Betterware De Mexico, S.A.P.I. De C.V Q3 FY2021 Earnings Call

Thank you and welcome to Betterware's Third Quarter 2021 Earnings Conference Call. With me on the call today are Betterware's Executive Chairman, Luis Campos; Chief Executive Officer, Andres Campos; and Chief Financial Officer, Diana Jones. Before we get started, I would like to remind you that this call will include forward-looking statements, which are subject to various risks and uncertainties that could cause actual results to differ materially from expectations. Any such statement should be considered in conjunction with the cautionary statements and the Safe Harbor statement in the earnings release and risk factors discussed in the reports filed with the SEC. Betterware assumes no obligation to update any of these forward-looking statements or information. A reconciliation and other information regarding non-GAAP financial measures discussed on the call can be found in the earnings release issued yesterday as well as the Investors section on the company website. Now I would like to turn the call over to the company's Executive Chairman, Luis Campos.

Thank you, operator. Good morning everyone, and thank you for joining us today. I will begin my remarks by providing a summary of our third quarter performance and highlighting the key features of our differentiated business model. That has allowed us to have a 20-year history of constant and profitable growth and will allow us to continue to grow going forward. Then Andres will discuss the main drivers of our performance for the third quarter and our expectations for the rest of the year and beyond. Diana will then review our financial results for the quarter and year-to-date. During the third quarter, our net revenues increased 4% on top of the almost 200% growth we saw in Q3 2020, while EBITDA was down marginally compared to the same period of last year due to the increased operating expense structure that was needed to align the company's operating capabilities to the new much higher level of revenues this year. After last year's extraordinary growth that showed an almost 200% year-on-year revenue increase, our cost structure is now aligned to our current level of operations. As such, going forward, we expect to recover the additional operating leverage that we achieved during 2020 as revenues grow. For the first nine months of the year, we are pleased with our revenue growth of 69% and EBITDA growth of 75% compared to the first nine months of 2020. From 2001 to 2020, Betterware had a compounded annual growth rate of 23% in net revenue, 27% in EBITDA, and 24% in our associates and distributors network. This growth accelerated in the last five years from 2015 to 2020 to a compounded annual growth rate of 57% in net revenue, 64% in EBITDA, and 63% in our associates and distributors network. And in 2020, which was an exceptional year for the company, thanks to the features of our differentiated business model and our three strategic pillars, we were able to capture the growth opportunity and grew 135% in net revenue, 154% in EBITDA, and almost tripled the size of our distribution network from 438,000 by the end of 2019 to almost 1.3 million distributors and associates by the end of 2020. For fiscal 2021, we expect our growth in net revenue to be closer to the lower end of our previous guidance, which implies growth in net revenues of approximately 49% and growth in EBITDA of approximately 48% on top of the triple-digit growth seen in 2020. Our consistent ability to deliver strong growth rates reflects the advantages of our differentiated business model. We expect the strength of our business model combined with execution of our growth initiatives to fuel a double-digit compounded annual growth rate in net revenue from 2021 to 2025. This rate of growth positions us to achieve our target household penetration of 40% by 2025. The main features of our differentiated business model are: number one, our high cash flow generation. Historically, we have had low CapEx requirements. We expect our CapEx to return to a more normalized level of 2% to 2.5% of net revenues per year beginning in 2022 and going forward as we move past the investment in our new national distribution center that reduced our cash flows during 2019, 2020, and 2021. Going forward, our investments will mainly be focused on technology. We also have a negative cash conversion cycle which allows us to generate cash as we continue to grow. In the past, these two factors combined have allowed us to have a cash conversion rate of approximately 65% of EBITDA and given that we are nearing the end of our campus investments, we expect to return to this rate in 2022 and going forward. Number two, we are an asset-light business. We manufacture our products through third-party suppliers. We currently work with more than 100 certified factories in China and Mexico. This allows us to scale to meet sharp increases in demand as we did in 2020 and provides us with the flexibility to adapt to the demand environment as it decreases. We also deliver our products to our distributors through six third-party carriers. On average we have been working with these providers for more than 15 years. We have built strong and trusting relationships with our business partners who have scaled their operations to meet our growth. This gives us the flexibility to adapt to changes in demand. Our cost structure is very flexible. Year-to-date, 8% of our total costs are variable. This allows us to adjust and keep our profitability levels, achieving operating leverage in periods of growth and adjusting our expenses when necessary. Number three, the flexibility of our business model. We have the capacity to quickly react and adapt to changes in the environment. Our new monthly catalog allows us to react faster than before to changes in the economic environment in order to adjust our commercial strategies to any particular situation. After the extraordinary growth seen in 2020, the first nine months of 2021 have been a transitioning period where our main objective has been to consolidate our network of new distributors and associates gained during 2020 and adapt our operating capabilities to the new much higher level of revenues. Now, we have successfully consolidated our network of distributors and associates, practically maintaining the same number of active associates and distributors that we had by the end of 2020 with a much more solid base. And our operating expenses structure is in line to support our current operations and our growth for the next years to double our household penetration to 40% by 2025. During the third quarter, we faced three unexpected external headwinds. The first one, overall consumption in Mexico declined compared to the previous quarter, showing the first contraction since Q2 2020 and the first third quarter with quarter-on-quarter decline since 2014. Consumer confidence also decreased 3.7% during the quarter. Number two, people accelerated the return to pre-pandemic activities, redirecting their spending to products and services that they were not spending on during COVID, such as for the return to in-person activities in the back-to-school season and traveling during the summer. And last, supply chain disruption in China, mainly the increase in freight costs from China, which have lasted longer than we expected. And the rationing of energy which is causing partial and total shutdowns in some factories, impacting the timely receipt of product and increasing product costs. Our business has proven successful during several economic environments and we have a proven track record of navigating headwinds. This gives us confidence that based on our flexible business model, our three strategic pillars, and our ability to adapt and react to different situations, we are well positioned to achieve our long-term objectives to double our household penetration to 40% by 2025 while also increasing our share of wallet. This would also result in doubling our net revenues from 2020 in 2025. I will now turn the call to Andres, our Chief Executive Officer, who will discuss the main drivers of our operational performance in the third quarter and our growth expectations for the rest of the year and going forward.

