Flow Beverage Corp

TSX:FLOW

Earnings Call Transcript 2022-Q4

[Operator]

Good morning, everyone. Welcome to Flow Beverage Corp.'s Fiscal Q4 and 2022 Conference Call. As a reminder, this conference is being recorded today, January 30, 2023. [Operator Instructions] I will now turn the conference over to Nicholas Reichenbach, Chairman and Chief Executive Officer of Flow. Please go ahead, Nicholas.

[Nicholas Reichenbach, executive]

Thank you, operator. Good morning, everybody, and thank you for joining us today. I'm joined today by Trent MacDonald, Flow's Chief Financial Officer. For disclaimers on forward-looking statements, please refer to Slide 2 of this presentation. We hosted an operational update conference call on January 9. So I'll keep my remarks brief and then pass it over to Trent to review the Q4 and year-end 2022 financial results.

Subsequent to our fiscal 2022 year-end, we made a number of game-changing moves to significantly improve the company's financial trajectory. As I said on our operational update conference call, the common thread to all of these initiatives is that we are taking an aggressive action towards our goal to achieve profitable growth for the Flow brand.

In November 2022, we sold our Virginia production facility for [indiscernible] USD 19.5 million -- we initiated an internal restructuring in December of 2022 and raised an additional [indiscernible] USD 15 million -- CAD 50 million from a senior secured debt facility in January 2023. This debt facility also allows us to draw another $5 million in fiscal 2023. These strategic initiatives have provided -- together have provided a cash injection of $31 million into the company and we expect to realize cash savings of $17 million in fiscal 2023 without impacting the growth of the Flow brand. In fact, we believe these initiatives provide the company with financial flexibility to invest even further behind sales and marketing to drive profitable growth for the Flow brand while achieving normalization and predictability on gross margins.

Today, Flow is in over 46,000 stores across North America. This is an increase of 88% over the previous year. Some recent wins include 11,000 stores in Dollar General, 5,000 stores in Family Dollar locations and another 500 combined locations in Fred Meyer, ShopRite, Market Basket and BJ's in the United States of America.

Turning to Slide 5. You can see that we remain the market share leader in carton format water in the United States. Our market share in this category has increased to 44% from 40% from the last time this year -- last year.

And this does not include the impact of our wins in the food service sector and recent innovation like vitamin infused water, which I'll discuss shortly. Most of you are aware that Flow has been sustainable since day one. In Fiscal '22, we made amazing progress to build our leadership and sustainability through our NASDAQ OneReport through NASDAQ, we published the first SASB report and voluntarily disclosure of our framework to investors.

We also maintained our B Corp certification status and remain one of the top B Corp certified companies in the world ranking us alongside with brands like Patagonia and Seventh Generation.

Turning to Slide 7. I would like to highlight our milestones for 2022 from an operational point of view. In addition to our store count and gain in market share, we launched our vitamin infused water in the United States and Canada and are getting great feedback. We also signed a number of agreements in the Foodservice sector with household names like Norwegian Cruise Line and luxury hotel operator, Accor. we also launched in BLADE urban mobile helicopters and seaplane lounges as well as signing a distribution agreement with Primo who serves 1.8 million subscribers and customers in the United States.

Turning to Food service. Our most recent distribution agreement has been with Foodbuy, which represents a potential 11,000 locations in North America and Starbucks Canada, which is also in another 1,000 locations that carry Flow. We have started -- we have stated consistently that our premium and sustainable positioning is exactly what food service partners are looking for. And we expect that sustainability in particular, is going to remain a high-growth segment in the beverage market for quite some time.

As mentioned, we launched our vitamin infused water, announcing in Canada, that we signed over 22 leading retailers representing 800 locations in addition to food and beverage distributors. We are very pleased that some of our flagship customers have taken delivery and orders in the vitamin infused water, and we think this product line has a lot of potential.

With that, I'll pass it over to Trent.

