Better Choice Company Inc.

Good morning. I will be your conference operator today. At this time, I would like to welcome everyone to the Better Choice Company third quarter 2022 earnings conference call. Today's call is being recorded. I'd now like to turn it over to Rob Sauerman, Chief Operating Officer. You may begin.

Thank you, operator. Welcome everyone to Better Choice's third quarter earnings conference call. This morning we issued our Q3 2022 financial results press release and posted our updated earnings presentation under the IR section of our website, which we'll be discussing today. I'm joined by Lionel Conacher, our interim 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 involve risks and uncertainties that can cause actual results to differ materially from those described in these forward looking statements. Please refer to the company's annual report on Form 10K filed with the Securities and Exchange Commission and the company's press release issued on Tuesday, March 29th, 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 the substitute for the financial information presented in the course of GAAP. Please refer to our press release and presentation issued on November 10th, 2022 for reconciliation of the non-GAAP financial measures, the most comparable measures prepared in accordance with GAAP. With that, let me hand it over to Lionel.

Thank you, Rob, and good morning, everyone. I'm excited to be speaking with you today for the first time as both the director and the interim CEO of Better Choice. It's only been a few months, but I've already learned a tremendous amount about this company and the passion our team has for engaging with pet parents. Before we move into a discussion of our third quarter results, I wanted to take time to share a bit more about myself, what attracted me to join the Better Choice board, and ultimately what led me to serve as interim CEO. Over the course of my 30-plus year career, I've had the opportunity to hold a number of senior positions in public companies and have helped many businesses realize their growth potential through the lens of operating, investment banking, private equity, and venture capital. In 2020, I've served as the chairman of DXL Group, where I've partnered with a great board and management team as we've navigated the COVID-19 pandemic and delivered strong operating results, which has directly translated to meaningful shareholder value creation. As I look at Better Choice and the trajectory of the Halo brand, I see a lot of opportunity to build upon an already strong foundation. Over the last two years, we've focused on assembling the building blocks for growth across every aspect of our multi-channel business. Our team with a track record of success in pet has driven a number of these initiatives, which include the development and launch of new products like Halo Elevate, the rebrand of our core product, Halo Holistic, and the transformation of the TruGuard brand under the Halo umbrella. Simultaneously, we've established several new co-manufacturing partnerships, meaningfully expanded our brick and mortar presence and pet specialty, and invested behind our rapidly growing international online business. Despite having dealt with significant macro challenges this past year, Better Choice is well positioned to continue on its growth trajectory as the strategic decisions we have made begin to pay off. Although the pet food industry has been and still is one of the most recession resistant categories within CPG, inflation is negatively affected supply side of the business industry-wide. September prices are up 14% year over year, driven by significant increases in raw material costs in late 2021 and early 2022. On the whole, our industry continues to grow meaningfully, but price, particularly in the premium sector among more excellent customers, will likely be the primary driver of overall growth. In addition, rising interest rates have fundamentally changed how many of our channel partners approach their working capital position, as larger partners like Amazon, Chewy, and Petco all utilize credit facilities to purchase inventory. As these partners look to reduce interest expense, they've chosen to materially reduce weeks on hand in their distribution centers across the board. This had a material negative effect on our net sales in Q3, and we anticipate that it's likely this trend will continue into Q4. In contrast, sell-through, particularly for elevate and pet specialty and holistic internationally, remains strong and growing, which bodes well for the growth of our brand. In aggregate, we've generated 45.3 million of net sales in the first nine months of 2022, representing more than 30% year on year growth and well exceeding industry averages. Although the launch of Halo Elevate and Pet specialty remains a core focus, it's worth noting that almost 70% of all Halo customers today purchase our products online, especially when you consider that more than 75% of our international consumers are online shoppers. While we've demonstrated exceedingly strong growth internationally, which Rob will get into in more detail later, our domestic e-commerce and -to-consumer channels have struggled on a relative basis. This has been driven by -of-stocks in the first half of 2022 and the delayed launch of new Halo Holistic from Q2 into Q4. In addition, Amazon has been the most aggressive of all our customers in reducing supply on hand as they continue to pull down inventory levels in their fulfillment centers across the board. That said, our PLS sales on Amazon continue to improve, reflecting a -to-date increase of 15% over the prior year and a 20% increase in the month of September. Turning to Chewy, our -to-date sales are roughly flat prior year driven by softer than expected PLS volume, but we've begun to see improved consumer purchases late in the third quarter. Successfully executing the launch of the new Holistic in Q4 will be a key driver of our e-commerce performance in 2023. The -over-year decline in our DTC channel has been driven primarily by a planned reduction to customer acquisition spent ahead of the brand migration that we successfully completed early in the third quarter. While this strategic shift has resulted in an expected short-term decline in sales, we are executing market strategies focused on both consumer retention and acquisition of high-value customers. While both our e-commerce and -to-consumer channels have experienced recent challenges exacerbated by supply chain dynamics beyond our control, delivering successful online growth remains a core strategic focus. Online pet food subscribers are highly valuable consumers, and it's worth noting that more than 50% of domestic online revenue has derived from recurring subscription, a number that we hope to build upon in the future. Switching to gross profit, we've delivered a third consecutive quarter of gross margin improvement driven by increasing profitability for both our domestic and international lines of business. In Q3 2022, our adjusted gross margin was 37% on 11.9 million of net sales, translating to 4.4 million of adjusted gross profit and getting us back to near pre-pandemic levels. This represents a 6 percentage point improvement from Q2 and a 12 percentage point improvement from Q4 of 2021. Most importantly, we are seeing signs that this gross margin profile is generally here to stay, as raw material costs seem to have stabilized and in some cases have retreated relative to the highs we saw earlier in the year. In addition to our improved gross margin profile, we continue to aggressively manage costs across all of our business lines without sacrificing future growth potential. As we turn to our balance sheet, I wanted to highlight our new $13.5 million revolving credit facility, which we closed in October. This facility extends our debt maturity through October 2024, materially reduces cash amortization payments and increases our total borrowing capacity offset by less than 1 percentage point increase in rate. I'll let Charlotte get into more detail, but it's worth noting that this refinance, coupled with positive trends we are seeing on the working capital side of our business, allows us to eliminate the growing concern risk from our Q3 quarterly filing. Taking a step back and looking at the broader picture, we are at an interesting point in our journey. To date, we've invested a significant amount of time, capital and resources building a brand and product platform designed to be successful across multiple sales channels. We have shifted our focus to execution across every aspect of our business, from sales and marketing to finance and operations. As we push towards profitability and ultimately look to deliver a return on the strategic investments we've made. Thinking now in my capacity as a board member, I want to provide an update on our search for a permanent CEO to replace me. We have officially engaged the search firm to lead this process and have already begun interviewing candidates to find an experienced CEO with strong leadership and operational skills, as well as an established background in multi-channel marketing. We plan to complete this process as quickly as practicable. With that, let me hand it over to Rob to discuss our progress in the international channel in more detail.

