Enwave Corp

XTSX:ENW

Earnings Call Transcript 2022-Q3

[Operator]

Good morning, and welcome to EnWave Corporation's Third 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] Finally, I would like to remind everyone that this call will be made available for replay via the link in the Investor Relations section of the company's website at www.enwave.net.

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

[Brent Charleton, executive]

Hello to everyone who has joined us today for EnWave's Q3 earnings call. Today, we will summarize our performance in Q3 and provide an overview of what we hope to accomplish in the near term.

Following my summary, Dan will go over our Q3 consolidated financials as well as point of notable metrics for each respective business unit. The information we are about to present contains forward-looking information that based on our management's expectations, estimates and projections. Our 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. On this call like others, we will refer to our proprietary vacuum-microwave quality business unit, which generates revenues primarily from machinery sales, royalties and toll manufacturing as EnWave, and our subsidiary that is selling branded and bulk shelf-stable cheese snack products as NutraDried.

Our business produced mixed results in Q3, inflationary pressure and recessionary fears presented challenges for us like most other companies globally, and NutraDried did not perform well. However, EnWave did yield several encouraging financial metrics, including a strong gross margin of 50% and close to breakeven. For year-to-date, EnWave is tracking towards breakeven while NutraDried has primarily accounted for the cash losses. We aren't in an anomaly as numerous industries are dealing with headwinds, and we are making further changes to reduce the cash burn in our business.

At EnWave, optimism remains strong in our technology royalty business as our pipeline for new large-scale REV machine orders is solid and our RevWorx toll manufacturing service to several qualified customers lined up for the next fiscal year. We've experienced 58% growth year-over-year in third-party royalty revenue, collecting just over $1.1 million year-to-date, and we will have 2 new large-scale machines begin commercial production before calendar year-end, 1 in Peru for BranchOut Snacks and the other in Italy for our partner, Orto Al Sole. We currently have 8 active technology evaluation agreements that could evolve into royalty-bearing commercial licenses in the next year, and we're pursuing repeat machine orders from a list of current royalty partners that are looking to scale from their 10-kilowatt units, respectively.

Several potential large-scale orders were delayed this year due to the cannabis market contracting internationally and the price of dairy inputs reaching abnormal highs. In Q3, we sold an additional 3 10-kilowatt units, 1 being GMP, which is about double the value of our standard machinery, and we recently sold a 120-kilowatt machine to Dole in the first few days of Q4.

Year-to-date, we sold 6 10-kilowatt units and 320-kilowatt machines and have signed 6 Technology Evaluation and License Option Agreements. We are working towards prospectively winning additional machine orders this fiscal year, most of which are associated with existing royalty partners who have had initial market success with the launch of the REV dried food products.

REVworx recently achieved its Safe Quality Food Level 2 certification, which satisfies a critical requirement for our largest prospects to use as service. We've hosted several dozen companies at REVworx and many have moved forward with paid product development line trials and are considering either using REVworx directly or renting smaller scale REV equipment for use at their own facilities. We expect to announce our first anchor tenants at REVworx later this calendar year, but for now, it continues to act as a showroom of source for visiting prospects.

We continue to work closely with many of our license partners to improve the chances of success, but we are particularly happy with the progress we've seen in our projects with Dole, Calbee, the U.S. Army, Yamachan, [ Newell ], Dairy Concepts Ireland and Pick-One of Mexico. And hopefully, there will be more information to share in the coming months regarding each of these opportunities. Our projects with PiP International for the drying of premium pea protein products and Wyckoff Farms for the drying of premium hops are a particular interest to us is these projects are exploring 2 new product areas for us, and we believe that the unique drying enabled through our REV machinery can yield superior results to incumbent methods. In fact, the global pea protein market estimated to be about $844 million in value as of 2021, big market to go after.

