Flow Beverage Corp.

Welcome to Flow Beverage Corp Fiscal Q1 2024 Conference Call. As a reminder, this conference call is being recorded on March 18, 2024. At this time, all participants are in listen-only mode. Following the presentation, we will conduct a question and answer session. Instructions will be provided at that time for research analysts to queue up for questions. Before we begin, we would like to remind you that today's presentation and discussion contains forward-looking statements that involve known and unknown risks and uncertainties, and other factors that could cause actual events to differ materially from current expectations, and may cause actual results, performance, or achievements to be materially different from those implied by such statements. The forward-looking statements are based upon and include the company's current internal estimates, plans, expectations, opinions, forecasts, projections, targets, guidance, or other statements that are not statements of fact. Any statements contained herein are discussed during today's session that are not statements of historical facts may be deemed to be forward-looking statements. A number of factors could cause actual events, performance, or results to differ materially from what is projected in the forward-looking statements. A more complete discussion of the risks and uncertainties facing the company appear in the company's annual information form dated January 29, 2024, and the company's management's discussion and analysts' for the three months ended January 31, 2024, which are available under the company's profile on CEDAR+. You are cautioned not to place undue reliance on these forward-looking statements, which only speak to the date of this presentation. The company claims any intention or obligation except to the extent required by law to update or revise any forward-looking statements. as a result of new information or future event or for any reason. Any forward-looking statement contained herein or discussed during today's session is expressly qualified in its entirety by the above cautionary statement. I will now turn the call over to Nicholas Richenbach, Chairman and Chief Executive Officer of Flow. Please go ahead, Nicholas.

Thank you, Operator. Good morning, everyone. I'm joined today by Trent McDonald, Flo's Chief Financial Officer and EVP of Operations. On today's call, we're going to start by providing an overview of Flo's recent milestones, which includes Flo's rebranded product line that is going to be launched on our summer hydration campaign. Before I pass the call to Trent, I'll review the strategic outlook of 2024, which will include during our year which was included during our year-end call. Trent then will take you through the details of our Q1 2024 financial results and share with you an update on our operations and priorities. After Trent's remarks, we'll open the call to analysts. Last year, last week at Expo West, we introduced an evolution of the Flow brand along with the more sustainable Tetra Pak, which we plan to launch throughout the summer on our hydration campaign. After extensive consumer research, we have updated our brand to evolve with our consumer in the premium hydration and premium water category and place an emphasis on our mineral-rich spring water with pure taste as a key differentiator. Along with our refreshed brand, we are launching a newly designed website for both the Canada and the U.S. consumers. The new version of our Tetra Pak carton contains recycled content using biopolymers and is made with over 80% plant-based renewable resources. Our carbon footprint on this package is seven times less than glass, four times lower than aluminum, and three times lower than plastic. With this innovation, we will solidify ourselves as the most sustainable beverage in the world. Our refreshed brand and new package materials relating to our original mineral water and our four organic flavors, cucumber mint, strawberry rose, peach blueberry, and blackberry hibiscus. We previously had six organic flavors, In addition to our classic OG, while working through our consumer research and brand refresh, we re-evaluated our whole product portfolio and decided to go with our four core flavors to optimize our path forward. We recently decided to exit our line of vitamin-infused products as well and focus on sustainability within our core SKUs. In addition to optimizing our product line, we made some difficult decisions to exit commercial relationships and sales channels that were not yielding expected margins. While this impacted net revenue in the near term, we believe these decisions will maximize mid- to long-term profitability. Turning to co-packing and co-manufacturing, we had two major contract wins with Beatbox and Balsio in Q1 2024. Along with Joyburst, we expect Flow will earn a minimum of $148 million in contracted revenue over the terms of these agreements. In the first quarter, we began production with Joyburst. In February, we started production of BioSteel, and we expect Beatbox production to start during fiscal Q3. We have recently announced the private placement for approximately $3.3 million. Our investor is the founder of NSF Leasing, our primary lender. Cliff of Rucker Investment and NSF have been great partners over the last eight years. And we think that their equity investment is a big endorsement in our future prospects. Turning to our strategic priorities in 2024. The game plan is the same as we presented as a part of our year-end 2023 conference call January 31st. For the Flow brand in Canada, we expect our partnerships with Starbucks and Live Nation to continue the growth of the brand through retail and e-com channels. We plan to focus our trade spend on national grocery, gas, and convenience channels where we're seeing a lot of success recently. Looking at the U.S. retail, we are maintaining the growth in our core channels of natural and conventional grocery, and we're putting together a strong summer campaign around our new brand launch. For U.S. e-com, the channel remains challenging, but we have a plan to respond to our competitive reselling and expect to mitigate this in Q3. Turning to the capacity of Aurora, our expansion is going as planned. In February, we commissioned the fourth line of production, increasing our manufacturing capacity by 25%. This was as a result of great effort from our team, and we are well positioned to scale with our new co-packing partners and contracts. Today, all four lines are running 24-7. With our contract revenue from co-packing, a return to growth from the refreshed brand, and continued financial improvement, we still expect to become adjusted EBITDA positive and cash flow positive from our operations in Q4 2024. That concludes my prepared remarks. I'll pass it over to Trent.

