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Mohawk Group Holdings, Inc. (MWK) CEO Yaniv Sarig on Q2 2019 Results - Earnings Call Transcript

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About: Mohawk Group Holdings, Inc. (MWK)
by: SA Transcripts
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Earning Call Audio

Mohawk Group Holdings, Inc. (NASDAQ:MWK) Q2 2019 Results Earnings Conference Call August 1, 2019 5:00 PM ET

Company Participants

Brendon Frey - ICR

Yaniv Sarig - Co-Founder & CEO

Fabrice Hamaide - CFO

Conference Call Participants

Dave King - ROTH Capital Partners

Brian Kinstlinger - Alliance Global

Operator

Good afternoon, ladies and gentleman, and welcome to the Mohawk Group Holdings, Inc. Second Quarter Earnings Report. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator instructions].

I would now like to turn the conference over to your host Mr. Brendon Frey. You may begin your conference, sir.

Brendon Frey

Thank you. Thank you for joining us today to discuss Mohawk’s second quarter 2019 earnings results. On today's call are Yaniv Sarig, Co-Founder and CEO; and Fabrice Hamaide, Chief Financial Officer. A copy of today's press release is available on the Investor Relations section of Mohawk's website at mohawkgp.com.

I would like to remind you that certain statements we will make in this presentation are forward-looking statements and these forward looking statements reflect Mohawk’s judgment and analysis only as of today and actual results may differ materially from current expectations based on a number of factors affecting Mohawk’s business. Accordingly, you should not place undue reliance on these forward looking statements. For a more thorough discussion of the risk and uncertainties associated with the forward-looking statements to be made in this conference call and webcast, we refer you to the disclaim regarding forward-looking statements that is included in our second quarter 2019 earnings release, as well as our filings with the SEC.

We do not undertake any obligation to update or alter any forward-looking statements whether as a result of new information, future events or otherwise. In addition, the company may refer to certain pro forma non-GAAP metrics on this call. Explanation of these metrics and reconciliations to the most directly comparable GAAP measures can be found in the earnings release filed early today.

With that, I will turn the call over to Yaniv.

Yaniv Sarig

Thanks, Brendon, and thanks everyone for joining us for our first earning call as a public company. When we co-founded Mohawk in 2014, our mission was to build a CPG company of the future. We set out to achieve this ambitious goal by building a team that combines the type of culture, mindset and technological prowess of a certain value startup with a world class supply chain and distribution capabilities of the leading consumer product brands.

We believe that proprietary technology driving efficiency through the entire supply chain is the next differentiator in the consumer product competitive landscape. In essence, Mohawk is a hybrid of technology and a CPG company. I often got people [indiscernible] would be Mohawk. Fast forward five years of inception will to-date I’m proud of our execution and our vision is proving true. Mohawk has achieved phenomenal growth by disrupting an industry that’s been slow to adapt by change in the consumer purchasing behavior. With companies like Amazon and Alibaba and others around the world disrupting the brick and mortar retail model through technology, the opportunity emerged for us to build a CPG company of the future.

The market model pioneered by Amazon has completely changed the consumer journey that traditional brands have relied on in brick and motor retail. More than anything the transparency and access to data that consumers have today has empowered them to make better choices.

In the past, consumers didn’t have Amazon or Google to have them do their due diligence on the product they were buying. Instead they relied on brand awareness, advertising medium term program of the purchasing decisions. The brand power was in convincing the customers that it was offering the right value at the right price. This all paradigm was favoring the brand interest over the consumers by limiting their access to choice and limiting the transparency around the real value of the product they provide.

When we had consumers [Technical Difficulty] behavior data, it is very clear that the base consumers are no longer constrained by the search limitations. The data shows that a significant maturity of consumer searches on Amazon do not include a brand name. Instead the consumer leverage the technology offered by the new retail platforms to search for the best solution for their problem. With transparency and access to data they now rely on technology compared to prices, features, reviews and recommendation to select a product that provides the best value preposition.

The trust created by the brand’s logo through advertising no longer stands up the social proof that regard to the consumer, what is best product for their needs? Consumer can now makes better choices with the mode of choice, thanks to heightened level of transparency provided by the online shelves. For consumer product brands this new reality requires that are basic.

