Enwave Corp

XTSX:ENW

Earnings Call Transcript 2022-Q2

[Operator]

Good morning, and welcome to EnWave Corporation's Second Quarter Fiscal Year 2022 Earnings Conference Call. My name is Donna, and I will be your operator for today's call. Joining us for today's presentation are the company's President and CEO, Brent Charleton; and Dan Henriques, EnWave's CFO and COO of NutraDried.

[Operator Instructions] And the conference is being recorded. [Operator Instructions] Finally, I would like to remind everyone that this call will be made available for replay via a link in the Investor Relations section of the company's website at www.enwave.net.

Now I would like to turn the call over to EnWave's CEO, Mr. Brent Charleton. Thank you. Please go ahead.

[Brent Charleton, executive]

Thank you, and welcome to everyone on the call today. Before I discuss our recent performance in Q2 and our outlook for the remainder of fiscal '22, I would like to remind everyone that the information we are about to present contains forward-looking information that is based on management's expectations, estimates and projections. These statements are not a guarantee of future performance and involve a number of risks, uncertainties and assumptions. Please consider the risk factors in the filings made by EnWave on SEDAR when reviewing this information.

Also, all amounts discussed will be in Canadian dollars unless otherwise noted. Now with the important disclaimer complete, let's discuss our recent performance.

For the purpose of this conference call, we will refer to our patented vacuum-microwave technology business unit, inclusive of our licensing, machine sale and toll manufacturing service, which we've dubbed REVworx as EnWave. And our operating subsidiary that leverages Radiant Energy Vacuum or REV technology for branded and bulk snack products as NutraDried.

I'll first provide an overview of EnWave's corporate progress in fiscal '22 and then a summary of the advancements we have made with NutraDried. Following my update, Dan, EnWave's CFO and COO of NutraDried, will summarize our Q2 consolidated financial performance.

Our performance in Q2 was a mixed bag. Our consolidated revenue grew to $6.9 million in the quarter, positive, which was an improvement of $2.2 million year-over-year and about $600,000 quarter-over-quarter. Our year-to-date third-party royalties also grew to $750,000, representing a 55% growth year-over-year, another great positive.

And in regards to segmented revenue, NutraDried's Q2 revenue grew by 142% relative to Q1, a great step in the right direction, while EnWave's Q2 revenue was down due to lower revenue recognition tied to machine sales. Machine sales at EnWave have been historically lumpy and Q2 reflects this. Sometimes, we closed multiple large system sales in close succession, and other times, there are months where it unclose, but progress is made within our pipeline.

We continue to fill the top of our sales funnel and work multiple prospects downwards in the funnel. Our pipeline is still strong, and through the latter half of this fiscal year, we hope to deliver positive lumpiness in the form of a machine order glut.

Like most other companies, EnWave continues to face supply chain challenges in the form of higher input costs and longer lead times. We've chosen to combat these issues by remaining proactive in our inventory build to ensure timely delivery of machines and have negotiated certain bulk pricing discounts with key suppliers.

Given our robust pipeline for potential new machine orders, we want to be ready with all critical long lead time parts to maintain a high service level to ensure timely royalty generation. In some cases, we have increased the pricing of our products to minimize the impact of growing input costs on our businesses.

Operating in the backdrop of a challenging labor and supply market, many of our prospective and current partners are encountering construction delays and elongated project time lines. This environment, particularly in the cannabis industry has led to some machine installation delays and purchase order decisions getting pushed out.

Currently, we are waiting to install 2 120-kilowatt machines for U.S. cannabis partners and a 60-kilowatt for a food partner, all related to facility readiness. Once these are installed, we expect more royalties to be forthcoming.

As of the completion of Q1, we felt the goal of securing 10 large-scale machine orders and 15, 10-kilowatt units in fiscal '22 was still attainable. With Q2 being slower than anticipated, it is looking like we may come up short on those ambitious targets and more likely close between 6 and 8 large-scale machines and 10, 10-kilowatt units in fiscal '22. If we are successful, this would be a significant improvement year-over-year. And to date, we've confirmed 2 large-scale and 4, 10-kilowatt units.

Our machine sales confirmed in Q2 include a 120-kilowatt unit to Orto Al Sole, our partner from Italy, to increase their manufacturing capacity to produce premium fruit and vegetable snack products. Orto is a family-owned vertically integrated agriculture company with a rich multigenerational history. We believe that Orto has the perfect mix to prospectively achieve commercial success, low-cost, high-quality raw materials and expertise in grocery product distribution and marketing.

Additionally, in the second quarter, EnWave signed repeat 10-kilowatt machine purchase orders with fresh business, our partner with operations in both Peru and Spain, with Dole Worldwide Food & Beverages Group, one of our most promising commercial relationships and Nomad Nutrition, a local Canadian company that has won new material distribution for its line of shelf-stable, ready-to-eat meals that are marketed towards those living active lifestyles and outdoor enthusiasts.

