Flow Beverage Corp.

Welcome to Flow Beverage Corp's fiscal Q4 and 2022 conference call. As a reminder, this conference is being recorded today, January the 30th, 2023. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question and answer session, and instructions will be provided at that time for research analysts to queue up for their questions. I will now turn the conference over to Nicholas Reichenbach, Chairman and Chief Executive Officer of FLO. Please go ahead, Nicholas.

Thank you, operator. Good morning, everybody, and thank you for joining us today. I'm joined today by Trent McDonald, FLO's Chief Financial Officer. For our disclaimers on forward-looking statements, please refer to slide two of this presentation. We hosted an operational update conference call on January 9th, so I'll keep my remarks brief and then pass it over to Trent to review the Q4 and year end 2022 financial results. Subsequent to our fiscal 2022 year end, we made a number of game changing moves to significantly improve the company's financial trajectory As I said on our operational update conference call, the common thread to all these initiatives is that we are taking an aggressive action towards our goal to achieve profitable growth for the Flow brand. In November 2022, we sold our Virginia production facility for $19.5 million. We initiated an internal restructuring in December of 2022. and raised an additional 15 million Canadian from a senior secured debt facility in January 2023. This debt facility also allows us to draw another $5 million in fiscal 2023. These strategic initiatives together have provided a cash injection of $31 million into the company and we expect to realize cash savings of $17 million in fiscal 2023 without impacting the growth of the Flow brand. In fact, we believe these initiatives provide the company with financial flexibility to invest even further behind sales and marketing to drive profitable growth for the Flow brand while achieving normalization and predictability on gross margins.

Today,

Flow is in over 46,000 stores across North America. This is an increase of 88% over the previous year. Some recent wins include 11,000 stores in dollar general, 5,000 stores in family dollar locations, and another 500 combined locations in Fred Meyer, ShopRite, Market Basket, and BJ's in the United States of America. Turning to slide five, you can see that we remain the market share leader in carton format water in the United States. Our market share in this category has increased to 44% from 40 from the last time this year, last year. And this does not include the impact of our wins in the food service sector, and recent innovation like vitamin-infused water, which I'll discuss shortly. Most of you are aware that flow has been sustainable since day one. In fiscal 22, we made amazing progress to build our leadership and sustainability through our NASDAQ-1 report. Through NASDAQ, we published the first SASB report, and voluntarily disclosure of our framework to investors. We also maintain our B Corp certification status and remain one of the top B Corp certified companies in the world, ranking us alongside with brands like Pandagonia and 7th Generation. Turning to slide seven, I would like to highlight our milestones for 2022 from an operational point of view. In addition to our store count and gain in market share, we launched our vitamin-infused water in the United States and Canada and are getting great feedback. We also signed a number of agreements in the food service sector with household names like Norwegian Cruise Line and luxury hotel operator Accor. We also launched in Blade Urban mobile helicopters and seaplane lounges. as well as signing a distribution agreement with Primo, who serves 1.8 million subscribers and customers in the United States. Turning to food service, our most recent distribution agreement has been with Foodbuy, which represents a potential 11,000 locations in North America and Starbucks Canada, which is also in other 1,000 locations that carry flow. We have started... we've stated consistently that our premium and sustainable positioning is exactly what food service partners are looking for. And we expect that sustainability in particular is going to remain a high growth segment in the beverage market for quite some time. As mentioned, we launched our vitamin infused water announcing in Canada that that we signed over 22 leading retailers representing 800 locations in addition to food and beverage distributors. We are very pleased that some of our flagship customers have taken delivery and orders in the vitamin-infused water, and we think this product line has a lot of potential. With that, I'll pass it over to Trent.

