Flow Beverage Corp

TSX:FLOW

Earnings Call Transcript 2023-Q3

[Operator]

Good morning, everyone. Welcome to Flow Beverage Corp.'s Fiscal Q3 2023 Conference Call. As a reminder, this conference call is being recorded on September 14, 2023 [Operator Instructions]Before we begin, we would like to remind you that today's presentation and discussion contains forward-looking statements that involve known and unknown risks and uncertainties and other factors that could cause actual events to differ materially from current expectations, and may cause actual results, performance or achievements to be materially different from those implied by such statements.The forward-looking statements are based upon and include the company's current internal estimates, plans, expectations, opinions, forecasts, projections, targets, guidance or other statements that are not statements or facts.Any statements contained herein or discussed during today's session that are not statements of historical facts may be deemed to be forward-looking statements. A number of factors could cause actual events, performance or results to differ materially from what is projected in the forward-looking statements.A more complete discussion of the risks and uncertainties facing the company appear in the company's Annual Information Form dated January 29, 2023, and the company's Management's Discussion and Analysis for 3 months ended July 31, 2023, which are available under the company's profile on SEDAR.You are cautioned not to place undue reliance on these forward-looking statements, which only speak to the date of this presentation. The company disclaims any intention or obligation, except to the extent required by law, to update or revise any forward-looking statements as a result of new information or future events or for any reason. Any forward-looking statements contained herein or discussed during today's session is expressly qualified in its entirety to be above cautionary statements.I will now turn the call over to Nicholas Reichenbach, Chairman & Executive Officer of Flow. Please go ahead, Nicholas.

[Nicholas Reichenbach, executive]

Thank you, operator. Good morning, everyone, and thank you for joining us today. I'm joined by Trent MacDonald, Flow's Chief Financial Officer. I'll begin today's call with an update on our transformation plan to achieve profitable growth. I'll review Flow's milestone in the quarter and then pass it over to Trent to go through the financial results. We will open the call for questions from our analysts.We have been ongoing a major transformation to achieve profitable growth. Our strategy includes a 4-pillar plan. The first step of our plan was to sell our Verona production facility, and we accomplished that in November, 2022. Our second step was to solidify our financial position through a $20 million secured line facility and most recently, through the extension of $11.4 million of unsecured debt announced 2 days ago. The third step was to simplify our operations. Accordingly, we have restructured our organization, reducing our corporate headcount by 30% and have simplified many of our processes.On that note, we're in the final stages of transforming to a third-party logistics platform, which represents the biggest financial piece of our expected cost savings. We are now executing on the fourth pillar of our transformation as we progress towards the sale of our Aurora production facility, which was first disclosed in our Q2 press release. The structured sales process of Aurora is going very well with many interested parties.As we previously mentioned, this sale is expected to generate a significantly higher price than the Verona facility given that Aurora is a profit center. It has capacity to expand, it has a deep skilled labor pool and is located in close proximity to all major distribution routes. We expect that the sale will provide us the necessary capital to get us through to profitability.Although all this change -- throughout all this change, we are delighted to report that Flow's branded growth has been uninterrupted. The Flow branded net revenue increased 21% in Q3 and is up 46% year-to-date. One factor that continues to drive the Flow branded growth is our expansion in the North American retail channel. As of July 31, Flow was located in over 59,000 stores in Canada and in the United States, representing 63% growth over this time last year.Some of the more significant additions to the store count are Albertsons/Safeway, Family Dollar and Dollar Tree in the United States, and in Canada, Circle K and Save on Foods.Looking at Flow branded growth revenue on a quarterly basis, you can see that we achieved a major milestone in Q3 2023, exceeding $10 million in the quarter of Flow branded gross sales for the first time. This slide also helps illustrate some of the choppiness in the quarterly revenue figures.Last quarter, we achieved 98% growth, but it was off a very low comparative quarter in Q2 2022. You might recall the wholesale CPG sector realizes low sell-in rates that quarter. You can see that the net revenue almost doubled in the quarter Q3 2022. And today, we are announcing that we have topped that by 21%. We believe our year-to-date growth on the Flow branded revenue of 46% is better representation of our achievements this year.Flow remains a market leader in the carton format water in the United States at 49% market share, [ sustaining ] market share against other beverages in similar packaging. We think it means that consumers are choosing Flow for its taste, our ZERO calorie flavors and our innovation like vitamin-infused water.Turning to our operational milestones for our year-to-date. As I noted earlier, we have increased our store count by 63% through a great retail partnerships and have maintained our market share as the leader in carton format water.Foodservice has been a big contributor to the revenue this year. We added 1,100 Starbucks locations across Canada. If you [ frequent ] Starbucks, close to your home, work or even at the airport, you'll see our [ Red OG ] alkaline water and strawberry rose flavor displayed in the chart next to the cash register. We believe this partnership is going very well.In June, we launched with Live Nation venues across Canada. Live Nation hosts millions of concert goers to over 1,000 concerts every year. Flow is a part of their goal to eliminate single-use plastic, reduce greenhouse gas emissions and become 0 waste by landfill by 2023.Our innovation, vitamin-infused water is now located in 8,000 stores across North America. Albertsons/Safeway are leading the way in new store counts carrying vitamin-infused water across the United States of America. And Circle K has most recently added to many of their locations across Canada.That concludes my remarks. I will now pass it over to Trent.

