Jamieson Wellness Inc

TSX:JWEL

Earnings Call Transcript 2019-Q2

[Operator]

Good afternoon, ladies and gentlemen. Welcome to the Jamieson Wellness conference call to discuss financial results for the second quarter of 2019. [Operator Instructions] Please be advised that reproduction of this call in whole or in part is not permitted without written authorization from the company. As a reminder, today's call is being recorded.On the call today from management are Mark Hornick, President and Chief Executive Officer; and Chris Snowden, Chief Financial Officer and Corporate Secretary.Before I turn the call over to Mr. Hornick, please note that a press release covering the company's second quarter 2019 financial result was issued this afternoon and a copy of that press release can be found in the investor relations section on the company's website. Please note that the prepared remarks, which will follow, contain forward-looking statements, and management may make additional forward-looking statements in response to your questions. These statements do not guarantee future performance and therefore undue reliance should not be placed upon them. We refer you to all risk factors contained in Jamieson's press release issued this afternoon and in filings with the Canadian securities administrators for more detailed discussion of the factors that could cause actual results to differ materially from those projections and any forward-looking statements.The company undertakes no obligation to publicly correct or update the forward-looking statements made during the presentation to reflect future events or circumstances, except as may be required under applicable security laws.Finally, we would like to remind listeners that the company may refer to certain non-IFRS financial measures during this teleconference. A reconciliation of these non-IFRS financial measures was included with the company's press release issued earlier today. Also please note that unless otherwise stated, all figures discussed today are in Canadian dollars and are occasionally rounded to the nearest million.I will now turn the call over to Mr. Hornick to get started. Please go ahead, sir.

[Mark Hornick, President, CEO & Director]

All right. Thanks a lot, Nadia. And good afternoon, everyone. I'm pleased to report another strong quarter for our company. We generated 9% second quarter revenue growth, 16% growth in adjusted EBITDA and 14% adjusted net income growth during Q2 of 2019.We're encouraged by the continued momentum that we're seeing across all of our business segments and we're reiterating our 2019 guidance. We'll begin with just an overview of our second quarter and the business highlight. So firstly, our Jamieson brand segment grew 9% led by a 12% increase in domestic Jamieson branded sales driven by 3 things; consumer demand, new distribution and as we expected, the normalization of shipments associated with the 2018 first quarter price increase.Our international sales increased 10% this quarter, led by strong demand in Europe and the Middle East. And importantly consumer demand in China was very strong in Q2, which is going to lead to strong sales in Q3 as our distribution partner in China replenishes inventory. During the quarter, we added 5 new product registrations in China, including the 3 that we previously announced. And we remain on track for between 15 and 20 new products available for distribution in the Chinese domestic market by the end of 2019.We began the introduction of new products to a very strong response at the Shanghai natural health expo in May. And we're building up distribution in domestic retail and e-commerce channels in China as we speak. This process is going to continue for the balance of 2019. We're proud to say that we've shipped our first batches of new registered Blue Hat products to China this quarter. And we're successfully building the partnerships and relationships to drive this business over the coming years.I'm also pleased to report that our specialty brands business continue to improve and sales increased by 1% during the second quarter, reflecting the successful deployment of our initiatives to improve sales execution, strengthen our customer and consumer relationships and expand distribution in the food and drug channels as well as continued growth in e-commerce.In the strategic partner segment, we had a very solid quarter where revenue was up 7% compared to the prior year. This is driven by the timing of new contract with existing customers. And of course partially offset by the continued transition away from another strategic partner who is established in-house manufacturing; I think we talked a lot about that in Q1.In summary, we're seeing continued positive commercial trends across all of our segments. We've returned the specialty brands business to growth and we expect further improvement in the third and the fourth quarters in that business. We're tracking towards the top end of our guidance for branded revenue, adjusted EBITDA and adjusted earnings per share expectations for 2019. And we remain confident with each of our growth initiatives.With that, let me turn the call over to our Chief Financial Officer, Chris Snowden. And he's going to discuss with you our second quarter financial results in greater detail. Over to you, Chris.

