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Good morning, ladies and gentlemen. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to the MAV Beauty Brands Q3 2019 Conference call. [Operator Instructions] Thank you.Mr. Craig Armitage, you may begin the conference.
Thank you, operator, and good morning, everyone. Thanks for joining us today. Please note that our remarks today may contain certain information regarding our expectations, future plans and intentions that may constitute forward-looking statements. I would refer you to the most recently filed MD&A from this morning, which includes a summary of the significant assumptions underlying these statements and certain risks and factors that could affect the company's performance and the ability to deliver on these forward-looking statements. The Q3 earnings release, its financial statements and MD&A are available on SEDAR and on the IR section of the company's site. I'd also note that there are slides available to accompany today's call. Those are available on the IR site as well for download. And I'll turn the call over now to Marc Anthony Venere. Marc?
Thanks, Craig. Good morning, and welcome to our Third Quarter 2019 Conference Call. I'm joined today by Tim Bunch, President and Chief Revenue Officer; and Judy Adam, our Chief Financial Officer. We have a lot to cover this morning. In addition to our Q3 financials and outlook, we have a new transaction to discuss, the acquisition of The Mane Choice, which I will review later in the call. Overall, Q3 was a solid quarter for the company, highlighted by improved gross margins, adjusted EBITDA and, most notably, free cash flow. In a category growing at less than 1%, our portfolio is growing by double digits. We continue to see independent founder-led brands outpace the big CPG brands, supporting our long-term thesis and vision for MAV Beauty Brands. While there are high points across many areas of the business that show our strategy and platform are working, clearly not everything has gone to plan in 2019. We're facing some challenges that will impact our results and moderate our near-term growth rate, causing us to fall short of the previous guidance. We want to walk you through the factors that are causing the shortfall in Q4 and what we are doing to address the issues. But first, I would like to ask Judy to quickly discuss the Q3 financial results. Judy?
Thanks, Marc. Good morning, and thanks for joining us today. Our complete financials are available online, so let me focus on the main highlights for the quarter. Overall, as Marc said, the third quarter results show good progress, both year-over-year and sequentially. Total revenues increased by 8.4% over the prior year to $28.4 million due to the growth of our brand. North American sales increased by 8% to $26 million, and sales from our international region grew 19% over 2018 to $2.3 million. Sales from North America were generally in line with our plans. However, despite our strong international sales growth, we still felt short of our aggressive plans. Gross profit for the third quarter increased by 22% over last year to $14.1 million. Improving the gross margin has been a key focus internally, and we are seeing productivity and efficiency savings. Q3 gross margins increased to 50% from 45% last year on an adjusted basis and 49% in Q2. On the slide, you can see a positive upward trend on gross margins over the past 5 quarters. Selling and general expense was $6.3 million in the quarter, compared with $5.9 million in the prior year. Excluding stock-based compensation charges of $0.7 million, adjusted selling and admin expense was $5.6 million or 20% of sales, compared with 24% in the most recent quarter, Q2. With the gross investment of our ERP and public company infrastructure now behind us, we are seeing early benefits of operating leverage in our platform. The combination of increasing revenue, gross margin improvement and operating leverage drove a 17% increase in adjusted EBITDA to $8.5 million, compared with $7.3 million in Q3 2018. Adjusted EBITDA margin was up to 30% in the quarter compared with 28% last year. Adjusted net income also improved this quarter to $3.8 million or $0.10 per share, compared with an adjusted net loss of $1.3 million or $0.04 per share in Q3 2018. A key highlight this quarter was a significant increase in free cash flow. Free cash flow was $5.4 million compared with negative $4 million in Q3 2018 and $0.8 million in Q2, our prior quarter. As expected, CapEx was much lower in Q3 by -- at about $160,000. In terms of capital allocation, we used approximately $1 million toward the NCIB program in Q3. On a year-to-date basis, we purchased and canceled roughly 730,000 shares. Recall, we allocated up to $5 million for U.S. or -- sorry, $5 million for share buybacks from April 2019 to April 2020. We have approximately $500,000 remaining. We used the higher free cash flow generated in Q3 to reduce our net debt. At quarter end, our net debt decreased to $105.6 million from $110 million at the end of Q2 and leverage was about 3.7x, down from 4x at the end of Q2. With the current NCIB program and our major CapEx expenditures nearly complete, we anticipate solid free cash flow and continued deleveraging in Q4. Pro forma, our acquisition of The Mane Choice, net debt to adjusted EBITDA ratio as at September 30, 2019, is 4x. Both MAV and Mane Choice have strong free cash flow profiles, underpinned by modest CapEx requirements. I will now turn the call over to Tim to discuss our outlook as well as some of the operating highlights across the business. Tim?