[Trent MacDonald, executive]

Thank you, Nicolas. I've mentioned, for the first time in our history, Flow brand net revenue topped $10 million in a given quarter, increasing to $10.5 million in Q2 2023. This represents a 21% increase year-over-year. As mentioned by Nicholas earlier, the Flow brand grew more than 98% in Q2 from our year prior as a result of some of the lumpiness between Q2 and Q3 last year.Last year, we did, in fact, have a difficult Q2, which was followed by a sequential increase of 80% in Q3. Yet this year, we were still able to grow 21% compared to that specific quarter, showing the strength of the Flow brand.Overall, the Flow brand has grown 46% year-to-date at Q3. In the quarter, we did have some logistical challenges in our e-com, which led to service interruptions, but this was more than offset by higher sales through foodservice along with new retail locations and of course, the launch of our vitamin-infused water.Consolidated revenue increased 8% in Q3 2023 to $13.8 million. If you may recall, our co-packing business in the U.S. was sold with the Verona production facility last year and continues to have an impact on our consolidated sales. Gross margins were 21% in Q3 2023 and have not yet benefited from the many changes we are making to our cost of goods through our operational restructuring. We believe, based on our recent execution of several of these initiatives and the imminent nature of several more, we can improve our margin dramatically over the next 2 to 3 quarters.Within the quarter, we are also impacted by a change in our e-com fulfillment methodology, which we have since rectified. Similar to Q2, revenue from foodservice partners now makes up a greater proportion of our sales mix. Food service remains an extremely important part of our revenue as it promotes customer trials, which should help drive revenue growth in retail and e-commerce given the thousands of new customers trying Flow. We believe that the current sales mix is somewhat of a temporary nature. In time, retail and e-commerce will grow dramatically as we also help normalize gross margin beyond the cost initiatives I just mentioned.EBITDA loss was $9.8 million compared to $8.6 million last year. EBITDA includes $3.8 million in nonrecurring charges, which I will touch on shortly. Excluding these charges, EBITDA would have been approximately $6 million loss.Turning to a more detailed review of our income statement. You can see that sales and marketing remain at a lower percentage of net revenue, which is -- which has been a good story. General and administrative expenses include the nonrecurring $3.8 million of costs I just mentioned. Now these costs include consulting and legal expenses attributable to our ongoing optimization initiatives and the Aurora facility divestiture.There are also temporary and legacy logistics costs as Flow transitions to third-party logistics and onetime write-offs of accounts receivable and an increase to allowance deductible to mitigate our risk around some of the -- some larger accounts. We also trued up costs related to the sale of the Verona production facility. Again, we do not see these costs ongoing past Q4 and certainly not into Q1.As we enter the final phases of our transformation and the sale of Aurora, we fully expect a material decline in general and administrative expenses. Salaries and benefits were slightly lower than the prior year, but it's important to note that Q3 only includes a partial impact from our restructuring and absolutely no impact from our transition to third-party logistics. Again, we believe the benefits of these initiatives will become much more evident in Q4 and certainly into Q1 and Q2 of fiscal 2024.Right now, Flow is trading at 1x revenue as compared to our publicly traded beverage peers trading at a simple average of over 4 revenue and 5x revenue on a weighted average basis. Flow is also outpacing the industry average revenue growth rates by a wide margin, having grown the Flow brand by 46% year-to-date as compared to the average growth rate of only 18%.Given the revenue to enterprise value multiples associated with the peer group, we see a significant opportunity to unlock shareholder value. All of that said, of course, we have to execute on our plan, the results of which we believe will become evident to shareholders in the quarters to come.As Nicholas mentioned, we are in the final stages of our transformation. We have solidified our financial position through the divestiture of Verona, debt extensions and the use of non-dilutive capital. We've restructured our corporate staff and implemented many processes that have changed the way we do business here at Flow, making us much more focused.Once third-party logistics is fully implemented and the sale of Aurora is executed, we will be operating a truly asset-light model, which should bring higher gross margin, more control in all of our operating expenses and very importantly, will provide the necessary capital to invest even more into accelerating growth of the Flow branded net revenue. All told, we continue to believe that we can generate cost savings of $22 million to $26 million from fiscal 2022 levels and solidify our path towards profitable growth. We appreciate all of your support.And at that, operator, please open the line for questions.