[Christopher Snowden, CFO & Corporate Secretary]

Thank you very much, Mr. Hornick. And good afternoon, everyone. As Mark mentioned, we're pleased with our performance this quarter and are building on our positive momentum for the full year. In the second quarter, revenue increased 8.6% to CAD 80.6 million driven by growth across all segments. By segment Jamieson brands revenue increased 9.2% to CAD 60.8 million consisting of 11.8% growth in domestic Jamieson revenue, 10.2% growth internationally and 0.6% growth in our specialty brands. Revenue in our strategic partner segment increased 6.9% to CAD 19.8 million. As Mark mentioned, this increase was primarily driven by new contracts with existing customers benefiting from the timing of shipment originally planned for the third quarter.Gross profit increased 11% to CAD 29.6 million and gross margin increased 80 basis points to 36.7%. The increase in gross margin percentage was due to margin improvement in both segments. On a segment basis, we generated 80 basis points improvement in gross margin within Jamieson brands driven by higher volumes leading to increased facility utilization and production efficiencies gained from capital expenditures designed to increase processing speeds and capacity for our production and packaging operations.In the strategic partner segment, gross margin grew by 20 basis points over year-over-year primarily due to customer mix. Selling, general and administrative expenses decreased 1.2% to CAD 16.9 million. The reduction was primarily related to lower business integration, international expansion and other nonrecurring costs of CAD 0.9 million compared to CAD 2.5 million in the prior year. Excluding these costs, normalized SG&A in Q2 2018 of CAD 14.7 million, increased by CAD 1.4 million to CAD 16.1 million in the current quarter, reflecting our investments in resources to support e-commerce and international growth.Operating increased -- operating income increased 30.8% to CAD 11.9 million and operating margin increased by 250 basis points to 14.8%. Adjusted EBITDA increased 15.8% to CAD 16.4 million and adjusted EBITDA margin increased 120 basis points to 20.3%. The improvement in adjusted EBITDA margin was driven by gross margin improvement, the timing of SG&A, including marketing activity, and higher volumes in both segments during the quarter.In the second quarter, interest expense and financing costs were CAD 2.5 million, compared to CAD 2.2 million in the prior year. The difference was primarily due to the prior year increase in benchmark interest rates and the impact of our adoption of IFRS 16 on January 1. This includes the recognition of interest on our lease liabilities.Our reported net income was CAD 8.2 million in the second quarter compared to CAD 4.8 million in the prior year. On an adjusted basis, our net income increased 14.4% year-over-year to CAD 7.9 million or CAD 0.20 per diluted EPS. All of the adjustments to net income are described in today's press release and included in the adjusted net income reconciliation table at the end of the release.Turning to the balance sheet and cash flow. We generated CAD 6.6 million of cash from operations during the quarter compared to CAD 8.5 million in the prior year. Cash invested in working capital of CAD 5.4 million was CAD 5.8 million higher than the prior quarter due to increased inventories and the timing of payments for income taxes. Inventories have increased to smooth seasonal production demand on our facilities and improved customer fill rates.Capital expenditures during the second quarter were CAD 2.3 million and we paid CAD 3.5 million in dividends. We ended the quarter with CAD 5.3 million in cash and equivalent, and total debt of CAD 173.8 million. The company had almost CAD 27 million in cash and amounts available through our revolving operating lines plus an additional CAD 60 million in term debt through an accordion feature included in our existing credit facility.Subsequent to the quarter end and in conjunction with our syndicate of lenders, we have initiated the process of amending and extending our existing credit facilities to improve borrowing rates and increase our available capacity for long-term flexibility. Our remaining deferred financing fees will be written off upon execution of the amended and restated agreement. We expect this process to be completed by the end of the third quarter or early in the fourth quarter.Now let me turn to guidance. We are reiterating our 2019 outlook, which we initially provided on February 27, 2019. Based on the performance year-to-date, we are trending towards the higher end of our net revenue and adjusted EBITDA and adjusted earnings per share ranges.Net revenue in a range of CAD 336 million to CAD 348 million, representing top line growth of 5% to 9%. Adjusted EBITDA in a range of CAD 73 million to CAD 76 million or 8% to 12% growth over fiscal 2018. And adjusted earnings per fully diluted share of CAD 0.90 to CAD 0.95 or 6% to 12% growth over fiscal 2018.Additionally, I would like to provide some assumptions to assist you in modeling. We anticipate Jamieson brand growth segment of 5% to 9%, including 3% to 5% growth in the Jamieson brand domestically, 25% to 35% growth internationally and specialty brands growth of 1% to 5%. Jamieson domestic revenue in the first half included a reduction in promotional activities versus the prior year. During the third quarter, we anticipate domestic Jamieson branded growth of approximately 5% to 10% as retailers prepare for increased promotional activity in the second half of the year.For international, we expect the rate of growth to improve throughout the second half of the year as for shipments of our newly registered Chinese Blue Hat products began in the third quarter and as we build additional distribution and register additional products per sale in China. We anticipate international revenues in the third quarter to grow between 15% and 25%.For Specialty Brands, we continue to expect improving rates of growth year-over-year as the second half of the year progresses. We're pleased with the results of our innovation and consumer -- customer, consumer and cultural initiatives, and anticipate 4% to 8% growth in the third quarter. We continue to anticipate Strategic Partner segment growth of 5% to 8%, given the new programs launched early in the year, and the timing of sales in the second quarter, for the remainder of the year Strategic Partners will be relatively consistent or slightly negative to the prior year period.We expect normalized SG&A increases of 11% to 15% to support our international market growth and e-commerce initiatives and increase in marketing to promote Specialty Brands as well as the normalization of variable compensation and Specialty Brand commission. Based on timing of our marketing activities and the amount of variable compensation realized in Q3 2018, we expect normalized SG&A growth of approximately 30% in the third quarter.We will see increased depreciation expense reflecting capital expenditure rates in 2018 and 2019 to support our growth and efficiency objectives, including the capitalization of operating leases with the implementation of IFRS 16. We are assuming interest rates ranging between 4.5% to 5.5%, which would include -- or which would lead to an interest expense of CAD 9 million to CAD 9.5 million based on our borrowing plus deferred financing fees. Additionally, our guidance reflects the assumption of CAD 1.33 per U.S. dollar exchange rate and a normalized effective tax rate of approximately 28%.Our estimate for fully diluted shares is approximately CAD 40 million. A complete discussion of our outlook and factors impacting our expected performance in 2019 is included at the outlook section of our MD&A.And with that, I would like to turn the call back to the operator for Q&A.

