Andrew Peller Limited (ADWA) Earnings Call Transcript & Summary

Good morning. My name is Joelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Andrew Peller Limited Second Quarter Fiscal 2023 Results Conference Call. [Operator Instructions] I will now turn the call over to David Mills. Please go ahead, Mr. Mills.

Good morning. Thank you, Joelle. Before we begin, this is a reminder that during this conference call, management may make statements containing forward-looking information. This forward-looking information is based on a number of assumptions and is subject to a number of known and unknown risks and uncertainties that could cause actual results to differ materially from those disclosed or implied. Please refer to the company's earnings release, MD&A and other securities filings for additional information about these assumptions, risks and uncertainties. I'll now turn things over to Mr. John Peller, Chief Executive Officer.

Good morning, everyone. Lovely to be with all of you. We have a beautiful day here in the Niagara Peninsula, certainly reminiscent of the lovely fall in autumn that we've enjoyed. We just finished our harvest on Friday. And I can say without reservation that the quality we'll get from the beautiful that we have will be at the highest level possible. Having said that, our yields are a little soft and down from normal levels in Ontario. In the Okanagan, we had quite a scare in the start of the year. We had a very cool spring and a very late start to summer. And having said that, summer did arrive, and we've had a phenomenal fall so that we have delivered -- cropped it, if anything, is slightly above what we've expected, and the quality is off the chart so that we're incredibly pleased with all of that. So looking to our second quarter and the completion of the first half of the year, it has kind of followed as we have predicted from the start of the year. Our revenues are recovering and our growth in the second quarter, and revenue was 2.6% were up 4.1% for the first 6 months. It's accurate to say that those numbers would have been more improved, higher, but we've dealt with shortages in supply, and we've had considerable stock outs, and we've been working hard to work around these issues, and we've been able to expedite and procure more wine for the back half so that we've eliminated a lot of those problems going forward. I think the market in beverage alcohol overall has been a little flat, both in Canada and the U.S. And having said that, we've grown very nicely. And we've grown particularly well in our premium end. And our spirits are doing well. Our cider has grown as well, and we've increased our position as one of the leading brands now in the country with our No Boats. So on the whole, we've done very, very well. We've had a bit of a softness in the consumer line-making business. And we feel maybe there was some pantry loading going on through COVID, and we're expecting a bounce back year in that business next year. We have talked a lot about the logistical challenges and the pressures of inflation that we've dealt with on our cost structure, which is up at least 30% on our cost, where we've never seen an increase in our cost of goods more than 2% or 3%. Our team has worked incredibly diligently to manage. It's our principal focus. We've had over 20 project -- cost savings projects that we've been focused on. We started up several more. We've lowered our CapEx to conserve our cash from a $30 million level down to about $17 million. And having said that, we're still making investments for our future. We have over a $3.5 million planning program in ultra-premium reds in the Okanagan that's beginning as we speak. So our asset base maintains a great deal of strength. I noticed with interest that there were significant vineyard transactions, both in the Niag region and in the Okanagan last week at record-high prices, so that I think it speaks to the fact that people in our industry invest for the long term. And that's how we've managed our entire life. And our long term is -- looks very, very positive, and we feel very, very good about that. So I'm generally pleased with everything that's happening. It's as we predicted. We know that the cost pressures will stay with us for the remainder of the year. We're prepared for that. We know things are already starting to come down. Transportation costs are starting to come down, but it takes a while for them to work its way through our system. We know next year will be another challenging year, but the future looks bright in that regard. So with that, I'll turn it over to Paul and look forward to having some closing comments.

