Organto Foods Inc

XTSX:OGO

Earnings Call Transcript 2019-Q4

[Peter L. Gianulis, Co]

Good morning, everyone. We're going to start the call right now. And as others join, we'll just add them to the list. So thank you very much. I wanted to welcome you all to Organto's first-ever business update and investor call. Thank you very much for joining us today. We appreciate your time taking out of your busy schedule to join us. Let me introduce myself. I am Peter Gianulis, Executive Vice President and Co-Founder of Organto. I'm joined on this call by Steve Bromley, Chairman and Interim CEO; as well as Rients van der Wal, our Chief Operating Officer and CEO of Organto Europe BV. On our call today, Steve will provide an overview of our progress in our business over the past number of months, including plans for the future. Following that, Rients will provide details on our commercial operations in Europe, our sourcing activities around the globe and the opportunities we have within our business. We will end the call by addressing questions received during the call via e-mail. Please feel free to send me your questions at [e-mail], that's P as in Peter, A, N as in Nancy, O, S as in Sam @organto.com at any time, and we will address those during the Q&A part of the call. We're going to try and limit the call to 45 minutes in respect of everyone's time. If we cannot address all questions received, we will follow up with you individually or in person. But before we get going, I want to remind listeners that commentary during this call may include forward-looking statements and, therefore, is subject to important risks and uncertainties. Actual results could differ materially from the conclusions, forecasts and projections as certain material factors and assumptions were applied in drawing conclusions and in making the forecast or projections upon which the forward-looking statements are premised. Additional information about these material factors and assumptions as well as other risks, uncertainties and other relevant factors are set forth under Forward-looking Statements and Risk Factors in the company's annual report for the fiscal year ended December 28, 2018, which is available on our website and on SEDAR at www.sedar.com. With that, let me turn over the call to Steve Bromley for his opening remarks. Steve?

[Steven R. Bromley, Chairman, Co]

