Better Choice Company Inc.

Good day and welcome to the Better Choice Company, Inc. Second Quarter 2022 Earnings Conference Call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one. Please note that this event is being recorded. I would now like to turn the conference over to Rob Towerman, COO. Please go ahead, sir.

Thank you, Operator. Welcome, everyone, to Better Choice's second quarter earnings conference call. This morning, we issued our Q2 2022 financial results press release and posted our updated earnings presentation under the IR section of our website, which we will be discussing today. I'm joined by Scott Lerner, our CEO, Sharla Cook, our CFO, and Donald Young, our Chief Sales Officer. Before we begin, please remember that during the course of this call, we may make forward-looking statements within the meaning of the federal securities laws. These statements are based on management's current expectations and beliefs and involves risks and uncertainties that could cause actual results to differ materially from those described in these forward-looking statements. Please refer to the company's annual report on Form 10-K filed with the Securities and Exchange Commission and the company's press release issued Tuesday, March 29, 2022, for a detailed discussion of the risks that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. Please note that on today's call, management will refer to certain non-GAAP financial measures such as gross revenue, adjusted gross margin, EBITDA, and adjusted EBITDA. Although the company believes these non-GAAP financial measures provide useful information for investors, The presentation of this information is not intended to be considered in isolation or is a substitute for the financial information presented in accordance with GAAP. Please refer to our press release and presentation issued August 11, 2022, for a reconciliation of the non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP. With that, let me hand it over to Scott.

Thank you, Rob, and welcome everyone to our 2022 second quarter financial results conference call. I'm excited to share that for the second quarter in a row, we've delivered record sales growth while simultaneously improving gross margin. In the second quarter, we generated gross sales of 19.8 million, bringing total gross sales for the first half of 2022 to approximately $40 million. On a net basis, this translates to $33.5 million of revenue, a 50% increase relative to the same period last year. In addition to driving incremental revenue growth, we also realized meaningful sequential gross margin improvement. We achieved an adjusted gross margin of 31% during the second quarter, representing a three percentage point increase relative to Q1. This adjustment takes into account one-time pet specialty launch expenses associated with the seasonal wall placement at Petco, which enabled us to launch Halo Elevate in May rather than waiting for full store resets in July. Today, Halo Elevate can be purchased in more than 1,500 pet specialty stores, which includes more than 1,000 Petco locations and 600 Pet Supplies Plus locations. Although it has only been three months since we launched at Pet Supplies Plus and less than one month since we moved from the seasonal wall at Petco to permanent placement in the dog aisle, we have observed consistent week-over-week point-of-sales growth. This has been supported by strong repeat consumer purchase rates at multiple retailers, which we've been able to track via customer loyalty program data, suggesting that the product is being well-received by pet parents. In aggregate, this has resulted in 133% year over year growth of our brick and mortar business. This growth has been driven primarily by $3.7 million of Elevate growth sales in Q2, bringing total Elevate sales to 6.2 million for the first half of 2022. Although we don't expect that Q3 Elevate sales will be as high as Q2, Since Q2 Elevate sales represent a mix of initial stocking orders and repeat customer purchases, current POS data is in line with our expectations as we continue to ramp. Internationally, we generated $7.1 million in sales in Q2, representing 75% year-over-year growth and another quarterly record. Most importantly, we saw continued end consumer sales growth during the June 18th promotional event in China, despite all the noise around COVID-associated lockdowns, demonstrating the strength of our business and the importance of high-quality pet food to consumers around the world. A portion of the sales made in June were also in preparation for 11-11, Normally, international sales are highest in Q3 as they represent the inventory buildup ahead of November promotions. But given some of the recent challenges associated with the global supply chain, we worked with our partners to bring some production forward and ensure that we'd be in stock to meet end consumer demand. While we still expect that second half international sales will be strong, it is likely that Q2 will be the largest international quarter this year. unlike Q3 in years past. Offsetting our growth internationally and in pet specialty, e-commerce delivered lower than expected sales growth. Although e-commerce sales increased 28% in the second quarter relative to the same period last year, year-to-date e-commerce growth was only 8%, which we believe is driven in large part by changes in working capital management by our customers. With that in mind, our point-of-sale sales growth for e-commerce, particularly on Amazon, materially exceeds our sales growth, indicating that our e-commerce partners are holding less inventory on hand, a response that has been seen cross-category amidst the current economic environment. While we've seen this trend persistent in early Q3, we are optimistic that e-commerce sales will more closely align with point-of-sales growth in the future. In addition, as we noted on our last call, rebranded Halo Holistic is estimated to be in production in the third quarter, in time for a late Q3, early Q4 launch, which should further bolster our e-commerce business. With regards to our direct-to-consumer platform, the integration of the True Dog brand underneath the broader Halo umbrella occurred on schedule in early July, with no disruptions in our ability to supply loyal TrueDog customers and subscribers. The transition of the TrueDog brand to Halo couldn't come at a better time, as it allows our direct-to-consumer platform to benefit fully from the launch of our multi-million dollar media campaign, a newly revamped consumer-facing website. In addition, we are exploring the opportunity to expand the Halo Freeze-Dried Raw offering into other channels, including pet specialty, and international now that they are sold underneath the broader Halo brand. Although our sales growth is very exciting, I'm most proud that we have been able to realize meaningful sequential gross margin improvement despite the challenging macroeconomic environment. When possible, we've looked to take preventative rather than reactionary measures to address raw material price increases, worldwide supply disruptions, and inflationary pressures. These measures, coupled with the implementation of domestic and international price increases in mid-April, helped us deliver an increase of approximately 300 basis points in Q2, with further improvements expected in the back half of this year. This improvement in Q2 2022 was driven by several key factors, which included the shift of domestic kibble production to a new co-manufacturer in January 2022, which resulted in an 8 to 10 percentage point increase in skew gross margin for new production, offsetting raw material price increases, consolidating and in some cases pre-preying production runs to capture gross margin, reducing contracted inbound freight per pound, and finally optimizing ingredient procurement where possible to mitigate supply chain challenges. As we look to the second half of 2022, we expect to realize continued gross margin improvements, driven primarily by the transition of our international dry kibble diets to a new coal manufacturer. This transition was completed in mid-June and resulted in an immediate 1,500 to 2,000 basis point improvement to gross margins. Prior to the transition, these diets represented approximately $10 million of net sales in the first half of 2022. If we had been able to make this change at the beginning of Q2 rather than at the end, we'd be looking at a 35% gross margin for Q2. While we are very excited by our sales growth in the first half of this year, we remain laser focused on driving continued margin improvements across our portfolio. As we continue to scale our business, launch margin-accretive innovation, and realize further cost improvements, we believe we have sufficient liquidity to reach profitability and are well-positioned to succeed in the current economic environment. The good news is that despite these challenges, the pet food industry remains one of the most recession-resistant categories within CPG. And while prices have risen, consumer demand has remained strong. In addition, we've also picked great retail partners that are growing rapidly and continuing to invest in premium consumers, our target demographic. Before turning it over to Donald, I wanted to highlight how some of our channel partners have publicly responded to recent inflationary trends, since our channel strategy is a fundamental key to our success. In March, Petco announced their 14th consecutive growth quarter, and called out their commitment to maintaining strategic investment levels and remained confident in their mid- to long-term guidance, specifically because their customers are typically higher spending. In June, Chewy delivered double-digit sales growth, calling out that their results were driven by resilient consumer demand and pricing strength in consumables and healthcare, the categories we play. while seeing continued pressure in discretionary categories such as hard goods. In August, Pet Supplies Plus announced eight new store openings and 20 new franchise agreements on top of 7% sales growth in Q2 at their existing franchise locations. With that in mind, let me turn it over to Donald to cover some of our key channel partnerships in detail.