[Trent MacDonald, executive]

Thank you, Nicholas. And good morning, everybody. I want to start by just reiterating that we are in the midst of an operational transformation that we believe will provide long-term financial sustainability to Flow and provide the company with a pathway to profitability. Look, one of the many imperatives of this endeavor was to strengthen the balance sheet and dramatically improve our financial position. While this will continue to be an ongoing focus, we believe we've accomplished a great deal over the past several months.

With this being the case, one of the items of our Q4 and year-end results will be one time -- one of the themes, I should say, of our Q4 and year-end results will be the onetime nonrecurring items and reserves. We felt it was very important for us to derisk our entire balance sheet at year-end, so we could set up the organization for a much cleaner and more profitable fiscal 2023.

With that said, let's discuss our results. So the Flow brand net revenue increased 38% in Q4 2022 and 26% for the fiscal year. The primary drivers across both these periods with the successes we've had in unlocking new retail stores across North America, while we continue to build momentum within our e-commerce channel.

Growth rates on a consolidated basis were slightly lower as our co-packing revenue was impacted by both our focus on the Flow brand and by the amendment of a co-pack manufacturing agreement, which became effective May 1, 2022, which was -- which formed part of the Verona divestiture announced subsequent to year-end. This amendment in the co-pack revenue had -- the amendment impacted co-pack revenue and gross profit by approximately $2.2 million on a run rate basis in Q4.

Our gross margins were 10% in Q4 and 19% in fiscal 2022. Our normalized gross margins, however, were 28% for Q4 and 25% for fiscal '22 when considering the impact of that co-pack agreement amendment and a onetime $300,000 inventory reserve associated with us choosing to exit the collagen-infused water market.

Even normalized margin was still impacted by the higher relative production volume coming out of the Verona facility. The cost per unit of flow water and co-packing was much higher at Verona, given it was not running at full capacity, and this increased the overhead cost applied to each unit of production coming out of that facility. I'll also add that we are not immune to cost inflation, and we started to see input and logistics costs creep up in the back half of the calendar year.

We anticipate that going forward, gross margins will improve following the sale of the Verona production facility, along with other operational cost initiatives that we are currently working on. Our EBITDA loss increased 10% in Q4 and improved 29% for the fiscal year. As it relates to Q4, we took over $2.8 million noncash charges, which impacts some of the improvements we have been making through cost discipline.

Turning to growth and net revenue. Growth in the Flow brand was relatively broad-based across Canada and U.S. retail as well as e-commerce. We have also made a lot of improvement as it relates to trade spend. As compared to Q4 2021, we spent $400,000 less to achieve 38% growth in the Flow brand.

Looking at co-packing revenue, as I just mentioned, we made the decision to focus on the Flow brand impacting our capacity to allocate to co-packing and the renegotiation of a co-packing agreement, which I mentioned earlier. Looking forward to 2023, we expect continued growth in the Flow brand, while co-packing revenue will decrease based on capacity allocation. With respect to trade spend, however, we expect that we will continue to be very diligent in this expense.

While I've already spoken to gross margin, I'd like to -- look, again, reiterate, these gross margin figures that we're showing are not representative of our trajectory, especially after the sale of the Verona production facility. With the sale, we have fixed our per unit cost for U.S. production through the co-pack agreements that we signed as part of the transaction. We removed the cost of unutilized capacity and added volume to Aurora, which will make that facility's production even more profitable. We are also working through several broad-based operational cost savings initiatives, which we believe will provide an even better pathway to improve margins in quarters to come.

Sales and marketing and general administrative costs included $2.5 million in noncash charges in the quarter that relate to accruals on trade credit reserves and receivables, again, in an effort to derisk our balance sheet going into fiscal 2023.

We do not expect these items to recur going forward. That said, it is important to note, while we are aggressively executing on cost savings initiatives, we realize it is imperative for us to continue investing in the Flow brand. It's distribution and its customer engagement. We have no plans to slow down in relation to these activities. With respect to general and administration and salaries and benefits, we would expect both these lines to decrease in fiscal 2023, given the impact of the Verona sale, our internal restructuring and the many other aggressive cost savings initiatives we've identified.