Thanks, Peter, and good morning, everyone. I appreciate you joining the call today. We're pleased to have the opportunity to discuss our business with you and the exciting progress that we've been making. My comments today will focus on 4 key areas: our current market conditions; our successful business repositioning over the past 18 months; our anticipated record results for fiscal 2019; and our exciting look for the future. So let me start with current market conditions. Healthy eating and healthy lending trends are strong and accelerating around the globe. Organic foods are a key part of this growth as consumers are seeking sustainable and transparent foods. Organic has been realizing significant growth versus conventional foods, in fact, double-digit growth versus single digits or even negative growth in some conventional foods categories. Our focus is on the largest and fastest-growing categories in organic fruits and foods, fresh fruits and vegetables. And there is still significant room for growth in these categories. In fact, in Europe, fresh fruits and vegetables now represent approximately 6% to 8% off the shelf at retail, and retailers are looking to increase this. This is supply knowledge-dependent, and that is where our scale is coming to play. And it's important to note that millennial and Gen Z generations are leading this charge to healthy eating and we're now just entering the higher-income family phases of their lives. So the future looks bright for these trends as these generations are passionate, healthy eaters, for sure. So in summary, our markets are very strong, and we have a wonderful opportunity to grow our business. Now focusing on our successful repositioning. Over the past 18 months, we have successfully transitioned from an asset-heavy, single revenue stream business model to an asset-light, multi-revenue stream business model. Our shift to an asset-light multi-stream business model included exiting our own growing operations and shifting to strategic third-party growers; exiting our own processing operations via the sale of our processing plant in Guatemala; exiting our own packaging facility in the Netherlands; dramatically reducing our overhead costs; shifting from a cost-heavy fixed cost platform to a variable-based low-cost platform and, in doing so we have reduced our overheads by over 50%; expanding our customer base to include specialty organic produce distributors in key geographies to address supply-demand imbalances that severely impacted our previous operating results. Today, we have multiple customers across 10 countries in Europe. Expanding our supply base to include established growers in Latin America and Africa, including Colombia, Peru, Argentina, Morocco, Mexico, Zimbabwe and others; adding financing and factoring lines of credit to our business model; and further developing our commercial resources with the addition of industry veterans with deep selling and supply-side expertise, some of the best in the business, we believe. And it has been a busy time, and we now find ourselves well positioned for the future. And also during this time, we acquired and disposed of our Colombian-based medicinal cannabis operations in order to focus solely on the opportunity in fresh organic foods, recapturing funds invested and leaving Organto as a shareholder in Xebra Brands, an emerging privately held cannabis company focused on the design and delivery of cannabis-based wellness and leisure products with operations in Mexico and Colombia. This was a passive investment for Organto, which, at some point, we planned to monetize to further our growth in organic foods. And our 2019 results have shown great progress in hand with the changes in our business model. Q3 revenues were a record $1.9 million with much improved gross margins. And just last week, we announced that Q4 revenues will be a record for the fourth quarter with revenues of approximately $1.6 million. As a result, we will have record revenues of approximately $3.65 million to $3.75 million for fiscal 2019 with positive gross margins for the year versus negative gross profit margins in fiscal 2018. We are very encouraged by the growth in our business and the outlook for the future as our new revised business model comes to fruition. So what lies ahead? Our markets are strong and our business is well positioned. Reaching cash flow breakeven is our next key step as we move forward. And we aren't very far from achieving that goal and fully understand what needs to be accomplished to do just that. We need approximately $17 million in annualized revenues or approximately $4.25 million per quarter at conservative gross margins of 10% to breakeven. Obviously, our intent is to realize gross margins in excess of 10%, and that will come as we shift to a higher mix of branded products. The current revenue run rate of $7 million to $8 million, we need to increase this by approximately $10 million. We know where the supply is, we know who the customers are, and Rients will discuss this later. The good news is that with our repositioned asset-light business model, the cost of scale of the business are primarily working capital-driven versus higher cost investment in infrastructure. For every approximately $10 million in incremental revenue, we need between $1 million and $1.5 million to fund requisite working capital needs, essentially a working capital ratio of around 10% to 15%. And obviously, once we reach cash flow breakeven, we will be in a position to fund continued growth from internal resources, which is also exciting. Beyond this, we see a real opportunity to consolidate the fragmented organic produce business in Europe and, in doing so, build a dominant player in the specialty organic fruits and vegetables category. We are currently in discussions with industry players who share our values and passion for the industry and belief in its growth. We believe we can use our platform to build a key player with profitable revenues over $100 million in Europe, well positioned in growing markets. And our team has extensive experience doing acquisitions in the natural organic food space. So we are confident in our ability to acquire and integrate any new operations. So lots of exciting things happening. And with that, I'd like to turn the call over to Rients to dive in and provide further details on our European and global operations. Rients?

[Rients van der Wal, Co]

