Colabor Group Inc.

Good morning, ladies and gentlemen, and welcome to the Collabore's third quarter 2024 results, résultat du troisième trimestre 2024 de Collabore conference call. At this time, all lines are in listen-only mode. Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call has been recorded on Friday, October 18, 2024. I would now like to turn the conference over to Louis Frenette, President and Chief Executive Officer. Please go ahead.

Thank you. Good morning, everyone, and welcome to Calabas Group's third quarter of fiscal 2024 results conference call. This is Louis Frenette, President and Chief Executive Officer. Last evening, we released our earnings results for the 12th and 36th week period ended September 7th. The press release and disclosure documents can be found on our website at sidarplus.ca. The accompanying presentation, including our statement on forward-looking information and non-IFRS performance measure can also be accessed online in the investors section at colabar.com. Joining me today on this call is Pierre Blanchet, our Chief Financial Officer who following my initial remarks will provide an overview of our financial results. Considering ongoing headwinds in the restaurants and retail channels that have resulted in a flat to no growth across the restaurant industry, our ability to grow our distribution business with new customers and growing purchasing volume among certain distribution customers demonstrated that we can still win in a challenging macroeconomic market. According to Restaurant Canada, last available data point, commercial food service sales in Quebec in July were up 2.2% on a nominal basis, and when adjusting for menu inflation, real sales were down 0.8%. During the third quarter of 2024, Color balance distribution sales grew 1.5%. This growth contributed to market share gains of 6.8% year-over-year, bringing our market share to 11.1%, up from 10.3% in the equivalent quarter of last year. I believe this once again demonstrates the resiliency of our business and unique value proposition, which continues to position us well in organic and non-organic market share gains. Our focus on growing our distribution platform allowed us to mitigate a reduction of 10.1% in wholesale revenue in second quarter of 2024. Our wholesale customers are more exposed to restaurant industry than we are and to the effect of a weaker consumer backdrop. Higher cash flows from operation allows us to reduce our net debt. This demonstrates the cash generation capabilities of our platform, even as lower volumes weighted on our operating profitability. Let's keep in mind that we are just starting to prudently scale our recently complex growth CapEx, which contributes to operating efficiencies as we grow ourselves. It has now been three quarters since we moved into the new hybrid distribution facility in Saint-Bruno-de-Montarville, and five months since we completed the transition of our existing customer to the new facility. We continue to work on many fronts to further improve our productivity and operational efficiency, and we are achieving good service levels. We started onboarding new customers, mainly smaller independent restaurants. We remain confident in our ability to continue gaining market share, compensating for the effect of the reduction in spending in the restaurant industry. Just this morning, we received confirmation that the agreement between Calabar and the institutional customer, which was subject to a public bid solicitation process, was renewed. The press release just hit the wire. The two-year agreement effective December 2024 includes two six-month renewal options at the customer's direction. This agreement represents approximately 11% of our expected revenues for the fiscal year 2024. This contract was awarded based upon a prevailing economic condition in the markets with significantly lower margins than currently enforced. In order to proactively manage the situation, Carabao has already identified several opportunities and measures in order to reduce the impact on future earnings. This demonstrates that we can win in a competitive market against large players. Please turn to slide number six of the document to see how our 2020 and 2025 plan is evolving. Efficiently managing our customer mix and product portfolio has allowed us to raise our gross margin in the past few years. As we onboard new clients with varying profitability profile, our job will be to pull on these levers to raise the lifetime value of a diversified customer base within the HRI and retail market. We can do this by increasing the share of private label We sell to our customers by improving our routes and field capacity. We also remain focused on growing our distribution platform both organically and with accretive acquisitions. New customer acquisition in and around Montreal in a slower market demonstrate that we are still in a very good competitive position. Our pipeline of M&A opportunities is also filled with accretive targets of varying size, so we are confident in our ability to improve efficiencies as we gain new customers organically and non-organically in the medium and long term. The new facility, along with continued improvement to our employer brand and better communication practices, are helping us keep our employees motivated and engaged. Our focus on quality and locally sourced offering is serving us well. and is becoming a hallmark of our differentiated offerings. It is helping us keep and win new business and it is key pillar of our success. Our private label sales are also doing well and they contribute to our competitiveness with a well-priced and differentiated quality offering. We are just wrapping up a very busy summer season. Our team dedicated to improving the efficiency of our new distribution activities and working to grow our presence in our territories.