Turning to Slide 13. Look, as we've recently acknowledged our stock price has underperformed and for several very legitimate reasons. As management and speaking for our Board, it was critical for us to stabilize the organization by mitigating risk on the balance sheet, strengthening our financial position and dramatically reducing our cash burn. While we needed to ensure we had a clear pathway to profitability and a runway to get there.

Only then could we possibly argue that Flow was undervalued. While we've been executing on that plan at a very [ hasten ] pace, and we believe there's a lot of -- for us to accomplish, still to come, we are very pleased to see that the markets are starting to take notice of our efforts. That said, Flows still trading, if you look at Slide 14, at 0.9x revenue versus 3.5x as a simple average for our peer group and 5x for the weighted average of our peer group. Even though we have gone from 0.3x to 0.9x revenue in the last month, we still believe there is significant value to unlock.

We are still at the beginning of a very long road, which will entail proven execution, improved results, lower cash burn and what we expect to be an aggressive investor relations plan. With that, please open the line for questions. Thank you.

[Operator]

Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session for research analysts. [Operator Instructions] Your first question will come from Chip Moore of EF Hutton.

[Chip Moore, analyst]

Nicholas wondering just on the gross margin ramp and maybe if you could expand on that, the ramp in Aurora, how you think about utilization there? And then sort of getting -- I think you mentioned Q2, Q3 seem more substantial benefit. Any way to help us -- should we be thinking sort of mid-30s margin potential? And then maybe that higher from there or any more color?

[Nicholas Reichenbach, executive]

Yes I can comment on the...

[Trent MacDonald, executive]

Go ahead. Sorry.

[Nicholas Reichenbach, executive]

I can comment on the utilization, and I'll let Trent comment on the gross margin impact. As we mentioned in our operational call in early January, we moved to 24/7 production in Aurora which means that we're running our 3 machines 7 days a week, 24 hours with cleaning and downtime. So we've reached a great utilization of those assets by moving our co-packing customers, some of our co-packing customers from the United States backed into Canada where they were originally producing.

So we have a significant volume from that coming back up as well as maintaining the growth of the Flow brand in Canada.

[Trent MacDonald, executive]

Yes. And look, that -- clearly, capacity utilization is going to be very important to us when it comes to absorption rates and our lower overhead costs applied to each unit of production coming out of Aurora. It's a much more efficient facility and we've done a great job on the operating of it. And so if you think about that in terms of the impact on gross margin, again, we stay away from guidance in terms of like what it's going to be 32%, 38%, 40%.

But we do know that we had normalized margins of 26% -- well, we had 26%, I believe, in Q3, 28% Q4 a normalized basis. I think our goal to go forward is to continue to build off of that and with each successive quarter. As we get better on some of the cost savings initiatives. It's not just about utilizing the capacity. It's about other things we're doing within the operational network to reduce costs that end up getting applied through overhead and other things, direct or otherwise. And so I think there's a lot still happening and good things to look forward to.

[Chip Moore, analyst]

Yes. That's helpful. And great job on the cost side. I guess, maybe if we flip it, Nicholas, you mentioned about having some flexibility to invest, obviously, the cash position is much improved and the growth trends are still quite healthy. Where might you step up some investment in more food service, more vitamin water? Just what are your thoughts there?

[Nicholas Reichenbach, executive]

Yes. With investing in the Flow brand, we want to maintain our velocity at retail in our core channels of growth in 2023. So we'll be investing in our growth channels, both in Canada and the U.S. to ensure that we maintain a market leader in the channels that are of higher margin but also of higher strategic importance.

So we'll be investing directly in those channels such as the natural grocery channel and food, drug and mass in Canada, where the brands rolled out with a very high ACV as well as we've mentioned numerous times that foodservice is a very big and attractive channel for flow. As we know the customers are looking for a sustainability and we'll further roll that out in foodservice, both in Canada and the United States in 2023.

