High Liner Foods Incorporated (OTCPK:HLNFF) Q3 2022 Earnings Conference Call November 10, 2022 10:00 AM ET
Company Participants
Kimberly Stephens – VP, Finance
Rodney Hepponstall – President and CEO
Anthony Rasetta – Chief Commercial Officer
Paul Jewer – EVP and CFO
Conference Call Participants
Arthur Nagorny – RBC Capital Markets
Kyle McPhee – Cormark Securities
Operator
Good morning, ladies and gentlemen. Thank you for standing by. Welcome to the High Liner Foods Incorporated conference call for results of the third quarter of 2022. [Operator Instructions]
This conference call is being recorded today, Thursday, November 10, 2022 at 10:00 a.m. Standard Eastern Time for replay purposes. I would like to turn the call over to Kimberly Stephens, Vice President of Finance for High Liner Foods. Please go ahead.
Kimberly Stephens
Good morning, everyone. Thank you for joining the High Liner Foods conference call today to discuss our financial results for the third quarter of 2022. On the call from High Liner Foods are Rod Hepponstall, President and Chief Executive Officer; Anthony Rasetta, Chief Commercial Officer; and Paul Jewer, Executive Vice President and Chief Financial Officer.
I would like to remind listeners that we use certain non-IFRS measures and ratios when discussing our financial results as we believe these are useful in assessing the company’s financial performance. These measures are fully described and reconciled to IFRS measures in our MD&A. Listeners are also reminded that certain statements made on today’s call may be forward-looking statements that are subject to risks and uncertainties. Management may use forward-looking statements when discussing the company’s strategy and business in the future. Actual operating or financial results could differ materially from those anticipated in these forward-looking statements.
High Liner Foods includes a thorough discussion of the risk factors that can cause its anticipated outcomes to differ from actual outcomes in its publicly available disclosure documents, particularly in its annual information forms and annual report. Please note that High Liner Foods is under no obligation to update any forward-looking statements discussed today. After the markets closed yesterday, November 9, High Liner Foods reported its financial results for the third quarter ended October 1, 2022.
The news release, along with the company’s MD&A and unaudited condensed interim consolidated financial statements for the third quarter of 2022 have been filed on SEDAR and can also be found in the Investor section of High Liner Foods website. If you’d like to receive our news releases in the future, please visit the company’s website to register.
Lastly, please note that the company reports its financial results in U.S. dollars, and therefore, the results can be — to be discussed today are also stated in U.S. dollars, unless otherwise noted. High Liner Foods common shares trade on the Toronto Stock Exchange and are quoted in Canadian dollars.
I will now turn the call over to Rod for his opening remarks.
Rodney Hepponstall
Hello, and thank you for joining us to discuss our third quarter performance. Before we get started, I would like to welcome High Liner Foods’ Chief Commercial Officer, Anthony Rasetta to the call. Anthony joined the team 16 months ago from Mondelez International, where he held a variety of cross-functional leadership roles in the U.S. and Canada. Anthony plays an integral role in our consumer, customer and category growth initiatives. We hope that his perspective provides helpful insight into our business and complements the strategic and financial perspective on our business that you hear from myself and Paul.
Turning to our performance in the third quarter. I am extremely pleased to report that we delivered our sixth consecutive quarter of year-over-year sales and adjusted EBITDA growth. Compared to the same period last year, we increased sales by $56.9 million or 26.6%, and increased adjusted EBITDA by $2.4 million or 10.7%.
Paul will provide a more detailed account of our financial performance shortly. Within High Liner Foods, there is a sense of renewed energy among our people. They are rightly proud of our success. We transformed our business, navigated through the pandemic and have executed consistently against our growth strategy. The steady momentum delivering for our customers and against our strategy is paying off as we capitalize on the rebound in foodservice.
We won new business, gained market share and remained resilient through major global supply chain challenges. Internally, the efforts we have made to cultivate a high-performance culture are paying off. Every day, we see our people going the extra mile for our customers and each other. Externally, we are expanding the reach of our products and shifting perceptions of the role that seafood can play on the menu or for family dinner. Foodservice operators are adding our products to their menus in new and creative ways, and retail customers are adding our products to their freezers to satisfy consumer demand for choice and quality at value price point.