Thank you, Nicholas. Look, on the surface, it was a challenging quarter. However, we believe the foundation is now a place from which Flo will continue to build very strong momentum. With that, Flo brand net revenue was $6.6 million in Q1 2024, down 9% from last year, and consolidated revenue was $8.3 million, down 16% from Q1 2023. In Canada, the Flo brand continues to have positive retail growth, led by grocery and food service, while our e-comm channel grew significantly year over year, both benefiting from increased conversion of customers who had trialed flow of water and food service channels, a strategy that is clearly starting to pay dividends. In the United States, we made the cognizant decision to pull out of certain unprofitable channels and commercial agreements, which impacted net revenue in Q1. That said, we firmly believe this will benefit flow in the longer term and help the company reach profitability. These decisions are consistent with our efforts to simplify our business and invest in only those areas that provide a solid return. Flow brand sales in the U.S. also continue to be hampered by competitor reselling over e-commerce platforms that we described during our last call in January. We have developed a strategy to greatly mitigate this impact, and we believe the positive impact of executing on this strategy will be seen in the second half of this year. Consolidated revenue in Q1, which includes co-packing, still does not reflect the impact of most of all of our newly signed co-manufacturing agreements. As Nick mentioned, we began manufacturing Joy version Q1 and BioSteel only recently began production in Q2, while Beatbox is currently set to start at the beginning of Q3. We expect to see significantly improved consolidated net revenue in quarters to come. Due in part to the factors I just described, gross margin was a loss of 15% compared to positive gross margin of close to 30% in Q1 2023. In Q1, we ramped up our cost base to ensure we could run at full capacity in Aurora starting at the beginning of Q2, coinciding with the go-live of our fourth production line and the start of co-packing BioSeal. At the same time, the lost sales from competitor reselling, and the exit of commercial partnerships in the U.S. This all caused a near-term reduction in production volume and greatly decreased overhead absorption rates, causing more costs to be applied to each unit of production and lowering margins. We believe this is going to be a very short-lived issue. with Q2 through Q4 set to see greatly increased production volumes and much lower costs per unit produced. While costs per unit out of the ROAR were high for the quarter, the commercial relationships we exited still managed to cause negative gross profit of close to $850,000 in Q1. In addition to this, We still had inventory from our October 31 year end that had been produced in Verona under a third-party manufacturing agreement, which carried a much higher cost per unit due to the co-packing fee within its cost base. Much of this inventory ran through cost of goods sold in the United States as it was sold into the market in C1, which itself had a negative $440,000 impact on gross margin. We expect there to be one more quarter of that Varroa COPAC fee impact, but not to the degree we experienced in Q1. Also within the cost, we unfortunately incurred an extra $610,000 in e-comm logistics and shipping costs over normal run rate, which is currently being corrected. There will be another small impact in Q2, but this should be fully straightened out on a cost-per-case basis to back to or even below normal levels by Q3 and onwards. Lastly, with the exit from our line of vitamin-infused products, which Nick alluded to, we took a $1 million non-cash write-up of all raw material inventory, which also obviously impacted gross margins. All of these many issues, almost all of which do not continue in a material way from this point forward, caused us to have negative gross margins. But if removing those and normalizing, we are at or above 23%. Again, we believe gross margins are going to dramatically improve in the quarters to come, and especially over the back half of the year. Turning to adjusted EBITDA, the 3 million variance from last year is mostly explained by looking at gross margins. Again, we expect a significant improvement in this metric in the near term. Turning to a more detailed review of our P&L, you can see that sales and marketing expense has remained stable. We are very keen to be in a position to invest more in our sales and marketing activities once we hit our profitability goals. General and administrative expenses were down significantly on a sequential basis by close to $2 million from Q3 in 2023 and down close to $3 million sequentially from Q4 2023. but they were up compared to the same quarter last year. While Q1 showed substantial improvement on a run rate basis, G&A does not completely reflect all of the total restructuring we've executed on to date. We will see more reductions in Q2 and then for the back half of the year, predominantly in logistics, where we believe there's still room to remove costs over and above what has already been completed. The salaries and benefits were 32% lower than the prior year. We feel that this particular operating expense line is now running closer to a sustainable run rate, and it reflects most of the restructuring that we've done to date. Looking forward, we remain on the cusp of realizing the full impact of our operational transformation. With our functional areas restructured, we are driving efficiencies through 3PLs, to meet our cost improvement objectives. Scaling our operations to meet the requirements of our co-manufacturing agreements is also going to be a big driver of lower cost per unit of all our production now coming out of Aurora. With the resumption of flow brand growth, our focus on profitable channels and cost control, and the scaling of our co-pack operation, we still believe the best is yet to come and remain very confident we can get to positive adjusted EBITDA and cash flow by Q4 of this fiscal year. Right now, Lowe's is still trading at 0.9 times revenue on a trailing basis and even less, down to about 0.7 times looking at our forward revenue streams. This compares for our publicly traded beverage peers, trading a simple average of over three and over five on a weighted average basis. We still believe the market is pricing flow for failure, and quite frankly, fairly so. We have yet to show the total impact of our transformation in our publicly reported results. It is on the flow team to do that, and to that end, we believe we are imminently close to doing so. We see the future as very bright and look forward to delivering what we hope to be a much better result in the quarters to come. In the meantime, we do appreciate all your support. And with that, operator, please open the line for questions.