Thanks, Steve. Appreciate everyone joining the call today. As you are likely aware, our commercial efforts are primarily centered in Europe at the moment, and we see large opportunities in the markets we are serving as demand for fresh organic fruits and vegetables continue to grow. There is plenty of demand. The key issue is supply. And that is where we enter as we leverage our global supply base and industry knowledge. We commenced our commercialization efforts in Europe due to the size of the retail footprint versus other markets and do believe the opportunity in Europe is a large one. Having said that, there's no doubt that there are further opportunities in Asia and North America, and we will pursue these as our business model develops. Today, we have active distribution with over 15 customers reordering on a consistent basis. Our current customers are located in 10 countries, including the Netherlands, United Kingdom, Belgium, France, Germany, Russia, Sweden, Denmark, Switzerland and Norway. We have a diverse customer base, including traditional retail, specialized organic retail, online retail, food service operators and specialty produce distributor. This makes -- of course, the customers has been a key for us in order to address the supply/demand imbalances that significantly impacted our margins before we repositioned our business model. They also play an important role in managing our working capital needs. We have spent a great deal of time bringing the very best people into our organization. Our commercial team based in the Netherlands brings extensive organic foods expertise to the market with over 80 years of direct industry experience. Just last week, we announced that Michiel Groenewegen has joined our team as Business Development Manager. Michiel has deep organic vegetable and fruit experience and will be an invaluable addition. We have deep industry knowledge from supply chain through certifications, and we now have to bring products to the market, all supported by a cost-efficient, agile and innovative infrastructure. Our focus is on doing business smartly, focusing 80% of our resources and efforts on large-scale products that we can take to the market where there is ample demand such as organic avocados. And 20% of our effort is focused on building new projects that we need to work at such as green organic asparagus. I'll talk about that in a moment. While we have expanded our customer base, we have also expanded our supply base, adding key growers for avocado from Morocco and Colombia with plans to expand avocado supply from Peru and Mexico in the short term. We have also added supply sources of a range of products from Zimbabwe, Peru, Argentina and Mexico and expect to add local European supply of key products from Italy and Spain when the local seasons commence in those regions. Our avocado program is going really well with current supply from Morocco and Colombia. This is a fast-growing and on-trend product with room to grow and scale. With additional working capital, this could be a $20 million to $30 million annual business for us, perhaps even more. It is amazing how the consumption of avocados continues to grow in Europe with per capita consumption only 1/3 of what it is in the U.S., 5 kilograms per year versus 2.4 in the highest country in Europe. Our organic asparagus program is an example of building a business, our 20% efforts. Working with our grower partner in Peru, we have methodically gone about building our program in Europe. We were the first to import organic green asparagus into our markets. We started with only 1 palate per week and are currently running 6 to 8 pallets per week and we are targeting to grow to approximately 15 pallets per week next year. Beyond the 15 pallets of supply, we have an existing grower relationship in Argentina, and we are in discussion to further expand supply from Mexico. We are also working to supplement our Latin American sources with supply from local growers in Europe based in Italy and Spain in order to continue our year-round supply during the local growing seasons with supply from green asparagus now confirmed from Italy commencing the first week of March. Beyond organic avocados and organic asparagus, we have active programs in a number of other products, including mango, pomegranates, blueberries and others. And we hope to bring blackberries to the market soon in hand with key strategic suppliers in Mexico. What is really interesting is that as we have successfully ramped up commercial operations with our new business model and our opportunities have increased, our customers are asking for more and new suppliers are looking for solid go-to-market partners are surfacing. One of our organic avocado supply partners would like to significantly expand their program with us, and that's just the beginning. Our organic beans, peas and snaps program with a strategic supplier is currently on hold as we prioritize our resources and go-to-market activities, but this can be very quickly activated as financial resources become available, another significant opportunity for us. With additional working capital, we could reactivate this opportunity within 3 to 6 months. And we have an award-winning brand in our I AM Organic brand. Our brand has been extremely well received by retailers who are very interested in carrying the brand once our supply is stable and consistent, which is now the case in some of our core products. Branded produce is a growth category, and we intend to maximize our opportunity in this regard. And the brand is a win-win, better margins for the retailer, better margins for us. And of course, with better margins and a successful brand comes improving stock trading multiples too, which is strategically important. And we have come to realize that an opportunity exists to license our brand to generate other -- another revenue stream, and we are actively pursuing this at the time. So to summarize, the European markets are strong. Our repositioned business model is working. We have a strong and experienced team in place, both in the Netherlands and in the field, that can scale as we grow. And we have numerous opportunities in front of us to grow our business. These are very, very exciting times. With that, I will turn the call over to Peter.