As we continue to demonstrate that we are resilient in the face of market challenges as evidenced by this quarter’s strong financial results we achieved despite headwinds that are impacting all aspects of the global economy. There is uncertainty and growing concern about where the economy is heading as North American consumers’ confidence dips in response to rising interest rates and inflation. Market data suggests that consumers are becoming much more price sensitive and are beginning to cut back, trade down and seek out value offerings. Although the global supply chain is in better shape than earlier this year, it has not yet normalized.
Nonetheless, we are able to draw on the strength of our diversified global supply chain to navigate the ongoing supply dynamics. Even though our fill rates are not yet back to our target levels, our customers tell us we continue to perform better than our competition. Likewise, despite economic headwinds becoming more pronounced around the world, High Liner Foods continues to drive sales momentum in our foodservice and retail businesses. Of note, in U.S. foodservice, we grew faster than the category. Our success can be attributed to the strength of our institutional business, which continues to lead category growth as well as the impact of our efforts to educate operators and grow the category.
Specifically, our steady growth in institutional, casual and quick service restaurants is aligned with our growth strategy. These are the segments in which we see the greatest upside potential over the long term and have the greatest resilience against recessionary challenges in the short term. In retail, we had another strong quarter on both sides of the border. Consumer behavior is certainly evolving in response to both economic environment and rising food prices. We continue to perform well despite the increasing price-sensitive environment. We believe our sustained strong performance is supported by the choice we offer consumers to shop within our product portfolio of products.
As a result, we saw a corresponding increase in our value products during the third quarter and are well positioned in the market should this trend become more pronounced. Overall, I’m very proud of what the team delivered during the third quarter. We are going from strength to strength and are positioning ourselves to continue this trajectory irrespective of market conditions, which brings me to another win during the quarter.
We invested in our working capital to gain an additional $50 million of financial capability we can use to advance our strategy to become the leader in branded value-added seafood in North America. The Board’s decision to increase the dividend this quarter is a further validation of our progress, our strategy and our potential. Paul will share more details on both points shortly.
But first, it’s my pleasure to hand the call over to Anthony for more specifics on our foodservice and retail performance in the past quarter.
Anthony Rasetta
Thanks, Rod, and hello, everyone. I’m thrilled to be joining the call today. To build on Rob’s overview, I’ll provide some perspective on how we delivered against our strategic priorities during the third quarter and what insights we can draw from this. In Foodservice, we saw broad-based success across all segments. We continue to grow faster than the category in noncommercial foodservice and expanded our reach in casual dining and quick service restaurants.
The team is going to market with strong and compelling value propositions and is really gaining traction. A great example of this is the recent success of a limited time offer with a leading quick service brand. Aligned with the strategic approach Rod outlined, we partnered with our customer to leverage one of our value-added seafood products in 2 creative ways on their menu at the same time, and it worked really well. The customer loved how it offered diners more menu options and the opportunity to enjoy seafood in a new and exciting way. The product sold out twice as fast as expected, and it was a great segue for us to solidify a long-term relationship.
And we plan on making the promotion bigger and better next year. Another great example in foodservice is that we were presented with the VIP Award for supplier excellence from one of our largest distributor partners being recognized for customer service, brand development and quality. In retail, our portfolio is also performing very well. The breadth of our portfolio offers consumers choice and flexibility, which allows them to shop based on budget, occasion or convenience with the assurance of quality every time.
During the quarter, we continued to expand distribution of our value brand, Fisher Boy, in the U.S., building on the success Rod spoke about last quarter and are supporting it with significant customer marketing investments. Our premium value-added products like Sea Cuisine remain an attractive proposition at the higher end of the retail market due to the different type of value offered.
That of convenience and the ability to enjoy an elevated dining experience at home without the restaurant price tag. We’re also driving gains through channels like club and mass merchandise by partnering with our strategic customers in both branded and private label offerings. Our growth momentum is allowing us to continue to invest in strong ROI marketing to build brand awareness and engage directly with our end consumers.