Pierre, on this, I will turn the call over to you, please. Thank you, Louis, and good morning, everyone.

I'm pleased to be here today to discuss our key financial results for the third quarter of fiscal 2024. Please refer to slides 7 to 10 of the presentation for highlights of our financial performance in the quarter. In the third quarter of 2024, sales were down 1.6% at $162 million. Revenue from our distribution activities increased by 1.5%, while our wholesale activities were down by 10.1%. Volume growth from M&A, market share gains, existing customers, and the contribution of 1.1% inflation pass-through allowed us to mitigate the effect of lower customer spending in the restaurants and retail channels, which had a larger impact on our wholesale business. Consolidated Adjusted is a debt from continuing operation reached $9.5 million, or 5.9% of sales, compared to 11 million or 6.7% in the third quarter of last year. As Louis mentioned, consumer spending was relatively strong in Q3 of last year before slowing down towards the end of the year. So lower volume combined with higher operating expense under utilization of our new distribution center and investment in sales and marketing weighted on the profitability. Net earnings were $1.2 million, or $0.01 per share, down from $3.5 million, or $0.03 per share, in the third quarter of 2023, mainly from front-loading of interest expense associated with the amortization of the new lease obligation in St. Louis, and lower adjusted EBITDA. Cash flow from operating activities were $9.9 million in the third quarter, up from $8 million in the equivalent quarter of last year, resulting from lower utilization of working capital. There were no significant CapEx investments aside from our regular basic maintenance. In 2024, we continue to guide our total annual CapEx in the range of $2 million, primarily for maintenance and smaller optimization projects. We ended the quarter with lower net debt of $50.7 million, down from $61.5 million at the end of 2023. We have made some adjustments to how we report leverage ratio to better align with the ratio used by its lender and to reflect its actual financial position. At the end of the quarter, we had $28.5 million of available borrowing capacity on our credit facility. I would now like to turn the call over to the operator for the Q&A period.

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 touchstone phone. You will hear a prompt that your hand has been raised. Should you wish to decline from the polling process, please press star followed by the two. If you are using a speakerphone, please lift the handset before pressing any keys. One moment, please, for your first question. Your first question comes from Kyle McPhee with Cormac Securities. Your line is now open.

Hi, everyone. Thanks for taking my questions. To start, so your filings mentioned that your distribution platform has added volume in new territories. I'm trying to better understand the size of that moving part so far. It sounds like you're adding independent restaurants. Can you ballpark quantify the year-over-year volume impact from these new winds and new territories? Or just broadly, are we over or under 1% range?

Hi, Cal. Thanks for your question. It's Louis. We estimate that it's about 4% new volume from existing and new customers. Of that, we have taken consideration that we did a small M&A, and that's around 2.2%, and inflation is 1.1%.

Got it. Okay.

And are you continuing to see these new independent restaurant wins kind of snowball into Q4, or is the macroenvironment creating a headwind for you to be winning new business?

We continue to develop the business. We're positioned to win more business in Q4 and into 2025. We continue to develop in the new and existing territories. So as you remember, we put more reps in Western Quebec to develop that market, and it's working well. And it's helping... It's helping our results in the tough macroeconomic environment, especially the restaurant's business. So we're confident that we'll continue to win new business and grow the share of Wallet.

Got it. Okay. And you mentioned a volume benefit from one of your clients is increasing purchasing volume. What do you mean by that? Can you explain that?

Yeah. What's that?

Go ahead, Louis. Yes, certain existing customers are growing, having more restaurants and ordering more volumes. So some are gaining.

Okay, so the clients themselves are just gaining share and they happen to be your clients. That's what you meant by that.

Yeah.

Okay. Shifting over to operating costs, most of the moving parts, And your operating costs were perfectly as expected, so great cost control from all of you during this tough macro period. But the line item that you referred to as other operating costs was higher than I thought, higher than recent quarters. Can you explain the source of the increase for that line item? Is it marketing costs that are buried in there as you pursue growth?

