Freshii Inc. (OTCPK:FRHHF) Q2 2022 Earnings Conference Call August 11, 2022 8:30 AM ET
Company Participants
Jeremy Mandel – Investor Relations
Daniel Haroun – Chief Executive Officer
Victor Diab – Chief Financial Officer
Conference Call Participants
Pulkit Sabharwal – Canaccord
Kyle McPhee – Cormark Securities
Operator
Greetings and welcome to Freshii Inc.’s Second Quarter 2022 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jeremy Mandel, Senior Director of Legal. Thank you. You may begin.
Jeremy Mandel
Thank you and welcome to Freshii’s second quarter 2022 earnings conference call. Joining me today is Daniel Haroun, our Chief Executive Officer and Victor Diab, our Chief Financial Officer.
Please note that the 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 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 second quarter earnings release, the financial statements and 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.
At this time, I would like to turn the call over to our CEO, Daniel Haroun.
Daniel Haroun
Thanks, Jeremy. Good morning, everyone and thank you for joining us today. In Q2, our revenue was up 87% over the prior year, driven by the consolidation of Natura Market and system sales growth in both our restaurant and CPG businesses, as we continue to make critical investments to help enable our future growth. Our Natura Market team has reacted well to a challenging e-commerce environment, doubling down on product selection, while being very disciplined in managing the business during temporary channel headwinds. Our CPG team continues to build strong relationships with retailers, focusing on our top SKUs in top markets.
And finally, I’d like to spend a few minutes to provide some insight into my first few months as CEO of Freshii, beginning with my time visiting markets across North America with our restaurant franchise partners. At our partner support center, we have established our North Star, happy, capable, profitable franchise partners executing at their best. In the past 90 days, I have had the opportunity to visit almost 100 restaurants across North America and meet with franchise partners that collectively own more than half of our locations. These visits were critical to help us develop a deeper understanding of our current opportunities and challenges on the ground as well as assessing our real estate for a post COVID-19 operating environment, as we work to lay the foundation for future growth.
In listening to our partners, it’s important to acknowledge just how challenging the past 2 years have been and continue to be on our restaurant partners. From the restrictions of the pandemic, labor and supply chain shortages and now a more challenging operating environment with inflation putting pressure on consumer discretionary spend. Despite those challenges, I walked away encouraged by the resiliency our partners have shown and the optimism they have expressed about the path forward, while acknowledging that pandemic has changed some trade areas for the long-term. And we see this in some of the stark differences between our higher performing locations and those that are further behind the rest of the network in their recovery.
A consistent message I heard was that time to go from playing defense back to offense. In short, we must forge ahead and compete with the current realities head on, while seeking to ensure that the brand and the network are well positioned for sustainable long-term growth. We took meaningful steps to begin that process in the spring and summer. We realigned our organizational structure by strengthening our leadership team with key additions and internal promotions, and are adding field resources to assist franchise partners in improving existing operations while also beginning to invest in key functions such as real estate development and construction to support our next phase of anticipated growth.
In addition, we continue to strengthen our North American restaurant pipeline, which currently includes agreements for the planned development of over 100 locations. We are particularly pleased to report that many of our multiunit partners are ahead of schedule in respect of their planned development. Our development team has also been very active in reengaging with the landlord community for a holistic review of our store network and are optimistic that these relationships will enable continued growth of that restaurant pipeline. We will, however, continue to be disciplined for the right real estate in the right trade area to set our franchise partners up for long-term success. We are also implementing new tools and processes to assist in the improved site and candidate selection. We believe these changes will improve the quality of the franchise network over the long-term.
We also began to shift to a more simplified approach to innovation, focused on our core menu platforms and offering a wider variety of price points for the customer, utilizing existing ingredients and preparation models to develop new offerings where possible, will allow us to deliver a great repeatable customer experience for our current menu while also offering exciting innovation for our guests, supported by marketing activity and traffic driving initiatives. For example, in August, we recently began promoting our Classics LTO lineup, which consists of four new menu offerings made up entirely of existing ingredients and workflows. In new innovation, such as our Classics lineup, as well as continuing to broaden the options we offer our guests becomes even more important in the challenging operating environment we see today.
We began to see a softening of restaurant system sales in the second half of the quarter, and that has continued into Q3, as we outlined in our release. We recognized the inflation challenges are impacting consumers in different ways. While some consumers may be returning to full-service dine-in, travel and other forms of entertainment after a long period of restrictions, others are feeling the impact of inflation and higher gas prices on the amount of discretionary spending they have available. We recognize we need to address the immediate short-term realities of our operating environment, while also laying the foundation for the business’ next stage of anticipated growth in the long-term. We will be launching a set of traffic driving initiatives in the fall as many households enter a new next phase of normal, with kids going back to school and some workers back in the office, whether it’s most days or just Sundays each week.