Thank you, Luis, and good morning everyone. I will start by highlighting the main operational drivers in the third quarter. We are pleased with our third quarter results as even considering the external headwinds faced during the period and the tough comparison base to Q3 2020 when we grew almost 200%, our net revenues for Q3 2021 grew 4%. As mentioned in our last conference call, in 2021 we have been focused on consolidating our larger sales force after the extraordinary growth we achieved during 2020. We are pleased with our progress to date, as we practically maintained the same number of active associates and distributors that we had at the beginning of the year. While we have faced a higher churn during 2021 because some of the associates and distributors gained in 2020 returned to their pre-pandemic lifestyle, we've managed to retain most. More importantly, we've been able to continue to attract new associates at the same rate that we had in the pre-COVID era. During the quarter, 468,000 new associates and 16,000 new distributors joined our sales force. This demonstrates that we have the right strategies in place to continue to grow our sales force and thus penetrate more households. After this successful period of consolidation, we are confident that our distributors and associates network can return to growth in the final quarter of 2021 and years to come. As Luis mentioned, during the quarter we faced three external unexpected headwinds: number one, a decline in consumption in Mexico; number two, a shift in spending towards products that people were not spending on during COVID; and number three, the supply chain disruption in China. As a response to the first two headwinds, we are adjusting our commercial strategies to adapt to current conditions. These changes include, among others, a change in our product mix to make it more attractive for our current associates to continue selling and for new associates to join the network of distributors and associates. While early, these adjustments already began to show positive results and are expected to continue to lead to improvements during November and December 2021. This, combined with the increased frequency of catalog distribution, is expected to generate increasingly positive results in 2022 and going forward. We are closely monitoring the economic environment to further adjust our commercial strategies in case it becomes necessary. As it relates to the supply chain disruption in China, our operations have been impacted mainly by two factors: the increase in sea freight costs. We have been able to partially mitigate the impact in our freight costs due to the contracts we negotiated at the beginning of the year, but the increase in costs has lasted longer than previously expected. This translates into an impact of approximately 1.6% of net revenues for the third quarter and for the fourth quarter. We expect the impact to be approximately 1.8%. The second impact comes from the recent limits in the use of energy. These limits our suppliers' operations and reduce their capacity. This factor did not significantly impact our operations during Q3 2021, but it will for Q4 2021. The impacts for 2022 are still uncertain and depend on how long it takes for the situation to normalize. Recent events indicate that it should not take too long to normalize. Given that we expect these three headwinds to last at least for the rest of the year, we now expect our results for fiscal 2021 to be closer to the lower end of our previous guidance of MXN 10,800 million in net revenue and MXN 3,200 million in EBITDA, which implies net revenue growth of approximately 49% for the year and EBITDA growth of approximately 48% for the year, on top of the 135% growth in net revenue and 154% growth in EBITDA in 2020. For the medium and long term, we are accelerating our plans to manufacture a larger share of our products in Mexico. This shift serves to diversify risks of concentration in China, give us greater commercial and operational flexibility, and help us advance in our sustainability agenda by reducing our carbon footprint and creating more opportunities for indirect employment in Mexico. Now moving on to our long-term organic growth expectations. In terms of household penetration, as previously stated, our target is to reach 40% household penetration by 2025. We feel confident about achieving this goal due to several reasons. Our target market in Mexico has approximately 29 million households. We know that today, we have approximately 25% household penetration, which means that approximately seven million households buy our products today. This means there are still 22 million households we do not yet reach. According to diverse market research carried out by our business intelligence unit, we estimate that more than two-thirds of those 22 million households will be willing to buy Betterware products if they knew an associate who would sell to them. To reach all those potential households, we need more associates. Given the fact that we are the category builders of the home solutions market in Mexico with a unique and broad product offering with no direct competition, we strongly believe we can reach our two million associate goal by 2025. As years go by, people are more and more in need of a gig to generate an extra income, so we have a strong tailwind effect from this long-term trend as well. To do so, we are carrying out strong strategies within our three pillars. First, we are close to launching our new Betternet 3.0 app for associates and distributors. This new app will enhance usability, allow us to communicate more seamlessly with distributors and associates, and motivate them more by showing them constant income opportunities with gamification features. We expect this to help us increase associates and distributors' activity and sales levels as well as increase their life span with Betterware. On the other hand, we continue to improve our business intelligence tools, such as our penetration digital map, which distributors use to find white spaces to recruit more associates as well as our loyalty and incentive programs which are becoming more effective as time goes by. We are also expanding the benefits that people can obtain from selling Betterware, like well-priced phone packages through Betterware Connect and much more. This strengthens people's willingness to continue to sell Betterware. Also, our new e-commerce platform, which we launched last year, is consistently showing positive results. Even when total e-commerce sales are not relevant to total revenue yet, third quarter 2021 revenues were 44% higher than revenues in the second quarter of 2021. September revenues were 95% higher than revenues in August 2021. This will continue to grow at a fast pace allowing us to reach more households. Given all of this, we are confident we can continue to grow our sales force to reach all those potential households. Now I will explain what we're doing to increase share of wallet. We currently participate in more than 11 category niches. We believe we have a strong potential to expand our share of wallet within these category niches. Our first strategy to do so is: number one, increase our catalog frequency from nine per year to 12. This will increase the number of times the customer sees our catalog throughout the year and allow us to play seasonalities more assertively, thus increasing frequency of purchase per household. Second, we are doubling the number of new products within these catalogs. This will result in an increase of approximately 30% in the number of total exposed SKUs per year. Third, our new home renovation category is growing a lot and we see a great opportunity to expand it even more. These strategies should increase the purchase per household. That said, we still have more strategies to come going forward to expand on these category niches where we play, thus achieving an increase in our customers' share of wallet. Overall, we are pleased with the continued operational progress we made in the third quarter of 2021 as we continue to focus on driving household penetration and start to roll out strategies to increase share of wallet. As we enter the fourth quarter, we are adapting our strategies to the current operational environment and are confident in our positioning to continue growing during the quarters and years to come and to capture the important opportunities we have for the coming years. I will now turn the call over to Diana to review our third quarter financial results.