[Operator]

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

[Martin Landry, analyst]

My first question is, you just ended up your remark trend with a comment saying that you're fully online to realize your cost savings of $22 million to $26 million. Can you tell us like how much of that -- those cost savings have been achieved so far?

[Trent MacDonald, executive]

Yes. Truly, not a whole -- [ full ] of them. I'd say on an annualized basis, about 25%, 30% of those have been -- you can see them in Q3. Although because of these onetime costs and a couple of other things, they're not as evident as you might think. And the cost of goods, there have been some temporary issues there that come from the logistics and some service interruptions in some of the e-com distribution things that we talked about, which again sort of cloud those savings. But we do expect in Q4 things will become much cleaner on the P&L and certainly into Q1.So those sort of 25%, 30% that you should be able to see today, you'll definitely be able to see them. And then in addition to that, we believe by the end of Q4, the entirety of the rest of the 75% -- 65% to 70% will be completely evident as well.

[Martin Landry, analyst]

So just to be clear, you're seeing by the end of Q4 all of those cost savings will have been realized. So by Q1 -- starting in Q1, we should see the full benefit of that in your results. Is that correct?

[Trent MacDonald, executive]

That is what I'm saying, yes. And so in Q1, we believe you're going to see a very different type of P&L coming in a Flow.

[Martin Landry, analyst]

And you talk about the foodservice channel being a bit margin dilutive. This may seem like a very basic question, don't fault me from asking, but why is it that the foodservice channel is margin dilutive? And why is it that you're promoting sample in food service and not in all your channel? I mean, can you just walk us through a little bit as foodservice is becoming a bigger part of your sales?

