees, our partners, and of course our shareholders for the commitment they have shown over the past 7 years to help build flow into a category leader. This is an exceptional accomplishment.

With that, I will pass the call over to Devan Pennell, our CFO, to discuss our financial results.

[Devan Pennell, executive]

Thank you, Nicholas. As Nicholas mentioned in his prepared remarks, the Flow remains one of the fastest growing brands in North America. Recent data shows that Flow brand grew 59% in the U.S. multi outlet channel in the last 12 months and 63% in the Canadian food, drug and mass channel. In Q2 2022 consolidated net revenue reached $9 million and Flow brand net revenue reached $4.8 million. Consolidated revenue includes co-packing revenue, which continues to be an opportunistic revenue source to cover our fixed costs. We made significant improvements to profitability in Q2 2022 as measured by EBITDA. Flow's EBITDA loss for the period was $8.5 million, a 49% improvement over the prior year.

Looking more closely at the factors that impact net revenue. Consolidated gross revenue reached $11.1 million in Q2 and $24.6 million in year-to-date Q2 2022. Gross revenue benefited from the Flow brand delivering strong performance to our e-commerce platform and in Canadian food, drug and mass. Looking at net revenue in fiscal Q2 2022, the company made investments into trade spend that helped drive our increased store count, but the revenue associated with these trade spend costs is expected to be realized along with the launch of retail activations in the coming months.

Co-packing revenue reflects lower demand for co-packing services from our partners. We continue to believe long-term value will be created by focusing on Flow brand revenue and therefore we utilize co-packing as an opportunistic basis to help absorb fixed costs. Gross margin was 12% in Q2 and 20% for year-to-date. While we continue to benefit from operational improvements, we experienced elevated shipping costs for certain customers that had reopenings in Q1. And in Q2, we incurred higher trade spend for new accounts and near-term activations.

We are very pleased to be delivering year-over-year declines in all operating expense categories. General and administrative expenses continue to include professional fees that we have incurred as we transition to a public company. As a reminder, in Q2 2021, we had much lower costs attributable to operating as a private company at that point in time. We have also made sequential improvements in salaries and benefits and sales and marketing expenses as well. We realized an EBITDA loss of $8.5 million in Q2 2022, which is a 49% improvement from Q2 2021 when we were not a public company. The improvement is largely due to reductions in stock-based compensation in addition to improvements in cash operating expenses.

We are maintaining our target for Flow brand product net revenue growth of between 45% and 55% for the second half of fiscal 2022 as compared to the same period in the prior year. We remain encouraged by the new authorizations we've received that will take delivery of Flow products over the coming months. Additionally, our contract with the Accor will reflect deliveries in the second half of the year as well as our new contract with Norwegian Cruise Line.

As a result of investments into trade spend in the U.S. market, that increased store count, the company does not expect to achieve its financial target of net revenue growth of the Flow brand of 45% to 55% for the fiscal year. Flow now expects net revenue growth of the Flow brand of 25% to 30% for fiscal 2022. We are confirming our target to reduce our EBITDA losses by 45% to 50% in fiscal year 2022. We still expect for the biggest improvements to be in the back half of the fiscal year as we compare our cost structure against periods as a public company and benefit from stronger net revenue over the summer months.

Regarding capital efficiency, we have improved accounts receivable with net trade receivables decreasing 24% from Q4 2021 and CapEx is down 86% this year. As of April 30, we had over $25 million in cash. We have some material non-trade receivables that we expect to collect in the coming months, and we expect additional improvements to working capital from inventory management. We said in our last 2 calls that our cash balance would take us through calendar 2023 if we perform in line with our forecast, and we are reaffirming this outlook today.

I will now pass the call back to Nicholas.

[Nicholas Reichenbach, executive]

Thank you, Devan. Our key growth pillars remain unchanged, and we have created a lot of momentum in generating future growth. We still plan to grow the Flow brand in our retail channels through increasing ACV, which means bringing on new retail partners. We also plan to increase the velocity through focusing on activation and retail awareness and campaigns, working closely with our distribution partners to ensure that Flow is fully stocked on shelf, positioned in multiple points within the retail location and increasing the number of Flow-branded products and SKUs in the store.