Thank you. Ladies and gentlemen, we will now begin the question and answer session. Should you have a question, please press star followed by the one on your touchtone phone. You will hear a three-tone prompt acknowledging your request. and your questions will be pulled in the order they are received. Should you wish to decline from the pulling process, please press star followed by the two. If you are using a speakerphone, please lift the handset before pressing any keys. Your first question comes from Martin Lander with CFO. Please go ahead.

Hi. Good morning, guys. Good morning, Martin. Good morning. So there's lots of changes and lots of new contracts that have been signed, you know, in your co-packing segment, lots of contracted capacity. Yet, as you mentioned, we don't see it in your results. So I was wondering, you know, that contracted capacity should provide you with some visibility on your revenue streams for Q2, for Q3 and for Q4. And is it possible to help us model that? Because right now, you know, you've provided some minimum contracted volumes over the length of the contracts. But, you know, if we dig down a little bit further and try to see how that translates into co-packing revenues for Q2, Q3 and Q4, is there anything you can give us in terms of range, in terms of size, in terms of just help us understand a little bit, what kind of magnitude of wrap up we, we should expect?

Uh, look, great questions, Martin. And, uh, you know, the reality is that to your point, they haven't quite started yet. Uh, we have joy burst and, uh, you know, throughout, uh, Q1, which was, you know, great that we did have that, but it's, uh, You know, in Q2, we did, in fact, start with biofield. And in Q3, very early in Q3, we should be starting with, you know, beatbox. And so from a volume perspective, our, you know, overall, we see volume increasing by, you know, I don't want to give a lot, like a lot. And so if you think about what that means for sales, it's going to be monumentally different. And so for us in Q1 coming in where we did, I would say Q2 and then Q3 and then Q4. I mean, Q3, Q4 are... much more than double our consolidated net revenue, like much more. And then in Q2, which is sort of the bridge to Q3, Q4, it goes up not quite double, but significantly more, like at least 50% more. And so that is going to have just a massive, massive impact on absorption rates, which, you know, stifled us, among other things, in Q1. So, you know, as much as we are literally getting, as a team here at Flow, getting sick of putting these, you know, these sort of transformational results out, there is a light at the end of the tunnel. And it's not even a tunnel. It's, you know, it's crossing a street now. And so it's really imminent. And so that's where we are. But it's The volume is going to go up dramatically. We had three lines running in Q1. Three, not four. And I would say those lines in totality in Q1 ran at maybe 60% capacity utilization, even a bit lower, okay, on three lines. In Q3 and Q4, we'll have four lines, and by the time Q4 rolls around, we're going to be on four lines, and they're going to be, you know, really pumping. So, it's a big difference, very large difference. Yeah, 90 to 100%. Yeah. Well, certainly as we roll into the next fiscal year, we'll be for sure.