We will also begin our normal course longer term strategic planning process and we will share more updates on this in the coming quarters. Across all of our divisions, we have a strong team working closely with our partners to enable growth in a disciplined manner. I am so proud of the way our partner support center has embraced the significant amount of change over the past 90 days and our team is laser-focused on our North Star, both in meeting the challenges of the current operating environment and capitalizing on the growth opportunity for the brand in the years to come.
I will now pass the call over to Victor who joined us in June as our new CFO.
Victor Diab
Thanks, Daniel and good morning everyone. I will be reviewing our Q2 results with a specific focus on consolidated metrics, followed by additional color on the restaurant segment. In Q2, consolidated revenue was up to $10.5 million, an increase of 87% as compared to Q2 2021, largely driven by the consolidation of Natura Market results and strong growth in our CPG business. As a reminder, our 2021 restaurant franchise revenues benefited from a onetime change in estimate related to our franchise fees.
Q2 SG&A was up $1.4 million versus Q2 of 2021, driven entirely by the inclusion of Natura Markets and onetime separation amounts in the quarter. After excluding the impact of Natura and the onetime separation amounts, SG&A was $0.2 million lower than the prior year.
Q2 consolidated adjusted EBITDA was $0.2 million, which represents an improvement of $0.1 million driven by higher sales in the restaurant and CPG segments. Q2 net loss was $1.7 million as compared to a $0.7 million loss in Q2 of 2021, driven by the onetime separation amounts charge, lower franchise revenue due to the one-time change in estimate mentioned earlier and higher depreciation as a result of the Natura Market acquisition. NAF restaurant same-store sales performance for Q2 of 2022 was essentially flat. It was a positive performance in the first half offset by a lower second half. The performance in the second half was primarily impacted by four major factors. First, based on industry data, the onset of significant inflation weighed on consumer demand and resulted in reduced customer visits and transactions.
Second, the year-over-year performance of the NAF restaurant segment is compared against Q2 2021, in which the quick service restaurant industry benefited from pandemic-related restrictions placed on travel, full-service dining and other experiences and at such a certain amount of normalization and same-store sales growth is in our view to be expected. Third, in Q2 2022, primarily as a result of the lessening of pandemic-related restriction, customer traffic shifted in part from digital channels back to in-store, which reduced our average check out transaction involving those customers. Lastly, the second half of Q2 ‘22, we saw its imperatively quieter promotional period as we entered the Tacos LTO and associated marketing earlier than planned, and this quieter promotional period has continued into the third quarter of 2022.
From a liquidity perspective, we ended the quarter with $23.7 million in cash, which is down $2.8 million versus Q1 of 2021, or $0.7 million after adjusting for share repurchases and the onetime separation amounts. The operating change in cash is largely due to timing of working capital movements.
As Dan mentioned, the impact of macro challenges have continued into Q3 and we continue to see a slower-than-expected return to office. Despite these short-term headwinds, we will continue to make investments in critical areas of our business such as the field team and development to set the business up for long-term growth.
I also wanted to provide a bit of perspective on my first couple of months as CFO at Freshii. I joined Dan on many of the end market visits and met a number of our franchisee partners. And while the degree of recovery and performance varied significantly, the passion for the Freshii brand shown by franchisee partners and respective staff stood out.
This no doubt remains a complex environment to operate in for us and our partners, but there was a clear rallying point to shift from a pandemic-driven defensive posture to going back on offense to drive growth. I’ve also been really impressed by the level of talent and dedication that our Freshii partner support center has demonstrated, working tirelessly to support our partners with a constant view to attempting to grow our brands and evolve our offerings. Together with our partners, I’m optimistic we can put Freshii on a path of sustainable long-term growth. As Dan mentioned, we will update you on future calls with respect to our normal course long-term strategy planning and capital allocation approach.
And now I’ll pass it over to the operator to open it up for Q&A. Thank you.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Our first question comes from the line of Pulkit Sabharwal with Canaccord. Please proceed with your question.
Pulkit Sabharwal
Hi, good morning. Just a couple of questions from my side. I wanted to get some more clarity on the restaurant growth pipeline. For the remainder of the year, especially, what should we expect in terms of openings and what the footprint is going to look like?
Daniel Haroun
Hi, Pulkit, thanks for the question. As we enter 2022, we recapped that our primary focus on the real estate and development side in 2021 and the front half of the pandemic as well was mainly on supporting our franchise partners on rent negotiations and support. And then we were beginning to shift back to building out that pipeline for future growth in 2023 and beyond. And that really message is consistent at this point in time. We continue to work through with our franchise partners, aggressively pursuing real estate opportunities. But doing so, leveraging new tools and processes. And so we really believe that 2023 and beyond are when we will start to get back to a more significant amount of new openings than you would have seen during the pandemic period.
Pulkit Sabharwal
Okay. That’s very helpful. And then in terms of the inflationary headwinds you guys touched upon, I’m wondering if you could provide some color on the different levers at your disposal to mitigate these.