Donald? Thanks, Scott. In addition to getting product on shelf in more than 1,500 locations, one of the most exciting events this quarter for me was scaling up the sales team. Although we began the year with only three team members, we've now grown to 10 individuals, all who have proven track records working with me in the past. It's very easy for these new team members to get up to speed, and we've been able to hit the ground running. When Scott just mentioned PetSplice Plus, we completed our April launch in more than 600 PetSplice Plus stores as a preferred brand. We would like to emphasize again that we really picked a great partner here, as their franchise and corporate-owned store models drive significant new store openings each year, which is a built-in growth driver for Halo Elevate. As a result of our time in the field working with managers and store associates, we've been able to partner closely with PSP's merchandising team to promote Halo Elevate as a premium option alongside of their three core private brands, which has helped us nearly double our weekly POS sales within the last month. It's a strong growth off a relatively small base, but the early trends are looking very positive. Turning to Petco, we officially moved as planned from the seasonal wall, 900 store set beginning in May, to the permanent dog aisle in July, where we are now in more than 1,000 locations. While the seasonal wall was ideal for retail store associates' education and brand awareness, moving to the permanent dog aisle is the key step, as this is where consumers shop every day. Even though July represents a new location for us in the store, like Fit Splice Plus, we've observed a nearly doubling of weekly POS sales within the last month. Since our launch on the seasonal wall in May, we've observed 14 consecutive weeks of incremental sales growth. This has been coupled with a 43% repeat consumer purchase rate at Petco, which we're able to track via the customer loyalty data. With that, I'd like to turn the call over to Rob to discuss a few marketing updates and our progress in the international channel in more detail.

