Freshii Inc

TSX:FRII

Earnings Call Transcript

[Operator]

Greetings, and welcome to the Freshii Inc. First Quarter 2022 Earnings Conference Call.

[Operator Instructions]

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Paul Hughes, General Counsel.

Thank you, Paul. You may begin.

[Paul Hughes, executive]

Thank you, and welcome to Freshii's First Quarter 2022 Earnings Conference Call. Joining me today is Matthew Corrin, our Founder and Executive Chairman, and Daniel Haroun, 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 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 2022 earnings release, the related financial statements and the management's discussion and analysis are available on SEDAR as well as the Investor Relations section of Freshii's website at freshii.inc.

All figures discussed on this conference call are in Canadian 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 our results or our business in general.

At this time, I would like to turn the call over to our Founder and Executive Chairman, Matthew Corrin.

[Matthew Corrin, executive]

Thank you, Paul. Good morning, everyone. Since founding Freshii more than 17 years ago, we've grown from a single salad-focused food court counter in Downtown Toronto, into a global health and wellness brand, spanning 13 countries now with 3 distinct business units, bringing healthy food to citizens of the world. The omnichannel health and wellness brands that I'd envision for Freshii has become a reality, and I believe that we are well positioned to serve the health-conscious consumers of the future.

As the company works to realize its full omnichannel potential, I believe that we will be best served by the appointment of Daniel Haroun as our CEO. Daniel and I have worked extremely closely together during his years as Freshii's CFO, and I've come to rely on his expertise and judgment in all areas of our business. This expertise and judgment combined with Daniel's pre-Freshii leadership experience at global franchise restaurants and retail grocery operators gives me great confidence that Daniel is the right person to lead Freshii through the next phase of our omnichannel growth.

I want Freshii to have intergenerational relevance for our customers, our team members, our franchise owners and our shareholders. And I believe this vision will be best realized by transitioning responsibility for the day-to-day leadership of the company to Daniel and the incredible team he has today and that he will continue to build around them.

In my new role as Executive Chairman, I intend to maintain my significant shareholdings in Freshii, be our biggest brand champion and our most loyal guests. I am confident in Dan's ability to lead our brand and culture on a path that is accretive to the company's share value. Thank you to all of our team members, our franchise and retail partners, and our shareholders, I believe the best is yet to come.

I will now pass the balance of this call to our CEO, Daniel Haroun.

[Daniel Haroun, executive]

Thank you, Matthew. It is such an honor and a privilege to lead our organization, and I'm so excited to get started. Our brand's first stage of growth had no precedent. Matthew and the team scaled the business rapidly and in doing so built a remarkable brand people love and trust. I want to thank Matthew for the opportunity to lead our next chapter of growth and recognize the incredible work Matthew and the team have done to scale the business to where it is today.

This week, I had the opportunity to spend time in restaurants with our franchise partners, including one of our most recent openings in Belleville, Ontario, 2 hours East of Toronto. This location was opened by a first-time franchise partner, Patrick, and I had the ability to spend some time with his team. Patrick and I actually both began our journey with the Freshii brand at the same time in August 2019. Patrick began exploring Freshii as a brand as we consider taking its first steps as an entrepreneur. And I joined Freshii as CFO right before the onset of the pandemic.

Fast forward to now, there's been no shortage of challenges and pivots along the way both for Freshii and myself but also for Patrick, and we're so excited that Patrick was finally able to open his first restaurant and Freshii was able to open in a market like Belleville with a population of over 50,000 for the first time. The restaurant looked great. It's off to a fantastic start, and Patrick is sprinting towards opening his second and third locations next year as part of his initial 5-restaurant development plan. We are so excited to support Patrick in his entrepreneurial journey as a small business owner and are proud of how he has represented the Freshii brand so far.

I also had the opportunity to spend time with a number of franchise partners across Ontario, who've been with the brand for many years, discussing the uneven recoveries across their locations and the significant challenges they face today, both in inflationary pressures across the supply chain and the availability of labor.

