Flow Beverage Corp

TSX:FLOW

Earnings Call Analysis

Earnings Call Transcript 2024-Q3

[Operator]

Good morning, everyone. Welcome to Flow Beverage Corp. Fiscal Q3 2024 Conference Call. As a reminder, this conference call is being recorded on September 17, 2024. [Operator Instructions] Before 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 interest, estimates, plans, expectations, opinions, forecasts, projections, targets, guidance or other statements that are not statements of fact. 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, 2024 and the company's management discussion and analysis for 3 and 9 months ended July 31, 2024, 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 expressed qualified in its entirety by the above cautionary statements. I will now turn the call over to Nicholas Reichenbach, Chairman and Chief Executive Officer of Flow. Please go ahead, Nicholas.

[Nicholas Reichenbach, executive]

Thank you, operator. Good morning, everybody. I'm joined today by Trent MacDonald, Flow's Chief Financial Officer and EVP of Operations. On today's call, I will start by reviewing our recent milestones and before I pass the call to Trent, I will also review Flow's strategic growth priorities. Trent will take you through a detailed review of the Q3 results and share an update on our path to profitability.

After Trent's remarks, I will open the call for questions from our analysts. This morning, for the second quarter in a row, we report the most profitable quarter since the company has been public. We delivered the lowest adjusted EBITDA losses as a public company as we scale our co-packing operations and realize our financial benefits of our operational transformation and restructuring.

The highlights of our results is an increase in gross margin to 34%, which resulted in gross profit of $4.6 million. This is the highest amount of gross profit in Flow's history. We achieved these results by focusing on profitable channels for our flow brand and flow branded products and by ramping up our co-packing operations, which increased 62% year-over-year.

We now have 4 lines operating on all cylinders in our Aurora production facility in Canada. We received approval for alcohol production and began producing for our largest co-packing client BeatBox. In August, we increased the size and term of our co-packing agreement with BeatBox to $213 million in net revenue over the next 6 years.

We have now reached $246 million in take-or-pay contracts, which will help us get to profitability and provide growth of net revenue for years to come. Also in August, we announced our latest innovation Flow sparkling mineral water Flow sparkling will be available in original and 3 of our signature flavors. Cucumber mint, Lemon Ginger and Blackberry Hibiscus. We will provide more updates on our plan launching over the next weeks and months to come.

In the meantime, we are staying true to our commitments towards the environmental sustainability by offering flow sparkling and aluminum bottles in a partnership with Kingston Aluminum Technology. This proprietary cutting-edge bottled deliver a high-end design experience and according to the supplier, they're also 100% recyclable, use 30% less aluminum and require 60% less energy to produce than traditional cans and bottles.

We have also just completed our first year of the exclusive hydration partner and official sponsor of the Toronto International Film Festival which was estimated to attract over 600,000 attendants over the 2 weeks of the event, and the event went amazing. Looking forward, we expect to return to Flow branded growth in Q1 2025.

We expect that the impact of the Flow brand from the decisions we made to exit unprofitable commercial channels is mostly behind us. Our sales team is making great progress in its efforts to get Flow in traditional grocery aisles from natural grocery aisles moving to conventional grocery and all major retailers could have an impact on flow being able to sell more cases and dramatically increase their volume -- our volume.

Turning to co-packing, we are still ramping up our BeatBox production in Q4. We are also seeing increased demand for the products that we're producing from our other co-packing partners as consumers get familiar with Tetra Pak format and companies are seeking the most sustainable beverage packaging option. Considering this demand we now have plans to add a fifth and sixth line in Aurora, and we expect it to be operational by next July.

Our co-packing business accreted the most gross margin, and we expect it to be a significant part of our growth and profitability in the years to come, and we look forward to providing more details soon. With our contracted revenue from our co-packing partners, our return to profitability for the Flow branded products and maintaining our cost discipline, we expect to achieve adjusted EBITDA by Q4 2024. This concludes my remarks, and I'll pass it over to Trent.

[Trent MacDonald, executive]

Thank you, Nicholas. As Nicholas just mentioned, for the second quarter in a row, Flow has, in fact, achieved its most profitable quarter as a public company. All in all, our adjusted EBITDA loss was only $1.9 million comparing that to a $10.7 million loss in Q3 of 2023 and the $3.5 million loss in our last quarter, which was also, again, the most profitable we had been at that point in time.

That is $8.8 million improvement year-over-year and a $1.6 million sequential improvement. Improvement in adjusted EBITDA starts with gross margin which increased to 34% in Q3 of 2024 from 3% this time last year and 28% in Q2 2024. Gross margin improvement can be attributed to a number of things: one, the consolidation of production of the Flow brand at the Aurora production facility; two, higher capacity utilization in Aurora with increased co-pack volume, three, the ongoing focus on higher profitability channels for the Flow brand and most recently, number four, profitability improvements in our e-commerce business as we have reevaluated our distribution strategy while mitigating the impacts of reselling.