Thanks, Donald. At the same time that we brought on new sales team members and launched in Petco, we also kicked off a global marketing campaign in June. Although we are only six weeks in, our campaign is resonating with millennial and Gen Z pet parents in the way that we had hoped. In these first six weeks, we already generated more than 42 million impressions and 22 million video views, led by a high level of engagement on social and extremely strong results versus other pet brands. On TikTok alone, our video content has been viewed more than 9 million times, with the video completion rate roughly four times higher than benchmark metrics. Most importantly, our message is resonating with our target demographic, and we are seeing significant increases in landing page visits and followers. As we look to the third quarter, we are planning to ramp our marketing spend and use our initial learnings to drive efficiencies. So far, we are pleased with initial results and are excited to see what the future holds. Turning to international, it was another record quarter of sales, as we generated $7.1 million of gross sales in Q2, representing 75% year-over-year growth and another quarterly record. In Q2, a significant portion of these sales were attributable to selling ahead of the 6-18 promotional event, which takes place in Asia every June. Historically, 6-18 is the second largest sales event of the year, surpassed only by Singles Day, which takes place in November. This year, end consumers purchased an equivalent of $4.5 million of Halo products in May and June alone, representing an approximate three times increase relative to last year's sales during the same period. On our flagship store, Halo-branded sales were roughly in line with last year's 11.11 promotion, a significant achievement given 11.11 sales are typically twice June 18 sales. These results demonstrate the strength of our business, the strength of our partnerships, and the importance of high-quality pet food to consumers around the world. As Scott did mention early in our call, international sales typically are highest for us in Q3, as they represent the buildup ahead of November promotions. But given some of the recent challenges associated with the global supply chain, we did work with our partners to bring some production forward and ensure that we would be in stock to meet end-consumer demands. for the November 11th promotions. While we still expect that second half international sales will be strong and in line with the $25 million run rate we discussed in our Q1 call, it is likely that Q2 will be the largest international quarter this year, unlike Q3 and prior years. Although there has been significant global uncertainty in recent months, we've been able to deliver record international sales growth in our core geographies and consistently work with our distribution partners to mitigate potential risk. In addition to the strong dry-kibble business we've built up in Asia, which makes up a significant majority of the $100 million in aggregate contracted minimum sales from 2021 through 2025, we remain focused on high-margin, incremental expansion opportunities. In the second half of this year, we are prioritizing expansion to Latin America, and have made significant strides in the regulatory stride to make on the regulatory side to make this a reality. With regards to gross margin, we've begun to capture significant international margin expansion, which I'll let Sharla touch on in more detail in her section. Sharla?

Thanks, Rob. In the second quarter of 2022, we delivered record growth sales of 19.8 million and net sales of 16.5 million, representing an increase of 5.5 million, or 50%, compared to the second quarter of 2021. while simultaneously improving gross margin to 29% or 31% on an adjusted basis as compared to 28% in Q1 of 2022. The increase in net sales is driven by yet another strong quarter for international, which grew 3.1 million or 75% versus Q2 of last year. Brick and mortar contributed 2.3 million to the increase driven by elevate sales ahead of the July store reset at Petco, and e-comm grew roughly 28% or 0.8 million versus the prior year quarter. Partially offsetting the strong growth for the quarter was a 0.6 million decrease in DTC, driven by a planned reduction to customer acquisition spend ahead of the brand migration that we successfully completed in early July. We anticipate that net sales as a percent of gross sales to decrease slightly into Q3 and Q4 as we ramp up promotional activity within the pet specialty channel. Gross profit for the second quarter totaled $4.7 million, yielding a gross margin of 29%. On an adjusted basis, excluding the impact of one-time watch costs for Elevate, gross margin was 31%, reflecting an improvement of almost three percentage points from Q1 of 2022 and a six percentage point improvement from Q4 of 2021. As we mentioned on our first quarter call, we were on target to complete the transition of our China production to our new co-manufacturer, and I'm pleased to report that we completed the transition in mid-June, resulting in a doubling of gross margin on those SKUs. To provide context as to how this transition will impact gross margin going forward, international gross margin would have been 37% in Q2 versus actual gross margin of 27% for that channel, assuming we had completed the transition at the beginning of the quarter. This would have resulted in an adjusted, consolidated, better choice gross margin of 35% for the quarter. Gross margin improvement continues to be one of our highest priorities, and we expect the back half of 2022 to benefit from the improved international margin, pricing action in the e-comm channel that will be effective at the beginning of Q4, and the relaunch of Halo Holistic planned for late Q3, early Q4, with recipes reformulated to provide even higher levels of nutrition, while also providing margin upside, even after taking into account the potential for further raw material cost increases. We also continue to focus on margin and creative innovation as we plan for 2023 and beyond. Turning to our balance sheet, we ended the second quarter with $17.8 million in cash and cash equivalents and restricted cash, compared to $23.4 million at the end of Q1. The change in our cash balance during the quarter reflects a few non-recurring working capital items related to our gross margin improvement initiative, including prepaying our international production prior to the co-man transition in June, which allowed us to realize the 1.5% margin improvement on new shipments. Additionally, we offered temporary extended payment terms to one of our key international partners while we switched co-manufacturing partners and to coincide with a material price increase that was effective at the beginning of Q2. Lastly, Our inventory balance reflects the return to near normal levels on our holistic wet production, as well as the final build of our Elevate inventory, which will allow us to continue to guarantee 100% fill rates and provide margin protection in an environment which continues to be impacted by inflation. While working capital could continue to fluctuate a bit more than historical levels, we expect to see a benefit to cash flow in the back half of the year. Net loss for the second quarter was 4.4 million, After adjusting for non-cash and non-recurring charges, adjusted EBITDA for the second quarter was negative $2.1 million, which is consistent with our prior estimates for quarterly cash burns. Although we are not looking to provide guidance at this time, based on where we sit today, we continue to believe that we have sufficient cash on hand to achieve profitability. As referenced, we've also provided a detailed reconciliation of Q2 EBITDA and adjusted EBITDA and Q2 net sales and gross profits and adjusted net sales and gross profits. With that, I will turn it back over to Scott.