Okay. That's helpful. And I was wondering if you could talk a little bit about the discontinuation of the vitamin water line. What didn't work there? I thought at the onset, this was a great product. This was broadening your portfolio. What's the learnings here? What didn't work and why did you pull out of that product line?

Yeah, it's a good question. The top, top view is our consumer, after going through all this competitive research, our consumer really focused in on our core mineral-rich spring water as being our point of differentiating us from our competitors. And innovation was way, way less important to them from delivering both the mineral-rich spring water with some organic flavors. They did very well. But also the sustainability of the package and the company really scored high on our consumer base. And we chose to do that innovation, which we announced last week at Expo West, to really innovate our pack and go deep on our core SKUs and be able to focus on those. So that's like top level corporately why. The vitamin water in the U.S. was a very competitive space and grocery and our channels required an extensive amount of trade spend support and trade marketing support to launch that. And as you saw from previous quarters, those trade spends were making the business not be able to actually reach great margins and overall dragging our margins down across the board. And so with the U.S. being competitive and requiring so much trade spend, we decided to discontinue that type of innovation into the functional beverage and go really strong into our core SKUs meaning the mineral-rich spring water, and focus all of our innovation on sustainability, which is core to the vision and mission of FLOW, to be able to have the highest-rated ESG scores and the highest you know, sustainability for our consumer and ultimately for the planet.

Merton, let me follow here. Look, we say it a few times, but I really want to reiterate and make sure we drive this point home. We need to be simplified. Our company has to be simplified. You know, our flow brand is a beloved brand. People love the brand. They love the water. We have more influencers drinking our water than you can shake a stick at, and we don't pay many of them to do that And the reality is this. We haven't even begun to reach the full potential of just our OG, one long flavors or vitamin or innovation. And so there's a lot of room for upside, and we need to focus on that. And operationally, if you think about the production facility and planning out your production scheduling, when you have three flavors of vitamin, six flavors of OG of our water, and then you have your OG on top of that, you're dividing up your production, and you're doing a lot of sips and van times. It's not efficient. You're getting a high. You're getting less capacity utilization, less absorption, and we're trying to do that while we're working with co-packing clients that are very important to us. So simplification is what we need to be focused on, and that's exactly what we're doing. We're getting back to the core, and we're going to drive it, drive it, drive it, and only drive it in profitable channels, which you may ask a question about, but we're pulling out of some channels That's the driver behind vitamin as well as all the things that Nick just said.

My last question is on your balance sheet. Your payables have increased significantly in the last two quarters. I'm wondering, I mean, you're stretching your payments with your suppliers. Is this causing any supply issues? Have some of your suppliers stopped shipping to you recently?

Yeah, look, we're managing it. It's not without its stress. There's no doubt about that. We made the decision to hold on to Aurora because we believe it's the best long-term decision we can make for our investors and for the our stakeholders, and these are the kinds of working capital issues that are caused in the short term. And so we're working closely with our supplier base and our most trusted and biggest suppliers, like Tetra, as an example, you know, to manage through this sort of process. But, again, we're in the middle of Q2 right now, like in the middle of it, and Q4 is only, you know, three and a half, four months away, four months away, I guess, to start at Q4. So it's tight. There's no doubt about it. And it's not without risk. But we're managing right now. And it's, you know, there's, I guess, keep saying there's a light at the end of that tunnel that we believe is there for us and for everyone who has been committed to flow, regardless of whether you're a stakeholder or investor, whatever it might be. And so we're managing through it.

