Genomma Lab Internacional SAB de CV

BMV:LABB

Earnings Call Transcript 2018-Q2

[Operator]

Good day, ladies and gentlemen. Welcome to the Genomma Lab Second Quarter 2018 Earnings Conference Call. [Operator Instructions]

I would now like to introduce your host for today's call, Mr. Enrique González, Head of Investor Relations. Mr. González, you may begin.

[Enrique González, executive]

Good morning, and thank you for joining us on our second quarter 2018 earnings conference call. With me today is Mr. Máx Juda, Genomma's CEO; and Antonio Zamora, our CFO.

During the -- today's call, we will make forward-looking statements that reflect the company's current expectations about the future plans and performance. These statements rely on assumptions and estimates, and actual results may differ materially due to the risks and uncertainties. I encourage you to read the full disclosure concerning forward-looking statements within yesterday's press release, which can be found on our corporate website at genomma.com -- genommalab.com.

With that, I would like now to turn the call over to Mr. Juda. Please, Máx, go ahead.

[Máximo Juda, executive]

Thank you, Enrique, and thank you, everyone, for joining today. As you may have noted in yesterday's press release, this quarter we've included additional detail on our operations and business segments. Therefore, today's call will focus on the key strategic highlights, so we can dedicate more time to answering your questions.

Our strategic roadmap defined a clear path to delivering on our 4 key priorities: leveraging our management talent to strengthen key areas of the company; improving our sell-in and sell-out ratios in Mexico; growing margins outside of Mexico; strengthening our brands and brand equity as we continue to expand internationally. This quarter, we made substantial headway in all of these areas. And we've also renewed our focus on product innovation in all categories. As I have mentioned in the past, innovation is one of the many tools we plan to apply to grow our top line. We are enthusiastic as our pipeline of innovation remains strong.

To begin with some highlights. We delivered a strong second quarter under the circumstances, with a 6.5% year-on-year top line increase that is a testament to outstanding sales performance. In doing this, we fended off a significant array of external headwinds in the markets in which we operate. The story behind our accomplishments this quarter was excellent execution of our go-to-market strategy in almost every markets in -- market in which Genomma has a presence, supported by a strong portfolio. Top line growth was also driven by our product innovation program and by implementing important expansion and distribution and visibility initiatives at the point of sale. It's important to note that the consolidation of our leadership team also played a strong role in our success this quarter, where we're seeing our seasoned operational management team worked cohesively across regions towards the same objectives.

Mexico is a compelling success story of executing on our turnaround strategy. We delivered 6.2% top line growth for the second quarter with strong sell-out. Excellent go-to-market capabilities supported by perfect store visibility, focused initiatives drove these results. These are built on important customer and category insights, allowing us to better understand shoppers' behavior and to identify and select several key variables, which significantly influence their purchase decisions at the point of sale based on store segments, unique retail outlet categories, store sizes and nuances of different geographies. In the Mom & Pop traditional channel in Mexico, we've expended 12,000 point of sale to reach a total of 67,000 points of sale with direct distribution, and we will continue to expand our footprint in this channel. We mentioned in our press release that our Suerox isotonic hydration drink achieved double-digit growth during peak season. And our product offering in this market will continue to expand through innovation. We will also benefit from Genomma's Mexico-based manufacturing facility, where OTC production is on track and expected to begin this fall, with Personal Care ramp-up expected to take place during the first half of 2019.

Turning to our U.S. operations, we were -- we also performed better than expected. Top line growth was 6.5% in local currency. Strong performance by both our Personal Care and OTC brands offset our discontinuation of nutritional supplements in this market. We also reached more than 3,000 new points of sale, securing new retail client agreements, which helped us achieve a healthy 20.2% EBITDA margin for the second quarter, supported by strict cost-containment and increased operating leverage resulting from improved sales growth.

As was mentioned on yesterday's earning release, we delivered a 5.5% year-on-year increase in second quarter net sales at our Latin America operations, which, when expressed in local currency, represented a 17.9% increase. It is a noteworthy performance considering that we leaned into considerable currency headwinds, which materialized at several emerging markets' currencies substantially weakened during the last 8 weeks of the quarter. Our performance here can again be attributed to product innovation and by perfect store initiatives at -- implemented at points of sale throughout the region.