[Peter L. Gianulis, Co]

Thanks, Rients, and thanks, Steve. We're going to enter the period now of our Q&A. I will ask to give me about a minute to look at the call and look at the questions that are asked. I'm sure, as we can see, we've made some great progress in the business. We're all very excited about what's the opportunities ahead of us. So our next step in our business is cash flow breakeven, as we talked about, and the opportunities to play a consolidator role, initially in Europe and then elsewhere, but there are significant amounts of opportunities for us to look at. So at this point, I'd ask for 1 minute just to look through the questions that I've received. And then I'll be back after I had a chance to organize this.

[Peter L. Gianulis, Co]

All right. We have a few questions here. First question is from John. Question is, can you talk about your decision to distribute in Europe? And are there any plans to expand into the North American market in the future? Rients, I think you're probably the best one to discuss this. Why don't you discuss [ Hammsen's ] question.

[Rients van der Wal, Co]

Okay. Thank you, Peter. Yes, I think there are huge opportunities for us to be realized in Europe, an opportunity well above the $100 million in revenue. The markets in Eastern Europe are also growing rapidly. So I believe this is also a very interesting opportunity for us in random order because the U.S. is likewise a very, very big opportunity for us. We will selectively pursue this as the European market opportunity is realized.

[Peter L. Gianulis, Co]

Okay. Perfect. Second question also from John. You talked about getting a higher blended margin with a sales mix more focused on branded versus white label. How do you see this unfolding? And what do you forecast for margin accretion going forward? Steve, probably you're best to discuss them.

[Steven R. Bromley, Chairman, Co]

Right, Peter. So the question was how could we get a higher blended margin?

[Peter L. Gianulis, Co]

Yes.

[Steven R. Bromley, Chairman, Co]

Right. Okay. I think we -- there's a little bit of learning to be done from history, Peter. Our full model, if you will, was focused on taking a branded product to market from our own supply. And we ended up with a lot of supply/demand imbalance, where 1 week, you've got lots of capacity and the next week you don't have as much. And so with that came a supply imbalance, which really impacted our ability to be successful with our branded listings and really negatively impacted our margins. And so as we look forward, stable supply is key. And so as Rients talked about, we've been building out a diverse customer base so that there are ways for us to manage the supply/demand imbalance. And we've made great progress on that, and that's more of the white label and distributed side of the business, which runs between 8% and 12%. Once you have that in place, you're then in a position to be able to take branded product to market because you've got that stable supply moving through the system. And so the distribution side of your business can be the balancing lever as you serve the branded markets. And so we find ourselves in a position now where we're really ready to go back into the branded. Branded comes at plus 25% margins. And so that's where we want to go. But our learning was you can't do that until you have a stable supply base in place, and we're working hard to put that in place and making good progress on that. Interestingly enough, branded comes with higher margins. Branded also comes with higher working capital requirements. And so that's something that we're balancing as well as we move forward. But our brand has been very, very well received, and we're now looking at products like organic avocado and organic asparagus, where we have consistent and steady supply. And as Rients talked about, we're bringing on new supply to fill the year-round supply model. So we'll be in a better place. So over time, we move from white label distributed into a branded product mix. We'll never be 100% branded because you need the distributor mix in there to help balance supply/demand, but we've made good progress. And so over time, you'll see branded take on a much bigger part of our portfolio and increase margins accordingly. And of course, the markets love brands, and so having brand serves us well from a trading multiple point of view as well.

[Peter L. Gianulis, Co]

Okay. Perfect. I've had 2 questions that come in dealing with supply and since we're talking about supply, I'll try to read -- try to combine them. Why don't you supply to the North American market? And then the second part of that would be -- give me a second. What about -- what amount of global supply does Organto sit in front of? And this is 2 questions from 2 different people. Rients, you're probably best to talk about our global supply chain. And could you talk about our supply chain globally? And then second part of that is, why don't we supply into the North American market?