In addition to the significantly improved gross margin, general and administrative expenses are down 51% year-over-year, and salaries and benefits are down 21% year-over-year due to the substantive completion of our operational transformation and the complete impact of our restructuring. We believe we can still improve on profitability in the coming quarters through continued increases in gross margin and through continued improvements in operational efficiency and capacity utilization.

Flow brand net revenue has been growing in profitable channels, such as natural foods, e-com and grocery and is quickly offsetting the impact of our choice to exit unprofitable channels. As such, we do expect Flow brand net revenue to resume growth in total by Q1 of 2025. Co-packing is also going to be a significant driver meeting towards meeting our profitability goals as we still have plenty of room to increase volume as we finish up some of the necessary capital spend in Aurora production facility, which is expected to be operational in the coming weeks.

As also mentioned and as we released publicly, we have plans to significantly increase our operational capacity with 2 additional lines, which we are planning to have fully commissioned by the middle of next calendar year. While our functional areas are fully restructured, we still believe there is more room to improve our underlying operations. At this time, we've completely redesigned our logistics strategy, moving to a 3PL model and consolidating much of our warehousing and distribution.

That said, we also see additional improvements coming in this area of our business which should positively impact both gross margins and G&A expenditures. Given the growth in the Flow brand, the continued operations and logistics strategy and the ongoing impact of our restructuring impact, we see continued improvement in gross margin and significant operating leverage to adjusted EBITDA for future quarters.

While Flow Enterprise value is only 0.9x revenue, and we actually trade at only 0.25x our revenue, which compares to our publicly traded beverage peer trading at a simple average of over 3x and 4.2x revenue on a weighted average basis. We believe there is a lot of room for upside. We think we can close this gap and to do that, we intend to continue to demonstrate our financial improvements through ongoing growth in the Flow brand within profitable channels.

As we continue to execute on our co-pack strategy, we also will be maintaining our discipline and operating expenses and our focus on innovation, such as the launch of our sparkling water, all of which we believe will start to build shareholder value. In our experience, the shareholders will eventually get it correct, but we need to execute, and we have done this execution for 2 quarters in a row, and we continue to expect to improve going forward.

At that, I would like to thank you again for all of your support. And I will now pass it over to the operator to open up the line for questions.

[Operator]

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

[Martin Landry, analyst]

Congrats on your profitability improvements. It's great to see. My first question is on your sparkling water launch. Can you give us a little bit more color as to why you're going into sparkling water? And why now? And what's the profitability profile of those Qs?

[Nicholas Reichenbach, executive]

Yes, Martin, I can kick that off. Flow recently announced that we did a full brand innovation and did a full new brand launch with our Tetra Pak packaging and we redesigned the entire packaging with all of our USPs based on extensive consumer research against our wellness consumer at the core.

And we identified a larger consumer base that is a little younger in age, but also value, sustainability, premium enhanced water and all of the waters attributes, including electrolytes naturally alkaline as well as the amazing pure taste of Flow being it from an artesian mineral spring water source in Ontario.

With that, we also identified that the consumer, both our consumer, the core consumer as well as the new consumer base that we are attracting to the flow branded products want to drink a premium enhanced mineral spring water both in still and sparkling. So we noticed that the occasion to have mineral spring water sparkling is a substantial amount of the market that we're attracting with the Flow core branded product.

With that, we did a competitive analysis across all of the different channels and spoke to our leading retailers on bringing flow into sparkling in the most sustainable way, and we got an overwhelming response back from our retailers and our consumers which are in the million both in Canada and the United States that they request and wanted the sparkling mineral water.

That kind of led us into trying to find the most sustainable solution for that at scale and also being in the competitive format that allowed us to be able to attract the consumers that are currently buying international brands that are bringing in natural mineral spring water and with some flavors attached to it as well.

And so with both of those things and finding the most advanced aluminum bottle on the market for sustainability as well as for format design, we structured an exclusive deal with the Kingston Aluminum Technology company to be able to bring a first to market beautiful aluminum bottle and in our natural mineral water with carbonation, lightly carbonated and as well as putting our organic certified flavors inside.

And since our launch of that product, we've got an overwhelming response from all of our retailers across Canada and the United States to bring this product to market as well as we've been starting to sell it on e-commerce and launched it at TIFF, the International Film Festival, which has all garnered a very positive response to this product extension of which most of the multinational companies that are in the premium enhanced water both still and sparkling.

So this is a natural evolution for Flow to maintain its position in the premium enhanced water market, but also extend our brand as well as our product into a poor category that is currently only being competed against in the international brands and allowed us to extend our brand equity into that market to extend it into our consumers.