On a final note, on Tuesday, we announced that the World Bank through the IFC and the Inter-American Development Bank, through BID Invest (sic) [ IDB Invest ], have committed long-term financing for approximately $100 million earmarked for the construction of Genomma's manufacturing plant in Mexico as well as providing strategic advice. These long-term loans will ensure that we are in a strong financial position to make the investments necessary to meet our manufacturing goals on time and are a point of strong endorsement of the advances we have made at Genomma.

In summary, we remain committed to executing on our goals, focused on bringing our manufacturing plant online and continuing to execute on successful marketing and points-of-sale strategies. As anticipated, we have accelerated our focus on growth and innovation, and we'll continue to do so in the second half of the year. We believe we have a powerful growth story with more catalysts to come, which we will usher along in the back half of this year and into 2019 and beyond as we continue to successfully navigate our way throughout potential headwinds.

Let me know turn the call over to Antonio, who will walk you through the segment of our financial results. Antonio?

[Antonio Zamora Galland, executive]

Thank you, Máx, and good morning, everyone. As Máx mentioned, let me give keep comments brief and focused, so we can turn to your questions.

It was a strong second quarter as we -- the successful execution of our strategy, coupled with the strict cost containment throughout the -- our organization, enabled us to achieve a 6.5% year-on-year increase in consolidate net sales despite considerable exogenous challenges. Improved sell-out and favorable local currency to Mexican pesos exchange rate conversion effect helped us mitigate these headwinds.

EBITDA for the second quarter of 2018 amounted to MXN 637.8 million compared to MXN 589.6 million for the same period of 2017. EBITDA margin for the second quarter 2018 reached 20.6%, which is up 30 basis points year-on-year expansion, reflecting the successful execution of important cost-containment strategies and initiatives, which we have been implementing since we began the turnaround process back in 2015.

In Mexico, improved sell-out and the strengthened fulfillment capabilities across the different sales channels resulted in second quarter 2018 net sales of MXN 1.28 billion, a 6.2% year-on-year increase. The perfect store visibility-focused initiative at the point of sale, which Máx has already described, also contributed to our results during this quarter as well as Genomma's renewed emphasis on innovation. Mexico's EBITDA margin contracted by 600 basis points this quarter due to the short-term sales effect, which Máx had already described.

Latin America's second quarter 2018 net sales increased by 5.5% year-on-year to reach MXN 1.49 billion. However, when expressed in local currency, year-on-year sales increased by 17.9%. The MXN 77.6 million increase in sales was driven by product innovation and by operational initiatives at the point of sale implemented throughout the region. This increase was partially offset by currency depreciation in Brazil and Argentina.

Second quarter EBITDA margin for the company's Latin American operations was 26.5%, which represents a 120 basis point margin increase and reflects a positive sales mix effect and our successful cost-containment program. Second quarter EBITDA growth was partially offset by ForEx headwinds previously mentioned.

Our consolidated gross profit increased by 1.5% to MXN 2.03 billion in the second quarter of 2018. Gross margin declined by 320 basis points, primarily due to the short-term product mix effect as certain higher-cost SKUs made a more significant contribution to the company's top line results during the quarter. This should be a short-term effect, as we expect to have substantial cost of good sale win -- savings once the new manufacturing facility is up and running.

Selling, general, marketing and administrative expenses declined by 2.8 percentage points as a percentage of net sales, closing at 45.8%, again, benefiting from our company-wide expense-reduction initiatives. But these savings were partially offset by the expenses associated with our new manufacturing facility ramp-up.

Moving to the balance sheet. Genomma's cash position was MXN 1.2 billion as of June 30, 2018, representing a 36.7% year-on-year decrease as we continue to pay down debt, and we have made important investments in our manufacturing facility. However, you'll note that our cash position has increased year-to-date despite the manufacturing plant investments, the company's acquisitions of 3 U.S. brands and our ongoing share buyback program. Genomma's cash and cash equivalents for the second quarter, therefore, increased by 8.6% since December 31, 2017.