Thanks, Lenny. On a year to date basis, we've delivered 19.7 million of net sales internationally in our core Asian markets, representing more than 80% year over year growth and already eclipsing our full year 2021 total by almost $5 million. These results demonstrate the strength of our business and the importance of high quality pet food to current consumers around the world. Although internationals are typically highest in Q3 as they represent the inventory build up ahead of November promotions, this year we worked with our partners to bring some production forward into Q2 and ensure that we would be in stock to meet end consumer demand, which continues to remain strong despite a strengthening US dollar. Although there has been significant global uncertainty in recent months, we've been able to deliver record international sales in our core geographies and constantly work with our distribution partners to mitigate potential risk. While our international -to-market strategy is tailored for each specific region, our target audience is the same, a young, educated, urban dwelling woman who in Asia in particular often owns a cat. To put it in perspective, more than 50% of the consumers that purchased Halo were born after 1990 and as Lionel mentioned earlier, more than 75% purchase our products online. Demographics are also working in our favor as the number of households that own a pet has doubled in the last five years with younger pet owners leading growth. While competition has increased internationally since we first launched, we feel strongly that our knowledge of local markets and our strong partnerships give us a unique competitive advantage. In addition, our longevity in the market as a well-known high quality brand helps insulate us from competitive pricing pressures as we believe a higher percentage of our customers tend to be repeat purchasers relative to other brands. In addition to the strong dry kibble business we have built in Asia, which makes up the vast 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, which we see as having similar trends and demographic opportunities in the Asian market. Before I turn it over to Donald to discuss our brick and mortar channel, I also want to touch on three key operational milestones that we achieved in Q3. With regards to our direct consumer platform, the integration of the TrueDog brand underneath the broader Halo umbrella occurred on schedule in early July with no disruptions in our ability to supply our existing subscriber base. Now that we have consistent branding and price, we are looking to expand the Halo freeze-dried raw offering to other channels, including Pet Specialty International. We officially began our first production runs of new Holista kibble, which will be sold predominantly via our e-commerce partners. Although this will likely have more of a 2023 impact to sales given its delayed launch later in the year, we've been able to make a few formula tweaks to deliver a more palatable and digestible recipe at slightly lower cost. We've completed our first full quarter of consolidated international production in our new co-manufacturer, enabling us to achieve targeted gross margins. In addition, we received official authorization from the Chinese Ministry of Agriculture for our key international diets, enabling us to sell product produced at this co-manufacturer directly into mainland China. With that, I'll turn it over to Donald.