In e-commerce, we are adding new users through paid advertising and through strategic brand partnerships. We are demonstrating traction on repeat purchasers with loyal programs increased subscribers and active communication through e-mail and SMS. We now walk through some significant growth drivers, including food service and our innovation pipeline. As we mentioned previously, the foodservice sector is expected to be a big growth driver for Flow. We are already seeing this with our 2 recent wins in the food service category. And as COVID opens up, we are getting more and more interested parties and retailers in our ESG-focused products.

While the pandemic continues to require all industries to make operational adjustments from time to time, we believe that the food service industry will emerge from these crisis levels and now are participating in an increased look in prioritizing their ESG initiatives. We believe that food service companies are taking a look at their bottled water practices and are seriously considering eliminating all plastic and substituting them with other products such as Flow. We signed the Accor deal at the end of our fiscal Q2. Accor is a very large hospitality operating in 110 countries with 3,000 locations. Like many organizations, they are seeking to lower their carbon footprint across its operations. They are also operating a number of premium brands. So it is also important to offer their customers an aligned premium experience. That's why they chose Flow.

And just yesterday, again, we announced a contract to become the additional partner of the Norwegian Cruise Line. NCL is a well-known brand operating for over 55 years. Norwegian has a large fleet with over 490 destinations worldwide. We have a very large activation program with Norwegian Cruise Line, and we'll be announcing further details on our partnership in the weeks to come.

Turning to Vitamin Water. Our current plan is to launch Vitamin Water at the end of the month in our U.S. retail channels and direct-to-consumer off our website, flowhydration.com. We have commitments from Kroger grocery chain, and is expected to launch in over 130 of their locations this summer. Our Vitamin Water flavors are delicious with 0 sugar and 120% of your daily dose of vitamin C and all organic certified ingredients. This makes this product uniquely positioned in the North American market against the health and wellness consumer.

Vitamin Water also expands Flow into an adjacent high-growth category, and we firmly believe that the coming months that the environmental package that Vitamin Water is in will be more important to consumers. Our product innovation also includes larger format of popular skews of Flow. We now have Peach Blueberry and Strawberry Rose in our #1 selling format, the one leader. We are currently rolling this out with key retailers like Sprouts in the United States, and it will also be available on our direct-to-consumer and e-com platforms this week. The rationale for launching these new formats are simple. We are building a product portfolio that consumers want, and we are focusing on innovations that are accretive to our gross margins and profitability. You will see this continued innovation in the quarters to come, while we put out more products and services against our core value proposition to our consumers.

I'll conclude today's presentation with a summary of upcoming milestones for Flow. It's going to be a very busy couple of months as we enter into a very active summer hydration season with our expanded distribution network. Some of our most significant events ahead are the activation of our 270 Walmart locations, rolling out of Accor hotels and shipping to NCL across the world. Our summer activation hydration with our key retailers such as Whole Foods, Loblaws, Fresh Thyme and others will make it a very important month, very important 2 quarters ahead as we activate the brand both in Canada and United States. If you make it to pride parade or our National Bank Open in Toronto, you will see Flow products there, and we will also have some media as we lead into the New York Marathon later this year.

That concludes my prepared remarks. Operator, we can now open the lines for questions.

[Operator]

[Operator Instructions] Your first question comes from Martin Landry from Stifel GMP.

[Martin Landry, analyst]

My first question, Nick, is you do talk a lot about sustainability in your format. And you have an interesting slide about your market share in the carton format. But I would like you to help me a bit reconcile your market share gains. It looks like you -- according to what you show, you've gained market share. You've gained 700 bps of market share to 45%. But your revenues are flat on a year-over-year basis in branded water. So does that mean that the category has declined on a year-over-year basis in the carton format?

[Nicholas Reichenbach, executive]

The category in the carton format has not declined. What has happened, Martin, is our penetration in our key retailers and the velocity within our key retailers have gained a lot of momentum against some of the competitors. Our increase in trade spend over the past couple of quarters have allowed us to start to gain market share against our competitors within those retailers. And that's why we've now taken the #1 position.