Along these lines, we reactivated the share buyback program by completing a MXN 10.9 million share repurchase during the second quarter 2018. We will be -- we will continue to be open to more of the same buybacks as we maintain our focus on maximizing shareholder value and are confident in our ability to deliver on our commitments. Based on the growing array of compelling growth catalysts, which today, we believe are the most substantial is with regarding our turnaround process.

Genomma's cash conversion cycle reached the lowest number in more than 6 years, down to 75 days at the end of the second quarter of 2018 compared to 93 days at the second quarter of 2017. It is further affirmation of our commitment to improve profitability and emphasis and focus on cash flow.

Finally, as Máx have commented already, we are pleased to update you that the IDB Invest and the Inter-American Development Bank, together with the International Finance Corporation, a member of the World Bank, a financing package for an 8-year term loan to support the company's debt refinancing program as well as the construction of Genomma Lab new manufacturing facility.

In closing, as our results demonstrate, the actions are taking to transform our company are enabling us to deliver against our financial priorities, growing the top line, generating cash and achieving significant cost savings in line with our stated long-term objective.

With that, we'd like to conclude our prepared remarks. Let's now open up the phone lines for your questions. Operator, please go ahead.

[Operator]

[Operator Instructions] Our first question comes from Vinicius Ribeiro of Bradesco.

[Vinicius Ribeiro, analyst]

Just I want to know if you guys have some update on the potential bid against an investment for the new factory as you have [ a great source of that ] with the IFC. And you have -- if I remember correctly, you have mentioned that 700 basis points of improvement in gross margin because of the factory, out of which 350 would be [ invested in ] gross margins. We just want to know if that's the -- the figure remains the same or if there is some update. And the second question would be if you guys expect some improvement in the Mexico City plant that you have recently acquired because, again, in the Genomma Day, you have mentioned the 90 bps improvement in EBITDA margins, so we just want to see if you guys have any update on that.

[Máximo Juda, executive]

Yes, thank you very much, Vinicius. This is Máx. Yes, we still maintain our savings of 700 basis points. We believe that it will be higher than that, but we still keep that to be at least our expected savings in terms of EBITDA margin. Then in terms of final plant, we are transferring products to this plant and launching some other new products. It's -- it will start to produce, I would tell you, at 100% of its capacity in the next couple of months, so we still expect to have that savings -- that -- those cost savings in about 2 months, plus approximately the 2 or 3 months that it takes to eliminate the inventories at the previous cost.

[Operator]

Our next question comes from Nicolas Larrain of JPMorgan.

[Nicolas Larrain, analyst]

I have a couple. So first off, in Mexico, I wanted to see if you could explore a bit the gross margin decline here. Was it mostly the mix effect that you mentioned in the release, or there was also some heightened competition from generics? And in Latin America, if you will, could you comment on the growth -- I mean, the volume growth in each of the countries or just probably in the region?

[Máximo Juda, executive]

Thank you, Nicolas. This is Máx again. Regarding your first question, 100% of the situation in Mexico is related to mix. There is no price situations or any kind of modification to customers or discounts to customers or to final consumers. That has remained steady, but there was an unexpected change in mix of our products. And we are working to change it again in the next couple of quarters, so that's where we are focusing right now. But it is 100% product mix. As you know, we have some products that have certain margins and some that have others, so it's related to that. And then to your question about generics, it has nothing to do with that. We had a pressure of generics now for many years, and that's one of the reasons in why we're investing into the plant. There is no change in quarter pressure in -- within -- with generics in -- or in our pricing strategy to cope with that. The second part of your question...

[Antonio Zamora Galland, executive]

Latin America.

[Máximo Juda, executive]

The growth, you said Latin America growth in units by country. As we said in our press release, the best-performing countries were Colombia, Argentina and Brazil. In spite of the FX situation in Argentina and Brazil, we had a -- in Argentina, in spite of the crisis, we had an increase in market share. Volumes in units are growing but growing slightly, very slightly.

[Operator]

Our next question comes from Marco Montañez of VECTOR Casa de Bolsa.