Adopting a direct-to-consumer model is no longer an option and developing technology solution that makes better and faster data driven decisions combined with delivering high quality product that address the consumer needs is the only way CPG companies of future will be able to compete. We believe that Mohawk is positioned to be the best of these companies. The reason for this belief is the fact that Mohawk has been able to capitalize on this consumer behaviorship, thanks to our incredible people, culture and proprietary technology called AIMEE, which AIMEE stands AI Mohawk E-Commerce Engine.

Developed by a talented group of experience top engineers over the last five years, AIMEE has just massive amount of data and automates various platforms for e-commerce, namely rapidly identifying required market opportunities, managing fulfillment and executing sales and marketing strategy.

With a tradition of 18 to 24 months go-to-market cycle for a common CPG company, Mohawk executes an approximately a third of that through its real time data-driven opportunity and trend tracking capability combined with our agile sourcing quality and logistics organizations.

Each of the products we launch under our portfolio of owned and operated brand, typically goes through four stages, procurement, launch, sustain [Technical Difficulty] what’s called the mode phase for those not succeeding move to liquidate. Efficient procurement of our product, sourcing manufacturers, qualifying them and developing high quality products continues to be a priority for us. We're working hard to enhance this function to enable the company to capitalize on the high throughput of quality ideas generated for many. We use that research engine for surface product opportunities that rely on large amounts of data, these opportunities maybe routed in a market inefficiency, a new transforming consumer needs, our degradation and customers satisfaction, where other parts we extract from the data.

The opportunities led by our research team move forward to sourcing, production and shipping from the manufacturing [indiscernible] to the target market. We aim to achieve this profit in six to eight month before the product is ready to launch. During our launch phase we leveraged our technology to aggressively manage pricing, media buying for our products. Our strategy is to generate strong consumer demand out of the and quickly establish premium, organic and paid search placement. It’s important to note that this strategy can only be successful if we actually build the right product that delight our customers.

Our goal is for every product we launch a transition to the sustained phase and become profitable in three months post launch. After several years of refining AIMEE based on our early learnings I’m proud to say that approximately 80% of our product launches over the last 12 months have reached a sustained phase.

What makes our business model so compelling compared to traditional CPG companies is that AIMEE’s automation that allows us to manage the growing number of products without having to meaningfully increase costs, specifically headcount, resulting in a significant expense leverage over time. Today we have more opportunity to offer approximately 250 SKUs of four brands, hOme, Vremi, Xtava and RIF6 and we focus on four primary categories, home appliances, kitchen wear, beauty and consumer electronics.

Looking ahead, we have multiple opportunities to drive long-term growth into improved profitability. Those include increasing our new product launch capacity, further optimizing unit economics of our existing product portfolio, expanding to new domestic and international marketplace, pursuing SaaS partnership and opportunistically adding new products and categories through acquisition.

Several of these initiatives are underway while others are [Technical Difficulty] in the coming months and years. As you heard me outline there is tremendous opportunity for growth across our business.

Our model generated strong quarter results in our core business which we will brief you in a moment. Before I turn the call over to Fabrice, I may leave you with a few key points that further bolster my confidence in the company’s future prospects. Our total addressable market is massive and growing. Worldwide e-commerce sales hit $2.8 trillion in 2018 and are expected to reach $4.5 trillion by 2021. I believe that with our proprietary technology, supplier relationship and advanced fulfilment capabilities Mohawk is ideally positioned to capitalize on the continued ship and direct-to-consumer.

And finally, we’ve assembled a great team with deep experience in e-commerce CPG and technology to execute on this growth strategy. I truly believe we’re developing something special.

And with that, I’ll hand it over to Fabrice.

Fabrice Hamaide

Thanks, Yaniv, and good afternoon everyone. I’ll begin by reviewing the details of our second quarter results. For the second quarter of 2019 net revenue increased a 108.2% to $30.4 million from $14.6 million in the year ago period. This year-over-year increase was driven by 123% growth in our direct channel from higher sales of historical products as well as products launched in recent quarters and to an earlier than expected impact in the seasonal distribution of sales of our environmental appliances product category.

We launched seven new products in the second quarter which follows four new products launched in Q1 and five in Q4 last year. Our strong direct performance was partially offset by a decline in non-core wholesale sales related to occasional product liquidation.

