Fresh Finance – An Update on Freshii Inc., a Canadian 2017 IPO Story

About two weeks ago, one of us had the opportunity to see a talk by the CEO of Freshii Inc., Matthew Corrin. Viewed as one of the few exciting Canadian IPOs this year, it IPO’d at $11.50 a share on January 31st and quickly ran up to about $15. Unfortunately, it has had quite a painful ride since then. The latest was a press release on September 25th where they lowered guidance for next year and beyond (including reducing expected 2017 openings by 60!). While we understand these things happen, particularly with a fast growing company (and find some action to be prudent, like ending a partnership with Target that wasn’t working very well), the challenge is when Mr. Market is banking on them growing like a weed. Following the September update the stock is now down to $5.70.

We like looking for bargains here and find IPOs are usually not the place to find them, since Company’s understandably try to IPO when things are going very well and investment bankers are eager to flog the shares to excited buyers. But we think its worthwhile sharing some of Matthew Corrin’s thoughts, and maybe at 50% off of the retail price in January, there might indeed be a bargain here for someone brave enough (let us know what you think)! Regardless, Freshii has been quite the growth story and we feel it is always worthwhile to listen to and learn lessons from people who are executing.

Source: Google Finance

Freshii CEO Talk at Small Business Conference Day Calgary - Matthew Corrin – Key Highlights

• Freshii Founder. Started at 23.
• Influenced by: Summer internship @ David Letterman, and worked for New York fashion designer Oscar de la Renta
• Goal: Wanted to take a food category and scale

Key principles

• #1 Talk Is Cheap. Execution Sets You Apart
• #2 Launch Fast, Fail Fast, Iterate Faster
• #3 Numbers Rule. If You Can't Measure It, You Can't Manage It
• #4 Build A Company With A Killer Culture, Not A Culture That Kills A Company
• #5 Pick Your Battles

• Started with family money (dentists), no previous restaurant experience
• Pitch: We want to energize breakfast/lunch/dinner
• Differentiated by healthy --> challenge is definition of healthy changes continually. “Originally sandwiches, then salads, now “avocado on quinoa” --> Solution: Wants to be the Zara of fast food. Zara goes to the top fashion shows to see the trends, then comes out with their own line 45 days later. Freshii goes to small trendy places with huge lines in California/Europe/etc, then brings the product to market and uses their scale.

Freshii’s innovation = copy fast + use scale. They focus on scalable trendy food ideas. Their goal is to run their stores efficiently and benefit from scale (bulk food, advertising benefits, etc) and build/maintain a brand known for healthy fast food. They try to launch fast/fail fast. OK with failure so long as it’s fast

Growth - First 100/200 stores faster than McDonalds/Starbucks, explained as due to:

• Global health/wellness trend
• Millennial push to adopt new brands
• Entrepreneurship push

Building a global brand – Freshii founded in 2005. By 2008 it was already in 4 countries and now 20. Wanted to build a global brand, not a Canadian brand. “The longer we waited to go to the U.S., the longer we would build bad habits”  --> E.g. Quickly expanded to Chicago to test concept.

How do you build an international food brand? Strategies:

• Subway = same everywhere
• McDonalds = 80/20 rule. Big Mac is #1 everywhere but they have local influences on shop design and food.
• Similar same but different --> Chinese often think KFC founded in China.
• Freshii’s approach – Benefit from chain via scale but focus on hyper-localization through local marketing and feedback and development with local franchise partners.

Q: Lowest point in Feshii’s history? - Went from Day 0 --> IPO by raising less than $4M through the process and are proud of the limited capital used. However, this was very challenging and were often short on capital (implies risk of failure). Richard Branson “I think that there's a very thin dividing line between success and failure. And I think if you start a business without financial backing, you're likely to go the wrong side of that dividing line.” And they were conscious of this.

Q: Comments on stock down since IPO – IPO @ $11.50 Jan 31 2017. Up to ~$15. Down to $5.41 Oct 22 2017 - Announced revision of outlook on Sept 29. Annual net new openings of 90 - 95 stores (including stores opened on an enhanced basis, or “e-stores”, as described in the Company’s Q2 MD&A), down from 150 - 160 stores. From a front-door openings perspective, the Company opened 21 new locations and closed 21 locations in Q3 2017, resulting in net new front door openings of 0 in the quarter. 18 closings related to ending Target partnership. Stock explained as down due to:

• Closing certain stores in some markets that just weren’t working while having opening and development delays (partly appears to be scaling issues, with store openings occurring in many markets, Canada, UK, U.S. east and west coast).
• To paraphrase - Nothing has changed in the business but our bumps in the road are now seen publicly. Stock not reflecting value and I have to divorce myself from share price including deleting my daily alerts.

Q: Pivotal point? – Going from linear to exponential growth - First store opened, customers said “I had this idea”. Problem is there are many talkers in innovation, we execute. Executive team is millennial with background at brands that I view as exceptional. Hire good people then empower them. To do this we foster a culture that is direct/accountable, not for everyone. Franchise partners = we are in business for them.

Q: Do franchisees market? – Two advertising buckets – local 1.5% of sales, global 1.5% of store sales.

Q: How do you expand internationally? – We assume every market is different and empower our franchise owners. Ties in with Numbers Rule – each team has analysts. Can’t blow a year if you catch it in a week. Tough lesson from previously – at 7-8 locations in 2007 we were looking at numbers monthly and was surprised by results one month.

Q: Keeping culture? – Check in with franchise owners, are they happy? Do they want to open more stores? 30% of new locations are existing franchise owners. What we do well is listen and ask questions. E.g. we survey franchise owners on changes.