[Rients van der Wal, Co]

Yes. Thank you, Peter. No, definitely. As we indicated a little bit earlier as well, we started with the European market because of the footprint of the retailers being smaller, which means that there is less capacity needed at a high level in order to enter the market. And of course, the footprint of a retailer in the U.S., for example, is much larger than a European one. So we specifically focused on first building the European market to make sure that supply comes to the right level in order also to start executing on opportunities, which are larger, which would also be outside of Europe. Maybe another thing, what is important to indicate, that when we built a supply program for a specific market, for example, now what we have done in Europe, 1/3 of that supply is coming from our African supply partners, 1/3 from the Latin American supply partners, and 1/3 is coming from local supply partners in the European market itself. So if you now take us into how do we leverage our supply when, for example, we enter into the U.S., we would use the same supply partners that we have activated already for the European market from Latin America and from Africa and we would have to build in the local U.S. component in order to go to a year-round model. So yes, I think by -- to summarize, if we would go now into a new continental market opportunity being that the U.S. or being that in Asia, it's very important to know that we have a blueprint from the European market. We also have a proof of concept, right, because there are some large retailers active in Europe that have a very big presence in the U.S. as well. So credibility is something that we can export as well to the U.S. And at the same time, we already have 2/3 of the supply base already built before we enter. I hope that clarifies the questions, Peter.

[Peter L. Gianulis, Co]

That's great. Shifting gears now, I have 3 questions that came in from acquisitions, trying to consolidate it without having 3 questions. But I'll start off with this introduction. Steve has had experience in consolidating the category when he was at SunOpta. What type of acquisitions would you make sense? I'll add part of that question, too. What are you guys thinking about acquisitions? What pieces do you think you're missing to solidify the platform and the business model? And then the third part of that question would be what -- do you have any competitors and who are they? So why don't we start off with Rients to talk about the competitive environment in Europe and how fragmented or consolidated the industry is, and then we'll turn it over to Steve to answer the second part of that question, which is with respect to acquisitions. And Rients, also you can kind of chime in. I think both of you guys are best to answer that together.

[Rients van der Wal, Co]

Okay. Let me start then with the part about the competitors. I think it's very interesting to tell you that above $100 million in Europe in the organic fresh produce industry, there are only 2 or 3 companies. And they're quite stable in the position where they are. And there are about 50 smaller companies participated well below that $100 million mark. Another important thing to note is that there is no organic fresh produce consumer brand. No major one in the market at this time. So I think, yes, there are competitors in the market. They're early stage companies that basically moved from being a small business started by philanthropists who saw the opportunity already a long time ago, who basically gone with the development with organics going more mainstream but they don't really have the DNA, nor the capabilities now to really scale their own business. And I think that's one -- a big part of the opportunity for us in the industry.

[Peter L. Gianulis, Co]

Rients, what -- on the first part of that question, you talked a little bit about what type of opportunities would we -- would fit into us in terms of what pieces do you think we're missing. And what would be the rationale behind those acquisitions in the event we were to go down that path?

[Rients van der Wal, Co]

Yes. I think we are now dealing with a few products, organic asparagus, what we touched on. It's a very interesting product for growth in the European market in the future. It's -- for us, it's now 6 to 8 pallets and hopefully 15 pallets by next year, but it's a niche in a niche. And well, if you see already the opportunity that we are having with organic avocados, that's a far, far bigger market. So -- and that we have to focus on small products that have the ability to grow into something large in the future. But at the same time, we also have to look at the real drivers of volume within the organic segment because that 6% to 8% that Steve was talking about for the European retailers, you're going to increase that percentage by also taking some high-volume products with it. So to give you an example, I think organic bananas have a very, very interesting opportunity for us. It's a product that we don't deal with today. It's a product from a branding point of view where it's very easy to brand. The -- well, everybody knows the banana is a big yellow skin that's very easy with a nice label or maybe laser-printed branding opportunities as well. So I think from a product -- expanding the product assortment, that's one reason. While we are active today in more than 10 countries and we have 15 customers on a continuous basis ordering from us, of course, the expansion of distribution is very interesting. It could be a very interesting driver as well for us, for an acquisition. And of course, we have now in-house a lot of knowledge. There are very interesting smaller companies around where maybe the company is built around 1 or 2 people, and they're specialized in a certain product. But they have no exit. They can't take the business really further. And I think we are able to offer them an exit, and we are able to offer them more growth by basically bringing it together with our -- bringing it in our infrastructure and with our strength on the side of marketing and financing and taking it into the next step.

