Freshii Inc

TSX:FRII

Earnings Call Transcript

[Operator]

Greetings. Welcome to Freshii Inc.'s First Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded.I will now turn the conference over to your host, Paul Hughes, General Counsel for Freshii. Thank you, you may begin.

[Paul Robert Hughes]

Thank you, operator, and welcome to Freshii's First Quarter 2019 Earnings Conference Call. Joining me today is Matthew Corrin, our Founder, Chairman and Chief Executive Officer.Please note that remarks in this conference call may provide certain information regarding our expectations, future plans and intentions that may constitute forward-looking statements. I would refer you to our most recently filed management's discussion and analysis, which includes a summary of the significant assumptions underlying such forward-looking statements and certain risks and factors that could affect our future performance and our ability to deliver on these forward-looking statements.The first quarter 2019 earnings release, the related financial statements and the management's discussion and analysis are available on SEDAR as well as our Investor Relations website at freshii.inc.All figures discussed on this conference call are in U.S. dollars, unless otherwise noted.Following our prepared remarks, we will open the line for questions. As we will not be conducting any follow-up calls this morning, we encourage you to use this question period to ask us any questions you might have about this quarter's results or our business in general.At this time, I would like to turn the call over to Matthew Corrin.

[Matthew Corrin, Founder, Chairman & CEO]

