Emerge Commerce Ltd

XTSX:ECOM

Earnings Call Transcript 2022-Q3

[Operator]

Good morning, and welcome to the EMERGE Commerce Third Quarter 2022 Results Conference Call. [Operator Instructions] This is being recorded on November 29, 2022. Your host today are Ghassan Halazon, Founder and Chief Executive Officer; and Jonathan Leong, Chief Financial Officer.

Before we begin, I'm required to provide the following statement respecting forward-looking information, which is made on behalf of EMERGE and all of this representatives on this call. Certain statements made on this call will contain forward-looking information. These forward-looking statements generally can be identified by the use of words such as intend, believe, could, expect, estimate, forecast, may and other words of similar meaning. This forward-looking information is based on our opinions, estimates and assumptions in light of our experience and perception of historical trends, current conditions and expected future developments as well as other factors that we currently believe are appropriate and reasonable in these circumstances.

Actual results could differ materially from a conclusion, forecast, expectation, belief or projection in the forward-looking information. Certain material factors and assumptions were applied in drawing a conclusion or making a forecast or projection as reflected in the forward-looking information. We caution investors not to rely on the forward-looking information. Additional information about the material factors that could cause actual results to differ materially from the conclusion, forecast or projection in the forward-looking information and material factors or assumptions that were applied in drawing a conclusion or making a forecast or projection as reflected in the forward-looking information are contained in EMERGE's filings with Canadian provincial securities Regulators.

During today's call, all figures are in Canadian dollars unless otherwise stated. And with that, I'd like to turn the call over to Mr. Ghassan Halazon, Founder and CEO. Please go ahead.

[Ghassan Halazon, executive]

Thank you very much, Colin. Good morning, everyone. We appreciate you taking the time to participate on our third quarter results conference call. Joining me today is Jonathan Leong, our CFO. This morning, I'll walk through EMERGE's third quarter results and share some insights on our business as well as our key priorities for the balance of 2022 and into 2023. Following my remarks, Jonathan will provide further details on our financial results, and we will conclude by opening up the call to analysts for questions. In Q3, EMERGE drove triple-digit revenue growth, along with our fourth consecutive quarter of positive adjusted EBITDA. Our results highlight the continued resilience of our diversified brand portfolio, despite this quarter traditionally being seasonally challenging for some of our key businesses and despite the challenging macro backdrop.

Gross merchandise sales or GMS for short, which represents the total value of purchases on our platform, increased 191% year-over-year to $26.8 million. Q3 revenue grew to $12.1 million, a 100% increase from $6.1 million in the prior year. Q3 adjusted EBITDA grew to approximately $756,000 from a loss of $512,000 in the prior period.

I am particularly proud that we have continued to build on our trend of positive adjusted EBITDA, as Q3 marks the company's fourth consecutive quarter of positive adjusted EBITDA and the 10th out of the last 11 quarters.

The company recorded Q3 positive net income of $1.8 million for Q3 2022 compared to a net loss of minus $1.1 million in the comparative period. The Q3 net profit is mainly attributable to ForEx and other gains as well as a fair value change in contingent consideration.

With respect to ForEx, it is worth noting that a large portion of our sales are derived from our U.S. businesses in USD, while a large portion of our expenses are in Canadian dollars, given our HQ operations are based here in Canada.

As such, the favorable ForEx environment is proving to be a tailwind for EMERGE. I will now provide a brief update on some of our progress, subsequent to quarter end. Yesterday, we announced our successful Black Friday results, exceeding management's expectations.

In total, EMERGE's e-commerce brand portfolio combined to achieve GMS of $846,000 during this year's Black Friday event, which was held on November 25, 2022, compared to $723,000 during Black Friday 2021, representing year-over-year organic growth of 17%.

In comparison, according to Adobe, overall online sales for the sector were up 2.3% year-over-year. A number of EMERGE brands achieved double-digit organic GMS growth year-over-year this Black Friday, including WholesalePet, UnderPar, Just Golf Stuff and WagJag.

