Freshii Inc. (OTCPK:FRHHF) Q3 2022 Earnings Conference Call November 10, 2022 8:30 AM ET
Company Participants
Jeremy Mandel – Investor Relations
Daniel Haroun – Chief Executive Officer
Victor Diab – Chief Financial Officer
Conference Call Participants
Derek Dley – Canaccord Genuity
Liam Dotchison – Cormark Securities.
Operator
Good morning and welcome to Freshii Inc.’s Third Quarter 2022 Earnings Call. As a reminder, today’s call is being recorded and your participation in today’s call is your consent to such a recording. [Operator Instructions] A question-and-answer session will follow the formal presentation.
I would now like to turn the conference over to Jeremy Mandel, Senior Director of Legal. Please go ahead, sir.
Jeremy Mandel
Thank you and welcome to Freshii’s third 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 remarks in this conference call may provide certain information regarding our expectations, future plans and intentions that may constitute forward-looking statements. I would refer you to our most recently filed management’s discussion and analysis, which includes a summary of the significant assumptions underlying such forward-looking statements and certain risks and factors that could affect our future performance and our ability to deliver on these forward-looking statements.
The third quarter 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.
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 Q3, we made significant progress in the long-term expansion of our omnichannel brand. Our North American franchise restaurant segment continued to grow its planned new store development pipeline in the quarter. It currently stands at over 125 locations based on agreements signed, including a recent multi-unit agreement from the planned development of 6 locations in New Jersey, which were signed with existing franchise partners. Additionally, we have also signed a conditional agreement for the development of the first purpose-built Freshii drive-thru in Western Canada, which we expect to open in 2023. We are excited about the continued strong interest from existing and potential new franchise partners who are passionate about our mission and long-term growth potential.
Our CPG business had a strong quarter, increasing its system sales with existing customers and launching in 500 new points of distribution near the end of the quarter, again, expanding our brand’s reach. These exciting initiatives give us confidence in the significant long-term growth opportunities for our brand. At the same time, we recognize a challenging and complex operating environment that we and our franchise partners expect to continue to face in the near term.
I want to clearly highlight two different dynamics about this operating environment, one, that is expected to be a short-term headwind, which we believe will end in Q4 of this year and another that is expected to be a significant long-term tailwind that we are beginning to see early positive signs from. First, let me start with the short-term headwind. Throughout much of 2021, Freshii worked to offset some of the pandemic-driven declines to in-store traffic with digital initiatives that increase the share of takeout orders resulting in lessened impacts in the delivery, dinner and digital components of our business.
We believe consumers felt safe and confident in choosing takeout options from Freshii at a time when other experiences such as dining and full-service restaurants were not available or not an appealing option to those consumers. Now that restrictions have been removed and consumers are more comfortable returning to their pre-pandemic habits, the full-service restaurant industry has opened back up as well as other travel and entertaining experiences. As a result, we are seeing the normalization of the dinner, delivery and digital components of our business, which began in the second half of Q2, and we expect that to complete in the fourth quarter of 2022 from a lapping perspective.
The second dynamic at play, which is a longer term significant tailwind for Freshii that is just getting started, is the return to office for employees. Victor will touch on this later, but here is the highlight. Return to office is still significantly below pre-pandemic levels, and that is for every geography we track whether it’s urban or suburban, Toronto or Pittsburgh.
In the fourth quarter, we are starting to see in many markets, increased office traffic in the middle of the week as employees are often choosing their 2 days a week between Tuesday and Thursday, for the situation where many employers are asking employees to come in 2 days a week at this point in time. Again, we track these trends by city, by day and by daypart. So in the third quarter and continued in the fourth quarter, we have had this normalization headwind where consumers that have gone back to their pre-pandemic habit. And in the fourth quarter, we are seeing very early signs of employees now starting in a hybrid way of getting back to their pre-pandemic habits.
While the pace of return to office is often beyond our control, we intend to position our partners to be able to continue delivering an exceptional guest experience as we continue to focus on bringing exciting menu innovation to customers and accelerating our digital transformation. Our talented, dedicated and resilient franchise partners and our partner center team have embraced the challenge of positioning the business for long-term sustainable growth, while recognizing the importance of providing value and accessibility to customers at a time when consumers’ discretionary spend is under pressure from high inflation and economic uncertainty. We believe our new fall and winter menu that just launched, featuring warm bowls, soups and pockets at a range of price points some under $5, many under $10 will position us well over the next few months, continuing to be a welcoming go-to restaurant for our guests.