Thanks, Paul. Good morning, everyone. I want to start by updating you on 2 central themes from Freshii during Q1 2019 and how they are contributing to our business. These 2 themes are menu innovation and traditional forms of marketing.Starting with menu, in Q1, we started rolling out our new streamlined menu. We eliminated our lowest selling menu items and highest waste ingredients in order to improve food costs and streamline our in-store operations. Our franchise partners are happy with the ease of ops, our guests are responding well to the newly designed menu boards and cost of goods sold and order and accuracy have improved. And equally importantly, we see no decrease in sales at all.In keeping with our new mantra, we are doing fewer things, but doing them better. So step 1 of our menu innovation was to streamline the menu. Step 2 is a total upgrade of our proteins. This has been a long time coming and we now have sourced a supply chain of full oven-roasted chicken breasts, baked salmon steaks, turkey meatballs and 2 elegant vegetarian proteins to start rolling out across our system this summer.We are just getting started our thoughtful and more frequent menu innovation cycle, which you'll continue to see and hear about.To complement our in-store menu innovation, we've also rolled out an exciting list of new consumer packaged goods, primarily in the drink and snack category, which are sold across our entire omni-channel network.In addition to some new healthy wraps and lunch boxes, in Q1, we've added immune elixir shots, kombucha in 2 flavors, a charcoal lemonade and celery juice, all Freshii branded as well as cocoa energy bites and additional trail mixes in the snack category.In short, our menu innovation pipeline is as exciting as I've ever seen it for our guests and our franchise partners.Our second area of focus for us in Q1 was expanding our traditional marketing footprint in many of our highest concentration markets. In our largest markets across North America this past quarter, we ran radio ads and billboards on busy streets and at transportation hubs for over 4 weeks focused on, "Let There Be Lunch" campaign. This was our first-ever traditional ad buy, and we now have built a baseline to iterate and improve on.We're using these more traditional initiatives to complement our store level and digital marketing and are beginning to see the positive impact that they're having. You can expect to see us continue these types of campaigns in both paid traditional advertising, complemented by our ongoing social and digital marketing strategy into the future.As you all have noted, our same-store sales came in at negative 0.9% this quarter. While this number is not yet back to where we want to see it, we are encouraged by the fact that we're heading in the right direction. The swing between Q4 2018 and this past quarter was a lift of over 5%. While the traditional and digital marketing initiatives that I described did contribute to this improvement, we also have to acknowledge that some of the shift is attributed to the Easter holiday slowdown falling into Q2 this year rather than Q1.I don't expect a full turnaround of sales in 1 or 2 quarters, but we are encouraged by the impact our recent efforts have had. More traditional ads are coming.Moving to store growth. This quarter, we opened 21 new stores around the world. However, in an ongoing effort to clean up the bottom bucket of our network, we also closed 14 locations. Our new net store count was 7 for the quarter. We believe we are making good progress in cleaning up the bottom bucket of our system by either closing sites or more ideally, transferring them to high-quality proven franchise partners, who have a desire for additional Freshii locations. We look forward to getting back to more normal net new opening levels in a few months, which we believe is realistic time line for this shift.Our pipeline remains strong. As at the end of Q1, we had 140 stores engaged in the active opening process. As a reminder, the active opening process includes any store that has a signed franchise agreement and is in site selection or lease negotiation stage or there is an executed lease, the store is in the design, build-out or preopening training stages of the process.We expect all of these active stores to open in the near to medium term. This means we expect our system-wide sales, royalty revenue and unit count to grow year-over-year through 2019.This past April, we had our largest confirmation day over the past 12 months of potential franchise partners who want to join our mission. We continue to receive quality interest from around the world and are being disciplined on who we invite to join our company. We believe our store count will continue to grow with both new and existing partners into the future.These new stores will open with an updated design that incorporates the latest technology and mobile ordering and culminating innovations and equally importantly, comes at a reduced build-out cost for our franchise partners.To get a sense of what I'm referring to, check out our Instagram page to see our newest store designs or visit our store of the future location, which recently reopened after renovation located in Toronto at the corner of Yonge and Bloor Street.Next, our omni-channel network is exciting and continues to grow. Our 100 Walmart sites are now open and operating and trending positively. Through our Shell partnership, we have launched 24/7 delivery via UberEATS, which is a very unique element for fast food and actually unprecedented for healthy fast food.For the first time ever in our brand's history, Freshii is now available 24/7, which goes back to our mission of making healthy food more convenient. We are selling a lot of food from midnight to 6 a.m. And I think that's pretty interesting.Our Air Canada partnership continues to grow in terms of sales, flights per day and numbers of products onboard. Watch for more menu innovation coming this summer.Finally, I want to update you on the continued strengthening of our Freshii HQ team. As I've said on past calls, we continue to evaluate our talent on a constant basis, making changes where necessary to ensure that we're serving our shareholders and franchise partners in the best possible way.Speaking personally for a second, late last year, I turned the lens on myself and evaluated my own performance. I recognized that the skills that allowed me to lead the brand to where we got are different from the skills required to get us where we want to be.So in short, I fired myself. I then rehired myself as a new CEO with a new focus on what's needed to continue our growth.In my first 100 days as our new CEO, I moved quickly to make necessary improvements. I increased our focus on data-driven decision-making. I upgraded our senior team to include more leaders with past public company restaurant experience. I upgraded our menu innovation team to include culinary professionals working to a faster innovation cycle. And overall, had built a more streamlined HQ team, who are doing less things but doing them better.I'd like to take this opportunity to thank my entire team at HQ and our franchise partners around the world for their ongoing commitment to our brand as we evolve the way we think about the business and move into the future.My people philosophy is that I don't want Freshii to just be a great place to work. I also want Freshii to be a great place to come from. And that's why today, the team is celebrating Craig De Pratto, who has been with Freshii as our CFO for over 5 years, but is now leaving to pursue a CEO opportunity with an early stage growth company.Craig will remain a friend to Freshii forever. I thank Craig for his support and partnership over the last 5 years. We have already begun an intensive search for a CFO and look forward to welcoming them to our team and introducing them to you in due course. In the meantime, our finance team is strong and continues to execute our day-to-day operations at a high level. I thank them for their leadership and extra work during this time of transition.So as I've discussed, we have made some really important strides in our business over the last few months. That said, I know we continue to have a lot of work ahead to drive growth and positive results for our franchise partners and shareholders. I look forward to reporting back to you on our progress each quarter.At this time, I would like to open up the call to any questions.

[Operator]

[Operator Instructions] Our first question is from Derek Dley with Canaccord Genuity.

[Derek Dley, MD & Consumer Products Analyst]

Matt, thanks for the update there. Just a couple of follow-ups on your marketing strategy. I think it was in Q4 result, you spoke about some regional marketing programs, which you were rolling out and looking to expand into some new markets. Can you just give us an update on how those have been progressing and perhaps how many markets you've targeted with those campaigns?

[Matthew Corrin, Founder, Chairman & CEO]

Sure. Derek, by the way, Craig is with me, so he'll answer any questions pertinent to some of the financial aspects. I just want to note that. We in Q1 started rolling out our first-ever traditional ad campaign in a half dozen of our largest North American markets. We define traditional, for the purposes of this conversation, where we bought billboards, radio spots, subway ads and bus shelters and so on.And so essentially what we do is at corporate -- at HQ, we design and produce the creative assets. So we create the billboards. We did photo shoots. We create the radio spot. And then we work with the stations and the marketing companies to help our local partners buy with their local ad funds, which they pool together to buy the advertisements.In Q1, we only had the benefit of about a month of the quarter with that traditional ad buy out there in the world. But even in that month, while it had some impact, we certainly didn't see the full benefit of a full quarter of the ad space and the ad volume, but we're actually starting to learn different things that we will then -- as we start to continue to deploy advertising into the future, we'll be able to apply. And so some examples would be brand-focused ad buys with our target guests in the ad as the main shot versus our hero product being the main shot like a Pangoa bowl or kale caesar salad as the focus of the shot. And so we're doing a lot of learning and testing. We did enough to start to learn some things. We have a lot more learning to do as we continue to deploy the ad buy.