[Devan Pennell, executive]

Martin, just to sort of further reconcile that. I think there's always that risk of disconnect between how we recognize revenue through our distribution network, so on sell-in to our distribution partners through the various networks and the market data itself. And so I think there, what we're seeing is some level of slowdown driven more than likely by inventory levels and sell-through. I think the positive that we see that gives us some confidence going forward is that the market data at the tail continues to show favorable trends for us. And so for that reason, we believe that this is a temporary blip in nature and that we'll continue to see increased velocity and penetration as we move forward through Q3 and Q4.

[Martin Landry, analyst]

Yes, I see, I see. What we're looking at in terms of market shares, retail sales. Okay. That's helpful. And then just trying to understand, again, what's happened during the quarter. You talk about your doors, the number of doors increased by 10,000 points of distribution. So it's a pretty impressive performance. But again, your revenues are stable on a sequential basis. And looking at your gross revenues, they're up 2% to 3%, which does not align with your growth in doors. Just trying to understand a little bit what happened. And is your velocity going down on a sequential basis or on a year-over-year basis?

[Nicholas Reichenbach, executive]

Yes. So I'll answer part 1, part 2 in my mind, and then Devan can follow through with a comment. Part 1, the increased door velocities have happened in Q2. So we're seeing the rollout of those doors happen right now. So the revenue growth within those channels will come in Q3, Q4, as Devan mentioned. And then Martin, as you know, not all doors are created equal. And so doors like Dollar General, although a very important retail partner for us in the United States to get our brand out and to service a lot more customers nationwide, do not have the same importance of velocity as the other doors such as Whole Foods or a larger grocery chain where we're a part of food, drug and mass. And so therefore, you'll see the velocity reflect the channel, and it's not a negative thing, it's more of just getting it out to a broader base of users in different channels, which Dollar General is a major contributor to the growth of our distribution network.

[Devan Pennell, executive]

And just for further point of reference, I think Q2 2021 was when we really leaned into the pivot to the nationwide DSD rollout. And so as a comp, Q2 is a tough comp because we -- that was our initial sell-in period to many of those distributors. So I think looking to your previous question and linking those 3 things, I think that helps to provide some narrative around sort of what we've seen in terms of financial statement reporting versus the data that we're seeing in the market data.

[Nicholas Reichenbach, executive]

And also our confidence within the H2 to maintain our guidance of 45% to 55% growth in the core Flow branded products.

[Martin Landry, analyst]

Okay. And then my last question is on your gross margin. During the quarter, the gross margin was impacted by the lower utilization of your co-packing equipment. I was wondering if you can discuss what does your gross margin look like for the branded water segment? Or if you don't want to disclose that, if you can give us some color as to how it's evolved sequentially versus Q1. That would be helpful because your gross margin was down considerably, and it was one of the lowest we've seen recently. So just a bit of color on that would be helpful.

[Devan Pennell, executive]

Yes, Martin, so just in terms of units produced, when you look at the actual units produced out of the facilities during the quarter, that's where we saw the biggest drag on margin in terms of fixed overhead utilization. So Q2 in the comparable period was both the highest utilization in terms of absolute units as well as line utilization.

So that is the single biggest impact in terms of other conditions that sort of have driven whether margin for the Flow branded product has changed materially. We've taken some price across the board, not significant, but reflective of what's gone on in the broader market conditions. But obviously we've seen some offsets in terms of the pressures, especially in things like logistics. So from a Flow branded standpoint, I think we're consistent.

I think we're really having the challenges right now. It's just full utilization of those lines and the impact driven primarily by utilization but also just in terms of how revenue is recognized on multiyear take-or-pay contracts. And so that -- those are sort of the primary drivers for why we're seeing the gross margin pressure in the current quarter, but also why we have line of sight as we increase utilization on the lines of taking margin higher in aggregate and continuing to sort of control the margin on our Flow branded products and make efforts to drive them higher over time.