[Marco Montanez, analyst]

Just a quick one in the financial side. Regarding the $100 million loan you just announced, is there any change in the target of reaching the ratio of net debt to EBITDA lower than 2x, as you mentioned in the Genomma Lab Day?

[Antonio Zamora Galland, executive]

Thank you, Marco. As you -- this is Antonio. As you know, we are currently having a ratio of net debt to EBITDA of 1.43x at this moment. As you know, with the plant investments, it may go a little bit higher. But obviously, the focus of the company is to generate cash as much as possible and to keep a low net debt-to-EBITDA ratio going forward. So we are managing this in a very solid and professional way. Temporarily, it may go higher than what we have but as soon as we can, we want to keep it as low as possible.

[Máximo Juda, executive]

But answering -- this is Máx answering your question. Our -- again, the ratio will be below 2x. Now we are approximately at 1.4x. We have made this quarter MXN 241.2 million of investment in the plants, MXN 60 million in brand acquisitions and almost MXN 11 million in share buybacks, and we still reduced our net debt. So the company has been performing during the last quarters very consistently, generating cash and reducing net debt. Maybe in the next 3 or 4 quarters, net debt might slightly increase due to the plant, but we plan to keep it at the same level and continue generating cash in spite of the large investment in the plant.

[Operator]

Our next question comes from Gilberto Garcia, Barclays.

[Gilberto Garcia, analyst]

Apology if I missed this from your remarks. Do you have a figure that you can share about your buybacks plan for the rest of the year? And is there any update on the timing of a potential dividend payment?

[Máximo Juda, executive]

Yes, thank you very much, Gilberto. First of all, we have had -- we initiated the second quarter our buyback program. We have had it -- we didn't use it in the last quarters. We are increasing it this quarter, and we plan to increase it in the next quarters, taking a very -- looking very closely at the plant investments not to increase our net debt. But we plan to increase our buyback program for the next quarters at this level of stock price. And that's what we plan. And once we finish the plant, we plan to increase it even further.

[Gilberto Garcia, analyst]

And regarding the dividend?

[Máximo Juda, executive]

And the question -- sorry, and the question of dividends, it is -- we plan not to move our dividend policy until we finished the plant and we understand the -- our cash generation. So don't expect any news about the dividends until the third or fourth quarter of 2019.

[Operator]

Our next question comes from Álvaro García, BTG Pactual.

[Alvaro Garcia, analyst]

My question's on your cash conversion cycle, which improved considerably in the quarter. And I was just wondering if you can give us more color on what's driving this and how much of this stems from your new ERP program and to what degree has it rolled out, right?

[Máximo Juda, executive]

Yes, thank you, Álvaro. Well, we have been saying during the last quarters that we were looking to reduce our cash conversion cycle, that there would be some volatility for some issues that we had in the past of fuel rate. We finished that. We plan to have some volatility again next year with the ramp-up of the new plants, but the objective of the company is to reduce the cash conversion cycle in the mid and long run, and we are working on this. We have had improvements in our inventories in the last quarter. We are looking very closely at this, so you should -- we cannot give you any short-term guidance for that, but you should expect it to remain at the same levels with some volatility moving forward and, in the mid and long run, a decrease in cash conversion cycle when we start controlling the production of the plant, reducing the inventories of the -- of some of the third parties that are producing today and we go into a controlled SAP supply chain system.

[Operator]

Our next question comes from Howard Siegelbaum of Chambers Street Capital.

[Howard Siegelbaum, analyst]

I noticed that for the first time, you started breaking out the tax receivables, and they're pretty substantial. Wondering on when you think you'll be able to utilize them, either -- I presume the government doesn't actually give you back that, I think, MXN 1.5 billion, but when can you start netting that out against the taxes you pay on a cash basis?

[Antonio Zamora Galland, executive]

Thank you, Howard. Yes, as you know, in many governments, it's hard to give money back to the companies or the people. The good news is that we'll able to use those VAT recoverables as -- to offset income tax in the future. So as the plant starts operating and our income levels go higher, we will be able to use that balance that we have there. So that's where we're going to get the benefit -- the cash flow benefit.

[Howard Siegelbaum, analyst]

Do you think you'll be able to use that over the next 2 years? Or is it a longer-term plan...