So I have out of all of the product launches, Martin, that I've been involved with Flow, this one has been received the most positive across all of our consumers and our retailers, and we're very bullish on how this product is going to be in and last thing I can say is that it takes fantastic.

We brought back our Lemon Ginger, which was an original part of our still organic flavored launch. We brought it back in sparkling. It is phenomenal tasting product as well as our core high-selling organic flavors like Cucumber Mint and then, of course, the OG. I'm sure as soon as we get our samples over to you, or you can see it on the retail shelf that you'll be equaling my sediments.

[Trent MacDonald, executive]

Let me finish that answer up to as well on the sort of why now and the profitability profile, the profitability profile, Martin, we've done based on our history and our improved standard operating processes and our focus on profitability, we don't want to go backwards. And there's just no 2 ways about it.

We aren't making the same mistakes. We are not going to be experts in repeating ourselves when it comes to errors. And so we have put a ton of resource and analysis behind this to ensure that we know all of the underlying inputs into the model. To Nick's point, we didn't take this lightly. We've talked to not just retailers but other big food service partners and other areas of other channels and areas of distribution to ensure that there was an actual market for this, and there is one with our partners.

And we have some commitments already, quite frankly. So we have decided to launch this in a bit of an asset-light model to begin. So we're not expending CapEx unnecessarily. Putting our working capital at risk. We do anticipate this is going to be margin accretive above that of which we believe is going to be our margin in the coming quarters anyway.

But we do, based on the model, think that this is going to be margin accretive, given it is positioned as a premium offering in the marketplace within the sparkling category. And so the price point will be competitive to that of glass bottles because it's bottles versus an aluminum can, a $3.55 aluminum can is not what we're competing against. And so we believe there is margin to be had there and our model is going to be sound.

And with that, we don't think the working capital impact is going to be negative. In fact, we believe in very, very short order. Based on getting some serious orders in the near term that we will not only be margin accretive, but cash flow accretive in the very near term. And so anything that's going to be cash flow accretive to us is of interest.

And this is something that we believe 4 years from now, we could be a serious, serious player in sparkling water, and this is the time to do it based on everything that Nick just said.

[Martin Landry, analyst]

Okay. That's helpful. Maybe switching gears a little bit onto your production you completed the installation of a line recently. So I was wondering now with that new line that will be operational or that is operational already. How much does your current operations can support in sales right now?

[Trent MacDonald, executive]

Great question. And so yes, we do have a fourth line. It is operational. We've been producing on it for some time now getting all the way back to, I believe, late February. There was one piece of equipment, and I alluded to it in my remarks that we have to have. It's basically our sterilizer that goes live. It's our second sterilizer. We have one that 4 lines are running off.

So it does limit our ability to use all 4 lines for co-packing at any given time or 3 lines or 2 lines. We can always use 2 lines, but the sterilizer will be live and operational in about another 10 days from now. It's just on the very last little portion of its commissioning. Full commissioning, at which time we'll have ultimate flexibility and it allows us to produce both flow on as many lives as we need in any given time.

But also co-pack when we don't need to be producing flow, we can use 3, if not all 4 lines for co-packing depending on what we're running on and what times. So all of that being said, Martin, it is without doubt, that 4 lines are inhibited in some ways for our growth. We do have flexibility in the near term, and we do believe that it's going to be enough to bridge us out to the middle of next year.

But it's going to be very important that we get the fifth and sixth line in. Our revenue that we can create on 4 lines is definitely larger than we have right now, and we can experience I'm going to go from -- on a trailing 12-month basis, I think you could easily say we could get 50%, 55% growth on the 4 lines from what we've experienced in the last 12 months.

But the fifth and sixth lines will take us to another level altogether, clearly, and then look, not giving a bunch of guidance and commitments, but our goal isn't just to be at 6 lines. Our goal is to get to well beyond that. And fortunately, here in Aurora, where I'm sitting today, we have the ability between this location that we're sitting in today and a new location, which we said we were going to be taking on very near to here geographically.

We could easily get up to 12, maybe even 14 lines. So we have lots of room for growth in the future. And so right now, I don't think we have any kind of bottleneck being caused by capacity today or in the future.

[Martin Landry, analyst]

Okay. So my last question for me. You're referring to your fifth and sixth lines being added next summer. I would assume that these lines have already been ordered. How are you going to pay for that CapEx? Are you going to use your usual financing partner? Or like how are you going to pay for that?

[Trent MacDonald, executive]

Well, there's where we got pretty creative. Yes, they are in order just to confirm that. They are in order, and we're on track. And so our goal is to accelerate that as quickly as possible, but we're saying middle of next calendar year as sort of the latest date by which we think we can get this accomplished.