Daniel Haroun
First of all, we work very closely with our supplier partners on managing the pressures of the day. And cost inflation is right now, it’s quite impactful to the broader industry. But we work to try and delay and mitigate as best as we can. When there are requirements made to pass it on to our franchise partners, we obviously work very closely with our franchise partners on price increases, on bundling, on comboing to continue to push average check up in some cases, but also especially on a digital perspective, drive frequency and rewards that way as well. So really, it’s looking at a recipe of how can you reinvent the cost structure as best as you can without disrupting the guest experience any more than we’d want to.
Pulkit Sabharwal
Okay, that’s very helpful, again. Thanks, again. I will jump back in the queue.
Operator
Our next question comes from the line of Kyle McPhee with Cormark Securities. Please proceed with your question.
Kyle McPhee
Hi, guys. So to start with the North American franchising business, the update you gave us shows that the permanent store closure rate has spiked back up after that had nicely trailed lower over the last year. So based on all your time spent in the field over the last quarter, how big is that contingent of stores that likely still needs to be closed? And maybe as a proxy, is it fair to say that you’ve disclosed bottom 15% of locations with AUVs half the rest will be closed?
Victor Diab
Hi, Kyle, it’s Victor. Yes. Thanks for the question. Yes, I mean, the way we look at it, I think we’ve hit on it with the data point, which is, if you look at the top 85% versus the bottom 15%. And the reason we do that is we said there is a stark difference in performance there. So as we think about the bottom 15%, really the variance in performances should be for a number of different reasons. In some cases, the trade areas have been severely impacted by COVID and for the long-term. In other cases, it’s a mix of operational issue or perhaps partner fit issues that we look at. So the way we approach that is we go market by market, store by store, and we develop action plans for each of those stores. In some cases, we do believe that there is going to be more closures as part of that 15%. I’m not going to quantify whether it’s an entire 15% or not. But I will say there is certainly risk in the bottom 15% of more closures. That being said, we’re actively working on, whether it’s relocations or again, improving operations to increase AUV and keep the store open, we’re looking at all those options, but there is continued risk in that volume of 15%.
Kyle McPhee
Got it. Okay. I appreciate that color. And then on the opening rate, that metric decelerated for you this quarter. Was that expected internally here or were there only the one opening or were there frictions in the quarter that maybe pushed out some of the openings or maybe you lost some of your franchisees given market conditions?
Daniel Haroun
Hi, Kyle, it’s Dan. Thanks for the question. No change whatsoever in franchisees that are in the pipeline, whether it’s a signed lease ready to move forward or a partner who’s still looking for real estate whatsoever in 2022 or beyond. It’s really the timing of when sites land, but I’ll refer to the comments to the previous question as well that again, we do see 2023 and beyond, given the lead time required to find real estate and then build out times as well, although we do have teams working in parallel to compressed time lines from, call it, signing to opening and from first interest to signing to continue to remediate that impact. But at this point in time, no change in franchisee interest or demand whatsoever. But we do expect that the front half of 2022 being largely represented of what we would have expected.
Kyle McPhee
Got it. Okay. And then shifting over to the retail and e-commerce segment, the CPG business had a very nice growth lift, but the DTC Natura business went the other way. It seems like that growth engine, which is not enough to offset the COVID lapping headwinds. Should we expect that to be the case for Natura through the back half of this year or are your investments in growth going to shift that platform back to growth in fairly short order?
Daniel Haroun
At this point, the broader – I mean, I think the challenges in the broader e-commerce segment are well documented. I think a lot of the things that we see in the industry have the period of time in shifting back between e-commerce and brick-and-mortar, really not changing dramatically over the next several quarters. And so at this point in time, we would expect that what we saw in Q2, roughly representative subject to a reasonable range as what we would see in the back half of the year, Kyle.
Kyle McPhee
Okay, thanks for that color. And I guess the last one for me on the balance sheet. It sounds like you need to make additional investments in OpEx to support your North American franchising business and maybe some investments still to drive growth with the CPG and DTC. So how will that balance out? Are you going to shift to a free cash flow burn before things start to get better on the growth front or are you still going to be managing right around free cash flow breakeven in the short-term?
Daniel Haroun
Yes, I’ll answer that and then allow Victor to offer any color as well, Kyle. I think at this point in time, we’re really focused on in the North American franchise restaurant division, making sure that the business is healthy and positioned for the long-term growth that we see. And so obviously, you heard about some of the investments that we’re starting to make into the third quarter, both in the field team and in the development team. And obviously, we need to continue to drive that improved guest experience across the network. We’re going to be quite thoughtful about the investments that we do make and where at all possible, want to fund those investments, obviously. But we’re also going to make the right decisions for the long-term. I think those discussions and evaluations are still underway, and I wouldn’t give too much further financial guidance on the free cash flow side at this point in time.
Kyle McPhee
Okay. That’s it from me.
Operator
There are no further questions in the queue. I’d like to hand the call back over to Daniel Haroun for closing comments.
Daniel Haroun
Thank you very much. We thank you so much for your continued interest in Freshii. And we look forward to speaking to you again next quarter.
Operator
Ladies and gentlemen this does conclude today’s teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.
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