Gross margin for the second quarter improved 130 basis points to 38.7% from 37.4% compared with the first quarter of 2019. The quarter-over-quarter improvement is mainly attributable to the growth in direct sales which is clearly higher margins than wholesale combined with product mix and lower launch costs of new products.

Turning to expenses, our the sales and distribution expenses as a percentage of net revenue decreased to 38.9% from 56% in the prior year period and from 52% in the first quarter of 2019. The improvement was attributable to a higher percentage of sales fulfilled to our own third-party logistics partners versus through e-commerce platform service providers as well as our ability to significantly leverage our fixed cost structure on a higher sales due to our AIMEE automation which as Yaniv highlighted earlier is of course strength of our business model.

With respect to the other expenses, research and development expenses increased $1 million to $1.9 million due in part to an increase in the number of developers to support growth, while general and administrative expenses increased $1.3 million to $4.4 million to a $1.5 million increase in stock-based compensation expense. In total, stock-based compensation expense was $2.6 million in Q2 of this year compared with $0.2 million last year with the increase being the result of restricted stock and options granted during December 2018 as well as in the first half of 2019.

Net loss for the second quarter of 2019 was negative $7.6 million compared to negative $8.9 million in the second quarter of 2018 and $8.4 million in first quarter of 2019.

Adjusted EBITDA for the second quarter of 2019 improved sequentially to $3.7 million losses from $5.6 million in the first quarter of 2019 and $7.5 million in Q4 2018. This is the result of growing sales, lower variable costs resulting in improved unit economics and flat fixed costs in line with our model.

Turning to the balance sheet, as of June 30, 2019 we have cash on hand of $39.5 million compared with $13 million as of March 31st. We reduced our cash use from working capital in the first quarter of 2019 of $5.4 million to cash provided from working capital to slightly above in the second quarter of 2019, while increasing revenue by approximately 70% to $30.4 million in the second quarter from $17.9 million in the first quarter.

Our improved cash provided by working capital is a direct result of improved inventory turns. Further, we reduced borrowings on our asset-based lending facility by $1.6 million during the second quarter of 2019. Overall, the cash burn for the quarter was $4.3 million compared to $7.1 million in the first quarter of 2019 and cash used in operating activities was $4.4 million in the second quarter of 2019 compared to $11.9 million in the first quarter of 2019.

As you know, in June, we completed our IPO raising approximately $29.6 billion in net proceeds from the sale of 3.6 million shares of common stock. We plan to use the proceeds for general corporate purposes and to support future growth and development of the business.

Our total debt at June 30, 2019 was $35.4 million consisting of borrowings our revolving credit facility of $20.4 million and $15 million from our term loan. This compares to a total debt of $37 million at the end of the first quarter 2019.

A few things to note before I turn the call back to Yaniv for his closing comments.

First, based on our current product offering, we expect our largest quarter in terms of sales to be Q3 followed by Q4. In terms of upcoming product launches, we expect to launch approximately 20 new products in the second half of 2019, which would bring our full year total to approximately 30 new products, while continuing to optimize our product sourcing and QA/QC competencies.

Second, with respect to M&A which we see as complementary that will not core to our growth strategy. As we disclosed in our S1 filing, we entered into non-binding term sheets earlier this year to acquire a home décor business and a personal wellness business. Upon completing our due diligence, we decided not to move forward with either transaction after determining that the longevity of their SKUs did not meet our internal thresholds and as well as identifying product safety concerns.

We have however resigned another Letter of Intent to acquire small personal wellness company. This acquisition is subject as usual to due diligence and is not contemplated in any forecast. We remain really excited about the numerous M&A opportunities we see ahead. And with our technology platform, we are uniquely positioned to evaluate potential acquisitions, which we are doing on a weekly basis as well as integrate acquisitions if we decide to complete a transaction. When it comes to executing our M&A strategy, we intend to negotiate deals with patience and will not compromise on value.

Finally, as Yaniv outlined, pursuing SaaS partnerships is part of our long-term growth strategy. That said our near-term focus is on driving growth of our core business given the significant opportunities we believe exist today. So we estimate SaaS revenue to be approximately $1.5 million in 2019.

With that I’ll turn it back to Yaniv.

Yaniv Sarig

Thanks, Fabrice. Before we open up the call to questions, I want to reiterate how excited I’m about the growth opportunities that we believe exist for Mohawk. It has taken a lot of hard work to get to this point and I want to thank our dedicated employees and partners around the world. Together, we move forward, committed to achieving the long-term vision we have established for the business.