Whether it's a franchise partner who just opened the first location or one who's been with the brand for a decade. What's so clear to me is the passion and belief in the brand is alive and well. Our partners have touched so many communities in driving our mission forward, but have also just gone through the most challenging 2 years in our industry. In the states and provinces across North America, where Freshii currently operates, there are hundreds of market cities or talents where Freshii could expand, and we've made significant progress in recent quarters on that planned geographic expansion.

The tremendous potential is exciting for our brand, but we also need to take the time to reflect on learnings from our first stage of rapid growth and ensure we are growing while strengthening the fundamentals of our business as well. Our growth will be driven by happy, profitable franchise partners delivering an incredible customer experience and those elements will be at the core of our go-forward plans.

Now shifting gears, I want to touch on our development pipeline progress and a high-level overview of our financial results today. I recognize these results are part of a very different operating environment, especially in Canada with the onset of the Omicron variant. As discussed last quarter, our real estate and development teams have turned their focus to growth and building our growth pipeline for 2023 and beyond.

Between our performance-based incentive program for qualified existing Canadian franchisees, previous development deals as well as recently signed multiunit agreements, we now have a pipeline representing over 100 new franchise locations to open. As we prepare for this growth, we expect to make investments in our franchise development, real estate, store design and store opening teams in the second half of 2022.

Now turning briefly to our financial results for the quarter. In Q1, consolidated revenue was $9.6 million, an increase of $5.9 million versus Q1 of 2021, driven by the inclusion of mature market results, strong underlying growth in our CPG business and year-over-year recovery in our North American franchise restaurant business. Q1 SG&A was up $1.8 million versus Q1 of 2021, driven by the inclusion of mature market in our results, timing of restaurant marketing spend, and a onetime charge in our Enterprise segment to exit a lease, which is one of only the 3 that the company was an intermediate leaser on from several years ago.

Q1 consolidated adjusted EBITDA was negative $0.7 million, which represents a decline of $0.2 million versus Q1 of 2021 as a result of the SG&A I just mentioned. Excluding the timing of marketing spend, adjusted EBITDA would have been flat to Q1 2021. As a reminder, Q4 and Q1 are typically our smallest revenue quarters from a seasonality perspective.

We do expect that as mature markets begin the last periods of abnormally high growth in the prior year, the year-over-year sales comparisons will reflect this reality through the balance of 2022. However, we remain excited about the long-term growth potential of the mature market.

Finally, I am pleased to have Victor Diab joining us as CFO from Canadian Tire. I've known Victor for several years and his finance background in franchise retail, e-commerce, loyalty and M&A will be a welcome addition to the team, and he will be joining us later in June, and you'll hear from him on subsequent calls.

In the coming weeks, I will work collaboratively with our franchise partners, store managers, restaurant team members and our team at our partner support center in Toronto to track our growth plans for the future, beginning with working with our franchise counsel coming to Toronto in 2 weeks' time.

I look forward to sharing further details on our obvious call, and we'll now turn the call back to our operator to open up for your questions.

[Operator]

[Operator Instructions]

Our first question is from Derek Dley with Canaccord Genuity.

[Pulkit Sabharwal, analyst]

This is Pulkit on for Derek, I am his associate. I just wanted to extend my congratulations on the transition. Best of luck with everything. A couple of questions on my end. You've talked about the restaurant growth potential and the new location potential over the course of the year. I just wanted to understand the pace of it in terms of how you're thinking about it, should we looking at more H2 or you also have some openings that are planned for Q2 as well.

[Daniel Haroun, executive]

Thanks for the warm words and the question. As we've touched on in previous calls, our primary focus in 2021 from a real estate and development perspective was supporting our franchise partners with lease of rent negotiations at a time when there was a significant amount of government restrictions and limits on traffic into their locations. We then shifted gears back into development about 6 months ago.

And as a result, in 2022, we do expect to have lower openings than we've had in recent years, but again, have spent our time and effort renegotiating those leases and then starting to build back that development pipeline. So we would expect to see incremental development pipeline versus the pace you've seen in the past several quarters, begin in 2023.

