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Good morning, ladies and gentlemen, and welcome to the MAV Beauty Brands Third Quarter 2020 Results Conference Call. [Operator Instructions] This call is being recorded on Friday, November 13, 2020. I'd now like to turn the conference over to Craig Armitage. Please go ahead.
Thank you, and good morning, everyone. Thanks for joining us today. Just a quick note before we get started, 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 or the AIF, both of which are available on our website and on SEDAR. These include a summary of the significant assumptions underlying these forward-looking statements and certain risks that could affect the company's performance and the ability to deliver on these forward-looking statements. Again, you'll find the Q3 earnings release, financial statements and MD&A on the IR section of the MAV Beauty Brands website. With that, I'll turn it over to Tim Bunch. Tim?
Good morning, and welcome to our third quarter 2020 conference call. Joining me for the call is Judy Adam, our Chief Financial Officer. In addition to discussing the financial results and recent market trends, I will update you on our growth strategy. Our organization and strategy have evolved over the past year, and we think it's an important context as we approach 2021. 2020 has presented some obstacles for our retailers in format from reduced store traffic to store closures. More than 3/4 of the way through the year, I'm proud to say we have faced these challenges and fared quite well. Our performance both for the quarter and year-to-date periods demonstrates the resilience and durability of our categories and the diversification of MAV's platform across brands, consumers, segments and retail channels. Our diversification serves us very well in periods of uncertainty, mitigating risk while allowing us to benefit from shifting consumer preferences and buying behavior. In 2020, we put much focus into weathering this extraordinary operating environment, but we also made significant enhancements to our operating platform. This includes the people, infrastructure and systems required to scale MAV and deliver consistent results. It starts with our team. We have added to our senior leadership over the past 2 years with top-tier talent from our industry and related fields. These are professionals who have built and managed multibillion-dollar enterprises. They bring the operational rigor and discipline we need to scale MAV as well as deep M&A capabilities. As you have also heard us discuss investments in infrastructure, over the past 2 years. These are significant pieces, things like the ERP system, better IT, deeper operations and finance teams that provide the necessary foundation for growth. This infrastructure allows us to better manage KPIs, working capital and inventory, all of which are so important as we grow. Turning to the results. It was another strong quarter for MAV, highlighted by double-digit revenue growth, robust adjusted EBITDA and free cash flow. These results speak to the great efforts of our team, the foundation and infrastructure we have put in place, and ultimately, our ability to execute this growth strategy. From an organic perspective, while the category has shown resilience is performing below historical levels due to COVID-related challenges, such as reduced in-store traffic. U.S. Nielsen data shows the hair care category has grown 1% year-to-date against a long-term compounded annual growth rate of more than 3%. Within these numbers, there has been a COVID shift in buying behavior, with relative strength in ship Hus, conditioners and treatments and declines on short-term styling products such as hairsprays. For the fiscal year-to-date, we've been successful in generating modest organic growth above the category. However, for Q3 specifically, while we reported 12% year-over-year revenue growth, our organic results were impacted by reduced in-store promotional activity as retailers reallocate space to daily essentials during the pandemic, which we identified last quarter as a likely headwind. Our e-commerce continues to be a significant tailwind in 2020. The third quarter e-commerce sales were once again up 2x over the comparable period. E-commerce remains an important focus and driver for the future, and we are increasingly taking an omnichannel approach to our marketing strategy. You'll hear us talk more about this in the coming quarters. Turning to our strategy update. With a platform in place to manage the business, we are focused on continued growth. Our strategy is simple: one, leverage this operating platform to grow our portfolio organically at above category rates; and second, layer in accretive acquisitions. The formula for above category growth rate comes down to 4 tactics, expand the distribution footprint of our portfolio, create winning innovation, amplify our brands and drive efficiencies. We've demonstrated our ability in each of these areas over the past year. New distribution has been secured for each of the brands and accelerated e-commerce sales for all of them. Innovation has expanded the MAV Beauty Brands platform from primarily hair care in 2018 into the large and resilient body care category. And in 2020, we expanded into facial skincare products through innovation. Brand marketing has built awareness and equity across the brands, and we are efficiently reducing our COGs, which is translating to gross margin expansion. The second component of our strategy is accretive acquisitions. We have done 3 deals today and see tremendous opportunity to layer in new brands in Personal Care. Despite the headwinds of store closures and specialty beauty, The Mane Choice continues to bring value to MAV Beauty and gives us exposure to fast-growing subsegment of parent care. This accretive acquisition is contributing to our growth in diluted adjusted earnings per share of 25% for the fiscal year-to-date. Those who follow the sector know how active the M&A environment has been in the past several years. This is likely to continue or even accelerate as many independent brands facing new challenges from COVID evaluate how best to scale and fund the infrastructure build that's required. We believe MAV can be an acquirer of choice for these brands, but we also understand is about finding the right brand at the right time. With that, I'll ask Judy to review the financial results in more detail. Judy?