Thank you, Andres. Good morning, everyone. As Luis and Andres provided our third quarter financial results and guidance, my remarks will focus on our year-to-date performance. Please keep in mind that the currency I will refer to when reviewing our results is the Mexican peso, which is our functional and reporting currency. For the first nine months of the year, we continue to show strong results. Total net revenues increased 69% year-on-year. Gross margin expanded 288 basis points to 56.9%. EBITDA increased 75% and EBITDA margin expanded 115 basis points to 30.3%. Our net income increased 461% and our adjusted net income increased 49%. For the last 12 months, our ROI has been 212% and our return on investment capital has been 222%. Our balance sheet remains strong in the third quarter of 2021 even as we face headwinds, reflecting the strength of our business model. Several metrics make it evident, among others, our net debt-to-EBITDA ratio, which closed the quarter at minus 0.1 times. Our net working capital calculated as a sum of the trade accounts receivable plus inventories minus accounts variable was essentially zero at MXN 41 million. Our equity increased by MXN 1,153 million from MXN 335 million in Q3 2020 to MXN 1,488 million in Q3 2021 as a result of retained earnings and net of a dividend payment of MXN 1,390 million for the last 12 months. Additionally, we were able to successfully refinance our previous debt under favorable conditions with a long-term bond issuance in the Mexican market and invest in our campus, which will allow for future productivity and improved margins. The investment of approximately MXN 1,100 million associated with our campus is financed with these new long-term debt where the order book was oversubscribed by more than three times, which demonstrates the strong support from investors for our business model and their confidence in our ability to continue to grow going forward. The flexibility of our asset-light business model and our cost structure, which is highly variable, enables us to gain operating leverage as the business grows, and our strong cash flow generation gives us the ability to continue to return value to our shareholders with our ongoing dividend payment. I will now turn the call over to the operator and we will take any questions you may have.