[Martin Landry, analyst]

Okay. Just to be clear, did you say that your gross margin on your branded products was stable sequentially?

[Devan Pennell, executive]

Yes. Relatively, just to be crystal clear, we don't report disaggregated on that. But directionally, it's been relatively stable.

[Operator]

The next question comes from Chip Moore, EF Hutton.

[Chip Moore, analyst]

Wanted to ask, I guess, on visibility in the back half on Flow branded growth, obviously new retailers ramping those nice food service wins. Should we think about this being relatively consistent growth or more weighted towards Q4? Or just how to handicap that in the back half?

[Devan Pennell, executive]

Yes. I would say likely consistent as we sort of ramp in. I think we'll see the growth will ratchet up quite dramatically, which is obviously why we're willing to hold the guidance for the second half of the year. And typically, as we look at sort of the Q3 and Q4, Q3 becomes sort of your new level of sort of growth and then things tend to stabilize or increase slightly in Q4. And so I think as you look to the guidance in the second half, that would be consistent with what we expect and that aligns with, one, the busy summer season for us, which is most impacted in Q3 with some of that coming through in Q4, and then the incremental growth driven off of the new contracts as we load in and penetrate the brand across the various locations, facilities, rooms, shifts, et cetera.

[Chip Moore, analyst]

Got it. Okay. That's helpful. And then the other question I wanted to ask was on foodservice, 2 nice wins here already. I think you talked about seeing things -- more interest as the economies are opening up. So maybe you can talk about sort of the pipeline there. And then how do you think about margins on that side. Obviously, you get some nice brand benefits. But is there a difference in the margin structure?

[Nicholas Reichenbach, executive]

Yes. Chip, we see food service as one of the most promising channels for Flow. Before COVID, we had a very large food service business, offices like Google and Facebook and JPMorgan, carry Flow to all their customers in the cafeteria amongst a lot of other premier channels and companies. As we see COVID dissipating, the foodservice channel is now surging up. And as was important back in 2019 and early 2020, ESG is starting to really bring itself forward within that -- the philosophy of those food service and the customers that they serve.

So in order to really -- I hate to say capitalize, but in order to capitalize and just leverage our market position, we've definitely dedicated more resources internally to this channel with sales in both in Canada and the U.S. And we're also starting to leverage our partnerships in order to get awareness around it and sign further contracts within those key food service channels. So we remain very positive moving forward with food service. We're allocating more resources to that channel to really leverage ESG coming into that channel in a big time way over the course of the summer and the quarters to follow.

[Devan Pennell, executive]

What I would add there, Chip, is I think the size of the partner dictates a lot around the individual unit economics, but obviously the more foodservice partners, the higher volumes we can run, that benefits from an overall gross margin standpoint. And so I think it's an individual-by-individual contract basis, but it's an important channel for us. It gives us quick access to the end consumer brand penetration association with leading brands. And so overall, I think the picture is that it will help further stabilize our gross margins and then allow us to hone in on finding efficiencies to further improve them.

[Operator]

[Operator Instructions] Our next question comes from Sean McGowan of ROTH Capital.

[Sean McGowan, analyst]

I'm hoping you can help me understand the -- what you attribute to sales shortfall to trade spend. When we're looking at the numbers, gross packaged water sales are only up 3%. So is trade spend affecting gross amount somehow?

[Devan Pennell, executive]

No, Sean, I think obviously that comment is driven by the data, which I think we talked about the comps relative to Q2 in terms of growth. And I think that the commentary, Martin asked a question earlier talking about inventory within the system and how to reconcile the market data, which is the [ TIL ] data versus what we're actually seeing in the business. And so the data does show that the growth was not where it needed to be in the quarter.

But again, for the reasons that we have talked about, we're confident that this is a point in time and not a reflection of the continued growth potential of the business as we move forward. Otherwise, we wouldn't be comfortable in putting guidance in the 45% to 50% range for H2 versus the same period prior year. So the comment is fair. I think the driver is reflective of some of the conditions in terms of how the supply chain works, for us in terms of right to the end consumer and how the consumer customer interface works on our side. But yes, gross margin was not at the growth that we had anticipated.