Thanks, Tim. Good morning, everyone, and thanks for joining us today. Our full filings are available online. So let me focus on the main highlights for the quarter and year-to-date periods. Overall, we reported another strong quarter. Our leadership team is highly focused on operational execution, and this produced record revenue and adjusted EBITDA for the quarter. Total revenue increased 12% over the prior year to $31.7 million, including the acquisition of The Mane Choice in late 2019. On a year-to-date basis, total revenue was $92.8 million, up 19% over the prior year from the combination of The Mane Choice acquisition and modest organic growth in North America. Gross profit was $15.7 million in the quarter, up 12% from last year, and gross profit margin was 49.6% versus 49.8% last year. As we have discussed in the past, we do expect some variability in gross margin quarter-to-quarter based on product mix and promotional decisions. When you look at our year-to-date results, we had gross margin of 51% versus 49% in the same period last year. Importantly, we've been successful at generating product cost savings over the past year, which has allowed for steady margin improvements. Excluding share-based compensation charges of $0.4 million, Q3 selling and admin expense was $6.9 million or 22% of sales compared with $5.6 million or 20% of sales in the same period last year. The prior year benefited from a reduction in short-term incentive compensation costs, which did not repeat in the current year. Overall, SG&A expense has remained fairly constant in 2020 and is in line with our expectations. Adjusted EBITDA for Q3 was $8.7 million, up slightly from the prior year and a strong result given the environment. Adjusted EBITDA margin was 27.4% this quarter versus 29.9% in the third quarter last year, principally due to the changes in SG&A and gross profit, as I mentioned. Net income was up 21% over last year to $3.6 million, and adjusted net income was up 9% to $4.2 million. On a year-to-date basis, adjusted net income grew 30% to $11.9 million, and adjusted diluted EPS increased 25% to $0.28 per share. Cash flow from operations for Q3 was $7 million, up 18% from the prior year. Adjusted free cash flow was $4.4 million in the quarter compared with $5.4 million last year. On a year-to-date basis, adjusted free cash flow grew 27% to $8.6 million. The current quarter reflects increased working capital investment compared to the prior year primarily higher receivables as a result of increased revenues and higher inventory investment as we prepare to ship new innovations in Q4. We continue to believe it's going to have additional liquidity and, at quarter end, we had cash of $14.2 million, similar to the level we were carrying at the end of Q2. Our net debt stood at $129.3 million, down $4.3 million from last quarter as we deployed free cash flow toward debt reduction. Including the results of The Mane Choice for the trailing 12 months, our net debt to adjusted EBITDA ratio was 3.9x, down from 4.0x at the end of Q2. We believe we will continue to demonstrate strong free cash flow generation, providing the financial flexibility to pay down debt and support the acquisition component of our growth strategy. I will now turn the call back to Tim for closing comments. Tim?
Thank you, Judy. Before we open the call to questions, I want to thank all our employees, our business partners and our retail customers for their efforts in these difficult times. We are pleased with how we have navigated 2020 and with the results we have reported for our shareholders. We're building -- we are a brand-building platform. We grow brands organically, and we make accretive acquisitions of other great brands to layer on to the platform. That is how we have grown, and that's how we continue to build now and create value for our shareholders. We look forward to reporting on our progress with the release of our Q4 results. We'll now open the call to questions. Operator?
[Operator Instructions] Your first question comes from Vishal Shreedhar with National Bank.
Maybe if you can update us on the growth by brands, that would be helpful. If you can start with that?