Okay. All right. Thank you. Best of luck. Thank you.

Your next question comes from Najib Islam with Canaccord. Please go ahead.

Sure. So my first question is, could you give me some information about exactly what you're doing on the logistics to bring costs down?

Sure. So the first thing we did was we went to 3PL. We used to run most of our own warehousing in the United States and in Canada. We at one point had two primary warehouses and up to four turf-free warehouses, all of which had labor equipment leasing like forklifts and things of that nature, utilities, you know how it goes when it comes to running a warehousing. We weren't really good at it. We didn't have warehouse management systems. It was costing a lot of not only cost but service interruptions and a poor customer experience. On time and in full as a KPI was not great, which caused obviously penalties within retail environments. So we were able to sort of reverse course and come off all of that. We only run one warehouse now, and that's right beside our Aurora production facility, which makes sense. when you're thinking logistically about how you manage raw materials and finished goods for coal packing clients. So we're down to just that one warehouse. We went full 3PL. We also did that. So we have that all set up. We then went to what we feel is a more efficient and lower cost alternative within our e-comm channel. And that's really brought down the price per unit. But we're not all the way there. There's a couple of more things we are doing right now. We are consolidating our lanes. We deal with too many transport companies in general. We're looking at what we can do on the West Coast because it's costing us too much once the water's landed out there to warehouses and pick, pack, and ship. And the last thing we're doing right now is really route e-comm where we believe that in some of our biggest channels that we sell e-com, like as an example, Amazon, we are now into some agreements where we believe we're going to dramatically reduce the cost to fulfill, like the cost to service. And so on a per case basis, there's quite a bit of room there. And we're basically in execution mode now. It's not a planning thing. So a lot of it's even going live. And so there's still some room to maneuver. it's just taken us a little longer than we would have liked.

Sure, got it. And another question I have is, could you give me an idea of how much improvement in branded revenue you're targeting in Q3 as you deal with the resellers? And could you maybe give me a ballpark estimate of how much of a headwind it's been so far?

Yeah, it's been a headwind. There's no doubt about that. We have really, and it was both in the United States and Canada, so And it's affecting, obviously, our e-com channel. That's where the resellers are. And so we have solutioned it in Canada. And that solution has, I believe, gone live or goes live next week. No, it's gone live. Yes, it went live. It goes live next week, literally, Monday, today. So there you go. So we have solutioned that. And it was dramatic, you know, dramatic. And the United States, just to give you an idea, We were up 40% in e-com in the first half of last year before these resellers came on. And in the back half of last year, we were down in e-com 11%, and we're down 14% in e-com in the U.S. in Q1. That's the impact. And it was a cliff. And so that's the problem. But we have the solution we put in place here in Canada. We're looking at an extremely similar one in the United States, and we believe that will not just greatly reduce that impact, but altogether help us start to grow it back. So not just reduce the impact, but start to grow that and grow it aggressively in the back half of the year.

Sure, got it. And last question for me is, could you give me a bit more detail about some of the changes you made with the updated website? Do you expect it to support e-commerce revenue growth going forward?

Yeah, absolutely. Obviously, with the rebrand of Flow, we're rebranding and making sure that we're consistent with all of our new brand messaging and how we actually convert consumers to it. But also, we're bringing in more intelligent software to be able to geo-filter our website, allowing us to deliver our packages with our new distribution network in the U.S. and Canada. to certain geographical areas like big, dense metropolitan areas across the United States, the top seven of them. And then in Canada, the top three. So over 10 markets where we're geo-filtering our advertising, but also we're geo-filtering the ability to deliver packages within those core. And we'll maintain that we'll do free delivery of with our purchases of over two cases, I believe, in those areas. And then, you know, in the future with more rural areas and less dense metropolitan areas, we'll put a delivery charge on certain packages going to their area, allowing us to mitigate the cost structure of that, but also allowing us to filter into those areas to optimize advertising spend and customer service. So that would be the big overhaul from how it improves our e-com business. But overall, we'll have an optimized site that's more easier to convert. And then also, in the summer, with that, we're putting some advanced subscription software on the website, encouraging and allowing our subscribers to be managed better, which is really one of the biggest advantages to flow, which is getting your packages delivered on a weekly basis or a monthly basis direct to your house on subscription and being rewarded for it with a discount. And we have high growth in our subscription business, and we'll be really focusing on those areas, the seven in the States and three in Canada, to drive more subscription revenue and a better customer service experience overall with your deliveries to flow. And we have thousands of customers already on subscription and plans to have high growth in that particular sector. So that's what we're doing with the website to improve not only our margin, our overall logistics, but also our customers delivering a better experience and also focusing in on our subscribers.