Thank you, Nicholas, and good morning, everybody. I want to start by just reiterating that we are in the midst of an operational transformation that we believe will provide long-term financial sustainability for flow and provide the company with a pathway to profitability. Look, one of the many imperatives of this endeavor was to strengthen the balance sheet and dramatically improve our financial positions. While this will continue to be an ongoing focus, we believe we've accomplished a great deal over the past several months. With this being the case, one of the items of our Q4 and year-end results will be one time, one of the themes, I should say, of our Q4 and year-end results will be the one-time non-recurring items and reserves. We felt it was very important for us to de-risk our entire balance sheet at year-end so we could set up the organization for a much cleaner and more profitable fiscal 2023. With that said, let's discuss our results. So the Flow brand net revenue increased 38% in Q4 2022 and 26% for the fiscal year. The primary drivers across both these periods were the successes we've had in unlocking new retail stores across North America while we continue to build momentum within our e-commerce channels. Growth rates on a consolidated basis were slightly lower as our co-packing revenue was impacted by both our focus on the Flo brand and by the amendment of a co-pack manufacturing agreement, which became effective May 1st, 2022, which formed part of the Barona divestiture announced subsequent to year end. This amendment and the co-pack revenue, the amendment impacted co-pack revenue and gross profit by approximately $2.2 million dollars. on a run rate basis in Q4. Our gross margins were 10% in Q4 and 19% in fiscal 2022. Our normalized gross margins, however, were 28% for Q4 and 25% for fiscal 22 when considering the impact of that COPAC agreement amendment and a one-time $300,000 inventory reserve associated with us choosing to exit the collagen-infused water market. Even normalized margin was still impacted by the higher relative production volume coming out of the Verona facility. The cost per unit of flow water and co-packing was much higher at Verona, given it was not running at full capacity, and this increased the overhead cost applied to each unit of production coming out of that facility. I'll also add that we are not immune to cost inflation, and we started to see input and logistics costs creep up in the back half of the calendar year. We anticipate that going forward, gross margins will improve following the sale of the Verona production facility, along with other operational cost initiatives that we are currently working on. Our EBITDA loss increased 10% in Q4 and improved 29% for the fiscal year. As it relates to Q4, we took over $2.8 million in non-cash charges, which impacts some of the improvements we have been making through cost discipline. Turning to growth and net revenue, growth in the Flow brand was relatively broad-based across Canada and U.S. retail, as well as e-commerce. We have also made a lot of improvement as it relates to trade spend. As compared to Q4 2021, we spent $400,000 less to achieve 38% growth in the Flow brand. Looking at co-packing revenue, as I just mentioned, we made the decision to focus on the flow brand, impacting our capacity to allocate to co-packing and the renegotiation of a co-packing agreement, which I mentioned earlier. Looking forward to 2023, we expect continued growth in the flow brand, while co-packing revenue will decrease based on capacity allocation. With respect to trade spend, however, we expect that we will continue to be very diligent in this expense. While I've already spoken to gross margin, I'd like to, look, again reiterate, these gross margin figures that we're showing are not representative of our trajectory, especially after the sale of the Rona production facility. With the sale, we have fixed our per unit cost for U.S. production through the COPAC agreement that we signed as part of the transaction. We removed the cost of unutilized capacity. and added volume to Aurora, which will make that facility's production even more profitable. We're also working through several broad-based operational cost savings initiatives, which we believe will provide an even better pathway to improve margins in quarters to come. Sales and marketing and general administrative costs included $2.5 million in non-cash charges in the quarter that relate to accruals on trade credit reserves and receivables, again, in an effort to de-risk our balance sheet going into fiscal 2023. We do not expect these items to recur going forward. That said, it is important to note, while we are aggressively executing on cost savings initiatives, we realize it is imperative for us to continue investing in the Flo brand, its distribution and its customer engagement. We have no plans to slow down in relation to these activities. With respect to general administration and salaries and benefits, we would expect both these lines to decrease in fiscal 2023, given the impact of the Verona sale, our internal restructuring, and the many other aggressive cost savings initiatives we've identified. Turning to slide 13, look, as we've recently acknowledged, our stock price has underperformed, and for several very legitimate reasons. As management, and speaking for our board, it was critical for us to stabilize the organization by mitigating risk on the balance sheet, strengthening our financial position, and dramatically reducing our cash burn. We needed to ensure we had a clear pathway to profitability and a runway to get there. Only then could we possibly argue that Flo was undervalued. While we've been executing on that plan at a very hastened pace, and we believe there's a lot for us to accomplish, still to come, we are very pleased to see that the markets are starting to take notice of our efforts. That said, flow is still trading, if you look at slide 14, at 0.9 times revenue versus 3.5 times as a simple average for our peer group and 5 times for the weighted average of our peer group. Even though we have gone from 0.3 to 0.9 revenue in the last month, we still believe there is significant value to unlock. We are still at the beginning of a very long road which will entail proven execution, improved results, lower cash burn, and what we expect to be an aggressive investor relations plan. With that, please open the line for questions. Thank you.

Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session for research analysts. If you would like to ask a question, please press star followed by the number one. on your telephone keypad. If your question has been answered and you would like to withdraw from the queue, please press star followed by the number two. And please stand by for your first question. Your first question will come from Chip Moore of EF Hutton. Please go ahead.

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

Yeah, I can comment on the... Go ahead. Sorry, you... I can comment on the utilization and I'll let Trent comment on the gross margin impact. As we mentioned in our operational call in early January, we moved to 24-7 production in Aurora, which means that we're running our three machines seven days a week, 24 hours with cleaning and downtime. So we've reached a great utilization of those assets by moving our co-packing customers some of our co-packing customers from the United States back into Canada where they were originally producing so we have a significant you know volume from from that coming back up as well as maintaining the growth of the flow brand in Canada yeah and look at that you know clearly

Capacity utilization is going to be very important to us when it comes to absorption rates and our lower overhead costs applied to each unit of production coming out of Aurora. It's a much more efficient facility, and we've done a great job on the operating of it. If you think about that in terms of the impact on gross margin, again, we stay away from guidance in terms of what is going to be 32%, 38%, 40%. But we do know that we had normalized margins of 26%. Well, we had 26%, I believe, in Q3, 28% in Q4 on a normalized basis. I think our goal to go forward is to continue to build off of that with each successive quarter. as we get better on some of the cost savings initiatives. It's not just about utilizing the capacity. It's about other things we're doing within the operational network to reduce costs that end up getting applied through overhead and other things, direct or otherwise. So I think there's a lot still happening and good things to look forward to.

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

Yeah. With investing in the Flow brand, We want to maintain our velocity at retail in our core channels of growth in 2023. So we'll be investing in our growth channels, both in Canada and the U.S., to ensure that we maintain a market leader in the channels that are of higher margins. but also of higher strategic importance. So we'll be investing directly in those channels, such as the natural grocery channel and food, drug, and mass in Canada, where the brand rolled out with a very high ACV, as well as we've mentioned numerous times that food service is a very big and attractive channel for flow. As we know, the customers are looking for a sustainability, and we'll further roll that out in food service, both in Canada and the United States in 2023.

Perfect. Okay, I'll hop back in, too. Thanks very much. Thanks, Jeff.

Your next question comes from Pilkit Sabarwal of Canaccord Genuity. Please go ahead.

Hi, good morning, everybody.

Good morning.

I just wanted to dig deeper into the market share gains you talked about, especially in the carton format. Could you just contextualize how the general category fared as a whole over the same time period and perhaps expand on the drivers behind the market share gains?

Yeah, I can dive into that because The sustainability package format in water is still relatively new. And so from a data perspective, we've only recently been able to track it over the last year. And we've seen significant growth in sustainability packaging in the premium enhanced water category. to the tune of it hit up towards 80 plus percent in 2022. And the drivers of sustainability packaging are made up of three categories, one carton, two aluminum, aluminum cans and aluminum bottles, and three glass. And so the drivers of growth within those categories are definitely in the the carton category segment, as well as aluminum, where we're seeing up towards an aggregated growth of 55 plus percent to the end of this year. And we continue to see that growth moving forward. That's the question number one. What was your second question?

Yeah, just the drivers behind the market share gains you were seeing versus the competitors. And yeah.