I believe there’s a lot of potential in this regard, and this was one of the reasons the opportunity at High Liner Foods helped such appeal to me before I joined the company. The way I look at it is, although High Liner Foods has been in business for over 100 years, the frozen seafood industry is in its infancy in terms of growth and development of the category overall.
There’s a lot of white space in terms of the possibilities to educate and engage consumers and customers on the benefits of frozen seafood as a versatile and healthy protein. High Liner Foods with its deep roots in the industry, amazing portfolio, integrated and diversified global supply chain is well positioned to lead this charge and benefit in the process.
I feel very privileged to have joined a company with outstanding people and culture. The amazing turnaround in profitability before I arrived has put us in an incredible place to be able to lead the category and invest for growth. My time with the company has only served to reinforce the growth opportunity I see in front of us and the capabilities within High Liner Foods to seize the opportunity and create value in all respects.
Value for the restaurant owner who wants to draw in diners, but is struggling with labor and menu simplification; value for the family that wants to serve a great tasting, healthy affordable protein or a special occasion at home; value for customers as they rely on us to draw on our resources at a time of unprecedented supply constraints to ensure customer service is strong.
And of course, as we do all this, we’ll surface value for our investors, which is a great segue to hand over to Paul for our financial review. Paul?
Paul Jewer
Thank you, Anthony. Great to have you with us, and good morning, everyone. Please note that all comparisons provided during my financial review of the third quarter of 2022 are relative to the third quarter of 2021, unless otherwise noted. Sales volume increased in the third quarter by 5.6 million pounds or 10.2% to 60.4 million pounds. We continue to experience increased demand for our products across our noncommercial businesses as well as higher sales volumes in both QSR and casual dining segments that are growth targets for the company.
The increase in sales volume was also due to growth in our retail business due to marketing efforts and increased sales in new product lines and new business. This was partially offset by the impact of global supply chain challenges on raw material supply to North America, that impacted the company’s sales volumes by an estimated 4 million pounds or 6.6% in the third quarter, similar to the impact in the first and second quarters of fiscal 2022.
Sales increased in the third quarter by $56.9 million or 26.6% to $271.2 million, reflecting higher sales volumes discussed previously as well as pricing actions related to inflationary increases on input costs. In addition, the weaker Canadian dollar in the third quarter of 2022 compared to the same quarter of 2021 decreased the value of reported U.S. dollar sales from our Canadian dollar-denominated operations by approximately $2.5 million relative to the conversion impact last year.
Gross profit increased in the third quarter by $8.8 million or 18.4% to $56.7 million, and gross profit as a percentage of sales was decreased by 150 basis points to 20.9% as compared to 22.4% in the third quarter of 2021. The increase in gross profit dollars reflects the higher sales volume and pricing actions, as mentioned previously, offset by some changes in product mix. In addition, the weaker Canadian dollar decreased the value of reported U.S. dollar gross profit from our Canadian operations in 2022 by approximately $600,000 relative to the conversion impact last year.
Adjusted EBITDA increased in the third quarter by $2.4 million or 10.7% to $24.8 million, and adjusted EBITDA as a percentage of sales decreased to 9.1% compared to 10.5%. The increase in adjusted EBITDA is a result of the increase in gross profit, partially offset by the increase in net SG&A expenses and in distribution expenses. In addition, the weaker Canadian dollar decreased the value of reported adjusted EBITDA in U.S. dollars from our Canadian operations in 2022 by approximately $200,000 relative to the conversion impact last year.
Reported net income increased in the third quarter by $800,000 to $10 million and diluted earnings per share increased by $0.02 to $0.28. The increase in net income was largely due to the increase in adjusted EBITDA and a decrease in business acquisition, integration and other expenses which was partially offset by an increase in finance costs and share-based compensation expense.
Excluding the impact of certain nonroutine or noncash expenses that are explained in our MD&A, adjusted net income in the third quarter of 2022 increased by $3 million or 26.5% to $14.3 million; and correspondingly, adjusted diluted earnings per share increased $0.09 to $0.41 compared to $0.32 in the same period in the prior year.
