MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FOR THE THREE-MONTH AND SIX-MONTH PERIODS ENDED APRIL 30, 2022
The following Management's Discussion and Analysis ("MD&A") is prepared as of June 13, 2022 and provides information concerning Flow Beverage Corp's ("Flow", the "Company", "we" or "us") financial condition and results of operations. This MD&A should be read in conjunction with our annual audited consolidated financial statements as at and for the years ended October 31, 2021, including the related notes thereto, and our unaudited condensed consolidated interim financial statements for the three-month and six-month periods ended April 30, 2022 and April 30, 2021.
This discussion contains forward-looking statements that involve risks and uncertainties. Our actual results, performance and achievements may differ materially from those implied by these forward-looking statements as a result of various factors, particularly under "Forward-Looking Information" and "Risk Factors".
The unaudited condensed interim consolidated financial statements for the three-month and six-month periods ended April 30, 2022 and 2021 have been prepared in accordance with International Accounting Standard 34, Interim Financial Reporting and are presented in Canadian dollars. Accordingly, unless otherwise noted herein, all financial information in this MD&A is presented in Canadian dollars. The disclosures contained in the condensed interim consolidated financial statements do not include all of the requirements of International Financial Reporting Standards ("IFRS") as issued by the International Accounting Standards Board ("IASB") for annual financial statements. The Financial Statements should be read in conjunction with the annual consolidated financial statements for the year ended October 31, 2021, which have been prepared in accordance with IFRS. In this MD&A, references to North America refer to Canada and the United States.
The unaudited condensed interim consolidated financial statements for the three-month and six-month periods ended April 30, 2022 and April 30, 2021 were reviewed and approved by the Company's Board of Directors (the "Board") on June 13, 2022.
Non-IFRS and Other Financial Measures
This MD&A makes reference to certain non-IFRS measures. These measures are not recognized measures under IFRS, do not have a standardized meaning prescribed by IFRS, and are therefore unlikely to be comparable to similar measures presented by other companies. Rather, these measures are provided as additional information to complement those IFRS measures by providing further understanding of our results of operations from management's perspective. Accordingly, these measures should not be considered in isolation nor as a substitute for analysis of our financial information reported under IFRS. We use non-IFRS measures including "Adjusted EBITDA Loss", "Adjusted Net Loss", and "EBITDA Loss".
The Company uses a supplementary financial measure to disclose a financial measure that is not (a) presented in the financial statements and (b) is, or is intended to be, disclosed periodically to depict the historical or expected future financial performance, financial position or cash flow, that is not a non-IFRS financial measure as detailed above. We use the supplementary financial measure "gross margin".
These non-IFRS and supplementary financial measures are used to provide investors with supplemental measures of our operating performance and thus highlight trends in our core business that may not otherwise be apparent when relying solely on IFRS financial measures. We also believe that securities analysts, investors and other interested parties frequently use non-IFRS and supplementary financial measures in the evaluation of issuers. Our management also uses non-IFRS and supplementary financial measures in order to facilitate operating performance comparisons from period to period, to prepare annual operating budgets and to determine components of management
compensation. For definitions and reconciliations of these non-IFRS and supplementary financial measures to the relevant reported measures, please see "How We Assess the Performance of Our Business " and "Selected Consolidated Financial Information " sections of this MD&A.
How We Assess the Performance of Our Business
The key performance indicators below are used by management in evaluating the performance of our Company and assessing our business. We refer to certain key performance indicators used by management and typically used by our competitors in the Canadian consumer health industry, some of which are not recognized under IFRS as identified below. See "Non-IFRS and Other Financial Measures " for more information on each non-IFRS financial measure, non- IFRS ratio and supplementary measure. See "Selected Consolidated Financial Information " for a quantitative reconciliation of each non-IFRS financial measure to its most directly comparable financial measure disclosed in our financial statements to which the measure relates.