We continue to pursue new leads in the cannabis industry as we know our technology will deliver high-quality economical results. In Q3, we sold another 10-kilowatt GMP, as I alluded to, unit to a European cannabis manufacturer. And we recently announced an evaluation agreement with a major Canadian cannabis cultivator. That being said, as this fiscal year has progressed, it's apparent that in all legal jurisdictions internationally, cannabis companies are dealing with business challenges including oversaturation of product and market, which is driving down wholesale pricing and supply chain challenges associated with infrastructure build-out.

Many cannabis companies are also having challenges securing new forms of capital as many jurisdictions are in decline. Cannabis will remain a viable market friendly to deploy REV technology into, but the number of qualified potential about fees has shrunk at the present as many of our leads have shifted their focus to solve the immediate business challenges aforementioned.

NutraDried has not progressed as we wanted. Revenue is not meeting expectations and our margins being pressured through the first 3 quarters by extraordinarily high cheese prices and lower plant utilization. Thankfully, cheese prices have come back from $2.50 a pound less than $2 a pound recently, and futures indicate they might stay at around this level, which is more in line with historical pricing. Given the cash burn at NutraDried in Q3, we are currently evaluating options to reduce expenses in that business unit -- this is essential to pave a sustainable path forward.

In the coming quarters, Nutra aims to expand distribution into large national and regional grocery as well as natural and mass customers. It takes time to get into distribution and the retail environment is challenging for new brands. We aim to leverage the power of Amazon as it has recently decided to go direct versus through a reseller and direct-to-consumer distribution via its online store. Moon Cheese Sticks is national at Whole Foods currently, and we've received word that Walmart will take sticks into 300 stores in the spring of 2023.

The performance of NutraDried must improve without delay, and we will continue to monitor its performance on a week-to-week basis ultimately make operational decisions that we feel is in the best interest of protecting shareholder value.

Now I ask Dan to summarize our Q3 financial results in more detail.

[Daniel Henriques, executive]

Thanks, Brent. Good morning, everyone, and thanks for joining us today. I'll take some time to review our Q3 2022 financial results. Please note the figures I'll go over today can be found in our press release from yesterday and in the financial statements and MD&A filed on SEDAR. All amounts, as Brent mentioned, will be referred to in Canadian dollars unless otherwise known. I will make reference to adjusted EBITDA, which is a non-IFRS financial measures. So please refer to our non-IFRS financial measure disclosures and a reconciliation to GAAP net income, both in the press release and in the MD&A. Also, please note the comparative period I'll refer to throughout in the prior year Q3 ended June 30, 2021.

So let's get started. Consolidated revenues for Q3 were $5.5 million compared to $7.3 million in Q3 of '21, a decrease of $1.8 million. Our revenue split was 52% Moon Cheese sales for $2.8 million and 48% EnWave revenue for $2.7 million. EnWave's revenue for machinery sales alone was $2.1 million for Q3 compared to $3.2 million in the prior year, with the reduction being due to fewer large-scale machines and fabrication for customers under contract during the quarter. Subsequent to Q3, we did confirm 1 new 120-kilowatt order for Dole, and we have many other large-scale opportunities in the sales pipeline that we're in to close in the near term.

EnWave's royalty revenue for Q3 2022 was $301,000, up from just $191,000 in Q3 of 2021, representing growth of 58%. We're very happy with this result. As our royalty partners grow their businesses and increase capacity utilization on their REV equipment alongside new REV installations arising from sales, we hope to continue to further grow this royalty stream over the coming quarters.

The NutraDried segment continued to struggle in Q3. Moon Cheese sales were $2.8 million, with the drop in sales compared to the prior year sales of $3.8 million, arising due to lower bulk channel sales in the current period, paired with soft grocery sales in June. We implemented a price increase in May, in an effort to mitigate margin pressure, but we saw many customers stock up right before the price increase, and that effect is carried on from June until now.

NutraDried sales team continues to pursue new distribution opportunities. However, the Q3 results did not reflect any new growth in our distribution footprint. Gross margin for Q3 was 26% compared to 36% for Q3 of 2021. The drop in gross margin was primarily due to 3 main factors.