Thanks, Cheryl, and thank you again to everyone that joined the call today. Although we have a lot to be proud of, $40 million of gross sales in the first half, a 1,500-plus store launch of Halo Elevate, a rapidly growing international business, a solid subscriber base on our online platforms, there's still more work to do. As I hope you can tell, we are focused on driving continued margin improvements over the back half of 2022 and into 2023 as we push towards profitability. While we still are investing meaningfully behind the launch of Elevate, particularly in Q3, we believe our current position is sufficient to support our growth plan, particularly since we expect to benefit from positive changes to networking capital beginning in the second half of 2022. Our entire team remains extremely excited, and we look forward to our third quarter results. Now I'd like to open it up for questions.

Operator, please. And we will now begin the question and answer session.

To ask a question, you may press star then one on your touchtone phone. If you're using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then two. Once again, that is star then one to ask a question.

And at this time, we'll pause momentarily to assemble the rock. And again, if you'd like to ask a question, please press star then 1. And our first question will come from Jim McElry with Dawson James.

Please go ahead.

Yeah, thank you and good morning. I just want to understand the gross margin impact from the international manufacturing. When you talked about total gross margins being 35%, assuming that you had moved the manufacturing for the full quarter, is that total gross margin excluding the launch costs, or does that include the launch costs?

Rob, do you want to take that one? Or Sharla?

Yeah, I can take that one, Scott. Hi, thanks for the question. That is an adjusted view of the margin. You can do the same math as far as the points that it would have added, but that does include the exclusion of the launch cost and the incremental pickup that we would have gotten if we had switched it April 1st.

Great, thank you. And then looking at gross margin for the second half, are there any special requirements launches or any other issues that we should be aware of that would impact gross margins on a one-time or one-time-ish basis for the second half?

There's a couple things that I would think about. I think the gross margin that we showed kind of gives a good idea of where we're trending. What will impact that in the second half is a couple things. First, we do have a price increase on the e-com side effective at the beginning of Q4. But what we'll also see is some timing of trade spend within the pet specialty channel. The trade spend in that channel has been pretty light the first half just as we get into the store and on shelf. You'll really see the promotional activity kicking up in the second half. That will kind of, I mentioned in my prepared remarks that you're Net sales as a percent of growth can decrease slightly, so that will have an impact on margin in the back half.

And so is second half gross margin likely to be close to that 35% or higher or lower?

I expect it to be close. I think you could have a little bit of lumpiness in Q3 and Q4 just depending on how that promotion spend hits. But I think that same kind of sequential improvement that you're seeing, we'll see in Q3 and into Q4. So on a total second half basis, yes, I do expect it to be closer to the adjusted margin you're seeing in the presentation.

Okay, great. And I just want to also understand the sales trajectory for Q3. It sounds like you brought some sales in earlier. From what you would have normally expected for Q3, you brought it into Q2. So it sounds like Q2 is a little bit higher than normal. Q3 is a little bit lower than normal. Is that a fair way to look at it?

Yes, that's a fair way to look at it. Exactly right.

Okay. Yeah, that's it for me. Thanks a lot. Thank you. Thanks, Jim. And again, if you would like to ask a question, please press star then one.

And this will conclude our question and answer session. I'd like to turn the conference back over to Scott Lerner for any closing remarks.

Thank you, everyone, for joining our Q2 earnings call today.

The whole team at Better Choice Company is excited about the future growth of the Halo brand, and we look forward to continuing the journey with you.

Thank you. The conference is now concluded. Thank you for attending today's presentation.

You may now disconnect your lines at this time.