Revenue is derived primarily from two main sources: the sale of packaged water and co-packing services. Packaged water is sold to distributors, retail, wholesale and direct customers.
For sales to distributors, revenue is recognized when control of the goods has transferred to the distributor, which is dependent on specific shipping terms. Following shipping, the distributor has full discretion over the manner of distribution and has the primary responsibility when selling the goods and bears the risks of obsolescence and loss in relation to the goods. A receivable is recognized by the Company when control of the goods has transferred to the distributor as this represents the point in time at which the right to consideration becomes unconditional, as only the passage of time is required before payment is due.
For sales to retailers, wholesalers and direct customers, revenue is recognized when control of the goods has transferred, which is dependent on the specific shipping terms. Payment of the transaction price is due at the point in which control transfers.
The Company enters into co-packing agreements with customers. The Company is required to make estimates regarding the total number of units to be delivered under the contracts. The Company also makes estimates regarding the total consideration to which the Company expects to be entitled to in exchange for the services provided. The total consideration to which the Company expects to be entitled to can vary based on estimates regarding penalties for minimum purchase commitments, total expected units to be delivered and pricing discounts. Revenue is recognized to the extent that it is highly probable that a significant reversal in the amount of cumulative revenue recognized will not occur.
The Company provides sales discounts and reductions through contract price discounts, payment terms, point of sale price reduction arrangements and customer returns and markdowns. If variable, the Company uses its accumulated historical experience to estimate the variable consideration to which it is entitled to, using the most likely outcome method. If considered highly probable that a significant reversal in the cumulative revenue recognized will not occur, such consideration shall be recognized in revenue.
The Company conducts extensive promotional activities, primarily through the use of cooperative advertising, coupons, in-store displays, slotting fees and other funded costs from retail partners. The costs of such activities are recorded as a reduction of revenue over the period in which the goods or services are transferred to the customer, to the extent the consideration is not in exchange for a distinct good or service.
The Company enters into sales agreements with customers who provide the Company trade credits in exchange for the Company's products. Trade credits are primarily used to purchase advertising services. The Company is required to estimate the fair value of the trade credits received, which includes estimates of the cost per impression based on the type of advertising channel the Company expects to utilize as part of future advertising campaigns. The fair value of the trade credits received are recognized in prepaid expenses.
Refer to Note 13 in our unaudited condensed interim consolidated financial statements for the disclosure on disaggregated revenue by Flow's two main sources: the sale of packaged water and co-packing services.
"Gross profit" is defined as net revenue less cost of sales. Cost of sales includes product-related costs, labour, other operating costs such as rent, production equipment repairs and maintenance, and amortization. Our cost of sales may include different costs compared to other manufacturers and distributors in the North American shelf-stable water market. Management believes that gross profit is a useful measure in assessing the Company's underlying operating performance before operating expenses.
"Gross margin" is defined as gross profit divided by net revenue. Gross margin is a supplementary financial measure.
Our sales and marketing expenses are predominantly comprised of marketing and non-customer-specific promotional costs.
Our general and administrative expenses are predominantly comprised of travel, professional fees, non-production repairs and maintenance, rent, and licenses and subscriptions. Our general and administrative expenses also include regulatory, legal, accounting, insurance and other expenses associated with being a public company.
Our salaries and benefits expenses are predominantly comprised of wages, long-term consultants and benefits.
"EBITDA Loss" is defined as consolidated net loss before: (i) income tax expense; (ii) finance expense, net; and (ii) amortization and depreciation of property, plant, and equipment and intangible assets. The amortization and depreciation amount is taken from the statement of cash flows, as it is inclusive of all amortization and depreciation that is allocated to overhead. EBITDA Loss is a non-IFRS financial measure and its most directly comparable financial measure that is disclosed in our financial statements is net earnings. We believe that EBITDA Loss is a useful measure to assess the performance and cash flow of our Company.