Turning to our results. We continue to be encouraged by our sales growth so far this year. Sales in the second quarter of fiscal 2023 increased 2.6% to $101.8 million and in the first half of fiscal 2023 increased 4.1% to $199.5 million. Consistent with the first quarter, the increases were driven by a number of positive factors, including price increases implemented at the start of fiscal 2023 to help offset ongoing inflation and supply chain pressures, increased sales of our premium higher-margin VQA products through our Ontario retail network at our estate wineries and through our direct-to-consumer wine clubs. We are also experiencing stronger performance across our hospitality and export business as consumers exhibit a renewed desire to travel and spend on experiences. As John mentioned, sales growth was muted by ongoing supply chain issues related to the pandemic. We continue to closely manage the timely delivery of wines from international producers in the sourcing of glass bottles and other input components from our suppliers. Additionally, revenues from our personal winemaking business were lower than the first half of last year, a period when we were experiencing higher sales during the onset in midst of the pandemic. In terms of our margins, we are pleased to see margins continue to stabilize, landing at $39.5 million, down $2.9 million or 6.9% to the prior year for the quarter and at $77.5 million down $2.1 million or 2.7% to the prior year for the 6 months ended September 30. Margin as a percentage of sales for the first half of fiscal 2023 decreased to 38.9% compared to 41.6% in the prior year due to the current inflationary cost pressures. 38.8% in the current quarter is up from the third and fourth quarter of fiscal 2022 as we continue to actively manage the inflationary pressures. Consistent with the second half of fiscal 2022, we are still experiencing higher-than-normal cost of raw materials, particularly glass bottles and packaging and international freight shipping charges and fuel charges -- surcharges remain well above historical levels. In [ response ] to these cost pressures, our price increases are helping as is the increase in sales of our higher-margin VQA products. In addition, we have been implementing a number of cost reduction programs this year, including optimizing certain warehouses and distribution networks to enhance efficiency, rationalizing our SKUs and looking to alternative lower-cost sourcing for our imported wine and glass bottles. Sales and admin expenses landed at $27.8 million for the quarter, up $1.2 million or 4.6% to the prior year and at $53.9 million, up $2 million or 3.8% to the prior year for the 6 months ended September 30. Sales and admin expenses have increased this year as we return to full operations following the pandemic, and we have also experienced an increase in Ontario's minimum wage. Despite the increase in expenses, sales and admin expenses were consistent with last year at 27% as a percentage of sales. With the lower margin and increased sales and admin expenses, EBITDA reduced to $11.7 million and $23.6 million for the 3 and 6 months ended September 30 compared to $15.8 million and $27.7 million, respectively, last year. For the quarter -- for the second quarter of fiscal 2023, we incurred a net loss of $0.1 million or $0.00 per Class A share. For the 6 months ended September 30, 2022, net earnings were $2.8 million or $0.07 per share. This compares to earnings of $13.1 million or $0.31 per Class A share in last year's second quarter and $16.4 million or $0.39 per share for the first 6 months of fiscal 2022. In last year's second quarter, we recognized a realized gain of $7.5 million or $0.21 per share on the sale of our Port Coquitlam BC property and assets. Turning to our balance sheet. Total debt decreased to $187.7 million from $192.1 million at the end of fiscal 2022. At quarter end, we had capacity on our revolving credit facility of approximately $162 million with shareholders' equity standing at $6.11 per Class A share. Thank you for your time this morning. I'll now pass it back to John to wrap up.

Thank you, Paul. And just to follow up on a lot of Paul's comments, we've -- we're having a good year despite the challenges of COVID, and we feel good about all the investments we've made in the last 5 years, at least $200 million. We spent $100 million on 3 state wineries in the Okanagan alone and an ERP system that will digitally transform our business going forward and our facilities and our people so that we have made these investments with confidence in our bright future. We have a lot of new products coming to market this year. They're focused in the premium wine segments. They're focused in the value price segments, we have several imported wines. We're launching in the below $15 segment. We have a product called Vivo, which is an Argentinian red, that's a #1 product in Eastern Canada that we're taking across Canada. We have an Italian bag-in-the-box and Australian bag-in-the-box products that we're launching out West. We've just launched our Gretzky 99 vodka -- Ice Storm Vodka. It's done very, very well. It was the #1 selling product out of our state this summer. We've also launched the double oak premium whiskey. We have new entries in our No Boats cider and some other innovative refreshment products. We're much more focused in that business now and feeling good about the positions that we've had. So we expect it to continue on at the same pace and with the same success that we're currently having. We will finish a tough year, and we know next year will be a challenging year with stability coming in the following year. But we're encouraged. Our business has built to last, and it's built to endure difficult times. It's proving that right now, and it's built to grow. So we're anxious to have you come and visit us. We know a lot of investors have been asking if they can come down. We've been particularly busy, and we've been through a blackout period for the last 6 weeks. So we'll be following up for -- with a lot of you to come down and walk the region with us and see what we're up to. It always has a very significant impact on people, seeing firsthand is believing. And so I'm anxious to take any questions if there are any. Thank you.