[Derek Dley, MD & Consumer Products Analyst]

Okay. Look forward to seeing some of that in Toronto. Did you extend that to additional markets after the initial 6 or is that something that we should expect later this year?

[Matthew Corrin, Founder, Chairman & CEO]

So the way the ad buy works is we need to typically have at least in the bigger markets enough critical mass of store counts that local partners can pool their local 1.5% of sales ad budget together and then be able to afford to buy the space.So in unique situations, we also in a very small town could have 1 partner with 1 or 2 stores deploy their 1.5% ad buy towards a traditional ad campaign. But typically, what we're seeing is it's in the larger markets that have enough scale of store count where the funds are being pooled together, so that you can get enough billboards out there to blanket the entire city or region to have the greatest impact and bang for buck.

[Derek Dley, MD & Consumer Products Analyst]

Okay. And you also mentioned a global media campaign. Has that been rolled out yet? And what should we expect when we think about the global campaign?

[Matthew Corrin, Founder, Chairman & CEO]

So the global ad campaign is largely centered around the digital aspect of it. So while the traditional would be local partners pooling funds together, we are able to use our digital assets, Facebook ads, Google AdWords, Instagram and geo target around all locations that we operate. And so that as our target guests opens up those social media platforms, the marketing materials and the ad that you would actually see on a billboard is actually in a social -- a digital setting. And so that's been in place as well. We started to do that as well in Q1.And we're also -- similar to our learning with the traditional, we're learning with the social and tweaking that in real time as we continue to deploy it. But both traditional and the digital ad buys are definitely our future, Derek, and we'll continue to work with our partners to help buy those ad spaces to continue to get the word out there to complement our free PR and marketing strategies.

[Derek Dley, MD & Consumer Products Analyst]

Okay. And switching gears a little bit. Can you provide an update on your small market strategy? I guess it's probably tough to quantify, but what do you consider a small market? How many of these markets are you in? And are you still very pleased sort of with the initial returns that you've seen on these stores?

[Matthew Corrin, Founder, Chairman & CEO]

Yes. Derek, still very happy with that strategy of having large markets as well as small markets surrounding some of our larger markets. And so that skill of the stores that we opened in the quarter, they were still within that cohort. There were small markets as well as additional penetration within existing and larger markets.

[Derek Dley, MD & Consumer Products Analyst]

Okay. And then last one for me. And Craig, maybe this is for you. Can you quantify the impact that Easter had on the same-store sales number this quarter?

[Craig De Pratto]

Yes. Derek, the impact we saw was approximately 1% to 1.3%, so it's around right in the mid part of 1.15% was the total impact for Easter.

[Operator]

Our next question is from John Zamparo with CIBC World Markets.

[John Zamparo, Associate]

Just one housekeeping question to start. I didn't see an impact on the P&L for IFRS 16. Is that something you can share with us?

[Craig De Pratto]

Yes. John, the impact that we thought was not a material one, given we are -- we don't have leases or not on the leases of any of our franchise locations. The impact kind of on quarter 1 versus what would have been otherwise reported under the old standard was about USD 120,000, which has just shifted down below into depreciation and interest lines.

[John Zamparo, Associate]

Okay. Maybe talk about the recent app and website redesign. What's the reaction been to this? And have you seen a meaningful increase in usage, I would say, in general and also versus third-party order aggregators?

[Matthew Corrin, Founder, Chairman & CEO]

We have a lot of work to still do around our technology both inside of our stores as well as guest facing. I would expect to hear a lot more next quarter on how we're going to market. By then, we'll actually be in test stores with some of the latest features around our digital strategy. We continue to be on third-party delivery platforms. I talked a little bit about 1 interesting anecdote. Just as we rolled our UberEATS partnership through Shell, we suddenly realized that we became a 24/7 operation. Where most of our traditional restaurants close around 9:00, we're now, actually, because of the Shell's operating hours, able to deliver our food overnight. And there's this whole night shift of workers and -- at least I'm assuming it's night shift workers. But from the hours of midnight to 6 a.m., we're delivering a wide variety of our Grab & Go products. So I think that's interesting anecdote. And we think we can do more with that both with Shell and some of our traditional operating partners as well.