As we look forward to 2023, we expect the year-over-year volatility faced by the dinner, delivery and digital parts to dissipate, and our franchise partners are ready and excited to welcome office traffic back to the restaurants for lunch and across all dayparts both in urban and suburban areas.
I will now pass the call over to Victor, our CFO, to go over our financial results for the quarter.
Victor Diab
Thanks, Daniel and good morning everyone. I’ll be reviewing our consolidated Q3 results followed by additional color on each of our key segments and a brief discussion of a non-cash goodwill impairment as it relates to Natura Market.
In Q3, consolidated revenue was up to $10.9 million, an increase of 87% as compared to Q3 2021, largely driven by the consolidation of Natura Market results and strong growth in the CPG business, offset by a decline in the North American franchise restaurant segment. Overall SG&A for the quarter was flat to last year, as the consolidation of Natura Market was offset by lower salaries and professional fees. The latter as a result of onetime costs associated with the Natura Market acquisition in the prior year. Adjusted EBITDA was $0.1 million, which represents a decrease of $0.3 million, driven by lower revenue and system sales at the North American franchise restaurant segment.
Turning to our North American franchise restaurant segment, where we saw continued pressure on the top line as Q3 system sales declined by 7% and same-store sales growth declined by 11%. We believe same-store sales growth in the quarter was primarily impacted by two major factors that are affecting customer purchasing behavior. First, the relaxing of pandemic-related restrictions beginning earlier in 2022 has resulted in consumer spending, shifting in part to goods and services that were unavailable or were more limited such as travel, dining restaurants and other experiences. This was particularly evident in our dinner daypart performance, which throughout the pandemic became a higher percentage of the daypart sales mix as the company was able to offset some of the pandemic-related declines with increased share in take-out orders on digital channels.
In Q3 2022, the dinner daypart same-store sales performance declined relative to the same period in the previous year as customers shifted back to dine-in restaurants and as such, return the dinner daypart culture to pre-pandemic sales mix levels. The decline in the dinner daypart explains the majority of the segment’s overall same-store sales growth decline on a year-over-year basis. We also continue to see the impact of inflation on consumer discretionary spend, negatively impact customer visits at the company stores. Our industry data from third-party sources suggest that the negative traffic we saw is consistent with the company’s quick service restaurant competitors with non-drive-through models.
Generally speaking, as a brand that focuses primarily on healthier options with a higher average price point than the broader quick service restaurant segment, Freshii performs better in a stable, low inflationary economic environment and with more robust office traffic. While office traffic recovery progressed in Q3 2022 that remains significantly reduced as compared to 2019 levels, down approximately 60% on average. We believe that a continued recovery of the workforces’ return to office could be a significant growth driver for the business in the coming years while also better insulating the company from economic volatility going forward, as the office customer has historically been a key driver and stable component of the restaurant segment. For context, in the fourth quarter of 2022 to date, we are seeing improved trends in same-store sales growth relative to Q3 of 2022 driven by stronger office traffic in the middle of the week, Tuesday through Thursday in both the breakfast and lunch dayparts as compared to other days. We are also seeing improved performance in certain regions of the country with more reported office traffic.
Moving to the retail and e-commerce segment, where we saw the CPG business delivered another strong quarter, growing system sales by 33% year-over-year and significantly improving EBITDA performance despite the challenging cost environment. The Natura Market business continues to operate in an environment where retail e-commerce growth is adjusting after a period of accelerated growth during the pandemic. Q3 2022 revenues are down 21% as compared to Q3 of last year. But for context, the business is still well above 2019 pre-pandemic levels. The challenging e-commerce environment also resulted in higher promotional activity and therefore, in lower margin in comparison to the first half of 2022.
In considering changes to macroeconomic conditions, specifically the sharp decline in market valuation as discount rate rises and Natura Market’s near-term performance, we reviewed the asset for impairment. As a result, the company reported a $2.9 million non-cash impairment loss, which has been fully allocated to goodwill. Our perspective on the long-term growth potential of the business has not changed.