Good morning, Kyle. It's Pierre. Thanks for the question. Yes, what's in there is that we have a purchasing group for which we report the revenue in the revenue section. But there's a volume rebate or there's a customer rebate that comes with those purchasing group. And that rebate gets recorded in that line. Therefore, when this line increases because of that, that's a good news. It means that the purchasing group had higher volume year over year. Therefore, the rebate, the volume rebate given to participants of that purchasing group is higher, which looks like bad news, but it is a good news.

Got it. Okay. Okay, yeah, I understand that moving part. It's good to know that that's what it was. And then last one for me here on your gross margin percentage. So there was a minor year-over-year decline in Q3. I just want to make sure I understand the moving parts that may be triggering this. So am I correct to assume that independent restaurants are experiencing the biggest macro hit within your distribution business, and that also happens to be the highest margin portion of your volume? Is that what's going on here?

Yeah, exactly, Kyle. It's the effect of the lower restaurants and stable institutional sales. So definitely the restaurant is the larger piece in there.

Okay, I'll pass the line. Thanks for the answer. Thanks.

Your next question comes from Frédéric Tremblay with Desjardins. Your line is now open.

Thank you. Good morning.

First of all, congrats on renewing the large contract with the institutional customer. In the press release, there was a mention about, and you spoke about it as well, about the contract having lower margins than the current contract. Is there any way for you to maybe clarify a little bit the magnitude of the margin decline initially and provide a bit of color on some of the opportunities that you may have going forward to bring that margin up over time?

Yes, there will be an impact. The contract that was renewed was renewed at the lower margin as it is in every bid process. So we bid low and we try to improve the margins over time. There will be an impact on profitability, but we have already determined and will implement mitigating measures to reduce the impact. So yes, there will be an impact, and we don't share numbers. We don't provide that to the public.

Okay, that's fair. Just in terms of the mitigating measures then, Does that include things like private label products or are we talking about something else? Typically, in a situation like this, how long would it take for those mitigating measures to have an impact on the contracts margin?

Usually, it doesn't happen day one, but we already prioritize some projects and we're, as mentioned before by Pierre, we're or the comment of Kyle, we're working hard on cost management. So this will cover a portion. And, yes, we're pushing our business on the private label side, which has greater margins. And we continue to develop our organic business to gain customers and gaining – with targets of gaining market share. So, all of these are helping. And also, we're looking at accretive M&A opportunities. So, all of that should reduce the impact at one point in time. Over time, it will be covered.

Okay. Yeah, that's really helpful. Thank you for that. Maybe a last one for me. Has there been one category in particular in Western Quebec where you've been more successful in driving new business lately and just maybe provide a bit of color in terms of where you're at, in terms of your volumes being gained there versus initial expectations? I know it's a difficult environment in the restaurant space. So has that had an impact on your initial volume ramp up in St. Bruno or are you on track with what you're expecting?

Yeah, even though the restaurant market is as strong as Edwin, as you all know, we were able to gain smaller independent restaurants and more in the full service category. You were asking about categories, but the restaurants we're gaining in western Quebec are especially independent restaurants with a better margin. So our plan is The fact that the restaurant business is slower doesn't block us to gain customers. There's no relation between the trends if restaurants are strong or weak. We continue our development path as planned in our strategic plan, and our job is to fill the capacities in St. Bruno as soon as possible. So nothing has changed in regards of our strat plan. IP with the gains we're making in Western Quebec. Some gains in Eastern Quebec also were much more developed, so a lot to win in Western Quebec.

That's very helpful. Thank you very much. Thank you.

Ladies and gentlemen, as a reminder, should you have a question, please press star 1. Your next question comes from Michael Glenn with Raymond James. Please go ahead.

Hey, good morning. Just on the cost mitigation that you're looking at, I think we should probably think about that more on the SG&A line. Is that a fair assumption?

Hi, Michael. Thank you for the question. If I understand, you're looking for the geography of our mitigation?

Yeah, it would be like you're referencing you're going to take some cost mitigation effects to offset the pressure from the new contracts. Would that predominantly be SG&A initiatives that you're looking at?

Predominantly, I wouldn't say that. I would say it's all over P&L. So we have measures on the stock line, operational efficiencies, and SG&E as well.

And then just stepping back and looking at some of the challenging situation facing the industry right now, as you're onboarding, I'm just trying to get a sense, how do you assess some of the credit risk element associated with the independent restaurant space? when you're thinking about adding these new clients on?