[Operator]

Your next question comes from Pulkit Sabharwal of Canaccord Genuity.

[Pulkit Sabharwal, analyst]

Good morning, everybody. Just wanted to dig deeper into the market share gains you talked about. It's actually in the carton format. Could you just contextualize how the general category fared as a whole over the same time period and perhaps expand on the drivers behind the market share gain?

[Nicholas Reichenbach, executive]

Yes. I can dive into that because the sustainability package format in water is still relatively new. And so from a data perspective, it's only -- we've only been recently been able to track it over the last year, and we've seen significant growth in sustainability packaging in the premium enhanced water category to the tune of it hit up towards 80 -- 80-plus percent in 2022.

And the drivers of sustainability packaging are made up of 3 categories: one carton two aluminum aluminum cans and aluminum bottles and three glass. And so the drivers are of growth within those categories are definitely in the carton category segment as well as aluminum where we're seeing up towards an aggregated growth of 55-plus percent to the end of this year. And we continue to see that growth moving forward. That's the question number one. What was your second question?

[Pulkit Sabharwal, analyst]

Yes. Just the drivers behind the market share gains you're seeing versus the competitors. And yes.

[Nicholas Reichenbach, executive]

Yes. So in the carton segment in Canada, we are actually one of very few, if not the only one in that segment. So we were awarded with a very large market share, probably 90-plus percent in Canada. And in the U.S., as mentioned in the slide, we have 2 or 3 other competitors within that segment.

The way that Flow is positioned, it's not only a sustainable water brand, but we're also a premium enhanced mineral water. And we also have organic certified flavors so we're starting to see the impact of a high quality -- or a higher-quality product than our competitors that are initially -- are significantly jumping our growth within the segment. And if you look at the pricing, it's not about pricing, we're actually priced higher than our competitors.

So we're starting to see the quality of our mineral water and our innovation really drives the growth that I was mentioning and that does not include vitamin-infused water, which is in a different segment altogether.

And I'll add to that, too. Look, I mean, we've -- I mean, industry dynamics and the growth trends are evident to most who have access to the research. But the -- it's come down off the peak, growth is still very solid, very healthy across premium, across functional across -- it's still healthy, healthy growth but it's come down.

And a lot of that is the comp coming out of COVID, and there was really high, high growth for a while. So it's hard to comp that. When you're looking at year-over-year, which is how do you measure this with this kind of growth. But if you look at our final quarter across most metrics that we -- in which we compete, we were overindexing to the tune of a 3 to 4x fold and certainly in functional water. And even you could say that about premium as well. We don't expect the growth to go away in those sectors. It might slow year-over-year, but then we do anticipate it will come back up.

We will obviously see some macroeconomic factors at play here. But we have been doing really well. And a lot of that is the growth in doors, the growth in distribution, the growth in foodservice, things that are really adding to our volume that perhaps our competitors are struggling with.

[Pulkit Sabharwal, analyst]

Okay. That's great color. And then just in terms of the partner [indiscernible] Could you just remind us what the partner network looks like going forward for Vitamin Water, especially for this year?

[Nicholas Reichenbach, executive]

Meaning distribution path?

[Pulkit Sabharwal, analyst]

Distribution as well as overall penetration across your networks?

[Nicholas Reichenbach, executive]

Oh, yes. That's great. Yes. So in Canada, where it's just launched in January, we signed 22 retailers and -- which represents 800 doors. Those are names such as Loblaws, Metro and other leading grocery stores. We also announced that the club channel with Costco, we rolled out a national program with Vitamin water. So I would say we have very good penetration within our core channels, across food, drug and mass in Canada, and that's where we'll focus most of the distribution of vitamin water throughout the year.

And we expect other channels like gas and convenience in Canada to pick it up more towards the later half of this year, where we have a smaller penetration but growing in gas and convenience. In the United States, we're focused on rolling out Vitamin Water in the natural grocery category and segment of which we have a very high ACV of, I think, about 55%, 60% of all natural grocery in accordance to the scan back Nielsen data and SPINS data.