In Q3 of 2021, we had that substantial order for bulk cheese sales at NutraDried that significantly benefited NutraDried's margin. That business did not repeat in the current year. The cost of block cheese has risen sharply in 2022 and it significantly hurt NutraDried's margins.

And equipment sales in Q3 of 2022 were slightly lower than Q3 of 2021 and the margins generated from machinery sales is typically better than for NutraDried. So the sales mix plays here.

Our cost of goods at NutraDried continues to be a challenge with increases for input cost of cheese, supplies, freight and labor, cheese being the largest contributing factor. The NutraDried plant also has a large fixed overhead base and without top line revenue growth and sales volumes, the resulting margin is narrow.

EnWave's gross margin for fiscal 2022 year-to-date has remained strong at 50%, with growth in that royalty revenue being a contributing factor. The EnWave business has the capability of delivering strong margins when we close lots of large-scale machine orders, and we've managed our manufacturing costs appropriately despite the challenging economic backdrop.

Adjusted EBITDA is a non-IFRS financial measures. So please refer to the MD&A for a reconciliation from GAAP net income to adjusted EBITDA. Adjusted EBITDA was a loss of $1 million for Q3 of 2022 compared to positive $937,000 for Q3 of 2021, a change of just below $2 million. The primary driver for the swing in profitability was the adjusted EBITDA loss generated by NutraDried in the period compared to the positive EBITDA generated in the prior year. The consolidated net loss for Q3 of 2022 was $2 million compared to a net income of $670,000 for Q3 of '21.

Now turning over to the balance sheet. We finished Q3 with cash on hand of $6.7 million and a net working capital surplus of $12.9 million. Our inventories increased because of additional 10-kilowatt units being fabricated to match the current [indiscernible] pipeline as well as long lead time parts on large-scale machines being purchased. We earned a contract with Dole in July that will utilize much of these longer lead time parts and allow us to deploy that unit on a tight delivery schedule. The capital project to build out at REVworx facility is complete and was funded from our existing cash resources. Aside from the small COVID-19 release loan and our facility leases, our balance sheet remains largely debt free.

Now I'll turn it back to Brent for some closing remarks.

[Brent Charleton, executive]

Thank you, Dan. Moving forward, I think it's important to acknowledge the macroeconomic factors, but there aren't any excuses to make. We need to close more machine sales and sell more dry cheese to better margins. We know this. We understand what needs to be done, and we'll put our best effort to improve shareholder value moving forward.

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

[Operator]

[Operator Instructions]

The first question today is coming from Neil Linsdell of iA Capital Markets.

[Neil Linsdell, analyst]

So can we go through just on some of the major customers on Moon Cheese. I think you mentioned Walmart and you speak quicker than I can take note sometimes. So can we go through like Costco Canada and the U.S., Walmart, what should we should be expecting as far as lumpiness? And you talked about inventory builds. Do you have any idea when those inventory builds will kind of be work through so we can expect more sales? Or is it still going to be kind of patchy or lumpy?

[Daniel Henriques, executive]

Well, starting with Costco. Costco is always inherently lumpy. We are working to earn new Costco business. But in Q3, we didn't have any sales to Costco there are some proposals out in front of Costco that could materialize probably more likely in fiscal '23. In terms of other customers, the large stock up that I mentioned came through mostly distributors, wasn't so much by retail customers. And it has -- we put the price increase into effect in May, and we saw a lot of distributors stock up prior to May because they have the ability to carry higher inventory levels to buy on deal.

And that sort of stock up kind of hurt the subsequent months sales, but we think based on the intelligence that we have available to us that we're through the worst of it, and it could come out, it could shape up better into the fall. It shouldn't be a permanent effect. And we do know that there was a lot of buying in May and April to support the inventory levels of those distributors. So it's not going to last forever, we don't think.

[Neil Linsdell, analyst]

Okay. And along the lines of -- you mentioned Walmart again. So are there any kind of lumpy orders we should think about coming in fiscal Q4 or more in fiscal in Q1, I think you're kind of indicating and anything we've seen, I guess, Whole Foods? What are we looking for as far as timing on some of these rollouts in Kroger as such?