Thank you, Judy, and good morning. As Marc mentioned, our brands remain healthy and growing, and we're expanding distribution across the portfolio, but there are headwinds that will impact our near-term financial results. As a result, we do not expect 2019 revenue and adjusted EBITDA to be within our previously stated guidance range. Excluding The Mane Choice acquisition, we believe Q4 revenue will be modestly below the prior year period, and adjusted EBITDA will be in line with Q4 2018. There are 3 main factors to discuss. The first and most significant is an expected decrease in distribution for newer premium-priced Renpure products in the Mass channel. Q3 is typically an active quarter with our retail partners, as we sell in our innovation and planograms are shaped for 2020. The fourth quarter is when we get visibility into major planogram resets in the U.S. region and Drug and Mass retailers. As we looked at 2020, our expectation was that we would have shelf gains at both Mass and Drug, based on the strength of the POS data, our history of adding shelf most years and the general trend to allocate more shelf to independently founded brands. The core Renpure proposition is strong and continues to perform well in the U.S. Mass channel. While planograms have not been finalized at all retailers, we expect decreased distribution for the new, more premium-priced Renpure SKUs in the Mass channel. These products, which have higher price points, have underperformed the core Renpure collections. These planogram decisions are not permanent, and we have already pivoted to bring new innovation in line with Renpure's high-performing core offering. The losses for Renpure are disappointing, no question, but we know from firsthand experience since these are not permanent permit decisions. We've strong collaborative partnerships with these retailers, Renpure remains a prominent and profitable brand on shelves, and we offer them attractive margins, timely innovation and now 4 independent brands, which is where they are seeing all the category growth. Offsetting this impact on the newer Renpure SKUs, preliminary 2020 distribution is showing positive signs that our innovation is quite well received across the portfolio, and we anticipate particularly strong gains in the Drug channel. The second factor impacting Q4 results is our decision to forego certain planned promotional programs that were previously in our sales forecast. We work with our retail partners to deliver these programs at different points in the year, particularly in the Mass channel. With one program in particular, the retailer recently asked for additional incentives, which would have brought our margin below our internal targets. This was a program that would have been on shelf in early 2020 with product shipping in Q4. We have a disciplined approach to pricing, and the retailer understands our point of view. We expect we will have an opportunity to requote next season. The third factor, which Judy mentioned, is our international business. While this segment increased 19% year-over-year in Q3, our forecast assumed more aggressive growth in fiscal 2019. As we look to 2020, you will see us concentrate on driving better results from our top-tier markets rather than opening in new countries. At this point -- points like this, it's important as an organization to identify what we need to improve. Over the past 12 months, we've significantly strengthened our team with a new VP of Ops and new CFO in Judy and additional depth in finance and new sales managers among other additions. And we're enhancing our internal systems and processes, improving our analytics and implementing the new ERP system that will support our growth and help us quickly integrate acquired brands. As you will see in today's press release, we announced the appointment of Tom Nestor, a highly experienced and accomplished consumer goods executive, to the new position of Chief Sales Officer. Tom has an exceptional track record in sales leadership, having spent over 30 years with several leading consumer goods companies. Most recently, he was Chief Revenue Officer for Sundial Brands. Tom [indiscernible] our executive team, and we look forward to working with him to further expand our distribution and continue to improve all aspects of our sales organization. While these new term financial results fell short of our expectations, we move forward with confidence in the fundamentals of our business. First of all, our brands are strong, and we continue to see positive signs in the U.S. POS data. Our portfolio delivered POS growth of 11% in Q3 compared with the category average of less than 1%. In The Mane Choice, we've added a fourth authentic consumer-driven brand that is also outpacing the category growth rates. Two, we know how to acquire and build brands. In 2019, we've continued to demonstrate our ability to grow brands by leveraging our operating platform and innovation engine. Cake Beauty has grown exponentially since 2018 and has been an outstanding performer. Gross sales have increased roughly 8x since the acquisition, we've introduced the brand in 8 new countries, including the U.K., and the brand expanded into the body care category in U.S. Drug in Q3. Renpure, despite this near-term distribution loss and the other issues we've had to manage through, should continue to deliver results well above the revenue levels it achieved prior to our acquisition, and the brand has a 3-year gross revenue CAGR of approximately 29%. And Marc Anthony True Professional continues to perform strongly. The brand has a 3-year gross revenue CAGR of more than 9%, and we're expecting North America distribution gains in 2020, including in Drug, where it has a very established presence. Recently, Marc Anthony True Professional [indiscernible] supplier of the year for 2019, a significant achievement that speaks to the company's long-standing partnership with this retailer. With that, I will turn the call back to Marc to discuss The Mane Choice acquisition in greater detail. Marc?