[Operator Instructions] Your first question comes from Nick Corcoran with Acumen Capital.

Just a question on the growth. I think it was a little over 5% in the first quarter and about 2.5% in the second quarter. Can you maybe explain what the trend has been and dig into it a little bit deeper what you're seeing in each of the segments between your B2B estate and wine kits?

Yes. I mean wine kits to -- handle that one, as I said, Paul and I both mentioned that the sales are below last year, they're soft. And we think that there's been some heavy pantry loading in the previous year in COVID. And right across North America wine is a little soft, flattish, if you will. I think that's very, very accurate. We go through spells like that because there was significant growth in some periods in the last 2 years that we didn't expect. So we still get the trend of 3% growth that have been here for a very long time will continue, but this was a bit of a flatter year. I think our premium VQA business was very strong this year. We've taken some significant growth in the East and the West. In the value price segments, we were a little softer than we had hoped, but part of that was our supply chain disruption. We had wine that was supposed to arrive in the West Coast and the ports were closed, and it caused us a great deal of [indiscernible]. We've had, as I said, expedite wine from California to replace it at significantly higher costs, but we [indiscernible] stock significantly, and we didn't want that burden for the rest of the year. So we've made those necessary adjustments. I feel good about how we performed in the marketplace, and we've taken some pricing -- significant pricing in above $15. We probably took up to 6%, 7% -- 5%, 6%, 7% lower channels. I read a funny -- not funny, but editorial on the European wine industry where the Italians were claiming that their costs were up between 40% and 50% for the year. And I've noticed they've taken very little price increases in our market. We took significant prices above $15. And by the way, our estate wine raised, we're oversubscribed all summer long. We've been turning people away just because the tours are full, our restaurants have been full. We have a very strong positive summer. And now we're actually seeing a lot of the corporate business returning. It used to be as much as 30% of our revenue, and it went to 0, and we were beating our numbers notwithstanding that. And now that business is coming back. So I'm happy to tell you that I keynoted earlier this week at the Niagara Economic Summit, and I was proud to be able to tell people that the economic future for the Niagara Peninsula is incredibly positive. People are wanting to move to be living in the wine industry. There are significant hospitality -- new hospitality investments coming in. There were some good wine in vineyard trades in the last few months at high prices. There's a great deal of support for an industry that is just going from crawl to walk in my perspective, and it has a very [ great ] future. So I don't know if that helps, Nick. But if you have anything else specifically, I'm happy to comment.

Yes, that's good color. And then maybe thinking about the growth year-over-year, can you help us understand how much of that was value versus volume?

I think we -- I can tell you that it was probably more 70% premium, 20%, 30% because we -- we're kind of flattish on the low end right now. We would have been up if we had the supply, but we still did well. And if I'm -- we're going to have -- we're going to have growth in both value and premium -- mid-premium and in the ultra-premium levels as well.

Great. And then just thinking about margins for the back half of the year, is there anything you can provide to kind of give some color on what to expect?

I think the best way to describe it is that most of our costs are locked in for this year. And they're at the kind of -- we've low margins, kind of gross margins that we've had in 10 or 15 years because of that cost inflation that we've talked about. I think that it's already clear to us that the transportation and energy surcharges have already started to come down and we'll start to benefit from those going forward. And similarly, we're out around the world now talking to people about the bulk wine purchases. The prices are starting to come down. I'm sure you're familiar that when oil companies take prices up, they go up fast and they come down [ slow ] and the exact same circumstances we're dealing with now. The people have take them up to what -- cost [indiscernible] levels and they're going to take their [indiscernible] time, letting them come down, but they'll come down. We've been through this before. They'll come down, whether it takes the rest of last -- the most of next year as well is what we predict. And then we predict the sun will shine brightly after that. But we probably will have another 1.5 years of this headwind to deal with. And even though next year will be challenging, it won't be that as this year, and we'll expect to grow both revenue and earnings next year on improved margins. And we've stayed focused and are staying focused in the short term on [indiscernible] full stop. And there's lots of investments we'd like to be making right now. We're holding back a bit just to keep our powder dry and to make sure things play out the way we expect them to. And that's just being prudent, and we're still making other investments, though, like I told you about planning those [indiscernible] reds out west because we need that volume for medium to long term. So we feel we're in a strong position. Our team is working incredibly hard, and I think they've managed very, very well.