We don't recognize the revenue tied to 10-kilowatt machine sales until the units are installed and commissioned for use. And we expect all 3 of these 10-kilowatt units to be operational in Q3. Our potential large-scale machine order pipeline for the next 4 months is tied to both exclusivity commitments by current royalty partners to scale up their manufacturing capacity in order to retain their exclusive license rights and the confirmed commercial success reported by other current royalty partners in regards to their respective product launches.

We expect many partners to need more REV capacity to scale their businesses. We also continue to focus on new partner opportunities in the cannabis industry with several live leads in Europe, Australia, the U.S. and Canada. Thorough evaluation of our tech is being completed by these companies, and we believe will compel many to adopt REV in the coming quarters. REV's value proposition is clear for cannabis processing, faster drying, smaller footprint, better cannabinoid and terpene retention and a premium smoking experience as per the many online reviews from different consumers of the current licensees of our technology.

REVworx has been operational now for 3 months, and we expect to earn our SQF, which stands for Safe Quality Food Level 1 certification in the coming weeks. This is a critical step towards being able to co-manufacture or toll dry for large consumer packaged goods companies. We've had many production runs in our plant to date and have showcased our technology's capabilities to numerous visiting prospects to our headquarters in Vancouver.

We are now working towards larger contracts for this service offering, many with current royalty partners. REVworx is meant to act as the ultimate showroom for our tech, provides bridge manufacturing capacity for companies that want to scale up and enable potential royalty partners to establish product success in market before committing large CapEx. We think REVworx will be incredibly valuable for us as we pursue the rapid expansion of our business.

Switching gears now to NutraDried. There have been many positive changes made over the past 3 quarters. Expenses remain in check and positive gains have been made in new distribution, new product launches and development of our team.

Revenue in Q2 was much stronger than Q1 due to a Costco Canada program and one U.S. Costco regional rotation. NutraDried's sales team has secured placement of 4 SKUs in over 1,800 Kroger locations and launched Moon Cheese sticks nationally with Whole Foods. We have also confirmed Walmart will pick up 3 Moon Cheese stick SKUs in 300 stores to start and will begin selling in October and a meaningful customer activation in [ Publix ] generated a 12.5x lift after a heavy promotion with almost 90,000 units sold.

Last quarter, 80,000 pound monthly sales was the metric to breakeven at NutraDried. With recent material increases in raw material cheese prices, this metric has now increased to 105,000 pounds per month, and our current average is around 80,000 pounds per month, the previous target. This challenging economy has moved the goalpost on us and we're adapting to these conditions. NutraDried's focus over the next quarter will include the pursuit of more meaningful distribution wins and a successful launch of sticks into the grocery channel, targeted to set up fiscal 2023 for profitability. We are also converting our Amazon business from a wholesale model to a retail model, a move that should further boost our online margins.

With that, I'll now turn it over to Dan Henriques to summarize our Q2 financials.

[Daniel Henriques, executive]

Thanks, Brent. Good morning, everyone, and thanks for joining us today. I'll take some time to go through our Q2 2022 financial results. Please note the figures I'll talk about today can be found in our press release this morning and in the financial statements and the MD&A filed on SEDAR. All amounts will be in Canadian dollars unless otherwise noted.

I will make reference to adjusted EBITDA a few times. It is a non-IFRS financial measure. So please refer to the non-IFRS financial measure disclosures and a reconciliation to GAAP net income in both our press release and in the MD&A. Please note, the comparative period I'll refer to throughout is the prior year Q2 ended March 31, 2021.

Consolidated revenues for Q2 were $6.9 million, quite strong relative to past quarters, compared to $4.7 million in Q2 of '21. This is an increase of $2.2 million or 47%. In Q2, 78% of our revenue is derived from Moon Cheese sales, with a major program within Costco Canada as well as new distribution gains in Kroger and Whole Foods in the U.S. grocery channel, a very important channel for us.

Positive gains in new distribution started shipping in Q2 and we're aiming to confirm more of these in the latter half of the year. The strong Moon Cheese revenue of $5.3 million offset softer equipment sales contract revenue at EnWave. EnWave's revenue from equipment sales was $1.06 million compared to $1.96 million for Q2 of '21. The timing of large-scale machine orders is inherently lumpy, and our Q2 kind of represents that lumpiness.

The pipeline of opportunities is still robust, and with several royalty partners planning to scale up capacity this year, we're aiming to confirmed large-scale deals over the coming weeks and months.

In Q2, we generated $245,000 of royalty revenues from third parties, which is a 50% increase from Q2 of '21. We're continuing to confirm new licenses, commercial opportunities to expand our royalty base and we expect this number to continue to grow as we execute on our business model around the world. Remember, that's the plan of EnWave, build the royalty base.