Sure, got it. Thanks. I'll pass it along.

Excellent. Thank you.

Your next question comes from Sean McGowan with Roth MKM. Please go ahead.

Good morning, guys. How are you? Fantastic. Can't wait to see you later. Question, how much of an impact in the revenue quarter was from the discontinuation of vitamin water?

It wasn't as significant. Sorry. In the quarter, on a year-over-year basis, I would say to the tune of about $750K, if not a bit more. Okay. So the real issue was more the e-com and the... You're asking about... Because last year we had launched in the U.S. and we had some sell-ins. And this year, obviously, we slowed it down dramatically because we're just trying to sell through the rest of the inventory. And then, of course, we had the actual write-down of the inventory raw materials, which hit cost of goods. But I think you're asking about that, right?

Yeah. Yeah. It just sounds like that was much less of an issue than the e-com issues and the unprofitable customers. Okay. Okay. When can we expect the co-packing revenue? You talked about the ramp-up, and it sounds very strong in the second half of the year, but when can we expect co-packing revenue to be up year-over-year? Does that begin in Q2?

Up year-over-year? Yes. Q2 should be up year-over-year. It'll be tight, but I think, yes, it should be up year-over-year. Last year, if you recall, and the reason it's down year-over-year this year, which it is down, um is uh due to the bio steel um impact you know we were manufacturing at uh at capacity with bio steel last year in q1 and uh that obviously did not repeat itself uh joy burst did mitigate for sure but not all the way uh but in q2 we did in fact start producing bio steel again under new ownership uh and so we expect there to be um you know, at least flat to marginally up, and then Q3 dramatically up. Okay.

Thank you. And my last question is, you know, it sounds like you've got a lot of absorption coming in the second half of the year. What should we be looking for as kind of the new normal, you know, ongoing gross margin on a consolidated basis, you know, once all these lines are up and you've got the co-packing and, you know, you take out a lot of this extraneous noise right now? What What does that margin look like?

Well, I'm glad you asked. I was waiting for someone to ask about that because I talked about gross margins and all the ins and outs a lot in my remarks. So here's the reality, and this is going to be sort of surprising to some. We originally, when we came into this year, we were planning on putting a lot of our logistics costs, specifically warehousing, 3PL warehousing, and shipping to our 3PLs. into COGS. And so at last we spoke, there were some questions about where we felt we could get to. And we said, without giving guidance, we think we can easily get to mid-30s. Now, in talking to our auditors and in consultation internally, we decided, you know what, those line items really belong in G&A. So G&A are going to be a little higher. They're going to be lower than what they were in Q1 for sure, but maybe a little higher than what we'd originally anticipated because those costs are going to be in G&A And with some of the initiatives that are in COGS, we now believe we can push the envelope, and by the end of sort of Q3, Q4, second half of the year, we think there's a possibility we can certainly get into the low 40s, if not mid 40s, on gross margin.

Okay, but there'll be some offsets. Are you saying that G&A... on a quarterly basis, would be below what we just saw in this quarter, but, you know, maybe higher than it would have been otherwise?

Yeah, it doesn't change our EBITDA impact, where we think EBITDA is going to be going. But, yes, if you think about G&A, again, it will be lower than Q1, but it's going to level off, you know, definitely, definitely lower. than last year. We had $22 million in G&A last year. So, you know, if you think about it, think about, you know, G&A for the whole year being around, you know, two-thirds of what it was last year. That's very helpful.

Thank you. I'll see you guys later. Thank you. Thanks, Sean.

Ladies and gentlemen, as a reminder, should you have a question, please press star followed by the one. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.