Yes. So the way we are going to be focused is on the portfolio. We believe the portfolio gives us the resilience and the diversification. And so when you look across the portfolio, we've grown organically year-to-date, and we're very happy about that. We're not going to segment by individual brands. I can give you a little bit color. I'd say we're really seeing some great acceleration within our Mass channel with the Marc Anthony brand, and Cake continues to perform strong in its expansion. And Renpure has had a lot of growth within Canada. So great growth across the brand portfolio, but we feel like the diversification is going to bring the resilience even in uncertain time periods.
Okay. With respect to -- and I know you've touched on this in the past, but with respect to the lower traffic in stores, and I know the team is focused on brand amplification. So maybe you could talk about some of the strategies that you're employing to help accelerate stores, your sales in the stores when there are a little bit lower traffic and lower promo?
Yes. I would say we're looking at store, and we're also looking at retailer.com as well. So in store, many of our retailers have specific programs to better reach their customers. And we're participating in that, especially as you look at the U.S. Mass channel, we've been participating with across the portfolio with several of our retailers there. The other place that we're really investing is many of our retailers have seen a lot of success in retailer.com. So as you're seeing lower foot traffic it's not necessarily going to reverse that because that's a change due to COVID. So we see it more as an opportunity now to how do we capture those consumers on the retailer.com site, the walmart.coms and target.coms of the world or shoppers.com as well as our Amazon business. And so this ability to adjust to where the consumer is at and not try to force their behavior to be something that it's not going to be, I think that, that is what has yielded some good results for us year-to-date.
Okay. And you talked a little bit about acquisitions. Obviously, free cash flow is dropping and your TV rating quickly. Maybe you can give us some context on where you are in your acquisition thinking? Like is this a near-term consideration or longer term? And what kind of brands do you think will fit well with MAV?
Yes. So we're not looking to close an acquisition in 2020. However, exiting 2020, I think that we have built a strong platform that we could layer on more accretive brands. And it's just about finding the right brand, and it's not rushing it. It's really being patient to find the right brand for us to expand. To us, what makes the right brand, we really have a focus within the resilient and large personal care categories. We like things that are on trend segments. And it's got to be an asset-light, similar to our model and, of course, accretive to EPS. And so those are the criteria that we really look for. The good news is the M&A activity out there is very hot. I've been in dialogues and even sent some information to several people on the call, what we really saw here is in Q2 when COVID hit, a lot of the M&A activity kind of went cold. Coming in Q3 and I'd say coming into Q4, it is as hot as I've ever seen, M&A activity in the space. I think there's a lot of brands looking for a partner to derisk their brand. And this is a good time for MAV to be looking what's out there. p
Next question comes from Matt Bank with CIBC.
I just wanted to follow-up on that online discussion. So can you maybe talk a bit more specifically on what investing in the retailer.com actually looks like? Is it about marketing spend? Is it about improving your own internal capabilities?
Yes, it's both. And the retailer.com, the ones that are excelling at it are taking models that are very similar to Amazon. And so what does that mean? So it's really how do you fuel marketing dollars, but it improves the overall algorithm in terms of how brands are seen and viewed on page to make sure that they're putting the right brands to the right consumers. So what we have done successfully on Amazon and now are playing sort of retailer.com, is making steady investments to make sure that we're constantly optimizing our marketing spend and reaching the right consumers at the right time. This has been very effective for us on Amazon, and we have dedicated resources to drive that on Amazon and retailer.com. The other piece is operationally. As a larger percent of our business has shifted into the e-commerce, that fulfills and shifts slightly different. And so we have adjusted that with our internal infrastructure across operations to make sure that we're able to fill that demand seamlessly for all of our customers and consumers.
Okay. Great. And then I want to ask more of a short-term question, Q4. I know Q4 typically has certain holiday promotions that can be a little bit noisier or onetime. So is there anything that we should consider in Q4 when we're comparing year-over-year?
Really, over the last few years, we got out a lot of that noise on the holiday. A few years ago, there was some of that. But as you compare 2020, it's going to be much more similar to like a 2019, of course, layering in the organic growth that you're seeing. And we'll have a full quarter of The Mane Choice, albeit The Mane Choice is also impacted by Special and Beauty. So as you think about Q4, I think those are kind of the details that we've previously shared, but you should not see any negative or big static issue of something with the holiday program as maybe you saw in prior years.