[Trent MacDonald, executive]

Sure, absolutely. Foodservice, first of all, before we talk about the margin at foodservice, there's a strategy that goes with foodservice. When you're in these places like, a great one obviously being Starbucks, it promotes trial. And trial promotes conversion into higher margin channels like e-com. Obviously, Whole Foods and Costco and Sobeys and Loblaws and all the things in the states with publics and Albertsons/Safeway, and that's where you really want people to start to shop, is all of these great retail partners that we have that have higher margin.And so you have to promote trial because trial is just a wonderful marketing tool versus going -- spending money on commercial advertising, television. Trial is great, but you have to look at the right sort of trial partners that can lead to those -- that conversion that we're talking about, specifically in foodservice because they're buying so much volume and there's margin that they need to make on it, especially when you're talking about travel like hotels at Accor hotel chain or Norwegian cruise lines, any kind of airlines.A lot of these folks give water away, quite frankly. And then they're running a tight margin themselves. It's not like your typical mainstream grocery store. And so it's very competitive, and especially given the nature of it being a marketing tool, it's very competitive when these things go to RFP. And so for us, there's a means to an end now.And so the margin, as we continue to talk about, is not going to be as high. It's never going to be as high in those channels. But the idea is that it becomes temporary in -- over quarters to come and years to come, you see a lot more conversion and your higher-margin channels continue to grow and grow and grow if you're doing it correctly.So as an example, Starbucks, we said before, is, we believe it to be going very, very, very successfully. And our e-com and the SKUs that are available in Starbucks immediately increased in terms of the volume coming through e-com and even other channels as a result of that initiative.So there is a benefit that comes from it. But margin is quite a bit lighter for sure.

[Martin Landry, analyst]

That was going to be a bit of a follow-up for me, given that you opened the door. Are you -- what kind of conversion are you seeing? You talked about some of the SKUs available, for instance, at Starbucks, where you've seen a lift on your e-commerce website. Can you talk about what kind of increase you've seen on e-commerce? I know you've had some issues, but let's say, in the month -- where you haven't had an issue this quarter, how much were your e-commerce sales up by?

[Trent MacDonald, executive]

Look, we don't normally disclose these kinds of things. But because you're asking, and we like you so much, I'll let you know that in the e-com, just in Canada, because here we didn't have the same sort of service interruptions as we did in [ States ]. And in this quarter, e-com Canada topped 75% growth, and it's never been that high, ever. Typically speaking, we're budgeting to do 35% growth in e-com, and we came 75%. And that again came off that same really big quarter last year. So 75% of that quarter, that's phenomenal and that -- we attribute that a lot to the success of what we're doing in Starbucks and other areas.

[Martin Landry, analyst]

Sorry, Nick, did you want to add something?

[Nicholas Reichenbach, executive]

The strategy, Martin, moving forward on foodservice is going to be supported by all of the core SKUs of Flow. In fiscal 2024, we'll have a QR code on either side of the pot, allowing consumers to take the photo with their phone and engage with us on our direct-to-consumer site. So that's really exciting news on how we're going to kind of maintain and grow that kind of connection to the consumer and also back to giving them the locations of other retailers, where they may want to actually buy 1 liters or a case of Flow.So we're really engaged with foodservice to make that trial and that low-margin account turn into a high-margin customer that has lifetime value for Flow.

[Martin Landry, analyst]

2 more, and then I'm going to wrap it up. Just trying to understand how big is the foodservice channel for you guys now versus 1 year ago? Do you have a breakdown of your sales by channel, just in terms of proportion of total sales? That would be helpful.

[Trent MacDonald, executive]

Yes, we do. We don't normally disclose that as well because it does change obviously dramatically quarter-to-quarter. But look, it's significant. Certainly not half for any stretch of the imagination, but it's significant enough. And so -- and e-com obviously has nothing to do with foodservice. And today, e-com represents what is about 25%, 30% of our total sales. So -- Flow branded sales, I should say. So I would say you're talking 1/3, less than 1/3 for sure.

[Martin Landry, analyst]

Nearly 1/3 of your sales are coming from the foodservice channel?

[Trent MacDonald, executive]

Today, yes.

[Martin Landry, analyst]

And then last question on your sale of your Aurora facility. I know it's -- some of it is out of your control, but is there a time line that you can provide us with in terms of where you can -- when you can announce something?