Notably, our main discount-driven brands performed exceptionally well, which we believe stands again in a weaker economy as consumers seek more deals. We believe these positive early results bode well for the Black Friday, Cyber Monday week and the peak holiday season to follow for shopping. We plan to balance our push to drive sales growth with operational rigor and ultimately, a strong focus on the bottom line as a top priority.

On October 17, 2022, the company announced a $1 million cost optimization and synergies initiatives commencing in Q4 2022 in an effort to enhance cash flow generation. The company is pleased to share that the aforementioned savings have now largely been executed with an estimated $500,000 to $1 million in additional annual savings being reviewed for a total potential of $1.5 million to $2 million annual savings and reduced overhead expenses in 2023. In addition to our cost optimization plan, on October 28, the company amended its $25 million credit facility with an initial 12-month term, plus an additional 9-month extension option for a term of up to 21 months total. Inclusive of the extension option, the maturity of the debt facility would be July 2024. The company remains in good standing with the existing lender, which it has worked with since November 2019. The company and the lender have agreed to reduce the debt facility from $25 million to $19 million over the next 12 months, inclusive of principal payments and amortization.

EMERGE continues to explore various options for debt refinancing and/or debt pay down in 2023 with the goal of doing so sooner rather than later. We intend to use this time wisely to start reducing our debt with the lender and ultimately strengthening our balance sheet in preparation for this next phase of growth. EMERGE has proven, it can be adjusted EBITDA positive consistently with 10 out of the last 11 quarters being positive. Despite this, EBITDA to cash flow conversion is weaker than we would like, in large part due to the interest payments associated with our debt. The rising interest rate environment has us reconsidering the level of debt we are comfortable operating with.

As such, we are exploring various options to reduce our senior debt with the ultimate goal of improving EBITDA to cash flow conversion. On November 24, 2022, the company completed a $2.78 million convertible debenture financing. Use of proceeds is primarily to pay down debt from the existing lender and for working capital and general corporate purposes. The interest rate is a fixed rate of 10%, making it cheaper than the debt it is partially repaying with its existing lender.

With respect to contingent consideration, certain acquisitions at EMERGE were eligible for earn-outs during 2022, conditional on meeting certain minimum revenue and EBITDA growth targets. The company confirms that no earn-outs have been achieved for 2022 with no contingent consideration payout expected for the 2022 fiscal year.

With the persisting challenges in the macro climate, management's operational priority for the balance of the year and into 2023 remains to optimize profitability and cash flow. Although the company continues to monitor a number of acquisition opportunities, its near-term focus will be on improving liquidity, driving organic growth, synergies and savings. We have made good progress with our strong start to the holiday shopping season, including a record Black Friday with strong organic growth of 17%. Our cost reduction efforts, our renewed credit facility and the recent infusion of cash from the debenture offering, all great progress. There's still a lot of work to be done to position the company for strength in 2023 and beyond.

To wrap up, I would like to sincerely thank and congratulate our team, Board and trusted partners across North America on another strong quarter and some key milestones achieved to pave the way for our next chapter together.

I will now turn the call over to Jonathan for a review of our financial results.

[Jonathan Leong, executive]

Thanks, Ghassan. Good morning, everyone. Our gross merchandise sales, or GMS, for the third quarter increased 191% to $26.8 million, up from $9.2 million in the comparative period last year. This increase was primarily driven by the BattlBox Group and WholesalePet acquisitions.

As a reminder, GMS is a non-GAAP measure and represents the total dollar value of customer purchases of goods and services through our brands, excluding applicable taxes and net of discounts and refunds. For the third quarter, our revenue increased to $12.1 million, up 100% from $6.1 million in Q3 2021. Similar to our GMS, this was primarily driven by our BattlBox and WholesalePet acquisitions.