Turning now to cash flows from operations in the balance sheet. Net cash flows from operating activities in the third quarter of 2022 decreased by $14.1 million to an outflow of $9.9 million compared to an inflow of $4.2 million in the same period in 2021 due primarily to changes in noncash working capital driven by investments in inventory to support business growth and customer service, partially offset by higher cash flows provided by operations.
Net debt at the end of the third quarter of 2022 increased by $46 million to $317.1 million, compared to $271 million at the end of fiscal 2021, primarily reflecting higher bank loans and partially offset by lower lease liabilities. Net debt to adjusted EBITDA was 3.2x at October 1, 2022, compared to 3x at the end of fiscal 2021. In the absence of any major acquisitions or unplanned capital expenditures in 2022, we expect this ratio to continue to be slightly above the company’s long-term target of 3x at the end of fiscal 2022.
Subsequent to the quarter, we increased the limit on our secured asset-based credit facility from $150 million to $200 million. All other material terms of the working capital facility remain unchanged. With access to an additional $50 million in working capital, we now have enhanced financial flexibility and capacity to drive growth. Additionally, I am happy to share that Moody’s upgraded our term loan B ratings in October, validating the significant improvements in our business and financial position over the past several years.
The Board considered our cash flow and capital allocation needs of the business as part of its consideration of the dividend. The decision to increase the dividend this quarter indicates the Board’s confidence that the company is well positioned and can support an increased dividend to shareholders while continuing to invest in growth plans to drive long-term value creation.
The company’s Board of Directors approved a quarterly dividend of CAD 0.13 per share on the company’s common shares payable on December 15, 2022, the holders of record on December 1, 2022. The quarterly dividend of CAD 0.13 per share represents a CAD 0.03 increase from the CAD 0.10 per share quarterly dividend paid during the third quarter of 2022.
I will now turn the call back over to Rod for some final remarks before opening up the call to questions. Rod?
Rodney Hepponstall
Thank you, Paul. To wrap up today’s call, I’d like to reiterate how proud I am all the team has achieved and the commitment to continuing to build on these results and show it is possible for our company and our industry. I am confident that we will deliver another year of adjusted EBITDA growth at year-end. When we speak next, I expect the economic headwinds that are currently circulating will be more pronounced, and we will find ourselves operating in a more challenging market conditions.
We are prepared for this and are ready with solutions to increasing pressure this will put on the customers and consumers. Foodservice operators are seeking reliable supply, efficiencies and innovations, we deliver. Retail customers are also still prioritizing supply, while wanting to drive traffic through maximizing choice and value, we deliver. Consumers, whether they are dining out or eating at home want the reassurance of quality and value whether that is monetary or convenience, again, we deliver.
Our purpose to reimagine Seafood to Nourish Life continues to inform our decisions and has played an important role in ensuring that we can have a positive impact on all stakeholders. Our purpose guides are broader environmental, social and governance initiatives. I am pleased to report that further to detail stakeholder engagement on these issues last year, we are making progress formalizing our targets around ESG initiatives, including: reducing waste in our operations and building on our track record in seafood sustainability.
In Nourish Life, we must drive ahead with plans to lower emissions to create a stronger greener tomorrow, and we’ll continue to prioritize our work in this regard. I look forward to sharing more on this in conjunction with our fourth quarter and year-end results.
With that, I will open up the line to questions. Operator, please go ahead.
Question-and-Answer Session
Operator
[Operator Instructions] Your first question comes from Kyle McPhee from Cormark Securities. Sorry — Sabahat Khan, can you please go ahead.
Arthur Nagorny
This is Arthur on for Saba. I just wanted to follow up on the consumers becoming more value conscious due to rising food prices. Can you just talk a bit more about what you’re seeing across food services and retail and what it means for High Liner? And then as a follow-up, can you also just talk about how you’re thinking about price increase from here or any other levers that you have to do with the current environment.
Anthony Rasetta
Thanks for the question. This is Anthony. We are seeing consumers shifting in the marketplace looking for more value. So we’re seeing that from a foodservice perspective in terms of the types of channels that they’re shopping in, looking at more casual dining and QSR versus some fine dining restaurants. Within retail, we are seeing more growth in our category and other categories associated with value products as well as some private label.