Yeah, so in the carton segment in Canada, we are actually one of very few, if not the only one in that segment. So we are rewarded with a very large market share, probably 90 plus percent in Canada. And in the US, as mentioned in the slide, we have two or three other competitors within that segment. The way that flow is positioned, it's not only a sustainable water brand but we're also a premium enhanced mineral water and we also have organic certified flavors so we're starting to see the impact of a high quality product or a higher quality product than our competitors that are initially are significantly jumping our growth within the segment and if you looked at the pricing it's not about pricing we're actually priced higher than our competitors so We're starting to see the quality of our mineral water and our innovation really drive the growth that I was mentioning. And that does not include vitamin-infused water, which is in a different segment altogether.

And I'll add to that, too. Look, I mean, the industry dynamics and the growth trends are evident to most who have access to the research. But, you know, the... It's come down off the peaks. Growth is still very solid, very healthy across premium, across functional, across it's still healthy, healthy growth, but it's come down. And a lot of that is the comp coming out of COVID and there was really high, high growth for a while. So it's hard to comp that when you're looking at year over year, which is how you measure this kind of growth. But if you look at our final quarter across most metrics in which we compete, We were over-indexing to the tune of a three to four times fold, you know, and certainly in functional water. And even you could say that about premium as well. We don't expect that growth to go away in those sectors. You know, it might slow year over year, but then we do anticipate it'll come back up. There's obviously some macroeconomic factors at play here. But we have been doing really well, and a lot of that is the growth in doors, the growth in distribution, the growth in food service, things that are really adding to our volume that perhaps our competitors are struggling with.

Okay, that's great, Keller. Thanks a lot. And then just in terms of the partner network, could you just remind us what the partner network looks like going forward for vitamin water, especially for this year? Meaning distribution paths? a distribution as well as overall penetration across your network.

Oh, yeah, that's great. Yeah, so in Canada, where it's just launched in January, we signed 22 retailers, which represents 800 doors. Those are names such as Loblaws, Metro, and other leading grocery stores. We also announced that the club channel with Costco, we rolled out a national program with vitamin water. So I would say we have very good penetration within our core channels across food, drugs, and math in Canada. And that's where we'll focus most of the distribution of vitamin water throughout the year. And we expect other channels like gas and convenience in Canada to pick it up more towards the later half of this year where we have a smaller penetration but growing in gas and convenience. In the United States, we're focused on rolling out vitamin water in the natural grocery category and segment of which we have a very high ACV of I think about 55%, 60% of all natural grocery in accordance to the scan back Nielsen data and spins data. We'll focus on launching across broad line distribution with our two largest partners in the U.S., UNFI and KE, going out to all of the leading natural grocery chains as well as the grocery category at large, conventional grocery, with some of our leading grocery partners. So we'll look to announce more in the future as as they turn on, both in Canada and the United States. If they're significant, we'll be launching and releasing news as it relates to the ongoing rollout and performance of this product line.

Okay, that's great, Keller. Thanks a lot for that. And then one last one from me is just, could you also just provide a timeline on what the rollout with Primo looks like over the upcoming year, just in terms of the SKUs you're rolling out and what the timeline would look like for the upcoming fiscal? Yes, absolutely.

So our Primo deal is in the United States currently, where we're rolling out to their direct-to-consumer customer base. For people that don't know Primo's business model, that's a lot of home and office delivery, where they have water coolers and all their premium products and beverages, mainly water products. that are going into the cafeterias and office sector as well as home delivery. We have launched the Primo partnership and they have initiated orders and reorders in the United States and their focus is on the northeast coast where flow has a much higher penetration in brand awareness, but also in other alternative distribution models, as well as in their core markets across the United States. So all intensive purposes, the Primo partnership is national and available off their website and a core focus on their core markets. And we'll be supporting that channel with additional resources programs and trade programs as well as consumer awareness as we roll it out across the U.S.

Okay, that's great. Thanks a lot.