Okay. And just one last one for me, if that's all right. Just a follow-up on the M&A timing. Can you just tie that into the net debt and where you would be comfortable, I guess, at what point you would be comfortable acquiring? And how big of a deal you'd be considering where you are with net debt?
So we're very comfortable with these debt levels. And we are a platform-based company, and we will have probably higher debt levels than a traditional company has not platform based that is growing through acquisition. And we're comfortable with that based on our liquidity and the free cash flow we generate. That said, we acquired The Mane Choice last year. We're focused on using our free cash flow to pay down that debt to allow for future acquisition. We, at this time, do not see expanding our debt significantly higher over 4x, but it all depends on the right acquisition at the right time. The other thing that I would point to is we've been very creative in terms of how we've been able to finance and do deals through both the debt, some level of equity to make sure that whoever is coming in also has stake in MAV Beauty. And also earn-out structures. And I think this flexibility to create deal structures that are accretive to our business, like what we've done with The Mane Choice as well as keeping our debt level within a manageable and reasonable space I think, is a hallmark to our success.
Your next question comes from Sabahat Khan with RBC Capital.
Just on the kind of the specialty channel and kind of The Mane Choice acquisition. I guess as you think about that brand longer term, is there an opportunity to maybe leverage it increasingly into some of your other channels over time like you've done with some of your other acquisitions?
Absolutely. So we talk a lot about the specialty channel with The Mane Choice because there was something a little unique for that brand, particularly Sally Beauty, which was a big part of the specialty channel for The Mane Choice that or other bands then play it. But you also have to look at where The Mane Choice is playing beyond specialty. It serves in Walmart U.S., Target, each of the key drugs, and we've expanded it across Canada, expanding into Walmart and other locations in Canada. And so what we're focused on is we actually like the fact that it has specialty because that's further diversification of our retail partners. But then we're really focused right now. And with the cases of COVID, especially, how do we expand that brand within drug and masks as we know that those are going to be more resilient if COVID spikes up again?
Okay. And then as we think about 2021, without getting it to maybe -- I'm not asking for guidance, but should we expect the growth next year, at least on the top line? Is it more about are you going to try to get some new innovation on the shelf? Is it getting more square footage? Or is it just still kind of focusing on velocity and maybe additional doors we've assumed? So I'm just trying to think of the mix of where the top line next year could come from? And maybe within the context, how you think about maybe comping against a year like this where the top line does look to be into the mid-teens so far?
Yes. So if -- you have to take in the context of this year, our top line also has The Mane Choice layered into it. And so we are anniversarying that without The Mane Choice. As you look into 2021 and our portfolio to date, assuming no new acquisition, you would look at it on a pure, more organic basis. And for us, I would encourage you to look at organic growth, not only from top line revenue, but also from the bottom line synergies that we're driving. I think that's one area that we just haven't talked about enough, but things like gross margin, when you look at year-to-date where we're at gross margin at 51%, which is significantly above where we were at gross margin last year, year-to-date. To us, that improvement is something that's very important to our model. In terms of a top line basis, Mintel, which is an industry leading forecasting category, is forecasting the category of hair care in U.S. to be growing at roughly around 2%. That is where their forecast. We -- our goal is to grow above the category organically. And so that is our focus. And we're going to get there through not just distribution, but also through accelerated marketing, great innovation and cost efficiencies for the bottom line.
Okay. And then just kind of thinking about the e-commerce channel. Obviously, there's been a spike across the broader consumer space, and it looks like historically, shampoo and conditioner, maybe the pack size wasn't well suited as an industry for e-commerce. So maybe can you talk about just what you've seen in the consumer behavior over the last little while? And as a category, do you think that continues into next year as part of the broader shift towards online? And is there anything maybe you're thinking from a product portfolio perspective or pack size that you think you might change, that maybe better positioned for that?