Gross profit for the quarter increased to $5.2 million compared to $2.6 million in the comparative period, an increase of 101%. The net income for the quarter was $1.8 million compared to a net loss of $1.1 million for the same quarter in the prior year. This is primarily due to higher gross profit, a gain on remeasurement of contingent consideration as well as positive impacts from foreign exchange.

This was partially offset by higher finance costs related to interest expense in 2022 compared to 2021 as well as higher amortization of intangibles during the period. The company reported adjusted EBITDA for the third quarter of $0.8 million compared to a loss of $0.5 million in Q3 2021. As Ghassan mentioned, this marks our fourth straight quarter of positive adjusted EBITDA.

Overall, we are pleased with the results this quarter, given the current macro environment and look forward to continuing to execute on our plans for the remainder of 2022 and 2023.

I'll now pass it back to Ghassan for some closing comments.

[Ghassan Halazon, executive]

Thanks, Jonathan. In closing, EMERGE is taking key steps to position the company well for 2023 and beyond. With a diversified portfolio of category-defining e-commerce brands, we plan to operate with rigor through the balance of 2022 and beyond. We believe, a disciplined capital allocation approach and an inherently bottom line-focused playbook will come handy during this macro climate.

We have made excellent progress in Q3 and in Q4 to date, as noted, but there there's still much work ahead of us, and we plan to keep our heads down and do that work. Our aspiration remains unchanged for EMERGE to rise as North America's preeminent acquirer of high-performing niche e-commerce brands, allowing acquired companies to take advantage of the benefits that come with our collective scale, unavailable to any individual bootstrapped e-commerce company with limited resources.

This concludes our prepared remarks. Operator, please open the line for questions.

[Operator]

[Operator Instructions] Okay, and your first question comes from Aravinda Galappatthige from Canaccord Genuity.

[Aravinda Galappatthige, analyst]

Just 3 for me. The first one is pretty simple. I was wondering whether maybe Jonathan can give me what the ex FX revenue growth was or just give me what the FX impact was to the 100% revenue growth you reported?

Second, I guess, because on WSB. I know that, that was always considered to be the more recession-resilient or the more resilient, in general, of the businesses that you acquired, given sort of the long history. I wanted to see how that was faring in the backdrop of, I think, the comment that you made about the absence of any contingent -- any earn-outs being sort of paid in 2022.

I don't know if you can give any color around whether that performance got close to that benchmark or whether sort of the overall conditions dragged you down?

And lastly, I guess, a more broader question on the balance sheet. Obviously, there's still some work to do to kind of create some buffer as we kind of look ahead in potentially uncertain year, would you consider maybe taking a step back and maybe divesting one of the assets to kind of give you some breathing space so you can kind of come back when sort of -- and recommence your acquisitions when the sort of the conditions start to improve?

[Ghassan Halazon, executive]

Yes. Great. Jonathan, why don't you take the first question on ForEx, if you have that info handy, and then I can jump in on the other 2?

[Jonathan Leong, executive]

Sure. Thanks, Aravinda. So I have to calculate the exact number for you, but just to give some color on it. In terms of the foreign exchange that we had for this year-to-date period, we were basically at 1.28 for the U.S. dollar to Canadian dollar exchange versus last year, which is an average of about 1.25. So I'll get to the exact numbers later, but that's kind of the color in terms of the difference there.

[Ghassan Halazon, executive]

Thank you, Jonathan. So I'll jump in on the other 2 parts of Aravinda's questions. On the WholesalePet side, they did indeed come quite close to achieving the 2022 earn-out. Basically, as you know, Aravinda, we build in minimum revenue and EBITDA growth targets. Now what you have to keep in mind is at the time we were acquiring these businesses, we were at the sort of peak pandemic levels.

And so the growth expected from those points at the time were more ambitious growth targets for both, revenue and EBITDA. As the world and the e-commerce sector has sort of come down from that peak pandemic level, WholesalePet has, in fact, been more resilient than all other brands, not only in the merged portfolio, but frankly, most of the other ones we look outwards from an M&A perspective.