[John Zamparo, Associate]

Okay. That's helpful. On your retail partners, how does the pricing structure work on product and, say, a Walmart or a Shell store? It seems like there's some difference between these channels. So I'm wondering what say you have versus the retailer and what the margins look like for you relative to regular restaurant operations?

[Matthew Corrin, Founder, Chairman & CEO]

So the short answer with the retailers is everybody is a little bit different, John. In some cases, we have total visibility and work with the partner to set the right pricing strategy. In other cases, we don't. So I'm not going to focus on that part, but I'll just remind you that the supply chain and the product overlap to our traditional restaurant division is very different. So we make our product with a different supply chain and manufacturing facilities for our Grab & Go that ultimately get distributed to the retail partners.So the cost structure is different there, but we also deliberately tried to have very little overlap. So only about 20% of our menu items between our retail partners and our traditional restaurant partners are overlapped. The rest are unique items for each of those respective divisions. And the reason why we keep some overlap, and I'll use like an antidote around our green juice is across our entire network and our energy bites are across our entire network. And there's 2 benefits. One is, I view some of those items to be a gateway into our traditional restaurants. So to benefit our traditional franchise partners, a shopper at Shell or at Walmart or Air Canada can purchase a snack or a green juice and use that as a gateway to come in and have a full, more holistic eating experience inside of a Freshii when they don't want to eat on the go. But I also view that as we have scale of our juices and our energy bites and some of our other consumer package items, we're able to leverage increased purchasing power and help keep the cost of goods down for our -- all of our partners, both our traditional restaurant operators and our retail partners.

[John Zamparo, Associate]

I wanted to follow-up on the store of the future you mentioned. Are there plans to have this rolled out at existing stores? And if so, what percent of the network will you target?

[Matthew Corrin, Founder, Chairman & CEO]

So every year, we have franchise partners who go under renovation to upgrade the look and feel of their stores. So that's sort of a rolling process that is constantly in motion as stores are getting tired or coming up for renewal, they would be renovating. So as that happens, for sure, they're opening the newest look and feel, which would be closest to the store of the future and they'd be incorporating the upgraded technology aspects, the upgraded mobile aspects. The store of the future that is at Yonge and Bloor today, just to describe it -- if you haven't seen it yet, it's got a wall for our swag so like branded water bottles, branded sweatshirts, branded tote bags, so we're starting to sell some of that product because we saw a lot of customers emailing us, asking to buy that products. And now we started to put it up on the shelves to see if somebody -- if there's any incremental sales through that stuff because we're clearly seeing demand on our website as well a digital order and pick-up station, so a very deliberate alphabetized digital order and pick-up station. Streamlining some of our seating strategy, so you'd see leveraging vertical to get incremental seats in a given site.Our newest technology, so -- a space allocated for a kiosk ordering, an evolution of our digital menu boards, our new point of sale. So there's -- and then ultimately, like the look and feel and the design to optimize the cost of construction. So there's a lot of things that go into that store of the future. And as stores renovate, they would utilize as much of those aspects as possible to then renovate or -- and/or open their new stores.

[John Zamparo, Associate]

Okay. That's great color. Maybe to move to the closures. Are you able to say where the majority of these were?

[Matthew Corrin, Founder, Chairman & CEO]

It's still coming from -- I'd say, generally speaking, there's no clear trend of where they come from, but what I will say the caveat is, if a store closes -- if there's a store that's on that list, it typically would be in a market that doesn't have a penetration of additional franchise partners because typically what we see is if it's a location that we like and then it's a great additional opportunity for a partner within a given market who are doing the right things and want to add an additional site for a discounted price because when they're taking over a store, they are not paying full CapEx costs. But typically, it wouldn't be in our most penetrated markets where there is critical mass of franchise owners who are looking to add to their portfolio. The only caveat would be if it closed within one of those markets, it would have been that we deemed at corporate the site to not be viable for any type of partner. So typically, I'd say it's in markets that don't have additional franchise partners, who are looking to add sites to their portfolio.