Yes. That second part is a very good particular question. So let me address the first one. Where we're seeing success on online, which has also been very much within our current margin structure, is more on aggregate platform sites like the Walmart.com and Amazon, where consumers are not just buying a single shampoo, they're buying a portfolio of products that are being shipped through in sets. And so across all personal care and beauty or other spaces as well. And so that really allows us to have the same type of margin profitability structure versus sending like a single shampoo in DTC. In terms of what we're seeing for form online, we do see some differences within Amazon and some of the top sellers. And so what we're looking at in our marketing and brand and innovation team is how do we further fuel that and do we need to bring any particular innovation for that consumer? The other piece of that is occasionally something performs really well in Amazon, and there's a great opportunity to bring that more into brick-and-mortar stores as well because you're seeing that trend first online. So we're looking at it very holistically from an omnichannel type perspective. And we'll do more of the omnichannel perspective even as we go forward.
Okay. And then just last one, maybe just a quick update on just the supply chain, both at your third-party manufacturers and maybe inputs, now that the second waves kind of taken hold, how does the supply chain overall look like?
Yes. I would say we're very fortunate as a company that none of our core suppliers or of our employees have been severely affected by COVID for health of their employees. As we do look at our supply chain, we did have some constraints in Q2. They've even lingered a little bit into Q3 on certain componentry initiatives. What we've been focused on as a team, and this gets to the great operational infrastructure that we've now built on this platform, is we are now like making sure that we have secondary options for sourcing, componentry and ingredients. So even if COVID does back up, we're taking steps to make sure that we can mitigate those risks to the best of our ability. As I look forward to Q4, at this time, we don't see any significant negative effect that the supply chain will have due to COVID. Albeit, I catch that from, that's from the data that we have today. And we all know that we're seeing spiking rates within COVID. And so I'd say that is for what we know today.
Next question comes from Joe Altobello with Raymond James.
So I certainly appreciate the commentary on the quarter-to-quarter variability that you guys are seeing on the gross margin line. So with that, what's a good annual gross margin expansion target that we should think about in terms of your growth algorithm?
Yes. I think we feel very comfortable with where we're delivering gross margin within the year of -- within this year 2020. As we look forward, we look to have slightly more growth expansion within gross margin year-over-year, so we drive out efficiencies. I'd say it's probably not going to be as dramatic as what we've seen from 2019 to 2020 because a lot of these savings are driving efficiencies to our recent acquisition. Now as we have more acquisitions, a lot of times, these smaller brands are not able to get the best product costs, and then we can layer in our operational platform very quickly and try to drive those costs out. So with future acquisitions, I would say that will be one of the primary focuses.
Right. So if you put the acquisitions aside, though, is it a 20, 30, 40 basis point in year opportunity that you see in the base business?
Yes. We're not going to give that specific guidance on it. I would just say, we look to improve the gross margin over time. And it will be a gradual basis. You've seen more dramatic improvement post acquisitions in the year post acquisitions. But then over time, we look for slight improvement, but not going to give specific guidance on the level.
Okay. Okay. And then my second question, with Cake now in U.S. drug and capacity and Renpure expanding in Canada, where do you guys see the biggest distribution opportunities for the portfolio in 2021?
Yes. In 2021, a large focus of our business is going to be in the U.S. Mass business. And U.S. Mass makes up over 50% of the U.S. market. We have very strong distribution within our brands within the U.S. drug channel. And we believe that there's an opportunity to drive out more value and more revenue in the U.S. Mass business.
And is that for all brands? Or any particular brands that you...
Yes. It's really across all brands. Because it's such a large segment of the business. Now U.S. Mass takes steady improvements. It's not something that changes dramatically from year-to-year. And so we're looking to see how do we make steady improvements across the portfolio in U.S. Mass. Right now, 3 of our brands play in U.S. Mass. And so -- the Marc Anthony brand, Renpure and The Mane Choice. And so we're really seeing how can we drive both velocities and distribution of those brands in Mass.
Our next question comes from Steph Wissink with Jefferies.
Most of our questions have been asked, but I have 3 just as follow-ups. Judy, 2 for you. The first is on working capital, and this relates to the question earlier on supply chain. But if you could just help us think through current inventory position versus where you expect to be end of year assuming that we don't see any variability in your supply chain? And same question on SG&A. It did come in a little bit higher than I would have expected. Just wanting to make sure we're fully accounting for The Mane Choice in our model? And then any sort of synergies you expect to get over the course of the next 6 to 12 months from the integration of that business?