[Trent MacDonald, executive]

Yes. Look, there's all kinds of moving parts there internally and externally. And so we're not going to -- I can't tell you definitively when we're going to go full 3PL and do some of the things we're going to do. And certainly, with the Aurora facility, can -- it's an ongoing process. Both of these things have -- we've been aggressively moving towards. So I can tell you that. And to Nick's point earlier on the Aurora facility, we have lots of interested parties and quite a few avenues for full or partial divestiture. So it's -- we feel very optimistic and expect fully that something will -- a transaction will occur, the timing and value which you'll find out, I guess, with everybody else, but we are happy with the process thus far.

[Martin Landry, analyst]

Is there a potential for that to close before the calendar year-end?

[Trent MacDonald, executive]

Yes. There's a potential. I'm not saying well, but there's definitely potential, yes.

[Operator]

The next question comes from Sean McGowan from ROTH MKM.

[Sean McGowan, analyst]

I have a couple of questions as well. A few surrounding margins. So can you just comment on what you're seeing in sort of the basic margin on Flow branded, putting aside any logistical issues and putting aside co-packing, absorption, et cetera? Like, are you getting the margin that you're hoping to get on the basic sale of Flow branded goods?

[Trent MacDonald, executive]

Yes. Yes, that's the short answer. But yes, we are -- we've done an in-depth -- we continue doing -- end up analysis on our margins. And what's -- where we believe we would be on a normalized basis even in Q3. Even with the mix that we continue to refer to, we think had just a few of the initiatives that we talked about been in full force in effect throughout just Q3. We would have been in the low 30% margin. That's 10% to 12% higher than what you see in our financial report.So -- and that's just from some of the initiatives without changing any of the sales mix. And so as the sales mix changes, clearly, that has an impact on those margins as well. So there are definitely things that we know. And that's why we feel so confident in Q1 and Q2 as we go forward. You'll see some more of it in Q4 than you did in Q3. But in Q1 and Q2, you'll definitely start to see what we're talking about here.

[Sean McGowan, analyst]

Is -- in aggregate, is co-packing contributing positively to the gross profit line?

[Trent MacDonald, executive]

Yes. Yes, it is. It continues to… that's because…

[Sean McGowan, analyst]

That's not like a surprisingly worse-than-expected drag. That's -- I'm trying to get my arms around like where is the -- it's a lot lower than I thought it was going to be in this quarter, and I thought we had talked about that. So I'm trying to get a sense of where is the shortfall? And how quickly can that be addressed? And is it already been addressed?

[Trent MacDonald, executive]

It had. There's 2 things that have already been addressed that we know are changing in the quarter right now. One has already executed on, is done. It's -- we've already executed on it in this quarter that we're currently in, Q4. And the other will be executed on, and literally within the next 2 weeks, we will have done what we need to do to rectify that situation as well. I would say rectify because it's more of a change in strategy than a rectification of an issue.But the 3PL and some other things we're doing by September 30, it's all -- it's done, it's executed. So then on the backside of that, you're a very different organization. There's just a couple of things that drag that we really hadn't expected and discovered in the quarter that made us have to react very quickly, which we did. So that will no longer be an ongoing issue. But like I say, these initiatives that we've been talking about for some time -- and true, it took us longer than we thought. We're probably about one full quarter behind where we would have liked to have been 6 to 8 months ago.But that being said, in the long run, years from now, I don't think anybody is going to remember one quarter of delay, but that's where we are. So we know we're very comfortable in saying in Q1, Q2 that it's going to be a very, very different [indiscernible] now.

[Sean McGowan, analyst]

So, it mean -- it sounds like some issues came up and you had to spend some money that you weren't expecting to spend, fix them. Did these issues have any significant impact on your actual ability to get revenue? Or is it you would just spend money to get the revenue that you could have gotten and you didn't really lose any revenue?