[John Zamparo, Associate]

Okay, understood. And last one for me, still with the closures. You mentioned you're looking to clean up the system. You're removing some underperforming stores. At what stage do you feel that cleanup is complete? And I guess another way of asking that is how many more quarters do you anticipate the closures will be elevated relative to your history?

[Matthew Corrin, Founder, Chairman & CEO]

I gave a little bit of color on -- in my prepared remarks. I think we have some more months to go to be really cleansing the partners that we don't think are right for our brand. I mean I also think in some ways, John, that this cleansing like it's obviously our franchise network is aware of it. And in some cases, they are not looking to exit our system, but we think it's the right thing to do to protect our broader brand. So there's a definitely some aspect of a wakeup call going on right now, where partners are being asked to leave the system, having to transfer stores over. We are -- they can go back into that store as a customer and see that traffic is up 300% within 60 days of a new owner operating it because they are doing all the right things that drive a successful and profitable operation. So there's a little bit of that going on where partners are waking up to it and getting closer to where we want them to operate. I would say we are not going to put a specific month or quarter that we think we're fully satisfied with the cleansing, although we do think our goal is to rip the Band-Aid off and not drag it out for years and years and years.

[Operator]

Our next question is from Elizabeth Johnston with Laurentian Bank Securities.

[Elizabeth Johnston, Analyst]

Can you talk a little bit about menu innovation. You mentioned specific protein improvements. Maybe you can just list them again, if you wouldn't mind? And are any of these part of a limited time offer or are they permanent menu items?

[Matthew Corrin, Founder, Chairman & CEO]

Our intention is as long as menu items are selling, they are going to be permanent menu items. So with the protein specifically, it's our intentions that they'll live and thrive on our menu forever. Some of the specific examples -- and I'll just share that they are not live at any stores, but I shared it because it really is Phase 2 of how we think of a long-term menu innovation for our restaurant partners. And I think it's the biggest -- it's probably one of the more impactful innovations that we've ever done to our restaurant division because we've -- we know that a lot of our guests would like to see better quality proteins. And we felt like we had to get that right as it relates to costs of goods on those better quality proteins as well as the price to the guests and where the threshold became too expensive or still in the affordable value to quality ratio.The proteins are a full breasts of chicken, a full piece of baked salmon, large turkey meatballs, an evolution of our tofu, so how we marinate our tofu and how we prep our tofu and elevation of that as well as an elevation of our falafel. So it leaves us with 2 plant-based proteins. Turkey meatballs, which are popular and delicious and nonmeat -- non-red meat. And then the best chicken that we've ever served and the best chicken that we can source on the menu, which -- I'll just give you a little sneak peek. The chicken is by far -- and I think it was like this for many fast-casual restaurants. The chicken is by far our bestselling protein on our menu today. So the way we think about it is if we can really go deep on elevating our chicken as the first and foremost, I think that's a great step in the right direction for a broad demographic of our current guest.

[Elizabeth Johnston, Analyst]

And are you still going to be offering a beef item?

[Matthew Corrin, Founder, Chairman & CEO]

This -- as we roll out that next level of the menu, unless it's a very unique case by case, our intentions are to not sell beef. And in fact, in Phase 1, which was the streamlining of the menu, we went away from beef because we weren't proud of the product. And almost across-the-board, and I'll say -- I'll caveat almost because there are a few examples where we put beef back on because it was such a good seller in that respective city, and I'll let you guess where. But almost across-the-board, nobody missed the beef, both the franchise partners and the guests. And as I mentioned, there was no -- they were either going to another protein or maybe adding some extra vegetables for their protein.

[Elizabeth Johnston, Analyst]

And you mentioned these are not currently live. Did you have any specific test markets where you were testing these items in a whole or in part?

[Matthew Corrin, Founder, Chairman & CEO]

Yes. So our rollout strategy has evolved as we've brought on some of our new leaders from other restaurant brands who have been doing this longer than us and in more data-driven scale than us. And so we have a very systematic approach to rolling out that streamline menu that I shared as well as how we're planning to roll out our proteins. And I won't give specifics, but I will say it does contemplate testing in stores that allow you to do proper AD testing as well as in stores that become based on their performance really bellwether of how a broader network would perform.

[Operator]

This concludes our question-and-answer session. I would like to turn the conference back over to management for closing remarks.

[Matthew Corrin, Founder, Chairman & CEO]

Great. Thanks, operator. And thanks, again, for your time this morning and your continued interest in Freshii. We look forward to providing an update next quarter.

[Operator]

Thank you. This concludes today's conference. You may disconnect your lines at this time, and thank you for your participation.