We'll focus on launching across broadline distribution with our two largest partners in the U.S., UNFI and KeHE going out to all of the leading natural grocery chains as well as the grocery category at large conventional grocery with some of our leading grocery partners. So we'll look to announce more in the future as they turn on, both in Canada and the United States. If they're significant, we'll be launching and releasing news as it relates to the ongoing rollout and performance of this product line.

[Pulkit Sabharwal, analyst]

Okay. That's great color. And then one last one for me is just -- could you also just provide a time line on what the rollout with Primo looks like over the coming year just in terms of the SKUs you're rolling out and what the time line would look like for the upcoming fiscal?

[Nicholas Reichenbach, executive]

Yes, absolutely. So our Primo deal is in the United States currently where we're rolling out to their direct to consumer, customer base that for people that don't know Primo's business model, that's a lot of home and office delivery where they have water coolers and other premium products and beverages, mainly water products that are going into the cafeterias and office sector as well as home delivery.

We have launched the Primo partnership, and they have initiated orders and reorders in the United States and their focus is on the Northeast Coast, where Flow has a much higher penetration in brand awareness, but also in other alternative distribution. Models as well as in their core markets across the United States. So all intensive purposes, the Primo partnership is national and available off their website. And a core focus on their core markets. And we'll be supporting that channel with additional programs and trade programs as well as consumer awareness as we roll it out across the U.S.

[Operator]

Your next question comes from Martin Landry of Stifel GMP.

[Martin Landry, analyst]

Morning. I was wondering if you could give us a bit more details on how you see the path to profitability unfold. Do you think it'd be possible for you to achieve one quarter of the positive EBITDA this year?

[Nicholas Reichenbach, executive]

Yes. Martin, it's a great question, and I would love to give you a definitive response. But if we do get to a positive EBITDA, it certainly wouldn't be until fourth quarter, but it is really not in our 3-year operating model to have positive EBITDA in any quarter this year.

We do expect to have significant like significant improvement, and it will come down to a number of things internally in terms of the that haste with which we can remove certain costs that some of these things that you can imagine can be done immediately. Other things take a little more time and you see the lagging indicators. We are in fact, tomorrow is January 31, finishing our first quarter. And so some of it will roll into our second year of the 3-year business plan. But we do believe we're going to be able to show the market some very significant results. And not just through cost of goods, decreases, which will improve, of course, our gross margins, but through G&A and salaries and benefits as well.

[Martin Landry, analyst]

Okay. And maybe I'll push this a little bit further, Trent, and wondering if we could see in fiscal '24, a full year of positive EBITDA. Do you think that, that could be doable?

[Trent MacDonald, executive]

Perhaps, perhaps it's a goal. Again, I can't -- I won't say definitively that, that's our expectation or that that's our guidance. But that would be our goal, but we mostly by the second half of fiscal '24, I think there's -- there could be a pathway there. Again, it's going to depend on our execution, but we're very aligned around what that looks like right now. So we'll see.

[Nicholas Reichenbach, executive]

I'll further just add one statement, which is over the course of the last 90 days, we've announced a lot of strategic initiatives that bring us closer and closer to a public profitability or a path profitability and you're going to see those improvements happen over Q2, Q3, Q4. So I think it will become very obvious to the path that will be going on as we roll out these initiatives, these strategic initiatives over the course of the first couple of quarters of next year -- of this year. So that's the statement.

[Martin Landry, analyst]

Okay. And just so that we have a bit of a better understanding on fiscal '23. Is it a matter of scale you think that scale will get you to positive EBITDA further down? Or is it a matter of utilization, although it seems like your utilization rate is pretty solid. So can you just explain to us a little bit what you still need to achieve that you haven't accomplished that will get you to positive EBITDA?

[Nicholas Reichenbach, executive]

Sure. I mean there's a couple of things there. You have to think about Q1 as its own its own sort of animal. At year-end, we were still sitting with inventory that had been produced in Verona at October 31, the transaction with Verona did not take place until subsequent to year-end. And so that high cost inventory is going to flow through in Q1.