[Daniel Henriques, executive]

So we've launched into Kroger. We did that in the spring, so that was in our Q3. And then in terms of Whole Foods, the stick items launched into Whole Foods, so that was also in Q3. Looking into Q4, it should be we don't have a lot of new rollouts that are going to launch in Q4. So you can expect it to be largely comparable to Q3 for the most part in terms of our customer base.

And then looking into the new year, we have a couple of -- we have expected deal from Walmart to take sticks into 300 stores, and we have a couple of private label opportunities that we're going to start to deliver on in fiscal Q1.

[Brent Charleton, executive]

Yes. There's a list of additional distributors, Neil, that Brad and team are working to secure. But until they are confirmed, we can't speak to.

[Neil Linsdell, analyst]

Yes, of course. And the bulk sales, do you expect that to rebound or pick up? Or is that really going to be lumpy as well? I shouldn't expect anything out of it?

[Brent Charleton, executive]

It's not going to be particularly lumpy, but it's going to -- it's taking time to build up. So we have a customer base that are using our product as ingredients, and we're going to some ingredient type shows and working on building out that channel. We don't have that -- that 1 major customer, we had last year doesn't seem to be a continuing relationship. So we're working to build out new ones.

[Neil Linsdell, analyst]

And then on the REV units, I mean, you've given guidance before, obviously, last few quarters. How does it look as far as we're trying to finish up the fiscal year, which is not too far away. And with the new -- with customers such as Dole, it sounds like you're hoping you're going to be able to make some better announcements soon. But how is -- could you give us an update on really some of those key customers' project rollouts? Because I'm thinking about Dole, you've got the snacks, but you've also got the secondary products to other ingredients. Can you give us more clarity on some of the major things we can look forward to?

[Brent Charleton, executive]

Sure, Neil. So first, again, state like not here to make excuses, just state the obvious that the cannabis market in the U.S. is contracting similar to what we saw in Canada and the dairy prices, which have affected NutraDried affected our international dairy partners that are prospectively looking at scaling up to larger continuous lines, hence, the push off in some of those decisions until prices normalize, which they're going towards and hopefully, we can then convert them in fiscal '23.

In regards to being the end of the fiscal year forthcoming, we do have some tangible leads on large-scale and small-scale machines to hopefully confirm within the next month or so here. In regards to the Dole relationship specifically. Obviously, they bought their 120-kilowatt machine to support a launch of their new snack program. There's a few different areas of opportunity outside of that into potentially the ingredient division. And along the snack launch, a major, major company like Dole and what we need to see here at EnWave our marquee royalty partners gaining traction in market with their products, which demands an increase in manufacturing capacity. And if we think about how we've seen our royalty partners grow year-to-date, it's been quite pragmatic.

And I would say that Dole, along with maybe like Calbee and a few of the other dairy companies are companies are capable of scaling quickly if there is consumer demand. So that's why the Dole relationship is still very important to us to continue supporting what they're doing to make sure that we have people on the ground supporting the R&D group as they bring new products to market in the coming quarters here.

[Neil Linsdell, analyst]

Okay. So it sounds like you're hopeful that you've got some stuff running that you'd be able to announce before fiscal year-end to hit your guidance?

[Brent Charleton, executive]

To continue the pace of closing large deals associated with current royalty partners who have already had smaller scale machinery with product in market that has gain enough market data to say, yes, now it's time to commit to large-scale machinery and make this more material for their own individual businesses.

[Neil Linsdell, analyst]

Okay. Great. And you just mentioned the cheese prices. It looks like things it's hard to tell if we're looking at further declines in cheese prices or stabilization, but it sounds like for all intent and purposes, you've got stabilization. Do you have any kind of higher cost cheese that's still going to work its way through in Q4?