Thank you. We will now be conducting a question-and-answer session. Thank you. Our first question is from Cristina Fernandez with Telsey Advisory Group. Please proceed with your question.

Hi, good morning. I wanted to ask about the outlook for the year, the revised outlook? And what it implies for the fourth quarter? On the revenue line, it seems like it still implies a reacceleration to double-digit growth in the fourth quarter. As you think about the macro situation in Mexico and some of the supply chain constraints, what gives you confidence that you can see that reacceleration in October? Perhaps maybe you can share with us what you're seeing so far in October?

Yes, Cristina. This is Luis. Last year, we significantly expanded our sales force, especially in Q3 and Q4, due to increased spending on home products amid high unemployment caused by COVID. We ended last year with nearly 1.3 million associates and distributors, up from 478,000 at the end of the first quarter of last year. This means we nearly tripled our sales force over two quarters, primarily in the third and fourth. This year has been different as we return to normal. The first quarter showed very strong triple-digit growth, but in the second and third quarters, many people returned to employment and started spending on different priorities like preschool and travel. As a result, our churn rate rose to 4.5%, significantly higher than the 2.8% we experienced pre-COVID. We focused on recruiting to strengthen our sales force, bringing in 468,000 new associates during the third quarter to replace those who left for permanent employment in Q2 and Q3. This represents a refreshed and solid base of associates. Although it was a challenge for our team, we've built a more stable network and can now begin to grow our sales force again. The churn rate has decreased to 3.1%, approaching our pre-COVID level. We are hopeful about the fourth quarter despite the challenges we mentioned in our results report, such as reduced consumption in Mexico and supply chain issues from China. We anticipate being at the lower end of our previous guidance for revenue and EBITDA by year-end, but we are well-positioned for growth next year. The first quarter will be a tough comparison to this year, but we expect stronger growth in Q2, Q3, and Q4. We'll provide our guidance at the beginning of next year, but we're confident in our growing trajectory.

That's helpful. And then a second question is around supply chain. What are your expectations as far as the costs? I mean, you broke down what they would be for the third and fourth quarter. Do you expect the freight costs to remain elevated through 2022? Also, regarding the shift in production to Mexico, how quickly can you shift some of that production? What are your expectations regarding that penetration in the next couple of years?

Sure. As we said in the report, we have an impact. We mentioned it in the report. We are having an impact from freight costs in Q3, and we expect an impact in Q4. In terms of supply, we have some impact in Q3, probably a little more in Q4. But we consider this a non-recurrent negative impact because we are not sure, of course, but we expect these headwinds that we are having in Q3 and Q4 to dilute in Q1 and Q2 of next year. Increasing our manufacturing in Mexico, we are working hard on that, and we will make progress next year. However, this is going to take some time. We do not expect disruptions in the supply chain next year. As you know, there is an expectation for stabilization in our case. We have some kind of priority with the factories we work with in China. This is why we are not facing major negative impacts in supply.