Okay. Thanks, Steph. Okay, maybe on the working capital, yes, I mean, we had spoken in prior quarters that we had made more investment in inventory as a more preventative measure for against the pandemic in COVID. And so -- but we're starting to see that sort of steadier level of inventory investment in going forward. Q3 typically is a bit more of an inventory build as we prepare for our innovation shipments in Q4. But we feel like inventory levels will steady out as we get into Q4. And AR typically will grow as revenue grows. And then maybe -- and then turning over to your SG&A question. Yes, when you look at the year-over-year increase that is primarily driven by the inclusion of The Mane Choice now, in 2020, and we also mentioned like when you look at the percentage to increase versus sales, the increase is really due to the prior year having some savings in compensation costs that didn't repeat in the current quarter.
Okay. That's really helpful. And then, Tim, for you, you're always informative in terms of giving us some sense around brand development, brand activation. So I'm wondering if you can talk a little bit about how a shift to online and also activation through social how that influences your innovation process, whether it's data, analytics, insights, observations? How does this kind of future state where it's a more digitally driven business? How does that factor into the types of products that you bring to market?
Yes. It plays a big role. And part of that is having the infrastructure to take advantage of it. I'd say where we were a few years ago to where we are today, like we have a top-notch brand team that is constantly listening and engaging and interacting with our consumers across digital. And so the way we are taking is we believe one way we're going to win is finding and sourcing trends faster. And then using the social channels to iterate and develop our products. So we have some great stuff coming out next year, and particularly one of our brands that has been so developed with social influencers involved in the packaging and how it's going to be presented on the shelves, but also importantly, online. The other part is, you're going to hear us talk a lot more about omnichannel. And I think we've always had a very strong presence and portions. We're really focused on how do we connect this and make this just seamless. We know that most consumers are, in some way, using digital in a part of their path to purchase. And so now we want to make that more seamless and connect, but also secure the data from that, so we can constantly be improving our innovation and our business. So those are going to be focus areas, very proud of what the team has done thus far. And I think still a lot of heavy lifting and work to go here over the next few years. Ladies and gentlemen, as a reminder, should you have any questions.
[Operator Instructions] Next question comes from Matthew Lee with Canaccord.
Congrats on a good quarter. I wanted to first ask if you had any update on early planogram conversations? Are you expecting extended shelf space in F '21? And are there any retailers putting back?
Yes. So we do have some visibility, but we're still waiting on outcome of certain planograms, especially on door accounts. And just a little difference in terms of how we're approaching, reporting here in 2020 is we want to make sure that we have real clarity before we start giving future visibility and guidance. I think that's a real shift for us here this year because we want to get the confidence out to our shareholder basis. So what I will say we have confidence in is based on what we're seeing from consumption trends, from distribution trends, we're confident that we're going to be able to generate organic growth from the portfolio, with the tactics that we've outlined, to above the category growth rates.
Great. And then I'm not sure if I heard you correctly earlier, but did you mention that organic growth was positive in the quarter ex The Mane Choice?
No. So to be clear, organic growth is positive for year-to-date. For the quarter, we were up against a big '19 comp, and we had lower promotional opportunities for the brands. And so the growth in Q3 is fully focused on The Mane Choice year-over-year. However, I think a much better measure is the year-to-date because it doesn't have the shipment variability or some of the variability that you see by quarter. And when you do look at year-to-date, we are growing organically and it's modestly above the category growth rate.
That's helpful. And then on the M&A front, maybe talk about the depth of your pipeline and maybe talk about whether the pandemic has created any opportunities to acquire brands at a lower price than former?
Yes. I think the pandemic has made one of the hotter M&A environments for us because a lot of smaller brands are really looking at do they have the resilience? Do they have the scale to actually survive through future turmoil or economic uncertainty? And so there's a lot of deals coming. I'd say it's probably more deals per week crossing my desk than what I have seen over the past 3 years because there was such a drought in Q2 and now a resurgence. So we think it's a very exciting time. It always comes down to the right deal, the right brand to make sure that we have the ability to grow it and it fits our platform. And of course, that is accretive to earnings per share. And so we're going to take our time and any brand that we bring on, we're going to make sure it's the right brand for us, but there's a lot of opportunity out there. And I think a very exciting time to look at M&A.
There are no further questions at this time. Please proceed.
All right. With that, I would like to just thank everyone for attending today's call, and please reach out with any further questions. Have a good day.
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.