I will tell you that in terms of our strategy, we believe that the diversity of our portfolio and offering everything from premium to value offerings in both foodservice and retail, the fact that we supply and support private label and branded product, the fact that we service as a noncommercial business in foodservice that is the larger part business and more recession-resistant and the fact that we’re partnering with key national account customers that are operating in that faster growing and more resilient QSR space, we believe we’re well positioned for growth for the future.
Paul Jewer
And on the pricing part of your question, as you can see in our results, we have had to pass on cost increases through prices. And we will do that when that’s necessary driven by cost increases. However, we’re also very focused in our business and finding ways to reduce our costs and pass those benefits on to our customers and consumers.
Arthur Nagorny
Okay. That makes sense. And then in terms of guidance, can you just talk about the puts and takes regarding your outlook for sales and EBITDA growth for 2022?
Paul Jewer
Yes. So at this stage, for the balance of the year, we would expect similar growth both from a sales volume and EBITDA perspective. We’re committed to continuing to grow across all of those lines in our business as we’ve been able to demonstrate over the last 6 quarters.
Arthur Nagorny
And if I can just sneak one last one in here. In terms of capital allocation, you obviously increased your dividend this quarter, but can you talk about how you’re thinking about your other priorities going forward?
Paul Jewer
Sure. Yes. The first priority in our business is absolutely to invest in our business and support the growth initiatives. And you’ve seen that with the significant increases in CapEx that we’ve had over the course of the last couple of years. You’ll see a similar level of CapEx in 2023 because we see lots of opportunity to continue to invest in the growth of our business. Following that, as we continue to generate higher levels of cash flow, particularly moving into 2023 as we work through some of the increased working capital that we’ve had, we still see opportunities to support value for our shareholders by increasing the dividend. And we also will continue to work on reducing our leverage because it positions us with a strong balance sheet to pursue any other strategic opportunities.
Operator
Your next question comes from Kyle McPhee.
Kyle McPhee
I hope you can hear me this time. Perfect. So on the topic of volume growth, part of the volume growth showing up is your rebound in foodservice channels that were hurt by COVID last year, and part of the volume growth is successes with new clients and product. Can you help us quantify that split of your volume growth in Q3? I have my own version of the math, but I’m curious what your internal numbers are telling me.
Paul Jewer
Yes, sure. I would say, increasingly, Kyle, it’s less about the COVID recovery, thankfully, because by the time we were in Q3 of last year, operations from a foodservice perspective were starting to return to normal. And in fact, we’re pretty close now to where we were in 2019 from a foodservice perspective. So the majority of the growth in foodservice for us, we believe, is driven by our good performance, the initiatives that Rob and Anthony talked to you about from a commercial perspective and the fact that we’ve worked very hard to mitigate the supply chain challenges that are out there and provide a good service level to our customers in that segment of the market.
Kyle McPhee
Got it. Okay. That’s great to hear. And in Q4 so far, I think you might have addressed this with the last line of questioning. But are you seeing the same type of volume growth into Q4 as it was in Q3? Or is the kind of rate of growth decelerating as remaining COVID lasting stuff is fading away?
Paul Jewer
No, we’re still — I mean, it’s early in Q4, clearly, but we’re pleased with what we’re seeing thus far in the quarter from a volume perspective. And while supply chain challenges, as Rod identified, haven’t gone away, we are seeing some abatement. And we believe all of the effort that we’ve put into managing through those challenges and the investment we’ve made in working capital are putting us in a better position right now in the fourth quarter.
Kyle McPhee
Got it. Okay. And looking into 2023, just as a general trend, is it reasonable to expect you’ll deliver organic volume growth?
Paul Jewer
It’s absolutely our intention in 2023 to continue to drive volume growth and EBITDA growth.
Kyle McPhee
Okay. Moving on to the topic of pricing. Should we expect you guys to hang on to all your past pricing gains you’ve put through the near term, hold on to the pricing gains? Or are you already getting into a situation here where you may be passing along deflation that I think might be showing up for some species?