Thanks, Tim. With today's announcement, we're excited to introduce the newest addition to our portfolio, The Mane Choice, founded in 2013 by Courtney Adeleye, The Mane Choice has quickly built an iconic brand, serving the natural textured hair care consumer. This is a segment of the market our retail partners have been encouraging us to look at. And The Mane Choice stood out as one of the fastest-growing brands in the category. Let me provide some background on the business today, the strategic benefits and the structure of the transaction. In a few short years, The Mane Choice has established a strong brand and consumer base, a broad portfolio and a national footprint. Their portfolio includes more than 100 SKUs, consisting of shampoos, conditioners, hair growth vitamins and other innovative treatments. Because of the breadth of their products, they are in multiple aisles, giving the brand extra exposure. Today, The Mane Choice is a leading brand in the U.S. textured hair market, with broad distribution in leading drug, mass and specialty beauty retailers. Like our other brands, innovation has been one of the pillars of their success, and the company has a history of firsts, including being the first to introduce hair vitamins for the textured hair care segment. Put simply, their formula is working. For the trailing 12 months, the company delivered net sales of approximately $24.4 million and adjusted EBITDA of $6.4 million with robust gross margins and free cash flow. Let me touch on 4 additional acquisition highlights. One, this is a complementary brand that provides access to new high-growth markets. There's very little-to-no overlap with our current portfolio and consumer base. One of the reasons we like the textured hair category is the consumers are big spenders. Currently, consumers spend more each year on hair products than any other texture type, an average of $247 versus an average of $139 for naturally straight hair consumers. Two, this brings additional scale and diversification to our business. We rise to #7 among hair care companies in the U.S. FDM channel. Three, we have structured the transaction to create strong alignment with the founder and to incentivize performance with a 3-year earnout and an equity component. In her words, Courtney chose MAV because she believes our platform can accelerate the growth of her business and allow her to focus on the things she really loves doing, creating excellent products for the consumers. This is core to our value proposition. Founders can continue to lead the growth of their business and be the face of the brand. And four, this transaction is immediately accretive to earnings per share and cash flow per share on a pro forma basis. Strategically, this acquisition is directly in line with our long-term vision. As you have heard me discuss, we're building a portfolio of high-growth, profitable, authentic brands that have the potential to grow faster by partnering with MAV. By leveraging our platform, we can cross-sell and significantly expand distribution for each of the brands. At the same time, the founders benefit from operational efficiencies and best practices and from being part of an entrepreneurial organization. We like businesses with asset-light models and strong margins in growing segments of the market. The Mane Choice checks all these boxes with a similar gross margin and free cash flow profile as MAV Beauty Brands. The final slide covers the structure and details of the transaction, the majority of which are also in our press release, so I will not go through each of these points. In addition to the transaction being immediately accretive, we were attractive to the longer-term opportunity for shareholder value creation as we leverage our platform to expand into new markets and drive revenue growth. So to wrap up our remarks this morning, we know our business has strong fundamentals, and we are excited about what we can do with a new brand in an attractive category. We understand that our performance, relative to expectations, has been disappointing. We expect better, and we are building from this experience. We appreciate your support and look forward to reporting on our progress with the release of our year-end results in 2020. We'll now open the call to questions. Operator?