That said, from a financing perspective, yes, we did lean on our existing lender who has been unbelievably supportive for us over the past couple of years. And from that perspective, we also went into a deep partnership with BeatBox. These lines are very, very, very important to them for their growth, and they want to ensure that we have capacity going forward.

So because of that and because it's so alcohol focused, we did work out an arrangement sort of a 3-way arrangement between us, BeatBox and Flow where the lease is actually taken on by BeatBox directly with NSF, our lender. That is a range between the 2 of them. The operating lines will be in our facility and operated by us but finance through NSF and BeatBox.

We will inevitably make those payments through another mechanism and it will be us who has the right to purchase those lines at the end of the lease term. So it's pretty creative but allowed us to be able to grow and grow both for BeatBox and for ourselves.

[Martin Landry, analyst]

Okay. Okay. And given that you're going to have to make some lease payments on that or given that you're not making lease payments, it's taken on by BeatBox, would that mean that your tolling fees on these lines are a little lower?

[Trent MacDonald, executive]

The way it works that the tolling fee will be basically the same. I mean we haven't negotiated MSA, which we believe is good for both BeatBox and ourselves and provides for profit. But yes, the lease payment will be a net -- like we'll just net that off of our invoice and on a monthly basis, but not until they're operational and we're producing.

And at that point, we've modeled that with BeatBox and ourselves, and we know what that volume is going to look like. And so we're very, very comfortable that the lease payments as we go forward is not going to be inhibited by any stretch of imagination based on the utilization we envision right now in both the 5th and 6th lines.

[Martin Landry, analyst]

Okay. That's it for me. And best of luck.

[Operator]

Your next question comes from Najib Islam with Canaccord Genuity.

[Najib Islam, analyst]

Sure. So I wanted to know, has the retail modernization of alcohol in Ontario opened up any additional opportunities for alcoholic beverage co-pack agreements at all?

[Nicholas Reichenbach, executive]

We're definitely seeing an increased interest in doing RTD, ready-to-drink alcohol beverages, both in our Tetra Pak as well as the new format that we're getting into, which is the aluminum bottle. So I would say that the -- yes, the decentralization of that in Ontario has definitely increased our pipeline of potential customers coming into flow, utilizing our facilities to create not only non-alc but alcoholic RTD beverages, both in Ontario, but also for export across Canada and the United States.

[Najib Islam, analyst]

Sure. That's good to hear. And on the e-commerce side, could you give me some color on which exact e-commerce channels you switch over to the wholesale model and how that sort of help the combat resellers?

[Nicholas Reichenbach, executive]

Absolutely. It's been a long time coming, but basically, it's Amazon. So we had always used a fulfilled by Amazon structure for fulfillment of our Amazon orders on e-com, which is inhibited. And I can't stress that enough how inhibitive it was our margins were sometimes even negative after taking into account fulfillment.

And so what we've been able to do over time and by the way, the resellers were able to command and compete against us because we were a shop in and of ourselves and anything they were doing with some old inventory and we'll get into all those things that they were able to pull off in those legal things that we needed to do to try to block that eventually.

This was the ultimate solution and that is getting on to the direct with Amazon platform. So Vendor Central is what that's called. We've done it in Canada. We've already moved on to that. So essentially, you're selling to Amazon. Amazon has been the actual seller owner of the inventory and selling the inventory which gives a preferential positioning on the Amazon homepage when you're doing a search for water.

Also, it is very margin accretive for us because we no longer have to pay for distribution and fulfillment. And it is also going to lead to much more velocity. And because of that, the reseller issues go away because we're not competing on price with them and it's Amazon, who's doing it in Amazon is much more aggressive when it comes to getting rid of resellers, selling products that they've already bought from themselves and are reselling.

And so there's a lot of good comes from that. It does impact, obviously, the top line sales because it becomes a wholesale model as we are actually selling to Amazon, not to an end consumer, but the margin is better because, again, we don't have any of the fulfillment costs, which were extremely cost-inhibitive. And now we go from small, small single digit to even negative margins to close to 40% margin.

So that is a good thing, and we now have a solution in the U.S. to do the same thing, and that will be completely launched and running in the coming weeks.

[Najib Islam, analyst]

Sure. Got it. And then on the Sparkling Mineral Spring water, are there any internal TAM estimates that you could share with me? Addressable market?

[Nicholas Reichenbach, executive]

Yes. The addressable market for sparkling mineral water in Canada is a substantial part of the premium enhanced water market, probably around 30% of all premium enhanced mineral water is sold in sparkling. So it does pose a very substantial amount of market share for us, and it's an easy extension into our current consumer base, both in Canada and the U.S.

[Operator]

There are no further questions at this time. I will now turn the call over to management for closing remarks.

[Nicholas Reichenbach, executive]

Thank you, everybody, for joining us today and look forward to releasing our Q4 results at the end of our fiscal period.

[Operator]

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.