Rodney Hepponstall
Yes. I would say we are focused on certainly a cost mitigation, as Paul referenced early in doing everything we can to offset any of the continued inflationary pressure we’re seeing. I think the benefit that we have in our portfolio is the wide range of products and customer base. And I don’t think there’s any question that in the tough economic time that we — that may be circulating in front of us that we are going to see some pressure on certain portions of our portfolio, but our intent is absolutely to maintain the momentum we have across all aspects of our business.
Kyle McPhee
Okay. Maybe just more generally, do you expect — based on what you’re seeing for supply and demand of all of your core species, do you expect price deflation throughout next year?
Rodney Hepponstall
Well, we are objective as certainly not to have price deflation. I don’t have — nobody has a crystal ball to determine how consumers are going to react to continued inflationary pressure or recessionary impact. Our objective is not to have any — the decline in certainly our net sales area or deflationary.
Kyle McPhee
Got it. I guess — sorry, I’m not asking really about your pricing levels. I’m talking about your input pricing, like the price you’re paying for [indiscernible].
Rodney Hepponstall
Oh, I’m sorry, Kyle. But indication at this point would suggest that we are not going to see deflationary pressure or benefit on the raw material input cost at this point.
Kyle McPhee
Okay. And then on the topic of gross margins, in Q3, your gross margin percentage deflated a bit year-over-year, also compared to the last couple of quarters. Any thoughts on the drivers of that move? I know the nature of your pricing gains would bring margins down just the way that the math works, but what else might be going on? Was there something like abnormal mix shift?
Paul Jewer
Yes. No, I think — thank you for highlighting the math, Kyle, you’re right on that. And I wouldn’t point to any abnormal mix shift. As you — as we talked about the last couple of quarters, we are seeing higher growth in the unprocessed business, particularly in foodservice. So that does bring some mix shift and impact on margin. But we’re pleased with how we’ve managed our gross margin dollars in this inflationary environment. So nothing significant that I’d highlight.
Kyle McPhee
Got it. Okay. And then I just wanted to dig in on the margin profile of the wins you’ve been announcing with new products, new clients. It’s been showing up for a while now. Can you provide color on the main buckets of that growth by channel or product type? Ultimately, I’m trying to understand the margin profile attached to your sources of organic growth? Is it margin enhancing or not?
Anthony Rasetta
Yes. Kyle, it’s Anthony. We’ve been quite successful in the new business that we’ve been bringing in. We talked about whether it was expansion of our Fisher Boy brand and some value channels in the U.S. or whether it’s been some key quick-serve restaurant wins. There have been products that have brought significant value add to the marketplace. And as such, we’ve been able to price them accordingly and maintain good margins on those.
So we’re very pleased with the new business acquisitions we’ve come in — we’ve come across in both foodservice and retail and given the value that they’re adding, given the benefit that they’re providing to customers and operators, think about a restaurant back of the house that is taking our product and able to shorten their menu, have that one item be very versatile across a number of different menu items and help them with a reduction in labor. We’ve been able to still bring value-added products that are — we’re pleased with the margins we’ve been able to pass on.
Kyle McPhee
Okay. And then last one for me. On the topic of CapEx and capacity. Can you offer any color on your expected CapEx budget for next year? And also commentary on whether or not you’re pushing up against capacity to limit at your facility, given all of your growth.
Paul Jewer
Yes. So on the CapEx side — sorry, go ahead, Rod.
Rodney Hepponstall
No, no. On the CapEx side, I think as Paul mentioned earlier, you’ll see consistent levels of CapEx as we have over the last several years. We continue to invest in our plants at an increasing rate than our historical levels. So we feel very good about that. As it relates to capacity, we’re very fortunate that we have the ability through shift changes and a variety of other means to increase and flex our capacity, where needed, to substantially grow our business, and that’s certainly our objective.
Kyle McPhee
Okay. So you can drive — you can increase capacity within your current footprint is essentially what I’m hearing?
Rodney Hepponstall
Absolutely.
Operator
There are no further questions at this time. Please proceed.
Rodney Hepponstall
At the close, I want to thank you for joining our call today. We look forward to updating you with our results for the fourth quarter of 2022 on our next conference call in February. Please stay safe and well. Thank you.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.
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