[Operator Instructions] And your first question will be from Mark Petrie at CIBC.
Just given the loss of the Renpure -- the select part of Renpure shelf space is known at this point, what are the other key elements of uncertainty holding you back from simply revising your 2020 outlook or giving new 2020 guidance?
Yes. The key holdback is, we have some of the information, but not all of it today. And we want to make sure that anything we put out in the future is something that we have full confidence in and can meet and deliver. So when we're looking at the information we have, what we've started to get very recently is understanding what SKUs, which items will be placed in distribution in the U.S. We don't have that full visibility in Canada. What we also do not have fully in the U.S. is understanding the depth of the doors that each of those SKUs will be in. We have some of that information of the few select retailers, but not across the board. So -- but we do have enough information on the SKUs that we understood it would impact our Q4 and how we would deliver in 2020, and thus are providing that information now.
Okay. So maybe, could you please give just some more granularity on the POS trends across the other brands and by channel, just so we can have some sense of the relative performance?
Yes. So we don't segment by brand, but I can get some kind of trends of what we're seeing. Overall, Cake is really strong exceptional growth wherever it has launched, and we look for that to continue in 2020. Marc Anthony has very solid delivery across all channels in which it is in and continues to perform and we look for its growth in 2020 as well. Renpure, which has primarily been a U.S. Mass business, the core is healthy. Those core products that have been part of Renpure are still in that channel performing. And when you look at the revenue growth of Renpure, even as we look at 2020, the revenue of Renpure will be significantly higher than the brand when we acquired it, as shown from the CAGR. Now, what we will say for Renpure in the Mass channel, some of the newer items that we launched at the more premium price point will now be discontinued. We're seeing that impact in Q4 because retailers are winding down their replenishment orders on those items, and we won't have the pipe for those items as it goes into the new planogram season.
And just to clarify, when you're saying the premium price, you're talking about like the reformulated Plant Based Beauty that launched earlier this year? Or what is that specifically?
Yes. So we did some of the plant-based items and not across the board. Some of the plant-based worked very well in some of its retail outlets. Within the Mass channel, it did not perform very strong. So we're pivoting. We've already pivoted, and we've looked at our core and because of our new cost structure on these brands as we've driven out our cost efficiencies, we're able to now bring more items in that -- similar to that core offering to expand, and we look for their success as we know better what is working within the Mass channel.
Okay. And then, if I could, just on The Mane Choice business, could you give us some sense of, sort of, the growth rates that you've seen in that business, its relative strength by geography and channel, like, sort of, what the most important parts of its business are? Or how that breaks down? And then how do you expect to operate or oversee that business? I guess, to what extent will it be integrated with MAV Beauty? Or will it remain, sort of, stand alone?
Yes. So The Mane Choice is primarily in the U.S., which offers a great opportunity for us to apply our global operational platform because the brand already has traction in some foreign markets and we know with our operational platform we have the ability to scale this quickly and bring it out. When you look at its current and historical growth rates, the brand is very fast growing. It's one of the faster-growing brands within this segment. And so we look for that to continue going forward. As we look at the management, there's a great management team in place today with the founder, Courtney. Courtney will continue to lead this business, as she has done very successfully. What we will look to in the future is to see how can we have better operational platform to support this brand, and we'll look for synergies where they are. However, as we look at the business today, it's strong, healthy and growing with good margins. And so we look for that to continue.
Next question will be from Joe Altobello at Raymond James.
So I want to go back to the loss Renpure distribution for a second. I guess, if we look at your previous guidance and your current guidance, at least on the top line, it looks like it's probably down about $9 million or $10 million in the fourth quarter. And I think you said the vast majority of that is the loss Renpure distribution. So -- if we annualize that out next year and assume you don't get any of that distribution back, I mean is that a -- basically, does that offset the acquisition of Mane Choice in terms of the loss sales for next year?
Yes. So let me first cover in terms of the loss of Renpure and the challenges in Q4. We have 3 core challenges in Q4. The first and the most dominant of that is the loss of the Renpure distribution, what we're seeing from a decrease in replenishment orders as well as pipeline going into 2020. We also chose not to do a promotional program, which did have an impact because we chose to hold our margin profile and make sure that we're making profitable decisions for the business. And the third is continued softness within international market, which we have had consistently, and we're taking a renewed strategy there to really focus on core markets and to not to lead our efforts into opening any new markets at this time. As we look at 2020, we're not really giving guidance into that. What I will tell you is the growth rate of Mane Choice is very strong and we look for that. We will have some setbacks on Renpure. But we have a growing portfolio across many brands, and we do look for the company to grow in 2020.