"Adjusted EBITDA Loss" is defined as EBITDA Loss before: (i) restructuring and other costs; and (ii) share-based compensation. Adjusted EBITDA Loss is a non-IFRS financial measure and its most directly comparable financial measure that is disclosed in our financial statements is net loss. We believe Adjusted EBITDA Loss is a useful measure to assess the performance and cash flow of our Company as it provides more meaningful operating results by excluding the effects of income tax expense, finance expense, depreciation and amortization costs, and expenses we believe are not reflective of our underlying business performance.
"Adjusted Net Loss" is defined as consolidated net loss adjusted for the impact of: (i) restructuring and other costs; (ii) one-time debt settlement costs; and (iii) share-based compensation. One-time debt settlement costs refers specifically to additional fees charged in the process of discharging our obligations. Adjusted Net Loss is a non-IFRS financial measure and its most directly comparable financial measure that is disclosed in our financial statements is net earnings. We believe Adjusted Net Loss is a useful measure to assess the performance of our Company as it provides more meaningful operating results by excluding the effects of expenses that are not reflective of our underlying business performance.
Some of the information contained in this MD&A contains forward-looking information. This information may relate to anticipated events or results and include, but are not limited to, expectations regarding industry trends, our growth rates and growth strategies, the impact of the COVID-19 pandemic on our business and other statements that are not historical facts. Particularly, information regarding our expectations of future results, targets, performance achievements, prospects or opportunities is forward-looking information. As the context requires, this may include
certain targets as disclosed in the AIF filed, which are based on the factors and assumptions, and subject to the risks, as set out therein and herein. Often but not always, forward-looking information can be identified by the use of forward- looking terminology such as "may" "will", "expect", "believe", "estimate", "plan", "could", "should", "would", "outlook", "forecast", "anticipate", "foresee", "continue" or the negative of these terms or variations of them or similar terminology. This information is based on management's reasonable assumptions and beliefs in light of the information currently available to us and is made as of the date of this MD&A.
However, we do not undertake to update any such forward-looking information whether as a result of new information, future events or otherwise, except as required under applicable securities laws in Canada. Actual results and the timing of events may differ materially from those anticipated in the forward-looking information as a result of various factors, including those described in "Risk Factors". Additional risks and uncertainties are discussed in the Company's materials filed with the Canadian securities regulatory authorities from time to time, including the Company's annual information form dated January 30, 2022 for the fiscal year ended October 31, 2021 (the "AIF") and the unaudited condensed interim consolidated financial statements for the three-month and six-month periods ended on April 30, 2022, a copy of which is available under the Company's profile on SEDAR at www.sedar.com . These factors are not intended to represent a complete list of the factors that could affect us; however, these factors should be considered carefully.
We caution that the list of risk factors and uncertainties is not exhaustive and other factors could also adversely affect our results. Readers are urged to consider the risks, uncertainties and assumptions carefully in evaluating the forward- looking information and are cautioned not to place undue reliance on such information. See "Risk Factors " for a discussion of the uncertainties, risks and assumptions associated with these statements.
The purpose of the forward-looking statements is to provide the reader with a description of management's current expectations regarding the Company's financial performance and they may not be appropriate for other purposes; readers should not place undue reliance on forward-looking statements made herein. To the extent any forward-looking information in this MD&A constitutes future-oriented financial information or financial outlook, within the meaning of applicable securities laws, such information is being provided to demonstrate the potential of the Company and readers are cautioned that this information may not be appropriate for any other purpose. Future-oriented financial information and financial outlook, as with forward-looking information generally, are based on current assumptions and subject to risks, uncertainties and other factors. Furthermore, unless otherwise stated, the forward-looking statements contained in this MD&A are made as of the date of this MD&A, and we have no intention and undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable securities laws. The forward-looking statements contained in this MD&A are expressly qualified by this cautionary statement.