So they've had a very sticky business here in the post pandemic world that remains highly elevated relative to the pre-pandemic levels. But when it comes to the earn-out specifically and the way we've designed these minimum revenue and EBITDA targets, it would have had to grow quite a bit more. And the fact that it did not reach it, is not a representation of any change in the inherent business.

It is still intact. The growth, EBITDA and ultimately, the cash flow remains very, very strong for WholesalePet. It just has not achieve those ambitious growth targets. And they actually came quite, quite close, and it was a final determination in sort of recent weeks, and then I would call it, in the last month. So that's how close it came to doing so. However, they did not meet that earn-out. Of course, they still have a chance to catch up and do an earn-out in year 2. As for the third question on the balance sheet, as I noted in my remarks, we are -- we have demonstrated a clear trend here of strong EBITDA results. And 10 out of our last 11 quarters have been positive. However, that EBITDA to cash flow conversion is weaker than we would like. And that's mainly because of these larger-than-we-would-like interest payments.

And so to your point about potentially divesting assets, certainly, we are pragmatic, right? You have to be, in this sort of market. So we have 9 brands at varying levels of revenue, profit and ultimately, cash flow. And in this market, I think it is prudent, and it is something we are open to, and in fact, exploring at all times, frankly, whether certain assets belong in the EMERGE portfolio or otherwise?

Now generally, when we acquire companies, our goal is to hold long term, perpetually. However, if certain assets are doing way better and we are learning new things about what models work best, what's stickier, what's a better cash flow conversion? What requires less cash investments? These are models that we would be keen to doubling down on.

While in other cases, if certain models are challenged for whatever reason, whether it's the macro, whether something has fundamentally changed since we acquired them, these are all reasonable thoughts to have. And we are certainly being open-minded about what that could look like. And noting, of course, that the peak pandemic highs have come down generally for the sector, but obviously, as we have a very long-term view on the industry, on e-commerce, 3 years, 5 years, 10 years out, we believe a lot of the businesses we're sitting on are well positioned.

But as I said, we will be pragmatic, and we are exploring different options that may yield us bigger cash amounts to pay down more debt and to double down where we're winning.

[Operator]

[Operator Instructions] Your next question comes from Andy Nguyen from Raymond James.

[Andy Nguyen, analyst]

This is Andy on for Steven. Given the market conditions, could you provide us some more color on the progress of some of the existing organic growth initiative or some of the new ones that e-comm is executing?

[Ghassan Halazon, executive]

Yes. So Andy, thank you for the question. In terms of organic growth, as you know, we don't officially break those out per business, but I can comment in general. Firstly, I wanted to note the double-digit organic growth that we saw on Black Friday, obviously, historically, 1 of the 2 biggest days of the year.

So we were quite pleased to see a number of the discount brands that I highlighted come out with double-digit growth, including WholesalePet, UnderPar, Just Golf Stuff and WagJag. Of course, that, as I said, is only 1 day. It's a big one, but it's 1 day still.

As we think of organic growth, we look at a few areas. So -- and I'll give you a couple of examples that we've probably pointed to in the past at varying levels. For example, with WholesalePet, one of the areas we are looking at propelling is their marketing engine. To date, WholesalePet has done very minimal marketing, and of course, as a B2B platform, there's certainly a long tail and a certain amount we believe we can capture in growth from marketing.

These are early tests done about quarter-and-a-half now worth of some early marketing tests that seem to be positive. So we think that's a big theme for 2023's growth trajectory for WholesalePet, which, by the way, was a company that was organically growing at a CAGR of 20% and last year grew 45%. So therefore, this year, growth is moderate or sort of much closer to where it was last year.

But next year, we think marketing is a big theme there. There is the possibility of geographical expansion, of course. It's something we're exploring, bringing WholesalePet to Canada as we did with BattlBox this year. Again, still early, but we're seeing some nice early results for BattlBox Canada on that front.