Okay. So you do see growth in 2020 even before the acquisition?
Yes, that's correct.
Okay, okay. And just staying on Renpure for a second, was that across the entire Mass channel that you lost distribution or just a handful of retailers?
So it was really focused within the Mass U.S. business, which is Renpure's core business. And so when you look at that, there are offerings in there that are doing extremely well. Renpure at the largest Mass retailer in the U.S. continues to have very good sales and growth across hair and body. However, the newer items did not perform up to that same level. They were still strong performing, and this was where we were a little surprised as we started having planogram discussions, you'll hear very recently, that those SKUs were not going to go forward into 2020. But the core is very well performing. And now with our pivot, we'll continue to build that out.
Okay. Just one last one, if I could, on Mane Choice. Maybe give us what kind of growth rates that brand has seen? I know you mentioned that it did $24 million of sales and little over $6 million of EBITDA. But just curious how fast that business has been growing in recent years?
So we're not giving specific growth rates on the brand and not providing guidance for 2020 at this time. What I'll tell you is this...
I mean historical. Yes. I'm sorry. I mean historical growth rates.
Yes. So what I can tell you is I could direct you into their POS growth rates of what we've seen on the POS. The POS growth rates have been very strong double-digit growth rates. You can see from the Nielsen results and is one of the fastest growing among that segment in textured hair care.
Next question will be from Steph Wissink at Jefferies.
Don't mean to beat a dead horse here, but I wanted to just get one more point of clarification on Renpure. The loss of distribution, just for clarification, Tim, is that space that you have that you're losing? Or is it also a space that you expected to get that you're not getting?
Yes, it's primarily space that we have, and there is a little space that we anticipate to grow given the growth of the brand. When you look at Renpure's POS sales in the Mass, it is strong and growing. And the plant-based and newer higher priced premium offerings did perform well. There was tough decisions that the retailer had to make. And so we are losing some of our existing space that was held by those higher-priced items in 2019. That will be in place as it goes into 2020 planogram. We also anticipate to grow that segment, some in 2020, and we will not have the pipeline orders for that in Q4 as we go into 2020.
Okay, that's helpful. And can you just talk us through the process of having those conversations with your retail partners? When a set of SKUs maybe underperform expectations, do they come back to you and look for you to fill that gap from an innovation perspective? Or is this just an automatic loss of opportunity that you have to then spend time to kind of regain over the course of the next couple of years?
Yes, it is a mix. We have very strong healthy relationships with these retailers. So it has been part of the dialogue. And these decisions are not permanent. These are ones where we're taking a pivot strategy, and we believe that we'll get this back into growing distribution shelf space at these retailers. Specifically, in these conversations, we begin to show new innovation in Q2. It's in the Q3 time frame that sometimes they start having conversations on what that planogram can look like. And then really in Q4 is when they start finalizing the decisions of the planogram and the doors. So we had dialogue on this. This is where we are able to take some pivot strategies, and we are bringing in some items that are more in line with the core offering of Renpure at both of those retailers. We're not able to salvage all of the shelf space that we were losing at those retailers, but we were able to bring in our pivot strategy enough where we will be able to show and prove to the retailer that we can create strong innovation on this brand in line with their consumer needs and grow it over time.
Okay. Last one, Judy, for you is just on leverage. It was encouraging to see that the cost structure did lever in the quarter. How should we think about the fourth quarter based on the guidepost that you've given, the integration of the new acquisition? And then as we look into 2020, do you feel like your cost controls are in place where the business can lever on a full year basis?