[Peter L. Gianulis, Co]

Okay. Thank you, Rients. And we have a few more additional questions. One is if you have so many opportunities for business, why don't you go out and raise additional capital? I guess I'll take this one. Steve -- for the prior question, Steve, do you have anything to add on the acquisition strategy before we move on?

[Steven R. Bromley, Chairman, Co]

Yes. You know what, Peter, if I could, just to jump in really quickly. I think the acquisition strategy is very interesting. This feels very similar to the way the North American organic foods industry felt back some time ago when we were able to do a consolidation play through SunOpta. But I see the opportunity -- I thought everything that Rients said made a ton of sense. I was just reading a study that was done by Bain Capital not too long ago. And they pointed out that the most successful M&A transactions, what's the best driver of success, and it's customer commonality. And I think the important part for any acquisition strategy for ourselves is as we've learned and we've had success but it's taken time is it takes some time to build these supply chains. And we've done a really nice job, but it does take time. And the good news is a lot of that heavy lifting is done for us. To have potential bolt-ons to the company, where we have an expanded product array going to the same customers, the same customers that we know today, is very appealing. And so when we look at things, acquisition candidates that expand our product capabilities, expand our sourcing depth, go to new and also complementary customers is really interesting for us. Interesting in that Rients mentioned bananas. Well, we can brand the banana. There's -- we've got -- it's not rocket science what we need to do to go brand a banana. It's not something that we have today. So I think that's all very interesting. It gets us to critical mass quicker, and it allows us to leverage resources. As much as organic is maturing, it's still growing. And the good news for us is that we've got deep depth, knowledge and understanding and agility built into the system that we have. So it allows us to leverage all of that. But I think we need to be selective, but we certainly know of, as Rients said, some of these smaller players who are just logical bolt-ons that enhance our relevance with our customers, which we think is really important.

[Peter L. Gianulis, Co]

Thanks, Steve. And I guess one of the final questions, I've had a few of these, which is what I think I read, if you have so many opportunities for business opportunities, why don't you go out and raise additional capital? I'll take that. We do have a lot of opportunities, and working capital is required in all those opportunities. And we're evaluating all those options. We will have to address that in the near future based on all the opportunities we have. So it's probably not the right time to talk about this. But we do realize that, and we are evaluating all these opportunities. I don't know, Steve, if you want to add anything to that.

[Steven R. Bromley, Chairman, Co]

Yes. No, no. I think that's right, Peter. And that we've done a nice job growing the business. Working capital is required to take it to the next step. And obviously, we want to get to cash flow breakeven as soon as possible. We do have the investment in Xebra Brands, and we have to evaluate any liquidation opportunities there versus other opportunities to raise the funds to move forward. But the business model is working. The market opportunity is there. So we're pretty comfortable in evaluating that as we go forward.

[Peter L. Gianulis, Co]

Perfect. I think that I tried to summarize it, so I don't have to read the same question over and over again, but I think that, that kind of exhausted most of the questions. There were quite a few. They were just a lot of overlap. I'd like to thank everyone who's joined the call. Steve, Rients, thank you for your time as well. We are entering a pretty exciting time in Organto. We've had 2 excellent quarters back to back. We look forward for the first quarter as well. We're not giving any guidance on that quarter at this moment, but we are very excited about what our future lies ahead. Our primarily goal, as Steve had mentioned, is to reach cash flow breakeven. And we hope that we can do that in the near future. So thank you all for your time. I appreciate it. If you have any other questions, feel free to contact any of us, and we'll try to follow up with everyone in the coming days. Thank you very much, and have a great day.