Obviously, they've expanded into Wanlow which is their kids adventure box or outdoor box. So that's also still early, but we are looking at strategically whether BattlBox Canada and Wanlow could play a bigger role on those 2 fronts.

With truLOCAL, we're building out more assortment. We are also looking at private label initiatives to improve margin. We are also adding sort of adjusting the overall experience. We're testing a service fee right now on checkout as well that might add some margin, right?

So these are some examples from our latest 3 brands. So there's no shortage of different initiatives, but I also want to highlight, in tandem with our organic growth push, the cost reduction side is substantial. We talked about the $1 million that pretty much have been executed and now in place starting Q4 on an annual basis.

There is an additional $0.5 million to $1 million that we expect to come into play shortly. So we are looking at really strengthening that overhead picture and reducing non-revenue impacting investments that we had in the past during a different time and market. So we're really looking to strengthen or tighten our belt there and give us some further room because, of course, that will flow straight to the bottom line in conjunction with all the organic growth initiatives.

[Andy Nguyen, analyst]

Got you. So I just want to switch gear and I just want to talk about like, does supply chain remain a headwind to companies like BattlBox? And do you see like the consumer spending remain resilient or it's sort of like deflated post-COVID?

[Ghassan Halazon, executive]

It's a good question and a fair one at a time like this. So firstly, I'd like to point out -- and as we look at sort of the subscription brands you mentioned, I think you said truLOCAL, BattlBox, but also WholesalePet. Really all our 3 acquisitions from last year, from 2021, which make up the majority of our GMS and our revenue, of course, company-wide, so our subscription brands and our B2B brand.

They all, first of all, remain substantially higher than where they were prepandemic in 2019, okay? This is a collective business in 2019 that had pro forma revenue numbers of close to $36 million back then, collectively as a group. We are way closer and we're not giving exact guidance yet, but if you can do the math, we are way closer to sort of the $57 million to $60 million range than we are to the $36 million range back in 2019.

So generally, these businesses are still well ahead of their prepandemic levels. Now when you look at sort of some of these -- the challenges in the macro, I think they have varying levels of impact. I do certainly think BattlBox is more prone in this climate to being more of a discretionary spend category.

Now of course, the enthusiast on BattlBox may differ and say that this is the way of life, right? There's a tremendous amount of enthusiasts on that platform, including on TikTok, where they have north of 7 million likes. But at the same time, we think truLOCAL grocery, for example, I can comment there and say, the business has continued to be very stable here in recent months. We're trying to improve the cost side of it and improve the margin of it. But we're actually making great progress on churn metrics that we don't really disclose, but I can say at a high level, even as late as this month, we are seeing one of the best sort of net churn metrics that we have seen overall.

So we're liking the stability we're seeing in truLOCAL, keeping in mind, we raised prices, so we passed along some of the inflation impact on meat prices to the consumer. Now that this is a business, we think, that should be more profitable, and we're taking some cost side measures, but there's some good stability there.

As I said with the WholesalePet, when you grow 45% last year and you were able to capture that, pretty much this year with potentially some growth in the calendar year, that's a big win for us. And then, of course, our discount brands, WagJag and UnderPar/Just Golf Stuff, these are businesses that got severely hurt during the pandemic, and we are starting to see like nice signs, as you saw on Black Friday.

Those were all names that were up double digit versus last year. And frankly, discount brands will stand to gain in this climate, we believe. A number of these have been actually built in the last recession, 2008 to 2010, UnderPar, WagJag. And the broader savings rolled online really started -- that was their big moment. And so we think this is another big moment for discount brands. And we think with the ones -- these ones that have been hurt during the pandemic may result in growth again, and we saw that on Black Friday.

[Operator]

There are no further questions at this time. I'll now turn it back to Ghassan for closing remarks.

[Ghassan Halazon, executive]

Thank you very much for joining us today, everyone, and for your continued interest in EMERGE Commerce. We look forward to reporting on our progress throughout the balance of the year and beyond. Thank you. Take care and stay safe.

[Operator]

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