Our goal is to mitigate that and to continue to improve margins through utilization in Aurora, but there is that we do have to mitigate in Q1. So that's going to be a bit of a drag on the full year if you think about it that way. Some of the initiatives that we've put into place have come throughout Q1. And so again, you won't see the full impact until Q2 and probably even the latter half of the year Q3, Q4 so there is going to be cost save initiatives. But a lot of it, it's really spread out, but a lot of it is in warehousing distribution, logistics, shipping and then, of course, general and administrative and then the cost of goods through better utilization.

So it's a pretty good combination of initiatives that we believe when taken as a whole are going to show dramatic improvement. But again, it's going to take a bit of time over the course of the year for all of those things to come through because your quarterly results are a bit of a lagging indicator because you're executing in real time, but you don't see them at the last effect.

[Operator]

[Operator Instructions] Your next question will come from Sean McGowan of ROTH Capital Partners.

[Sean McGowan, analyst]

A couple of questions here as well. Trent, you went through sort of calling out a onetime charges on the sales and marketing. But were there also some exceptional charges in the G&A line, that was also higher than I thought it would be.

[Trent MacDonald, executive]

Yes. Definitely in G&A, there were some higher items for sure. We got aggressive on our allowance for doubtful to clean up our -- like again, the theme of Q4, and I tried to sort of say this upfront in terms of my section was to say, we are derisking the balance sheet.

And not just from a leverage perspective and financial stability, but also from a working capital item perspective. And so we did take some pretty big reserves that did impact that G&A. So again, there's the allowance for doubtful, there are some things within our accruals. And I won't get into all of it, but there's -- because there's so many little ones as well, but they all add up. And for us, we just want -- we want to have a nice clean distinct balance sheet. So we didn't -- so we don't -- we're not going into Q1 and Q2 and Q3 and having to take all these hits and death 5,000 cuts. I want to have a nice -- all of us want to have a nice clean P&L going forward.

[Sean McGowan, analyst]

Yes. Makes sense. And you called out some factors that might still drag down gross margins in Q1. Would there also be some kind of onetime unusual charges elsewhere in the P&L in Q1.

[Nicholas Reichenbach, executive]

There shouldn't be. There shouldn't be. We didn't -- like I never say never, but we did a pretty good job. Like we were pretty thorough going through the through all of our working capital items. We took an impairment on one of our long-lived assets in relation to Collagen Water which obviously doesn't hit G&A, but it still got P&L. So we -- there's a lot of things that we've done to clean it up. I don't see there being anything specific that I can look to that is going to cause any issues other than hot inventory flowing through the P&L when in it gets sold through.

[Sean McGowan, analyst]

Okay. Perfect. That makes sense as well. Are the assets held for sale already disposed of now. So should we expect that line to be zeroed out at the end of Q1?

[Nicholas Reichenbach, executive]

Yes. Yes. That was all part of the Verona transaction, which was announced on November 9 and closed.

[Sean McGowan, analyst]

And then last question for me. Is this new credit facility that you have, does that represent the company's total borrowing capacity? Or are there other pieces of debt that would show up on the balance sheet?

[Trent MacDonald, executive]

Yes. We haven't yet -- we only -- we didn't draw the entire amount. So when we announced today that in our [ PR ] that we have, I think, $26 million of cash, we still have -- we still have other -- we have a hold back on the Verona facility -- we've holistically expect to receive by the end of the year. We have $5 million that we can still draw on the credit facility itself. And we do actually believe we have more borrowing capacity if we ever did really want to do that on it, whether it's equipment loans or other things, but that's -- we're not actively looking to do that right now. I think we I think we've bought ourselves a pretty good pathway for the time being. So now it's about execution.

[Operator]

Ladies and gentlemen, at this time, there are no further questions. So this will conclude your conference call for this morning. We would like to thank everyone for participating and ask you to please disconnect your lines.