Excellent. Thank you. Your next question comes from Martin Landry of Stifo GMP. Please go ahead.

Hi, good morning, guys.

Morning, Martin.

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

Yeah, Martin, it's a great question and I would love to give you a definitive response. If we do get to a positive EBITDA, it certainly wouldn't be until fourth quarter, but it is really not in our three-year operating model to have positive EBITDA in any quarter this year. We do expect to have significant improvement, and it'll come down to a number of things internally in terms of the haste with which we can remove certain costs. Some of these things, as you can imagine, can be done immediately. Other things take a little more time and you see the lagging indicators. We are, in fact, tomorrow is January 31st, finishing our first quarter. And so, you know, some of it will roll into our second year of the three-year business plan. But, you know, we do believe we're going to be able to show the market some very significant improvements. not just through cost of goods, you know, decreases, which will improve, of course, our gross margins, but through G&A and salaries and benefits as well.

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

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

Okay.

And just to be clear.

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

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

Sure. I mean, there's a couple of things there. You have to think about Q1 as its own sort of animal. At year end, we were still sitting with inventory that had been produced in Verona at October 31st. The transaction with Verona did not take place until subsequent to year end. And so that high-cost inventory is going to flow through in Q1. Our goal is to mitigate that and to continue to improve margins through utilization in Aurora, but there is that we do have to mitigate in Q1. So that's going to be a bit of a drag on the full year, if you think about it that way. Some of the initiatives that we've put into place have come throughout Q1. So again, you won't see the full impact until Q1. Q2 and probably even the latter half of the year, Q3, Q4. So there is going to be cost-based initiatives, but a lot of it, it's really spread out, but a lot of it is in warehouse and distribution, logistics, shipping, and then of course, general and administrative, and then the cost of goods through better utilization. So it's a pretty good combination of initiatives that we believe when taken as a whole, are going to show dramatic improvement. But again, it's going to take a bit of time over the course of the year for all of those things to come through because your quarterly results are a bit of a lagging indicator because you're executing in real time, but you don't see them until after the fact.

Okay. Thank you. That's it for me. Thanks, Martin.

Ladies and gentlemen, once again, if you would like to ask a question, please press star 1 at this time. Your next question will come from Sean McGowan of Roth Capital Partners. Please go ahead. Good morning, Sean.

Good morning. A couple questions here as well. Trent, you went through sort of calling out a one-time charges on sales and marketing, but were there also some exceptional charges in the G&A line? That was also higher than I thought it would be.

Yeah, and Jay, definitely in G&A, there were some higher items for sure. You know, we got aggressive on our allowance for doubtful to clean up our, like again, the theme of Q4, and I tried to sort of uh, say this upfront in terms of my section was to say, you know, we are de-risking the, the balance sheet and not just, not just from a leveraged perspective and, uh, financial stability, but also from a working capital item perspective. And so we did take some, um, some pretty big reserves, um, that did impact that, uh, GNA. So again, there's the, uh, There's the allowance for doubtful. There's some things within our accruals. I won't get into all of it because there's so many little ones as well, but they all add up. For us, we want to have a nice, clean, succinct balance sheet so we're not going into Q1 and Q2 and Q3 and having to take all these hits and death by 1,000 cuts. you know, I want to have a nice, you know, all of us want to have a nice, clean P&L going forward.

Yeah, makes sense. And you called out some factors that might still drag down gross margins in Q1. Would there also be some kind of one-time unusual charges elsewhere in the P&L in Q1?

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

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

Yes. Yeah. We, that was all part of the Verona transaction, uh, which was announced on November 9th and closed.

Uh, and then last question for me, um, This new credit facility that you have, does that represent the company's total borrowing capacity, or are there other pieces of debt that would show up on the balance sheet?

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

Thank you very much.

Appreciate it. Thanks, Sean.

Ladies and gentlemen, at this time there are no further questions, so this will conclude your conference call for this morning. We would like to thank everyone for participating and ask you to please disconnect your lines. Please wait while the recorder is connected The conference is now being recorded