From a liquidity perspective, we ended the quarter with $22.4 million in cash, which is down $1.3 million versus the second quarter, largely driven by a $0.8 million deferred cash consideration for the Natura Market acquisition and certain Freshii mobile app related capital expenditures. Operating cash was otherwise flat as compared to the last quarter. While we continue to see pandemic-related volatility in our results this quarter, we expect to have a cleaner baseline for the business in the New Year. Combined with the gradual return to office tailwinds, menu and digital innovation and continued momentum in growing and executing against our development pipeline.
I will now pass it back to the operator.
Question-and-Answer Session
Operator
[Operator Instructions] Our first question comes from Derek Dley with Canaccord Genuity. Please go ahead.
Derek Dley
Yes. Hi. Thanks and good morning everybody. Just a couple of questions on the retail e-commerce and Natura segment. So, I understand you segment them all together. But can you break out the retail and e-commerce portion of Freshii and Natura aside, I get at $3.2 million in sales. But are these profitable sales? Like are you guys breaking even on those revenues?
Victor Diab
Hey Derek. Thanks for the question. We do break that out in the financial statements. I would say we are close to breakeven. We weren’t necessarily breakeven for the quarter. We said we did see some pressure on the margin line for Natura, given the promotional environment. But we – our plan is to operate at close to breakeven. So, while we were probably a little bit shorter on the EBITDA line there this quarter, we are confident over time we will get that business back to breakeven.
Derek Dley
Okay. That’s helpful. And then just when we think about the progress in terms of new store openings versus net closure – versus closures, sorry, we are still kind of in that net closure mode. And given your strong pipeline of new store openings plus some of the MFA agreements, do we think we will be in a net opening position by the end of the next year?
Daniel Haroun
Thanks. Hey Derek, it’s Dan. Thanks for the question. We are certainly encouraged by the continued momentum we see both in – both prospective new franchise partners looking to join the mission, but also existing partners looking to expand their entrepreneurial journey with the brand. I would say if we refer back to the initial comments we made at the start of 2022, we do expect to significantly increase our store opening pace in 2023 and beyond and obviously, having a strong pipeline and building out that real estate and development and design and construction team is what we have been quite focused on. And so we are excited to see the net opening pace continue to grow in 2023 and beyond. In terms of closures, we are really focused on that bottom 15% where AUVs are significantly below where they were – where the rest of the system is. And so for that dynamic, it really comes down to site-by-site. Is there an opportunity to relocate within the trade area, is there a site that just needs a different operator, or is there a deal that to be done with the landlords so we can exit that site successfully on behalf of our franchise partners and come back in the trade area a little bit further down the road as the better real estate opportunity exists. Timing that site-by-site is obviously challenging, as you know. But from an opening perspective, we are pretty optimistic about the pace we are going to continue to see sites come onboard in 2023 and beyond.
Derek Dley
Okay. That’s helpful. And how about your MFA partner level, I believe is the name? Have they begun to open any of their stores in the U.S. or Texas?
Daniel Haroun
Yes. So, they are actively in discussions for multiple sites in the Texas trade area. They are being thoughtful about how they want to enter the market, and we are supporting them and working very closely. We are completely aligned on the strategy to enter the market. And we absolutely expect our first sites to come onboard in that market in 2023.
Derek Dley
Okay. And then last one for me. Just on the daypart conversation around dinner and even around breakfast, can you provide us with the daypart split? I know historically, you haven’t done that, so I might be a bit aggressive in asking for that, or perhaps what percentage of your sales are dinner now versus the pandemic? And do you see a bigger opportunity perhaps in breakfast going forward versus dinner given the sort of normalization in consumer behavior that we are seeing now?
Victor Diab
Thanks Derek. I appreciate the question. You are right. As you know, historically, we don’t break out the channel mix, but I can certainly give you some context from a daypart perspective. For breakfast, for example, we did see positive growth in the quarter driven by a combination of return to office and more hours of operation as some of our franchisees go back online in the morning. So, that was a positive improvement for us. From a dinner perspective, as we talked about, we expect that normalization to basically be substantially complete, let’s say, by the end of Q4 as we kind of lap some of the dinner growth we saw in the prior year as a result of the COVID conditions. And then from a lunch perspective, we saw that very closely to office traffic. So, where we are seeing positive office traffic and momentum, we are seeing positive lunch growth and momentum as well, especially that data point we shared around Tuesday to Thursday, where we tend to see on general, on average across the country, we are seeing more office traffic on those days. And those days tend to be positive days for us, and we continue to see that momentum into the fourth quarter. So, we are generally feeling positive around – dinner will continue to be a headwind in Q4, but we are seeing momentum in breakfast going into Q4 and lunch, especially where we see positive office traffic. So, we are seeing that correlation between office traffic and lunch performance, and we are continuing to see that into Q4. And as Dan said, I think over the long-term, given where office traffic is overall, 60% down relative to 2019, there is a significant opportunity for us as we go forward. It would be slow and gradual, but we feel like that’s going to be a sustainable tailwind that will help drive growth going forward. And frankly, it helps insulate our business from some of the economic volatility because that office customer base tends to be more loyal, more sticky and tends to drive frequency for us. So, we are encouraged by some of the results that we are seeing there.