Performance notes:

• Paid off debt at IPO ($15M demand loan).
• Cash burn - Had $29.5M of cash at March 26, 2017. $25.2M as of June 25, 2017. However, actually had positive OCF before W/C changes.
• Dual share structure - CEO still controls the company while only owning 5M of the ~30M outstanding (his class B’s count as 10 votes, i.e. 50M shares). Immediately prior to the closing of the initial public offering, the company (i) filed articles of amendment to, among other things, (a) amend the authorized share capital to provide for Class A subordinate voting shares and Class B multiple voting shares, (As at March 26, 2017, there were 5,248,017 class B multiple voting shares and 25,233,152 subordinate class A voting shares issued and outstanding. Class B shares have 10 votes, whereas class A shares have 1 vote per share. 

I Trust You So Much That We Should Document What You Just Said - Rental Agreements

Several years in corporate banking taught me the importance of the terms and wording in credit agreements and other legal documents. This is especially so when you have lawyers being paid $750/hour (which is cheap compared with our American friends!) to find ways to use agreements to one party’s favour or detriment. And much more so in the case of distressed companies, where decisions are sometimes hastily made based on verbal agreements, which may end up falling apart when papers are actually drafted.

You don’t want to take the idea of documenting everything too far, though…

But important items – particularly points that can foreseeably be disputed – should be documented.  

When I moved to the UK this fall, I quickly realized how inefficient stupid backwards different the process is compared with Canada. In London, it is common that landlords hire a letting agent and pay them commissions of ~10-14%+ of the entire lease rent + a whole bunch of other fees; my favourite of which is a per-viewing fee which so clearly sets up a wrong incentive. In Canada, most landlords do viewings themselves, and then copy+paste a nice little rental agreement that they probably found on Google.

It is one of the things that makes me proud to be Canadian – that our landlords are so sophisticated that they can rent out their own properties all by themselves.

Just Sign It, Don’t Worry!

The first step in my UK letting process was to sign what was basically a 7-page term sheet/application form. I brought up several issues with the term sheet – some of which didn’t make any sense, and some of which I thought were (in my view) too landlord-friendly…but was assured these could just be addressed in the full tenant agreement.

Then I received the first draft of the full 17-page tenant agreement. I spent about 1.5 hours going through it, and created a Word Doc with about 1.5 pages of – again – things that didn’t make sense or were unfairly landlord-friendly.

Some of my notes were:

• Tenants could not do anything “immoral” on the property
  • I was really hoping the landlord was a heathen
     
• If I died on the property, I (or I guess it would be my estate) would have to reimburse the landlord for losses or damages to the property
  • I guess it wouldn't be worth haunting the house after death
     
• I had to sweep the fireplace/chimney at the end of the lease term
  • …except there was no fireplace in the flat
     
• If I was in breach of the agreement, I would have to pay for the landlord’s parking costs related to rectifying the breach
  • OK, I get that I would be liable for reasonable costs, but I thought it was odd they would specifically include parking costs in the wording
     
• A fee that was payable by the landlord in the term sheet was now payable by the tenant in the draft lease agreement
  • This issue was subsequently settled
     
• No mention of whose responsibility it was to maintain the garden
  • The leasing agent advised multiple times that it would be the landlord’s responsibility

I was basically told that nothing was negotiable.  Even things that didn’t make sense like the fireplace/chimney.

Anyway, I only had a few days left on my temporary AirBnB home so I was starting to panic. I’m all for new experiences and all, but I didn’t want to be homeless 2 weeks after moving to London. So, I held my nose and signed.

You Should Not Have to Shoot Yourself In the Foot To Know It Hurts

A few days after moving in, I spoke directly with the landlord, who (i) purchased a lawnmower that would be stored at the flat, (ii) arranged for a gardener to complete only the initial weeding/gardening, and (iii) told me that weeding/gardening thereafter be only the tenant's responsibility.

I told the landlord that his leasing agent advised that the garden would not be our responsibility, and he responded that he made it clear to his agent that the garden upkeep was the tenant’s responsibility. Since the gardening responsibility was not explicitly covered in the lease agreement, I figured the disagreement was not so much between the landlord and me, but his agent (who made the misrepresentation) and me.

After a few weeks of back-and-forth, the leasing agent got his “director” involved, and then put forth an argument that this supposed disagreement has already been resolved because the landlord purchased a lawnmower that I can use. The director called this a compromise.

After reading the email, I felt like this:

actually, no wait, it was more like this:

I replied generally stating (i) the timeline and facts, including the fact that the agent has admitted to making the misrepresentation, (ii) the damages are quantifiable as one year of gardener costs, and (iii) I failed to see any “compromise” since the landlord did not purchase the lawnmower as a “gift” to me and that I am still entirely responsible for the garden when I should not be in any way.

To be perfectly honest, the cost of hiring a gardener for a year is really not material, and neither is the time to maintain the garden ourselves. However, what I do not like is when people make blatant misrepresentations (intentional or otherwise) and try to weasel their way out of it. I understand people make mistakes. If the letting agent simply said, “Oops, we apologize, we kinda screwed up there…would you be OK if you maintain the garden?” I’d probably say yes, given it is a pretty small sum.

Given they are being weaselly about this situation, my strategy is to take a very aggressive stance and hope that they reimburse me a small portion of that 10-14% in fees they made to just make me go away. The fun part about this situation is that I don’t get the sense the letting agent knows it is a very small sum – probably about £15 every 6-8 weeks. Stay tuned!