Thanks, Rob. This quarter was an exciting milestone for me. It marks the first point where we've had full permanent distribution for Halo Elevate. As of today, Halo Elevate is now for sale in more than 1,800 rooftops, with our sales team of 10 to actively focus on driving recommendation with district managers, store associates, and end consumers. At Petco, we officially moved to the Permanent Dog Isle in July from the seasonal wall, where we are now in more than 1,000 locations. While the seasonal wall was ideal for retail associates, education, and brand awareness, moving to the Permanent Dog Isle is a key step, as this is where the consumer shots every day. Like we touched on in our Q2 call, after making this move, we saw doubling of weekly POS sales, and we have continued to grow our weekly sales from that point forward. In addition, our most recent customer repurchase rate at Petco was 51% following initial trial. Representing an increase from 43% that we noted in August on our Q2 earnings call. As a reminder, we completed our April launch in more than 600 PetSupply Splut stores as a preferred brand. In addition, PSP's franchise and corporate-owned store model drives significant new store openings each year, which is a built-in growth lever 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 PetSplice Plus' merchandising team to promote Halo Elevate as a premium option alongside their three core private brands. Although independent store growth will be more of a focus for us in 2023 and beyond, we have had the opportunity to secure several new independent partners with local and regional players. While this won't have a material impact on sales this year, we've secured a 2023 launch of Halo Elevate with PetSupply Market, which has 220 locations focused primarily in the Southeast. With regards to the South of Halo Elevate, we are continuing to see point of sales data that indicates that the brand is being well received by consumers. In Q3, we eclipsed another important milestone. We achieved our first week of more than 100,000 of sales. We continued to build upon this number, and we are progressing well against our joint business plans with Petco and PetSupply Plus. As a point of reference, I also want to highlight our performance relative to the launch of Stella and Chewy's The Central Line, which our retail partners consider a -in-class launch within the last five years. Even though we have a much smaller starting presence in independent pet, we've outperformed the first 13 weeks of that launch, which gives us and our retail partners confidence that we are building something special with Elevate. As we look at Brigham and Morton Channel in aggregate, we delivered 1.3 million of net sales in Q3, representing a decline relative to Q3, 21 net sales of 1.8 million. That said, on a -to-date basis, we have delivered 9.6 million of net sales relative to the 5.4 million in the same period last year, representing more than 75% growth. As Lionel mentioned earlier, Brigham and Morton sales have been negatively impacted by our customers' decision to hold less inventory in their DCs, regardless of the strength of our sell-through. While this doesn't impact our total sales in the long term, it will have a negative effect on the short-term results. In addition, Q3 results include the effect of our strategic pullback from Food, Drug, and Mass channel, representing a 250K -over-year decline, which is a helpful point to note when comparing performance relative to last year. With that said, let me turn it over to Sharla.