And you kind of touched on it. Just thinking about CapEx for the back half of the year, what are you expecting there?

Yes. I think we -- in years passed, we've kind of been investing in the kind of $25 million to $28 million. We've gone up to $35 million in years where we've had heavy investment. This year, we've held back on some equipment and purchases that we [indiscernible] and some improvements to the wineries that can wait, but we've prioritized the CapEx around areas that are critical to our growth going forward. And we probably should come into the high mid-teen level.

And just the last question, when you think about the inventory levels. I think you mentioned on the first quarter call that there might be an opportunity to fully draw them down over time. Have you made any progress on that?

No. We, unfortunately, have not because, in fact, we've had to go out and expedite inventories. And I think we're in a reasonably good spot. But balancing inventories has been a challenge to say the least. We were short on the things that we really needed, and we had to bring in some extra volumes. But I can tell you that next year will be a much better year for us to balance our inventories and that going forward, we know we will operate at lower inventory levels. So we're looking for to that. But right now, we're just ensuring that we avoid large stock outs in the back half of the year and get ready for a better year next year. .

Your next question comes from the line of John Sartz with Viking Capital.

Actually, my question is about the interest expense in the second quarter. It was over $6 million, more than twice the level of last year and almost twice the level of Q1 and I found the commentary somewhat vague, and perhaps you can shed some more light on the dramatic increase.

I'll let Paul handle that.

Yes. Thanks, John. Yes, interest expense in Q2 had a catch-up adjustment in there, just an accounting adjustment, which represented about [ $1.1 million ]. So ongoing interest we expect to land currently at current interest rates in around the $4.8 million range, and that's strictly related to the increase in interest rates that we've experienced.

Okay. And that's a number that I can reasonably expect for Q3 as well? Or are we...

Yes. I mean subject to obviously market conditions.

Your next question comes from the line of Douglas Smith, private investor.

In back talking about the interest expense, again, in your MD&A, you mentioned your sensitivity to rising interest rates. I think you mentioned for every 100 basis points, they go up. Your sensitivity is about $1.4 million. My question is, are you taking any steps? Or what steps do you anticipate to try to mitigate that expense?

Yes, we are. I mean, obviously, in our disclosure, we disclosed that our swaps expired in September, and we're in the process of evaluating our options and look to make a decision in Q3.

Okay. So it's work in progress. You've also mentioned that you did not do any stock buybacks this quarter. What does Q3 look like?

I mean we have our NCIB in place. We're mindful of the price of -- our shares are trading below book value. And at the same time, we're -- as I told you, our short-term focus on ensuring our margins get where they want to get to actually put our money and grow our business in the future. And we think that's a significant investment so that we're keeping options open, doing things to manage our business in the short term that we need to and still making investments in our long term.

Okay. And on September 22, you announced your intent on selling about 569,000 shares. Could you give us an update on where you stand on that program?

Yes. I mean those shares, if you follow up on the SEDAR, those shares were sold. They were from the estate of my youngest brother who passed away last year.

Okay. So they have been sold. And my last question is around the disclosure in your proxy statement, you noted that the new director, [ David Margo ] has joined the Board. Does David have any responsibilities beyond his Board responsibilities with the company? And what might they be?

David has -- he is a former lawyer with Goodman's in Toronto. He ran CIBC's investment bank for 8 years, and then he worked with [indiscernible] about 3 years for seasons in their formative years when he developed a model that is now the foundation for their success. He started an investment bank in London, England and called back in that bank. That bank is the premium banker for the luxury hotel globally. And he's been with Pfizer over -- we've never had any retainers with him. We've looked at various investments. Over the years, he has significant connections into the wine business throughout Europe. And as I said, in the hospitality industry, and he brings a great deal to the table. But the question is, do we have any current business between us? The answer is no.

There are no further questions at this time. I would now like to turn the call -- the conference over back to Mr. Peller.

Thank you very much, everyone, for questions and interest. I want to thank many shareholders who have called me in the last several months offering their support and confidence in what we're doing. And as I said, we're anxious to follow up with any of you who're prepared to come and meet with us either by Zoom or in person, we'll look forward to connecting with you. And if all you want to do is jump on the phone and then give us a call, don't hesitate. So thank you very much for your time, and we will follow up with you soon. Cheers.

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