Gross margin for Q2 of 2022 was 20% compared to 10% for Q2 of '21. Our gross margin came down from the high in last quarter of Q1, which was 43%. But remember, that was boosted by the retail of 120-kilowatt we have sold for a very high margin. Cost of goods at NutraDried increased in Q2 with rising block cheese prices. Block cheese pricing will impact the gross margin in [ strike ] for the balance of the year with commodity pricing for cheese up 35% over last year.

In May, a wholesale price increase of 6% across our customer base took effect in an effort to partially offset these cheese prices. And as we look at cheese futures, we're hoping these increases will abate towards the end of the year. EnWave's margin for Q2 was slightly compressed due to the decreased overall large-scale machine revenue. We put our resources to work, building 2, 120-kilowatt machines on spec in anticipation of demand and as we work to confirm new machine orders from the equipment sales pipeline in succession, then we'll be able to deliver strong margins at EnWave.

Adjusted EBITDA, which is a non-IFRS financial measure, so please refer to the reconciliation to GAAP net income in our MD&A, was $1.2 million loss for Q2 of 2022, compared to a loss of $1.9 million for Q2 of 2021, an improvement of about $700,000.

The consolidated net loss for Q2 of 2022 was $2.4 million, compared to a loss of $2.3 million of last year. By and large, our SG&A expense structure was in line with Q2 of '21. The path to a positive adjusted EBITDA exists when we realize more REV machine sales and Moon Cheese sales, and we can scale our revenues without adding significant new costs.

We'll continue to invest where we need to, particularly in sales and marketing in order to drive revenue growth in both business units, but we'll also prudently manage our nonrevenue-generating costs to control our expenses.

Our balance sheet at March 31 remains very healthy, with a strong treasury of $9 million and net working capital surplus of $14.7 million. The capital project to build out the REVworx facility is now complete and was funded through existing cash resources. Aside from a small COVID-19 relief loan and some facility leases, our balance sheet remains debt free.

[Brent Charleton, executive]

Thank you, Dan. As you heard, we are well resourced to scale our businesses. We have ample new opportunities to pursue, we are confronting the economic challenges in the marketplace. And regardless of some of the recent delays we've experienced with projects, our pipeline of potential sales remains very strong. We have the opportunity to confirm 6 to 8 large-scale and 10, 10-kilowatt machine sales cumulatively this fiscal year. If we can achieve these targets, then we will be profitable.

NutraDried is winning new material distribution for both our Moon Cheese sticks and [ bite ] items, and expenses are being managed prudently. We have a headwind of unusually high cheese prices at the moment, but once pricing returns closer to historical norms, NutraDried should be profitable again. We are very pleased with the progress being made here. We've had -- we have a strong treasury to execute on our plans, and we will be conservative in deploying our capital. But for growth opportunities, we won't pull back. Collectively, our team remains driven to achieve consolidated profitability.

And with that, I'd now like to open the call for your questions. Operator, please provide the appropriate instructions.

[Operator]

[Operator Instructions] Our first question today is coming from Neil Linsdell of iA Capital Markets.

[Neil Linsdell, analyst]

First, can we just start off on the -- basically the revised guidance on the REV units. So the last time when we were talking about the guidance on the number of units you had, I think you said 60% of the units you expected to be from existing partners. So I understand you've got some global supply chain problems and you've got customers which are deferring. Is it hitting everybody or existing customers taking a full allotment and new customers are being a little bit more cautious or delaying projects?

[Brent Charleton, executive]

Thanks for the question, Neil. In regards to the guidance provided and those large-scale purchasers that we thought we were going to consummate through fiscal '22, the ones that have gotten pushed out into fiscal '23 are primarily tied to existing partners in the cannabis space, whom communicated the need to scale up manufacturing capacity to us throughout the first half of this fiscal year.

And then more recently, literally within the past few weeks, have communicated delays in their construction of new facilities in which would house these prospective new units. Hence, the reduction in the number of large-scale machines targeted for this year, that's the primary reason.

[Neil Linsdell, analyst]

Okay. So that makes sense. Okay. And on the margin pressure, I guess, on the Moon Cheese snacks. A couple of questions there. So on the cheese pricing, your suppliers, are you expecting to see stabilization of the cheese prices, a drop in the cheese prices, further inflation? And how is that coordinate with your potential to pass through price increases perhaps on some of your existing partners?

[Daniel Henriques, executive]

Thanks, Neil. Yes, we watch cheese prices all the time. I think you can imagine, it's about -- well, it's our #1 input cost of NutraDried. So pricing relative to last year is up 30%, 35% in lots of cases. So I mean, we watch the futures very closely, which kind of gives you an indication as to where things are going to go several months down the road. And futures are lower than where spot pricing is today. So that gives us hope that prices are going to come down.