Thank you, Donald. In the third quarter of 2022, we delivered growth sales of 14.2 million and net sales of 11.9 million, representing a decrease in net sales of 1.3 million, or 10%, compared to the third quarter of 2021. As mentioned on last quarter's call, a portion of international sales that are typically generated during the third quarter ahead of 11-11 in China were pulled forward to Q2 in order to ensure production and avoid potential shipping delays. On a -to-date basis, we've delivered growth sales of 53.7 million, net sales of 45.4 million, and adjusted net sales of 45.9 million, an increase of 10.9 million, or 31%, versus net sales in 2021. The decrease in Q3 net sales relative to the prior year period was driven by declines in our e-commerce and DTC channels, as well as the strategic exit of the FDM channel. Consistent with what many Amazon customers are experiencing, our e-commerce sales have been impacted by ordering patterns with Amazon as they continue to pull down inventory levels in their fulfillment centers. We have heard directly from our vendor management team that ordering programs across essentially all categories have been affected by network capacity constraints. Our POS sales on the platform continue to improve, reflecting a -to-date increase of 15% over the prior year and a 20% increase in the month of September, despite a pullback in marketing spend ahead of our holistic relaunch that is currently underway and will be rolled out over the next few quarters. As inventory levels normalize and we optimize our marketing investment to drive traffic to updated product pages with improved formulas and rebranded packaging, we expect to return to higher sales volumes over the coming months. As it relates to our performance on the TUE platform, -to-date sales are roughly flat to prior year driven by soft POS volume. TUE has reduced customer acquisition spend across their platform and has focused on driving retention and basket building through increased promotional activity. We began to see improved POS volume late in the third quarter and expect to see continued improvement as we execute the holistic relaunch in Q4 and focus our promotional spend on new customer acquisition and driving trial with our rebranded and reformulated product offerings. The -over-year decline in our DTC channel has been driven primarily by a planned reduction to customer acquisition spend ahead of the brand migration that we successfully completed early in the third quarter. With a complete offering now available on the Halo Pets website, we are executing marketing strategies focused on both customer retention and acquisition of high-value customers. Quarter and -to-date net sales in our international channel are up 31% and 82% respectively due to continued growth in Asia driven by strong consumer demand and continued penetration of the Halo brand in that region. Brick and mortar net sales declined 26% in Q3 driven by a decline of .3 million resulting from our exit of the FDM channel. On a -to-date basis, brick and mortar sales have increased 78% due to a 6.3 million or 129% increase in pet specialty driven by the Halo Elevate launch, partially offset by a reduction of .8 million in FDM sales. Growth profit for the third quarter totaled 4.2 million yielding a growth margin of 35%. On an adjusted basis, excluding the impact of one-time costs related to the holistic relaunch and backing out the positive impact of customer refunds in the econ channel related to prior year periods, adjusted growth margin was 37%, reflecting an improvement of 6 percentage points from Q2 of 2022 and a 12 percentage point improvement from Q4 of 2021. The improvement in growth margin throughout the year is consistent with expectations and reflects the successful execution of several key growth margin improvement initiatives, including the transition of our dry kibble production to a new co-manufacturer, the execution of multiple pricing actions since Q4 of 2021, and supply chain efficiencies including the selective prepayment and consolidation of production months. Turning to our balance sheet, we ended the third quarter with 12.6 million in cash and cash equivalents and restricted cash compared to 17.8 million at the end of Q2. The change in our cash balance during the quarter reflects an increase in inventory primarily related to the rebrand of TrueDog under the Halo umbrella. 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, and we will see a positive working capital impact in Q4 resulting from those collections. During October, we completed the refinance of our credit facility resulting in a $1.3 million increase to our total borrowing capacity, the elimination of $4.7 million of quarterly amortization payments through January 2024, a reduction to the minimum liquidity covenant from $13 million to $8.5 million, and a reduction to restricted cash from $6.9 million to $6.3 million. Additionally, the improvement in our liquidity position and amendment of the liquidity debt covenant allowed for the removal of disclosures within our 10Q, expressing doubt about our ability to continue as a going concern. It's important to note that the initial inclusion of this disclosure within the Q2 filing was related to the potential for future noncompliance with the liquidity covenant under the terms of the prior credit facility, not our expectations regarding our ability to sustain operating cash levels. Net loss for the third quarter was $6.5 million. After adjusting for noncash and nonrecurring charges, adjusted EBITDA for the third quarter was negative $2.9 million. On a -to-date basis, adjusted EBITDA was negative $7 million, consistent with our prior estimates for quarterly cash burn. As referenced, we've also provided a detailed reconciliation of Q3 EBITDA and adjusted EBITDA and Q3 net sales and gross profit and adjusted net sales and gross profit. With that, I will turn it back over to Lionel.