[Operator]

[Operator Instructions]. We'll take our first question from Peter Sklar with BMO Capital Markets.

[Chang Ding, Associate]

This is Chang Ding filling in for Peter. I know earlier you gave an update about China, but can you talk a little bit more specifically about the Costco opening and kind of Jamieson's rollout in terms of that and also the impact it's had.

[Mark Hornick, President, CEO & Director]

So just respecting our customers' views on making announcements, all I could really say at the moment is that the Costco has plans to imminently open their store in Shanghai. We will play a very significant role in that opening. And that everything from our end of that is on track and ready to go. But I think in just out of respect for Costco itself, I can't -- I kind of decline to say more than that. That's more up to them to kind of announce whenever they want to do so about what's happening with the overall Costco in Shanghai. All I could say is we're in a great position and we're ready to go.

[Chang Ding, Associate]

Okay. Understand. And obviously, the growth rate that Chris cited earlier incorporate Costco in the international, right?

[Mark Hornick, President, CEO & Director]

That's right.

[Chang Ding, Associate]

Okay. Perfect. Can you talk about some of the more prominent products that you guys have introduced to market over the last few years? Up to you, whichever one you want to talk about, and kind of how they're doing in terms of, are they meeting your objectives, time lines, et cetera?

[Mark Hornick, President, CEO & Director]

Chang, are you speaking about China or are you back to Canada in general or…

[Chang Ding, Associate]

Back to Canada, just your overall portfolio.