[Trent MacDonald, executive]

No, we actually did lose a little bit of revenue, quite frankly, specifically in e-com in the United States with some of the logistical issues we're having in the -- and there were a few things in terms of service interruption caused by that sort of side of our business. And as a result, our subscription -- our monthly subscribers took a bit of a hit for a bit. Now they've stabilized, and we're starting to come up the other side. But we could see a material impact for about 3 months there.And as a result, our e-com business in the U.S. in the quarter for first time ever actually declined in Q3 versus that 75% increase. I just talked about Canada. So it added impact. But now we've already -- we've been watching and closing. We've already seen it, like I said, stabilized and started to come up the other side, which we expect will continue.

[Sean McGowan, analyst]

And were these e-com issues problems on your end, problems on the partner's end, some kind of combination or was it capital…?

[Trent MacDonald, executive]

Yes. You know what, I'd love to say it was a pure combination and sort of place [ blame ] in others. But look, we have to look at ourselves when it comes to these kinds of things, and we own it. And -- but that's part of -- we had logistical and I don't want to -- we have a great team. We have a lot of dedicated team members in that area of our business. So I give them all the praise in the world. But as an organization, holistically, we've made it very complex and it's hard to manage by time and it's nobody's individual fault. But we -- it's a very complex, convoluted area of our business that costs a lot of money, certainly well beyond what would be an industry norm per case.And sometimes these issues come up as a result of that complexity that we created, which is all the more reason that we have been aggressively moving towards an entire [ leading ] strategy.

[Sean McGowan, analyst]

And then last question from me, changing gears here is -- and maybe you've talked about this or maybe not. Just given the discussions you've had on Aurora and the sale, Is -- do you have any sense of what the gross proceeds could be?

[Trent MacDonald, executive]

Well, we -- yes, again, we can't disclose exactly, but we've been saying every time that comes up that the overall value that is significantly and materially higher than Verona, for all the reasons we said. I mean, it's a profit center. It has very, very healthy EBITDA. It has expansionary capabilities. It's on our major distribution channels. It has a growing and skilled labor pool in that specific geographic area. It's -- there's a lot about it that is extremely attractive to potential suitors.And as a result of that, we expect that we're going to get multiples of the value that was originally placed on [ Verona ].

[Sean McGowan, analyst]

And just to -- there's a lot of different ways of talking about the value of a real estate type of transaction. So what would -- how would you characterize Verona? Like, what was that deal which serves as a base case? [indiscernible] moved to $19 million or something?

[Trent MacDonald, executive]

Yes. It was $26 million, including the debt. So the enterprise value that we got was about $26 million. And so, that had a very different strategic purpose for us as we said in the 4-pillar plant.

[Sean McGowan, analyst]

Just to try and understand, when you say multiples of Verona, you mean multiples of that number, not multiples…?

[Trent MacDonald, executive]

That's right.

[Operator]

[Operator Instructions] Our next question comes from the line of Najib Islam from Canaccord.

[Najib Islam, analyst]

The question -- I just wanted a bit more clarity on the gross margin number. Could you maybe give me an idea of how much of the gross margin change was attributable to margin versus the change in fulfillment technology which was mentioned in the press release?

[Trent MacDonald, executive]

Yes. Look, we believe that -- well, we broadly run our numbers, and I said there -- a couple of minutes ago there that we believe on a normalized basis in Q3, we could have easily been over 30%. And so it's significant, the things that we're talking about here.

[Najib Islam, analyst]

And I also had some questions on the cost savings that you're hoping to achieve. Is the number you're targeting completely independent of, if the [ Verona ] facility takes longer to sell? Or is it completely independent?

[Trent MacDonald, executive]

It is completely independent.

[Najib Islam, analyst]

And I also had a question about your market share in the carton format. I saw that you're at 49%. Do you think there's a lot of additional runway ahead? Or are you comfortable with kind of where you're at now?

[Trent MacDonald, executive]

Nick, do you want to talk?

[Nicholas Reichenbach, executive]

No, there's definitely significant runway ahead as we gain market share against our competitors. And I would see this continuing all throughout next year as the Flow branded products grow at a similar pace.

[Operator]

There are no further questions. This does concludes conference call. Thank you all for attending. You may now disconnect your lines. Thank you.