Yes. Okay. Thanks, Stephanie. And yes, we were really pleased with the results of Q3 from a free cash flow generation perspective and a deleveraging perspective. So yes, Q3, with strong free cash flows of $5.4 million and we focused on debt reduction, getting our leverage down to 3.7%. As we look out into Q4, especially with the onetime investments, large CapEx investments really behind us now, we anticipate low CapEx spend similar to where we are at Q3. So we would expect free cash flow generation to be similar to what we saw in Q3. When we layer in The Mane Choice, it has a very similar profile to MAV in terms of strong gross margins, it's a CapEx-light business and also strong free cash flow. So together, we anticipate, again, just a strong free cash flow profile going forward, continued CapEx-light and focus on deleveraging.
Next question will be from Matthew Lee at Canaccord Genuity.
Can we maybe just get some color on the planogram performance on the brands that are not Renpure, so MAV and Cake?
Yes. So Cake has had exceptional performance as shown from both our shipments and our POS data. We will look to expand Cake rather large as we go into 2020. I'm also very pleased to say, in Q3, Cake expanded into the body care category at its major drug retailer in the U.S. and initial results of that have been very solid, and we're pleased with that offering as well. So we're looking at the Marc Anthony brand. Marc Anthony brand continues to grow and build sales and share across its distribution. We look to have some really good shelf gains within the drug channel, but also gains within mass. Renpure, what I'll say is, while we have hit some setbacks in the mass channel, will grow actually within the drug channel, and we're very happy with that. And so overall, the company is growing distribution across the portfolio, albeit, we do have some setbacks on Renpure that we're pivoting and look to make up in the future.
And just a quick follow-up on that. Can you give us a rough idea how much that total distribution growth is across the portfolio?
So at this point, we're still understanding the doors that we'll be getting for across this portfolio. And that's part of the reason why we're not talking about 2020 performance to date. And so as that information comes in, we'll be able to make better forecasting decisions on our business and be able to discuss that and talk about publicly.
[Operator Instructions] And your next question will be from Sabahat Khan at RBC Capital Markets.
Just one on 2020. I guess, you indicated that because of the lack of visibility, you're not providing guidance at this point. But should we expect updated guidance at Q4 reporting once you have more visibility?
So what we'll do is we will make the decision at that time. We need to understand as everything comes in on our distribution, we're committed to consistently delivering on the expectations that we put forward. And so right now, we're assessing as we have the setback on the Renpure distribution to understand what the future looks like on that, and we'll come back at that point.
Okay. And then just on The Mane Choice, it looks like some of the products are a bit higher-priced than your kind of core offerings. How are you thinking about that brand over the long run? And, I guess, is it still going to follow its own strategy? Is that kind of a price point that you wanted to increase exposure to? Or just thinking about how that fits within your broader portfolio?
Yes. So the first thing is, we're not going to change the strategy on it because the brand is in a very solid position and very fast growing and has amazing feedback from both consumers and retail partners. So the strategy will remain the same. One thing that is great about the texture and hair care market is that consumer is willing to pay even higher price premiums for the products that they love and use. The Mane Choice has a very loyal following and really what this shows is that consumer is so bought into that brand that they're willing to pay even higher price points than category averages to become a part of that brand and to use those products.
Okay. And then just one on international markets. I guess, can you maybe provide a little bit of color around what you see as the outlook? Is some of the, I guess, headwinds you've had, is that market-specific, brand-specific? What are you seeing on the horizon that's causing you to be a little bit more cautious on the markets outside of North America?
Yes. So first, international had a strong Q3. When you look at the year-over-year Q3 results, we did a very, very solid growth for international, which I'm pleased with. As we look at our international strategy, we took a very strong expansion strategy as we launched into new markets. Now we're actually going to shift that strategy to make sure that we're focusing on our core markets with the highest sales, to ensure that those are all growing and we're expanding our portfolio into each of those regions. What I would say is in terms of the softness, we have an opportunity, first and foremost, to more accurately forecast this business, especially in terms of operating as a public company. We understand that from the forecast that we have put forward on international market, we have not consistently delivered on that. And so we're looking at how do we approach that. The second piece is, there is a mix within either countries that are having some economic conditions, but as well, there's softness in one of our major country regions that we're having. And so now as we focus our resources in terms of our core regions, we're committed to getting this into a healthy growth space that we can consistently deliver on.
Thank you. And at this time, Mr. Venere, we have no other questions. Please proceed.
I'd like to just end by thanking everyone for their support and for joining us on our call today, and please reach out with any further questions. Have a great day.
Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines. Enjoy the rest of your day.