[Mark Hornick, President, CEO & Director]

Okay. So just to remind you of kind of the overall innovation strategy. So in general terms, we look to capture new consumers and increase the usage of different segments in our vitamin world by launching new products. Typically, those products are either to meet new emerging consumer trends or to make our products either easier for consumers to incorporate into their repertoire, like easier to swallow, for example, or products that incorporate new and upcoming ingredients with exciting new science behind them that resonate really well with consumers in the market.Typically, the pipeline of products that we seek to put into the market every year is responsible for about half of the growth. So somewhere between 2% and 3% incremental growth in the portfolio comes from innovation. So some of the things that -- some of the things that you will -- would have seen in the market over the past couple of years, things like our Cold Fighter sub-brand of products that we introduced, our vitamin sprays, lot of focus on gummy vitamins, lot of chewables for example.Our TRU-ID certification where we are showing consumers for the first time that Jamieson is of such a high quality that we actually DNA verify the ingredients within our products. We are the only company in the world, for example, that can say that they do that on their entire line of herbal products would be an example as well.And just to round up the answer to your question, we are completely on track with the innovation that we've launched. In the first half of 2019, we did -- we put into the market 17 new products on the Jamieson Canada side and you will see almost 30 new products coming out on the Specialty Branded side in the second half of 2019, all of which so far are on track to deliver the expectations. And especially on the Jamieson side where we've already got our distribution built for our first half launches, we're seeing consumer off-take that is completely in line with our expectations and replicating the success of our innovation that we've seen in previous years. So very, very satisfied overall.

[Operator]

[Operator Instructions] We'll take our next question from Sabahat Khan from the RBC Capital Markets.

[Sabahat Khan, Analyst]

So just one on the specialty side. I think you indicated some volume growth during the quarter. And when you look to the second half of the year, I think you called out a mid- to high single-digit growth. Is that on a unit volume basis? Is that on a dollar basis? And then can you just talk a little bit more about what you're seeing in the back half of the year in that channel or the platform? Is it an increased traction for the products? Is it in the overall market? What are some of the factors contributing to that sequential improvement?

[Mark Hornick, President, CEO & Director]

Okay. Sabahat, so all of the growth that we talk about is always in dollars just to keep everything consistent. So, so far, we've really been happy with the turnaround on our specialty brand. It happened a little bit earlier than we had originally been looking at, which is a great sign.So you got a -- you have a combination of getting our brand back on track with customers in terms of promotional programs, increasing distribution, gaining new distribution in several different customers with various components of our portfolio. And then you have quite a large innovation pipeline then being rolled out in the back half as well to kind of continue to bring the momentum back to specialty brands and to continue to grow.So we're looking for that growth to steadily ramp up as our new products gain traction with consumers. And then our new -- and our new distribution that we've seeded in Q2 comes to fruition in Q3 and Q4 with consumer off-take of the product and then of course the replenishment of those products. We really have right now a very highly motivated and engaged sales force who is really humming under our new leadership with Mike. And that, coupled with some excellent marketing initiatives and of course new product portfolio, that's very exciting for the consumer. All of that is going to then continue the momentum that we've established in Q2. And we believe that we're in a really good spot with that segment of the business.

[Sabahat Khan, Analyst]

Okay. And then just on the broader Jamieson brand itself. I think it was mentioned that there was, I guess, less promotional activity in the first half of the year. Just kind of thought process behind that. Was it because there was going to be that refill in the channel? What's causing you to do maybe a little bit more promotion in the back half of the year? Just the thought process around how you -- kind of the sales pull over the course of the year.

[Mark Hornick, President, CEO & Director]

So most of the difference between the first half and the second half promotion is really us meeting our customers' strategies and matching up our promotional needs with the rest of their operational priorities within the store. So that was all planned kind of customer by customer, and the materiality of it is that a couple of customers preferred to do much more vitamin focus in the back half of the year than the front half, and they're trying some new things in terms of promotion cadence. And so we're really looking forward to the results of that.But independent of that, we are still completely on track with the shelf off-take that we're anticipating with the Jamieson brand. So you may see them in Q3 of course a little bit more accelerated growth, as Chris talked about in his guidance messaging, as retailers stock up for those promotions.So we had a little bit of change in promotional cadence but met our shipment and sales objectives anyway. So that kind of gives us a little -- kind of gives us confidence in terms of targeting towards the upper end of the range for the year.