[Daniel Henriques, executive]

Yes. So on our balance sheet at the end of Q3 as cheese that was bought and manufactured leading up to June. So that's the highest -- peak, cheese prices peaked in June. So we're going to have to work through some higher-priced cheese in Q4 that will work its way through. And then the cheese we're buying today is coming in at more reasonable prices. So we see some abatement there in the cheese price issue.

[Operator]

[Operator Instructions]

At this point, I will turn the floor back over to management for web-based questions.

[Brent Charleton, executive]

Thanks, Donna. The first question that I'll address is from Jamie Kozak of Copycat Invest. He asked, you expect an announcement for an anchor customer of REVworx later this year. Can you describe where you are in the process of signing, how meaningful this customer might be? And why is customer wasn't ready to go upon commissioning?

So to answer the question, line trials are absolutely critical to gain commitments long term on the continuous production line. It's 1 thing to produce a product on our 10-kilowatt units, but it has to be shown that the same quality and consistency of product can be produced in line trials. And that's what's been happening over the past month or so, are those line trials with several different prospects. One of the more likely prospects that we hope to confirm again, in the coming months here, could make up to 1/3 of capacity utilization in the plant.

In addition to the -- I know this addresses one of the other questions that I see on the webcast here. It's how many companies do you have in line to prospectively become REVworx customers?

And right now, I would state that 8 viable companies mostly large companies that have the financial wherewithal to engage in the service are going through the line trial process throughout this month, again, with the hope of confirming several next quarter.

Next question that we will address is the available cash has become less applying to private placement in the near future? And so for that, right now, we have ample cash on our balance sheet, and there's no immediate need to raise though. That being said, we've gone through NutraDried's financial performance. And given that EnWave is leaning towards breakeven for the year and NutraDried has lost cash, as I mentioned, we're going to be undertaking some expense reduction plans in the business. And hopefully, we can get NutraDried back to breakeven sooner rather than later on that front.

Second question from the same contributor was, are you planning to launch a youth product later this year, is still in the pipeline?

The product itself, yes, certainly is in the pipeline, but the immediate focus at NutraDried is to lower expenses and get back to breakeven. And following that, with available cash resources, launching a new product and innovation to market because it is risky, of course, always when launching new innovation to market.

A question from John Shavel. When Dole's 120-kilowatt comes online, do you expect EnWave's royalty revenue to be over CAD 2 million per year?

The answer to that is no, not on a single 120-kilowatt been installed right now. As I said, year-to-date, we're about $1.1 million in third-party royalties being collected, which is again up year-over-year significantly. For each of our large-scale units from experience can generate anywhere between $100,000 to $300,000 in royalties per year, really depends on the product that's being produced, and of course, capacity utilization. So we do need to close additional large-scale POs as well as getting those 2 machines that I talked about starting up in Peru and Italy going to move towards a $2 million threshold in the coming quarters.

And the last question here that I'll address on the webcast is, has there been any change to anticipated additional machinery purchase by the U.S. Army ration client? Or more specifically, what is the government saying cause for delay of this purchase?

So we've been told that the application for funding has been approved to introduce a cheesecake ration into their programming in 2023 and that the funding is -- should be released sometime this calendar year. Of course, the U.S. government works on their own time lines. and we will wait patiently until hopefully, that funding gets released, and we can move forward with more meaningful production and fulsome introduction of the first inclusion REV dried inclusion into their ration program.

Concurrently, we are working with other industry partners of the U.S. Army to develop different prospective inclusions for the military ration packs, which we're hopeful could be the next wave or support system to achieve further funding down the line.

And with that, I do not see any other webcast questions that we'll be addressing today.

[Operator]

Sir, did you have any closing comments for the audience today?

[Brent Charleton, executive]

I want to thank those who joined us for our Q3 conference call and encourage those who have questions after the fact that maybe weren't addressed on this call to reach out to Dan or I to in the coming days. Thanks very much.

[Operator]

Ladies and gentlemen, thank you for your participation. This concludes today's event. You may disconnect your lines at this time, and enjoy the rest of your day.