Well, there's very little risk because they usually pay before we send the next order. So this industry is managed tightly. It's not only Calabar. This is a practice of the industry. And we... As you saw, there were many restaurants that closed during the year across Canada and maybe a couple of hundreds in the province of Quebec over the last year. And we have good credit checks. Sorry for my English, but we're good at credit. being paid and there's very little risk on that.

That's excellent. Just the lease payments on the cash flow statement are coming in, I guess, lower than I would have thought. The lease liability payment was 1.8 in the quarter. Is that the good run rate or should we expect that number to step higher at some point in the future?

you're correct. I think we did a good job in negotiating the lease and we had a free period, three months at the beginning of the lease, the new lease. But yes, it's not the actual run rate that you have so far after 36 weeks. But it's going to recover or go back to norm shortly.

Are you able to say what the, let's call it $2 million average year to date in quarterly lease liability payments? Is that Are you able to say, like, is it up a million dollars or something like that on a quarterly basis? Just trying to get a sense of how much the increase could be.

The run rate will be close to 2023, I would say. I think it's a fair estimate that we will go back to closer to 2023. Okay.

And any thoughts on working capital from here? You had a small inflow in the quarter, which was positive. Like from here, should we think that working capital is in the right place? Or should we expect some further growth?

No, no, no. It's in the right place. It's in the right place.

Okay. And then just the update on the CapEx spending you're looking at. the year and maybe an early read on next year?

In my prepared remarks, I mentioned that $2 million is probably where we're going to end the year in or about. And I'd say next year, I don't expect anything much greater than that. We have the regular maintenance capex and some optimizations So in the range of two to three, as we mentioned earlier this year, is a good range. This year, you know, considering Edwin's and stuff, we slowed down. That's part of our prioritization. So may not reach two this year or close to. And next year, well, it's going to be back to about the same range.

Okay. Excellent. Thank you for taking the questions. Welcome. Thank you for being there.

Your next question comes from Kyle McPhee with Cormac Securities. Your line is now open.

Just one follow-up from me. I'm just trying to better understand the margin impact on this contract renewal. I know you're not going to quantify it for us, but is it fair to say that that client would have already been a much lower gross margin percentage type client versus you know, the average for Colobor as a whole, given, you know, big clients typically have lower gross margin attached to the client. Like, is that a reasonable starting point?

The client had a good gross margin. And as I mentioned, it's going to be reduced significantly. And we have the mitigation actions to... to reduce that margin reduction. Kyle, if you remember when we were in COVID, we changed a mix of our customers. We were way too long in restaurants, and we went through COVID in an excellent position because we diversified our portfolio. So when you bid on... on schools, on hospitals, jails, the margins are okay. They start low, and we can adjust them over time by selling more menu, sorry, our private label brand. So at the end of the contract, the margins are good. But when we start, it's always much lower, and we know how to navigate that. with this and the more we'll have, the more institutional contracts we'll have, the gross margin may be reduced but at the end of the day, we capture up, we grow it over time. It's something that we have in our cards and we plan to do, continue to do, and the focus of the team is to minimize the effect at the beginning and maximize the revenues on the mid and long term.

Got it. Okay. So I think I understand all those moving parts. I guess as one last final challenge, is it fair to say that these types of institutional clients would be lower gross margin than, let's say, an independent restaurant?

Absolutely. Okay. Okay, thank you.

I don't know for the questions at this time. I will now turn the call over to management for closing remarks.

Thank you, and thanks, Kyle, and Michael, for your questions. for your questions. I'm proud of our team and our ability to navigate through these macroeconomics . Our diversified customer base and efforts to grow our business clearly contribute this quarter. As we look ahead, we are laser focused on penetrating new markets and improving the lifetime value of our customers. Our teams and facilities are in great shape to receive more volume as we gain market share. We continue to grow on improving our product mix and operations to support our profitability targets. And we are managing our balance sheet and operational cash flows to position us well in the current context and to be able to execute our strategic plan in a proactive and opportunistic manner. We are ready for our second phase of growth. Our teams have worked hard to help us achieve this solid position and maintain our competitive edge. I'm excited about our growth prospects and of the unique value proposition that we are increasingly recognized for in the marketplace. This concludes our call for the third quarter of the fiscal year 2024. Thank you all for joining us and stay safe and healthy.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.