Daniel Haroun
And Derek, one thing I would just add is we were also encouraged by the amount of interest we saw during 2021 from customers for Freshii for dinner. And that tells us that there is an opportunity for us in that daypart and it’s absolutely something that’s on the roadmap for us is to start to think through warmer, hardier options with – filled with labor to continue to offer the guest Freshii as many dayparts as possible. Some of your office locations might be first to get back to breakfast, but we absolutely believe that in the mid-term, dinner is a significant opportunity for us as we continue to build the right offer to get there.
Derek Dley
Okay. Thank you very much.
Operator
Next question comes from Liam Dotchison with Cormark Securities. Please go ahead.
Liam Dotchison
Thanks. So, to start on the retail and e-commerce segment. What time – at what point in time do you expect Natura Market may have lapped the tailwinds provided by COVID and shifting to a period where it’s facing maybe more of a normalized comparable period. So, I am assuming Q4 will likely be comparable to Q3, but can we expect some leveling off in the year-over-year declines kind of entering 2023 and beyond?
Victor Diab
Hey Liam, thanks for the question. Yes, from our perspective, we are probably expecting continued headwinds probably into the first half of next year. And then hopefully, that levels off and then we start to see the general e-commerce trends, which we – Natura follows closely as sort of the broader e-commerce channel returns to growth, our growth tends to follow with that. So, we think we are going to see headwinds probably into the first half of next year. And then we are expecting that Q3, Q4 should be a better result.
Liam Dotchison
Great. Got it. Thanks for the color there. And then now shifting down to OpEx. Do you have any expectation for any incremental spend needed versus the run rate kind of seen in Q3 as it relates to supporting franchisees, some of the new ones in the pipeline and aiding and driving any growth for new locations?
Victor Diab
Yes. Look, on SG&A, we are sort of happy with the way we are managing here right now, which is flat for the quarter despite consolidating Natura, which we feel good about. In terms of going forward investments, we have called that out in the past in terms of areas that are key to the business that we want to continue to invest in, such as operations, our development, which are key in the restaurant business, which are key to supporting our growth going forward. We are going to continue to be very thoughtful and disciplined around our overall SG&A spend and where we allocate our SG&A dollars. So, I would say, in terms of our focus area, again, consistent with what we have said in the past, but we are going to continue to manage that line very closely as we have been in the last couple of quarters.
Liam Dotchison
Got it. Okay. And then last one here for me, just on the labor side. Have you guys seen any issues ongoing or otherwise regarding franchisees with staffing, issues with hiring? And then I guess thinking along the same lines, is there any upwards pressure on pay or store is still able to find labor at an acceptable cost?
Daniel Haroun
Yes. Thanks for the question. It’s obviously a very important one in our industry. I would say it really does differ by geography to some extent, but it’s still an ongoing challenge for our franchise partners in recruiting and training good staff at quickly and retaining those staff. We are starting to see some progress in that area, and that enabled some of our franchise partners to start to expand customer access by broadening their hours of operations and we continue to work with our franchise partners in a measured way to continue to do that. So, I would say it’s challenging, but we are managing through that alongside our franchise partners. And we will continue to watch the operating environment from that perspective very closely to make sure that we can continue to expand customer access through those optimal hours of operation and of course, deliver the fast guest experience that we want to be able to deliver. So, challenging, but we are continuing to work through that with our franchise partners.
Liam Dotchison
Great. Thanks guys. Appreciate it.
Operator
There are no further questions at this time. I would like to turn the floor back over to Daniel Haroun for closing comments.
Daniel Haroun
We thank you all for your interest in Freshii and we are looking forward to speaking to you again next quarter.
Operator
This concludes today’s teleconference call. You may disconnect your lines at this time and thank you for your participation.
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