[Sabahat Khan, Analyst]

Okay. And then just one last one, a housekeeping one. The timing amount that you called on the strategic partners' side. What is the -- just the magnitude of that shift that you had in Q2 versus Q3? And should we kind of expect Q3 to be kind of lower by that amount just in terms of the back of the Q3 and Q4 cadence?

[Christopher Snowden, CFO & Corporate Secretary]

So just to be clear, we've experienced about $8 million in growth in our strategic partner business year-to-date. When you look at our guidance for strategic partners, that would indicate between $4 million and $6 million worth of growth. We expect to be close to flat in Q3 and the majority of that difference to be reconciled in Q4.

[Operator]

We'll take our next question from George Doumet from Scotiabank.

[George Doumet, Analyst]

On the 12% year-over-year growth, Jamie domestic, that's a big number. Can you maybe break it down in terms of bucket or maybe innovation any pricing that was taken at all or the size of that new distribution channel that you guys called out?

[Mark Hornick, President, CEO & Director]

So the vast majority of it is just the truing up of the inventory versus a year ago that was prestock for the 2018 price increase. So it's kind of just normalizing those shipments versus year ago. There's no additional pricing in the quarter at all. We did have -- we had innovation shipping but at very similar levels to that of -- that you would have seen in the previous year. And the incremental distribution, we do have some exciting new pockets of distribution for the Jamieson brand here in Canada, but it wasn't material in terms of the pipeline that you would have seen. So kind of, I don't know, 1% to 2% of the -- less than 1% as well.

[Christopher Snowden, CFO & Corporate Secretary]

So it helps reconcile it. If you look at the 12% growth in the quarter and you look at our year-to-date growth rate of 4%, that would indicate about 8% of that is timing Q1 to Q2. When you look at that 4%, that is consistent with our expectation for off-take, and I would say less than 1% of that is related to new distribution.

[George Doumet, Analyst]

Great. That's helpful, guys. And just following up on the specialty brand channel, there's a nice recovery in sales growth there. I'm just wondering if -- have we seen a corresponding recovery margins in that segment? Or is that kind of expected to lag?

[Mark Hornick, President, CEO & Director]

I think margins in that group are consistent with our expectations for the year and have been priced into our brand growth -- our brand margin growth expectations for the full year, where previously, we've talked about continuing to drive margins, that 400 to 500 basis points over the long term.

[George Doumet, Analyst]

Okay. And just one last one if I may on leverage. Looks like we're going to be below 2x by year-end. We've refinanced our facilities. Can you maybe talk a little about the M&A landscape? Have multiples kind of started to come down a little bit? And maybe how does our wishlist look like right now?

[Mark Hornick, President, CEO & Director]

So as we progress with the execution of our internal organic growth initiatives, we will then prepare to look for exciting opportunities from an M&A perspective. There's nothing imminent, but we're continuing to monitor the market. So I think that the best answer to that question is just holding pattern until we see something that makes a lot of sense.

[George Doumet, Analyst]

And have you guys at all noticed multiples coming down at all? Or is it kind of same as they were a couple of years ago?

[Christopher Snowden, CFO & Corporate Secretary]

I think they've come down a little bit in the last year as you've seen markets contract and the expectation for public market multiples to come down a little bit as well. But I still think they're higher than what we're willing to pay on average. So we will be very disciplined. And as I've mentioned before, we're targeting 20% IRR on any M&A opportunity. So we've got very high standards from a synergy and accretion perspective.

[Mark Hornick, President, CEO & Director]

And then of course -- and as you could tell, we have quite a very deep pipeline of organic growth opportunity that's keeping us busy.

[Operator]

[Operator Instructions] We're taking our next question from Mr. Endri Leno from the National Bank.