Okay. You broke up a little bit, so I missed some of the explanation, but I think I got most of it. The last question I had was perhaps for Andres. Could you talk about your commercial strategies and the adjustments you've made? Can you explain in more detail the changes you're making to the product mix to make it more attractive for associates and distributors to join? That would be helpful in understanding the changes going on.

Yes, Cristina. As we mentioned in the call, we have made some changes in the price ranges to make it easier for consumers to buy our products. This has been the main strategy to make it easier for them to purchase the products. I think this will help us navigate through that headwind and aid us for the fourth quarter results by the close of the year.

Thank you. I'll let someone else ask the questions.

Thank you.

Thank you. Our next question is from Eric Beder with SCC Research. Please proceed with your question.

Good morning.

Good morning.

Good morning.

Can we talk a little? I'd like to discuss the supply chain and some of the improvements you're making. I believe you have the recent upgrade in the HQ headquarters supply chain flow-through. How do you see the Mexico City launch? When is it going to occur, and what impact do you expect it will have?

Hi, Eric. How are you? We are launching the new tower of pick-and-pack lines during the fourth quarter. We have already started operations in this new pick-and-pack line, and we expect the Mexico City new distribution center to open by the end of the first semester of 2022.

How do you think that's going to impact the business?

Well, Eric, we don't anticipate it will be significant. The most important thing is that we are on schedule. As I mentioned before, we have managed to bring the churn rates back to pre-COVID levels, and this quarter, our associates are essentially the same as last quarter, indicating we are still on track for top-line growth. Although we expect to see lower operational expenses from the two strategies you mentioned, I believe it's crucial to emphasize that the key factor will be returning to growth in associates and revenue in the upcoming quarters.

Speaking of that, could we get an update on your international plans? I know it's small, but can you speak about Guatemala? Are you still focused on expanding outside of Mexico with larger countries?

Yes. We are making good progress in Guatemala, growing incredibly fast at double-digit rates and already achieving positive EBITDA. We are working to replicate our business model there to ignite more growth. We are exploring possibilities for further geographic expansion over the next two years. We are working more intensively than before on this goal.

Lastly, regarding your buybacks and the dividend. What should we be thinking about those pieces going forward?

Well, as you know, Eric, we have a very attractive dividend and we plan to continue our dividend policy in the years to come.

Okay. All right, guys. Good luck for the holidays.

Thank you.

Thank you. Our next question is from Alvaro Garcia with BTG. Please proceed with your question.

Hi, gentlemen. Thanks for the call. A couple of questions. The first one is on e-commerce. You mentioned this sequential acceleration, particularly in September. I was wondering if you can describe what you think is driving that acceleration and whether or not it's helping you retain associates or improve engagement. That's the first question.

Hi, Alvaro. Regarding the website and e-commerce, it's still not significant within our strategy to increase associates and distributors. However, it is important to mention that it has greatly grown recently as we reported. In the last two months, it has grown month-on-month: 44% in September and 95% in October. This is a very good sign that it will quickly become significant in the business.

Great. My second question goes back to the recent changes in the catalog and product mix. Could you share some examples of how that's working out in the fourth quarter to really drive that associate number higher? It’s clearly more catalogs. Have you seen any early results, I guess, that we can see as to how that's helping the ecosystem improve? Thank you.

Yes, Alvaro. We just started this, but we see good reports from this change. We expect to drive increased consumption per consumer. Specifically, we anticipate that consumers will see the catalog more often, resulting in increased spending with us. Simultaneously, we are increasing our innovation by doubling the number of new products showcased in each catalog. Starting with catalog one of next year, the number of new products will double compared to before. We expect that quarter-by-quarter we will see an increase in consumer spending from these strategies.

Great! Any early signs from the mobility category, which is new for you? How is it engaging your sales force?

We are focused on the 11 category niches that we have mentioned. One of the categories seeing continued strong growth is the home renovation category, which is accelerating rapidly. As people return to a more normal lifestyle and engage in activities outside the home, the mobility category is also starting to gain traction.

Great! Thank you very much.

Thank you, Alvaro.

Thank you. There are no further questions at this time. I'd like to turn the floor back over to management for any closing comments.

Thank you, operator. Thank you everyone for joining us today. We look forward to speaking with you when we report our fourth quarter results and meeting with many of you at upcoming investor conferences. Thank you. Have a good day and a good weekend. Bye.

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