Obviously, the world is changing rapidly and all it takes is a little bit of a shock to move things in another direction. But based on what we're seeing, we think the prices are going to abate towards the end of the year, looking at the futures. But today, the spot prices are up quite a bit. So we have to deal with that reality.

In terms of passing pricing on to our customers, in the CPG world, there's only so much price increases you can push through and you have to stay within line to your competitors. Otherwise, you're going to take -- you're going to eat that price increase by way of consumption on shelf. So we've taken what we think is the right level of pricing increase right now, 6%. It takes effect this month. And obviously, we're going to continue to watch cheese pricing and watch what our competitors do. And if we need to do -- take more action down the road, then we'll do that. But if the futures come back into line, we should be back in a much better place.

[Neil Linsdell, analyst]

Okay. So it's more of a market dynamic against your competitors versus contractual obligations to maintain certain prices?

[Daniel Henriques, executive]

Yes. I mean every time we raise prices, the retailers will pass through at shelf. So your price on shelf moves up. And so if you come out of line in the category, it's going to really impact consumption. So it's a delicate balance you have to strike.

[Neil Linsdell, analyst]

Okay. Fair enough. And just on your breakeven when you talk about the pounds per month of cheese passing through the facility, with the cheese -- I don't know, this may be competitive -- competitively sensitive. But when you're producing the Moon Cheese versus the sticks, I get the impression there's more air puffed into the sticks product, such that for specific volume, you'd actually have a lower kind of unit cheese cost. Is there a difference in profitability between the 2 products, say, or the amount that the cheese price is going to impact your margin?

[Daniel Henriques, executive]

It doesn't so much have to do with the puffiness of the end product. It's more to do with the moisture content, the water that's in the cheese before it goes into drying. So the yield that we get on different cheeses varies by cheese variety. Cheddar has a lower moisture content than Mozzarella, so we get a slightly better yield on Cheddar than we do, say, Mozzarella. So the sticks yield is actually a little bit below Cheddar, so it's slightly less profitable from a pure cheese perspective. But with volume, that will -- the yield difference between Cheddar and Mozzarella is not significant enough. So if we can push enough volume through it, it still has the opportunity to be a very profitable item. But it's more to do with the moisture content of the incoming cheese.

[Neil Linsdell, analyst]

Okay. And you are obviously making significant advancement, it looks like on the NutraDried sales among a number of partners. How much lumpiness should we expect as we try to model that in between Costco and Kroger and Walmart and other partners that you're looking at? Was this a particularly lumpy quarter? Or are we talking about more stable run rates? Should we expect something in, say, Q3, Q4, Q1, that's kind of out of line.

[Daniel Henriques, executive]

So in terms of channels, like our grocery channels, I would say, not lumpy. It's very consistent. So the growth we got by way of Kroger this quarter, we'll repeat next quarter, and we hope that to continue to be a very strong account for us. The lumpiness you're going to get is always going to come through Costco and you've been watching us for long enough to know that Costco orders can really have a big impact. So we had a large program with Costco in Q2 within Costco Canada, which was obviously great.

We don't have another one confirmed for Q3 at this point. So that's going to drive some lumpiness. And our goal is always to build that grocery channel. So that's the primary value driver behind a business like ours. So the wins at Kroger and Whole Foods, when they start to add up, that's going to create a lot of value.

[Brent Charleton, executive]

And just to add on to Dan's response there, Neil, something to consider and good information to share with you folks is that Moon Cheese when compared to its 2 primary competitors ParmCrisps and Whisps, has had the best growth versus prior year in dollar amount in the category over the past 6 months. In fact, most of the other category and Whisps has had negative growth, what we define as growth, it's not growth. And then we've outperformed ParmCrisps. So that's a key insight.

And also, what we found is that Moon Cheese consumers are greater than 80% incremental to the category, i.e., only 10.4% of consumers that buy Moon Cheese actually buy ParmCrisps and only 17.5% by Whisps, in addition to Moon Cheese. This is quite an interesting statistic to consider as we're winning new distribution. We're not necessarily going to be cannibalizing the sales of retailers who are carrying the alternative products that substantially.

[Neil Linsdell, analyst]

Okay. Great. Sounds good progress. That's it for me.

[Operator]

[Operator Instructions] We're showing no questions coming through at this time, and we have reached the end of the question-and-answer session. I will turn the call back over to Brent Charleton, CEO, for closing comments.

[Brent Charleton, executive]

Thanks very much. I just want to thank everybody for joining us today. If you have questions that come to your mind after this call, we are readily available to answer those. So please reach out to us either to our e-mails directly or give us a call. Thanks so much to everyone, and thanks for your continued support.

[Operator]

Ladies and gentlemen, thank you for your participation and interest in EnWave. You may disconnect your lines or log off the webcast at this time, and enjoy the rest of your day.