[Endri Leno, Associate]

A few for me, but I'll start -- just wanted to clarify something because I believe on the previous conference call, they talked about shipping to local retailers, if I'm correct, in China as well as Costco opening in the area. So is that still the case? Or I mean, we're looking at both of these channels, right?

[Mark Hornick, President, CEO & Director]

Yes. Yes, both channels, Endri. So Costco is scheduled to open in a couple of weeks. And from the other channels, we will build distribution with local drug and food stores in China between now and the end of the year. We're currently working with distributors, sub-distributors through our partners in China on the ground, making sales presentations, arranging pricing, figuring out assortment, aligning on promotional calendars, et cetera, similar to what we would do here in Canada. And then by the end of the year, the Jamieson brand will be basically available in all regular commercial channels in China, right? Prior to this whole Blue Hat registration, we could only ship into cross-border e-commerce. Now we'll be available in domestic e-commerce as well as in domestic bricks-and-mortar stores, including Costco.

[Endri Leno, Associate]

Okay. Great. And just one more follow-up on that. So Costco generally, at least from their remarks, is that they tend to open 10 stores. So they tend to need 10 stores at any given country to break even or achieve profitability. Like, how does that square with your expectations of growth in terms of capacity? And like, any thoughts around that.

[Mark Hornick, President, CEO & Director]

So I can't comment on Costco's strategy or profitability model. That would be for them to discuss with you. But from our perspective, Costco is proceeding in what seems to be fairly normal for them in terms of starting with one warehouse, then proceeding with another, another, et cetera. Right now they're going to start in Shanghai, which is a population base of more than 30 million people. So you've got their first foray into a market almost the size of Canada, in a market which is very pro vitamin, very high vitamin penetration, very high vitamin usage. And there is no doubt that in our mind that that's going to attract a lot of local attention in support from the Chinese consumer. And then they're all based on the success that they have there, they will continue to roll out as they see fit. I can't really comment on that.But from our perspective, we are going to have a significant role in that rollout and based on how well the Jamieson brand is doing in China in cross-border e-commerce. And the fact that the Jamieson brand has a long-standing heritage in China, we believe that we will be very well-positioned for success during the Costco opening, and that should only pave the way for future growth with that retail partner as they choose to expand.

[Endri Leno, Associate]

Okay. Great. Thank you for that. And a couple more quick question for me on the international side. I mean first on if you have a progress and timing on that U.S. online launch, the first. And the second, is there any potential for a third shipment into India this year? Or is that more of a 2020 opportunity?

[Mark Hornick, President, CEO & Director]

Okay. So from the U.S. perspective, everything that we are doing is on track. We will end up shipping our product into the U.S. for that test at the end of the year. We're currently just finalizing our formulations. We have an opportunity to take an existing chassis or existing cadre, I guess, of really strong unique selling proposition products under the Jamieson brand, adapt them somewhat for the U.S. market to make sure that they are as competitive as possible and then get those products into the market through an e-commerce launch before the end of Q4 this year. That is totally on track. And then we will see how that materializes in terms of sales, but so far everything is a go, and we're feeling optimistic. On India, we -- our partner MedPlus is very satisfied so far with the traction of the Jamieson brand. They are currently rolling out distribution and training their pharmacists on our product, and it is highly likely that we would end up with still further product going into India, just piggybacking on the success that we've had so far. But as we said, India is a long-term investment for us but very important given the size of the population and the future expansion of that market. And so we're in good shape, and things continue to progress exactly as we expected. So green light so far.

[Operator]

Thank you. At this time, I'll turn the conference back to Mr. Hornick for closing remarks.

[Mark Hornick, President, CEO & Director]

All right. Thanks again, Nadia. And thanks, everybody, for joining us. It's a really exciting time for all of us to be part of the company. We're really pleased with our results and the momentum that Jamieson Wellness has in the global market. Thanks again for joining us, and we look forward to speaking with you on our next earnings call. Have a great night.

[Operator]

This concludes today's call. Thank you for your participation. You may now disconnect.