[Pulkit Sabharwal, analyst]

Okay. That's very helpful. And then you talked about on your restaurant opening in Belleville, could you just remind us of all the -- when you think of small cities in Canada, what is the potential that you're looking at in terms of store openings over time?

[Daniel Haroun, executive]

Sure. We did -- we've done an extensive market mapping of the Canadian market in the summer of last year and believe that there is significant runway to more than double our restaurant count in the Canadian landscape alone. And so we've got about 275 locations, give or take, in the Canadian market. So that gives you a sense of the amount of runway that we see and that runway exists both in -- continued to the existing core urban and continues to exist in suburban, small town locations as well. So we're really excited for the growth to come for our brand and for our small business entrepreneurs to continue to have an impact in the communities where they live and work.

[Pulkit Sabharwal, analyst]

That's very helpful again. And then one last one actually. In terms of the labor market, Q1 was a little bit tricky as reported by other companies as well. I just wanted to get a sense of what you guys are seeing on the ground and how have things changed since Q1.

[Daniel Haroun, executive]

Yes. We definitely continue to see our franchise partners with -- operating with fewer operating hours than they've had at the beginning of the pandemic. On average, operating hours are down more than double digits on a per location basis, which obviously has an impact on our sales and our traffic. We're going to continue to work with our franchise partners on gradually adding back operating hours in a thoughtful way, recognizing the current labor challenges that we see in the market.

[Operator]

Our next question is from Liam Dotchison with Cormark Securities.

[Liam Dotchison, analyst]

So just to follow up on that original store opening question. Can you provide any additional color on whether there's going to -- that's going to come with an acceleration of new openings solely or also an end to closure. So if you keep opening new locations at a similar rate as has been showing up? Is there going to be a similar decrease in closure pace that we've seen over the past couple of quarters.

[Daniel Haroun, executive]

We do expect closures to significantly moderate. We included incremental disclosure in our MD&A this quarter, Liam, around really, the difference between the top 85% of our system and the bottom maybe -- bottom 15% of our system from an AUV and traffic perspective. And it's really driven by the fact that we still have a number of locations where they're relying on office traffic and that office traffic has not come back yet.

We're going to continue to work with those franchise partners in that, call it, that bottom 15% that represent about 5% of our system sales and revenue to work on the best strategy for that location, whether it's a relocation, whether it's rent negotiation, whether it's a simplified menu to continue to protect that location where possible and unfortunately, sometimes they're on locations that have to close because the dynamics of that trade area have changed for the short and the midterm.

So we would expect closures to begin to slow down as we get into 2023. But recognize that, call it, bottom 15%, which represents about 5% of our revenue. We do need to work on store by store on the right strategy for that trade area and maybe that location isn't the right location for that trade area any longer and there's an opportunity to enter a different retail node in the coming year.

From an openings perspective, I'll refer back to the earlier comments, we do expect to continue to move through our development pipeline at pace, and we'll be adding resources to be ready to handle that for 2023 and beyond. And so ideally, if things continue to progress, you'll see development start to slightly accelerate and then closures start to slowly reduce gradually over time as we work through some of these trade areas literally store by store.

[Liam Dotchison, analyst]

Great. Awesome. Just to follow up on that, too. Regarding the new store pipeline of 100 locations that you mentioned earlier, some of these new locations, you said we'll have a temporarily lower franchise royalty rates. So can you guide us on any additional color on how material that temporary reduction is? And will it move the needle for the consolidated royalty rate we've been seeing in the results or is it more immaterial?

[Daniel Haroun, executive]

I appreciate the question. We're not going to give further guidance on that at this point in time. Later on in the year, once we have better visibility to the timing of leases and opening dates, we'll be able to share that in a bit of a framework that helps you understand the impact on the consolidated royalty rate. But just rest assured that there isn't an impact to the long-term royalty rate. And these -- again, these are performance based incentives. And so obviously, it does also depend on how these locations open up and when they open up as well.

[Liam Dotchison, analyst]

Got it. Got it. Okay. Last one on the restaurant segment. Regarding your SG&A, which was down materially quarter-over-quarter here. I also see your commentary that segment SG&A will be increasing as you invest in real estate, store design, franchise development teams. So can you guide us on what to expect for SG&A from this segment, whether specifically or maybe just stressing on how the EBITDA margin percentage might be managed for the segment?