Flow was founded by Nicholas Reichenbach in 2014 after seeing mountains of plastic bottle waste while attending the Burning Man Festival in Nevada's Black Rock Desert. Having grown up on a rural property in Southern Ontario with a natural, mineral rich aquifer, he imagined a packaged water company that could be "better for people and the planet". After scientific analyses showed that the water was spring water, free from contaminants and packed with natural minerals and electrolytes, Nicholas, along with friends and family, formed Flow and sought out the Tetra Pak Group to provide the most sustainable package available in order to bring the water to consumers while preserving its benefits.
Key Milestones During and Subsequent to Q2 2022
Flow is an innovative beverage company and one of the pioneers in the "better for you better for the planet" consumer needs state. The majority of its business is represented by Flow Alkaline Spring Water, however the Company has expanded into a variety of organic flavoured waters and collagen favored waters and has plans to further expand in other adjacent categories of the non-alcoholic beverage market. Flow owns two virtually identical water sources in terms of key minerals, in Bruce County, Ontario and Augusta County, Virginia. Flow packages its products in its production facilities in Aurora, Ontario and Verona, Virginia, both of which are in close proximity to its water sources. The packaging facility in Aurora, Ontario consists of approximately 150,000 square feet, operates three Tetra Pak A3 / Flex filling machines and has a capacity of approximately 500,000 Tetra Paks per day and the packaging facility in Verona, Virginia consists of approximately 52,000 square feet, operates five Tetra Pak A3 / Flex filling machines and has a capacity of approximately 750,000 Tetra Paks per day. In total, the packaging facilities have a total theoretical installed capacity of more than 450M units/year. Flow markets its premium alkaline spring water in original unflavoured, a range of award-winning organic flavours and collagen-infused waters with natural flavours in sizes ranging from 330 ml to 1 liter, and in six (6), twelve (12), eighteen (18) and twenty-four (24) pack. Flow gets product to market through an omni-channel distribution strategy, including the conventional channel, the food service and the convenience channels. As part of this strategy, the Company leverages a network of 47+ distributors to support our coverage of +35,600 stores in North America. Flow operates a fast-growinge-commerce business mostly developed with Shopify with more than 5,100 subscription customers. Flow has also developed strategic partnerships with third party premium brands in adjacent categories to co-pack their products in the Tetra Prisma format. As at the date hereof, Flow had approximately 195 full-time employees; 87 in Canada, 107 in the United States and 1 in Switzerland. Flow has a robust ESG agenda, including sustainable package, resources preservation, carbon neutrality and a high score of 126.5 on our B Corp certification.
Our Market and the Opportunity
The total North America packaged water has been growing significantly over the last 20 years and has become the largest beverage category in volume in North America, overtaking soft drinks.
The size of the total addressable shelf-stablenon-carbonated water market in North America is approximately $16 billion dollars annually and is growing at a rate of 11% per year. Within the category, three sub-categories have been the main drivers of the overall category growth and Flow is uniquely positioned at the intersection of those three categories: (i) premium water (23% growth year over year); (ii) sustainably packaged water (78% growth year over year); and (iii) functional water (20% growth year over year).1
We see the opportunity to gain significant market share and to become one of the leading premium water brands in North America. We envisage we will continue innovating with highly differentiated products in current and adjacent categories.
1 Source: Quads Trended Report, MULO + Natural Channel, Shelf Stable Water, Non-Carbonated. Data ending April 2022. Nielsen Canada, Food Drug Mass, and Convenience & Gas Channel, Brand and Item Report. 52 Weeks Ending April 2022.
Premium Water: e.g. Flow, Just Water, Evian, Fiji, Essentia, Eternal, Smartwater, Hint, Icelandic, Voss, VitaminWater etc.
Sustainable Packaging includes: Carton, Box, Can, Glass
Functional Water: e.g. Flow, Essentia, Alkaline88, Smartwater, Propel, Cloud Water, Karma, Celsius, VitaminWater, Blk, B-Better, Eternal, etc.
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