Thanks, Carla, and thanks again to everyone for joining today. Let's wrap our prepared remarks today. I wanted to leave you with a few thoughts. Despite what has been a challenging operating environment so far this year, we now have the foundation in place to be able to compete and grow across all of our distribution channels. We've committed brick and mortar retail partners, a network of international distributors, a recurring base of online subscribers, strong e-commerce partners, co-manufacturing partners with a capacity to support growth, and a banking relationship that allows us to strategically deploy working capital. Going forward, it's our plan to focus on execution, reduce our quarterly cash burn, and grow to ultimately deliver a return to shareholders. Now I'd like to open up the call for questions. Operator, please.

Thank you. 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. At this time, we'll pause momentarily to assemble our roster.

Our first question comes from JP Wallum from Roth

Capital Partners. Please go ahead.

Great. Thanks, and good morning, everyone. Thanks for taking my call. I want to maybe first touch on the point of sales data from brick and mortar. Donald, I know you said that during the quarter you achieved the first week of 100K in sales. I was just hoping, you know, I don't know if you want to or are willing to disclose kind of average weekly sales for the quarter, but maybe if you could kind of just help us understand what the trend looks like, maybe when in the quarter that 100K hit and kind of how things have looked since then. Any clarity or detail there would

be highly appreciated. Thank you, JP. Go ahead, Donald. Go ahead, Rob, I'm sorry. No, go for it,

Donald. Yeah, again, as we talk about the sales, it is that momentum build. We've looked again how long we've been in the market, and really the key point for us is the distribution of the 1800 stores. That's what really is building the momentum. It's a continue to continue to just grow week over week, pay what sales. As you know, JP, we really don't do forward leaning. I would say again, right now, the key to that that we talked about really is, is we are progressing very, very well against our joint business plans, which makes both Petcom, PetSpice Plus extremely excited about our launch and what

they consider best in class. Okay, great. And then maybe if we could just touch

on kind of the difference, if you guys are seeing any kind of difference in what's going on between Chewy and Amazon, I think you mentioned Amazon point of sale systems are point of sale is 15% year over year, and Chewy is about flat. So just curious if there's if there's any major noticeable differences in the two channels. Thank you.

Awesome. AJP, it's Rob. I'll take that one. What I would say between the two is, you know, Amazon has been more aggressive in terms of managing inventory and their warehouses than Chewy, but has had slightly stronger POS growth than Chewy, as we mentioned. I would say that generally speaking, Amazon was was maybe a little less impacted relative to out of stocks earlier in the year than Chewy was. And that's probably a bigger, a decent reason for that change.

Okay.

And then if I could just sneak one last one in, just on inventories, I know there was a sequential increase. Just curious if there's anything you want to highlight going forward and maybe how you're feeling about that level.

Charlotte, you want to

take that one?

Sure. Yeah. And I mentioned during the prepared remarks, if you think about the brand migration from Trudog to Halo, we actually on the kind of freeze dried raw inventory that we sell on that DTC platform primarily, inventory levels in prior quarters were actually, you know, depleted to pretty low levels, just given that we were changing packaging. And so what you're seeing in the quarter is a build back up of that freeze dried inventory. That'll start to come back down, obviously, as we put that on the platform. It's available now and start to sell through on that. But that's primarily the reason for the increase in Q3 from Q2.

Great.

Thanks

for taking my questions. Again, if you have a question, please press star, then one.

There are no more questions in the queue. This concludes our question and answer session and the conference has now concluded. Thank you for attending today's presentation. You may now disconnect.