[Daniel Haroun, executive]

Absolutely. I appreciate the question. The SG&A is also a factor of the timing of the seasonality of the quarter as well and the revenue that's coming in from an add-on perspective is essentially a flow-through on the SG&A line as well. So there's often moving parts there that we can help you better understand with commentary around timing. But we would expect SG&A to increase from current levels in the restaurant division as we invest both in growth in adding these new locations, but also investing and strengthening the recovery of our franchise partners as well.

So I would say both those elements you should expect to see incremental spend on. And from a long-term perspective, we would expect that call it, beyond the next 12 months that the restaurant division would continue to grow both sales and profit at a fairly aggressive pace as we continue to see brighter days on the other side of the pandemic.

[Liam Dotchison, analyst]

Good to hear. Just a couple more. Moving on to the retail and e-commerce segments. So specifically, the CPG subsegment. You now have 1,500 approximately points of distribution, which was a pretty big lift versus last quarter. So beyond the 7-Eleven wins that I don't think make up the entire gap. Can you give any color on the additional new ones that might be making up the rest of that jump through?

[Daniel Haroun, executive]

There wasn't a significant addition beyond the 7-Eleven in the recent quarter. There has been some expansion with existing retailers that's fairly small from a point of distribution count and then we've had some food service and other locations start to reopen as well versus where we were in December as a result of Omicron. But I would say 7-Eleven the biggest incremental point of distribution count in the quarter versus where we were 90 days ago.

[Liam Dotchison, analyst]

Great. And then just another follow-up on that, sorry. So the growth for point of distribution seems to be a little bit higher than the retail revenue growth that showed in Q1, where I guess, dollar revenue growth is actually down quarter-over-quarter. So just any additional color on the disconnect on why revenue expansion is trailing that distribution expansion would be great.

[Daniel Haroun, executive]

Yes. From time to time, we will have a temporary, call it, departure and the relationship between points of distribution and revenue. But as you know, in the long term, those should continue to be good litmus tests. The points of distribution difference versus revenue is really driven by 3 factors. One would just be changes in seasonality in the business with some of our retailers between the fourth quarter and the first quarter.

The second would be the fact that we do have a time -- a small amount of pipeline fill into a new retailer so that might happen in the quarter before you start to see point of sale or revenue start to show up from a system-wide sales perspective. And then the third, that's probably the biggest is the fact that not every point of distribution is the same in terms of the range that they carry.

Some of our retailers would carry a full assortment. Others would start with bites or start with like a snacking or beverage option and expand that gradually over time. And so some of the locations that we've added recently have started either in the snacking or beverage space. And then we'll continue to work on opportunities to expand our relationship moving forward.

[Liam Dotchison, analyst]

Great. Just final one here. Again, for the retail and e-commerce segment. You seem to be managing it to growth and remain around EBITDA breakeven as of yet. So is that relationship ownership in either direction near term or more the same in terms of EBITDA margin for the -- from the segment kind of going forward?

[Daniel Haroun, executive]

I mean there's going to be ebbs and flows quarter-to-quarter with some seasonality in the business and some of the seasonality in retailers as well. We do expect the next 1 to 2 quarters in the broader e-commerce space to be a more challenging dynamic than the long-term potential of that channel, and that's been well established and well documented in recent weeks and months. But I would say that over a several quarter period, we would expect to manage that consolidated segment around breakeven, give or take.

It doesn't mean that we wouldn't make an investment if we thought that, that investment was a good investment for the company and for the business long term across any one of our segments. But that's the general framework that we'll be thinking about as a baseline.

[Operator]

There are no further questions at this time. I'd like to turn the call back over to Daniel Haroun for any closing comments.

[Daniel Haroun, executive]

We thank you very much for your interest in our company, and we're very excited to continue to work closely with our franchise partners to build the next stage of growth for our business. We look forward to speaking more about that in the next quarter.

[Operator]

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