[Sean McGowan, analyst]

No, I didn't mean gross margin. I meant your gross sales.

[Devan Pennell, executive]

Sorry, apologies, gross revenue. Yes. Gross sales. The growth of gross sales was not as we had initially contemplated in arriving at our initial guidance.

[Sean McGowan, analyst]

I guess when I saw the headline this morning that there was trade spend that kept the sales in the quarter from being stronger. I guess I expected to see gross sales up more and the trade spend up even more than it was. What is your outlook for the trade spend in the second half kind of as a percentage of gross sales -- or comparable for the second quarter.

[Nicholas Reichenbach, executive]

Yes. No, thanks for bringing that up. No, we're -- we invested in Q2 in trade spend heavily to set up new distribution path into our channels and new programs going into our channels. We are monitoring the trade spend in Q3 and Q4 and expect our trade spend to go down as we move in and fan out all of these distribution paths.

[Devan Pennell, executive]

In addition, as we move forward, just looking back at the historical information, if you look at our sequential trade spend through Q1 -- through Q4 in the prior year, you see a significant acceleration in each respective quarter, culminating in Q4. And if you look at where we're trending now versus where we were in Q4, we've added some additional layers of discipline and consistency in terms of how we optimize our trade spend. And so we expect that as a percentage of revenue trade spend will come down, which will allow us to drive both the absolute growth but also growth in the quarter-over-quarter comparatives.

[Sean McGowan, analyst]

Okay. And then to circle back, I think, on Martin's question about the gross margin impact on both of these. So I think he was saying that the gross margins for water or branded water was relatively stable, but it's relatively like about the same as last year or about the same as the first quarter.

[Devan Pennell, executive]

I would say relatively stable in aggregate. The big weight on us is underutilization coming through in [ POX ]. So that's the primary driver of what we're seeing. And the netting out of that is we see -- we continue to see increased efficiency on a run-by-run basis, both on our Flow branded products as well as on our co-packing product, which is a testament to the continued competence and capabilities of the team. But where we are having the increased pressures, start, stops and the implications of -- from a cost structure of those on an operating facility. And so that's where we're seeing the biggest pressure. As we see increased utilization, the efficiencies that we talk about on a line-by-line run-by-run basis will start to come through in the P&L. Which as you just said, as you look back to the comparable period in Q2, with -- if I'm quoting correctly, I believe it is 35% gross margin. That's a testament to what we can do when you have utilization of the underlying assets as well as efficiency in the production process.

[Sean McGowan, analyst]

Right. But were the units down in your branded water, so really bulk co-packing and branded water would have had that impact of lower units?

[Devan Pennell, executive]

Yes. From a unit standpoint, yes, because the inventory position continues to improve as we focus on working capital. So overall units were down in aggregate through the facility.

[Sean McGowan, analyst]

Okay. All right. That's helpful. And the last one again circling back to an earlier question. When you were talking about some of the puts and takes on growth in revenue, 3Q, year-over-year growth, 3Q and 4Q, it sounds like you're kind of leaning towards maybe the fourth quarter would be a little bit stronger, but did I hear that right?

[Devan Pennell, executive]

As a comp or as a -- in terms of absolute growth? Yes, to clarify, I think that the comps across the P&L become more favorable to Q3 and Q4 as you compare like-for-like cost structures as well as the potential for growth in Q3 and Q4. So we believe that we will continue to see improvements across both metrics that we have provided guidance on as we move forward to allow us to deliver the committed guidance that we've provided during this call.

[Sean McGowan, analyst]

Yes. I think I was just looking for whether or not you expected year-over-year revenue growth in the third quarter to be higher or lower than the year-over-year revenue growth in the fourth quarter.

[Devan Pennell, executive]

Year-over-year revenue growth.

[Sean McGowan, analyst]

Which quarter will…

[Devan Pennell, executive]

Yes. I would say relatively consistent.

[Operator]

Thank you. There are no further questions at this time. Ladies and gentlemen, this concludes your conference call for today. We thank you for your participation, and we ask that you please disconnect your lines. Thank you.