[Antonio Zamora Galland, executive]

No, no, obviously...

[Howard Siegelbaum, analyst]

[ Not only for this year's tax rate. ]

[Antonio Zamora Galland, executive]

Obviously, we will be able to use it during the next 2 years. As we have mentioned, the cost savings of the new manufacturing plant are substantial. EBITDA margins will go higher. And that's going to create more taxable income. And that taxable income will be offset by using these VAT recoverable taxes, so 2019 and 2020 for sure.

[Máximo Juda, executive]

And as you know, Howard, also, the plant carries VAT, which increases that tax. Once we finish the construction of the plant, the taxes that we have there will reduce in terms of -- at the speed at which we are creating that bucket.

[Antonio Zamora Galland, executive]

And that is precisely the reason why we wanted to provide disclosure of that line because, as we are investing, that line would go higher for the short term, but then we will be able to reduce that.

[Howard Siegelbaum, analyst]

How much more do you think the plant will add to that tax receivable?

[Máximo Juda, executive]

Less than MXN 300 million.

[Operator]

[Operator Instructions] Our next question comes from Rodrigo Alcantara of UBS.

[Rodrigo Alcantara, analyst]

Just a quick follow-up on the sales mix effect in Mexico. So as you've said that you would change again your mix in the next quarter, should we continue to expect low to mid-double-digits margins in Mexico for the rest of this year, maybe a bit higher in 4Q, driven by the benefits of the new plant?

[Máximo Juda, executive]

Okay. I think maybe it's a misunderstanding, but we said that we will be working on the mix on the next quarter. That doesn't mean we will be working to change it. It doesn't mean that we are committing to change it. And we cannot -- we still plan to meet our full year guidance. And if we have any update on that, we will let you know. I don't know if that answers your question. Sorry, Rodrigo. Does that answer your question?

[Rodrigo Alcantara, analyst]

And just a bit, just wanted to get a [ carrier match ] on your -- or your margins in Mexico and the possibility for you guys to expand it sequentially, perhaps?

[Máximo Juda, executive]

Yes. Well, we -- so in -- it's divided in 2 phases. The first phase is the next 2 or 3 quarters, how we will manage the operation in terms of mix in order to increase our margin and reduce our cost of goods sold. So that is, I would say, management, marketing management and brand management. So it is -- we are working on it. There's a little bit of a question mark, but we think we can make improvements. The second thing is what we believe is not a question mark, that is related to the start-up of the plant and the margin increase. So in the -- after the next 3 -- 2 or 3 quarters, you will start to see how the cost of goods sold of the new plant kicks in. And you will start seeing for sure an increase of gross margin and reduction of cost of goods sold.

[Operator]

Our next question comes from Jeronimo de Guzman of INCA Investments.

[Jeronimo de Guzman, analyst]

Maybe I could start with a follow-up on the last question. I mean, it seems like the product mix has been mentioned in the last, I don't know, 4 or 5 quarters. So just wanted to understand, I mean, what has been the issue exactly? And how quickly can you reverse it? Because if it is just -- it seems like it's just -- seems to be continuing. So how much can you really influence it given that, that's what -- I guess, that's what -- that's influenced by the sell-out?

[Máximo Juda, executive]

The difference in -- between this quarter and the last quarters is that it has been a trend but this quarter, the increase has been significant. So that is why we believe that we can work in terms of management to change that. Regarding the underlying or the fundamental problem, it will be solved in the mid-run with the plant, and that's where we are working right now. I don't know if that answers your question, Jeronimo.

[Jeronimo de Guzman, analyst]

Yes, yes. I think -- I guess it'll take some time, but I guess you did see it as not a permanent thing, I guess, and the plant can offset.

[Máximo Juda, executive]

We don't see it as a...

[Jeronimo de Guzman, analyst]

[indiscernible]

[Máximo Juda, executive]

Yes, sorry. We don't see it as a permanent thing. With the plant, it will be solved and we will working on the short run to change the mix and change that situation for the next quarters.

[Jeronimo de Guzman, analyst]

Okay. And then just wanted to understand. You started having more of the pre-operating expenses, and I wanted to understand how much more you expect in these expenses in the next couple of quarters?

[Máximo Juda, executive]

Yes. Well, we plan a -- we -- there is a situation in which maybe the next couple of quarters, it increases. We don't think it will increase significantly. We think that it is contained approximately to that level. And once the plant starts producing, that we believe it will be in the fourth quarter, but the old plant -- as you know, the Mexico City plant we acquired will be -- will start producing in the third quarter, it will offset those expenses.

[Jeronimo de Guzman, analyst]

Okay, that makes sense. And I think you mentioned that, but you -- how do you stand in terms of your guidance for the year in terms of sales and EBITDA? And just -- I mean, I would think that given this big FX pressures, even with kind of sales performing in line with or better than you expected, it would still be difficult to meet the guidance. So just wanted to get your latest thoughts on that.

[Máximo Juda, executive]

Well, we are very confident today on our innovation program that we plan to ramp up until the fourth quarter of 2019. It has had very interesting early wins. Our sell-out is growing. The less -- the last measurements of sell-out in this quarter, in the third quarter, are good and better than we expect, so we want to wait for some more months to understand what's happening to our sell-out and the positive trends that we are having to give you any update on that. For the moment, we are keeping our sales and EBITDA guidances because both our innovation and our sell-out, our week-to-week sell-outs, are up to our expectations.

[Jeronimo de Guzman, analyst]

Interesting. Okay. And just a final question on this innovation. I mean, anything else you can give? I know it's difficult just for competitive reasons, but any more details on this? And also, I think in the past, it's been a little bit difficult to manage the innovation because you don't want to do it too soon before you launch the new plant. So how do you manage also the complexity of launching these new products because you have the new plant on board?

[Máximo Juda, executive]

Thank you very much. The first part of the innovation is that -- remember that for the last 3 years, we were very focused on the turnaround and trying to show a consistent cash generation and being consistent in our numbers and those things and reducing our structure, so we didn't invest much of our time in innovation. We have started with this just last quarter, the second quarter. And really, the numbers, in terms of innovation, were better than our expectations. And we are continuing now to shift from a turnaround situation into a growth and innovation situation across the company. So that's the first part. The second part is, yes, it's true. There is a complexity. Our products are not very complex. At the end of the day, we do cosmetics, personal care and OTC, so it's nothing that is very complex to transfer to the new plant. But in terms of our R&D teams, we have the R&D team, although it's the same team, it's split between innovation and technology transfer. So some people continue to work in innovation. About half of the team works in innovation, and about half of the team is working on the technological transfer of the previous products and innovations into the plant, so we can work both things at the same time. I don't know if that answers your question.

[Jeronimo de Guzman, analyst]

Yes. I mean, I guess I'm just wondering how much having this new plant and waiting for the new plant holds back the innovation because you don't want to launch a new product without a third-party supplier and then, 3 months later, have to take it away and put it through into your new plant. That's kind of what [ I'm asking ].

[Máximo Juda, executive]

We are not stopping the innovation for the plant [ resets ] at all because, today as we told you, after the 3 years we worked on the turnaround, growth -- we are starting to focus in growth. So we are not stopping any innovation for the plant. And the plant doesn't receive all of the products at the same time, so we have plenty of time to transfer some products that are not part of our innovation and have everybody busy there at that time.

[Operator]

Ladies and gentlemen, we have reached the end of our question-and-answer session. I would like to turn the call back over to CEO, Máximo Juda, for closing comments.

[Máximo Juda, executive]

Thank you for joining us this morning. We hope that you have come away with the same level of confidence that we have in the actions we are taking. We continue to benefit from focused execution of our strategy, containing costs, refining our portfolio, spending behind our brands with innovation, marketing support and new product development while investing in important projects to improve our overall profitability. While we acknowledge there is still work to do, we are pleased with the considerable progress we have made. We all look forward speaking to and seeing many of you over the next couple of weeks and months during the upcoming road shows and conferences. In the meantime, please don't hesitate to reach out to any member of the team. As you know, we will always be happy to assist you. And with that, thanks again for participating in our call today, and have a good day.