Operator, we’re now ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Your first question comes from the line of Dave King from ROTH Capital Partners. Your line is open.

Dave King

Thanks. Congrats guys on the strong revenue growth. I guess first on the contribution margins which were also pretty strong. Can you see the stock-based comp accelerating from current levels at all and if not does that suggest more of an opportunity to lay in the marketing or take down the pricing a bit to drive more volume? Just curious on your thoughts there.

Frabic Hamaide

I’m sorry Dave, this is Frabice I’m not sure I understand the relationship between the marketing spend and the stock-based comp. Is that what you said...?

Dave King

So, I guess -- yes, so what I’m asking about is it looks like your contribution margins were better and it looks like there the recent contribution margins are better. It looks like the stock-based comp was lower I think than what we have been forecasting. And so with that being the case, what I’m wondering is do you expect to sustain these levels of contribution margins. And is that because of less stock-based comp going forward or with the contribution margins being where they are, can you take marketing, can you take down pricing, just trying to get a sense of how you’re planning to use that as a benefit going forward?

Fabrice Hamaide

Okay. So, on the stock-based comp the reason it may have been a little lower is because it’s mostly the timing of cost recognition as some of the turns were actually accounted for starting from the IPO date. So, it’s actually going to increase -- the non-cash comp is actually going to increase in future quarters, I don’t have the exact number in front of me, but we can actually -- I can provide you with that detail later on tonight if need be. Our contribution margins are strong yes indeed, the direct result of the fulfilment platform that we engineered completely last year which is starting to really -- we’re really starting to get the full benefit of it this year. It’s going to be even stronger in Q3 for seasonal reasons, going to the product mix, so I mean products are actually delivered through our third-parties platform versus Amazon.

Dave King

Okay, that’s great to hear. And then switching gears, the cash burn was also better than expected. How do you see that cash from working capital trending over the remainder of the year? Do you see those turns continuing to provide support on that line item?

Fabrice Hamaide

So, I think the cash position is a direct relation of, of course, EBITDA and working capital. And as we said from cash flow, working capital was quite essentially no burn for the quarter. This is a direct reflection of our better inventory turns. We were low in inventory for long time in particular because of tariff situation. And the fact that we’re moving all of our inventory to new warehousing locations late to that new fulfilment platform which definition means that you have extra inventory during that period of time. We are aiming to actually get to 3x on the turn side and combined with turns and with the vendors as well as with the ABL financing, we aim to actually continue being able to actually growth at a limited pace without burning additional cash or any significant cash on the working capital side.

Dave King

Great. And then I guess last one from me. Do you have what the SaaS revenue was in the period and I just -- more higher level, how are things going in terms of signing up new relationships there? Are CPG companies receptive on any fronts, just add anything to share would be great?

Yaniv Sarig

I will take that. So given that we’re in pretty early stage in our SaaS, we don’t want to comment at this point on the number of clients, win, losses. We think that’s immaterial. That said, we believe the SaaS represents a very compelling market opportunity and we continue to export those relationships. Unlike the direct business we are now in full control of the pace of development as it takes time -- more time to embrace D2C. Remember that one of the reasons we can disrupt all these companies a lot because there is still B2B companies and for them to really be able to ready to use a lot of our technology on the SaaS side they need to transform this operationally and a lot of them are not ready. So it just takes more time but we are still extremely excited about the opportunity and we expect to continue to pursue that growth there as well.

Operator

Your next question comes from the line of Brian Kinstlinger from Alliance Global. Your line is now open.

Brian Kinstlinger

Solid first quarter as a public company. Can you -- maybe I missed, can you quantify how many total SKUs you have at the end of the quarter and then maybe talk about the success rate of reaching a sustained phase of products that you introduced this year, I think 11 of them versus what those rates were looking like last year?

Yaniv Sarig

Yes, we have about 250 SKUs right now. And then in terms of success rate so far we are still trending at around 80%. As you know we just launched a few SKUs and so those are still kind of in launch mode. But overall we see the trend improving. I think we will have better numbers in the next quarter to give you an update on that. But overall we are seeing a trend in the right direction with our capacity to move from launch to sustain at a very efficient rate.

Brian Kinstlinger

And then clearly in the past -- very recent past, the revenue growth has been result of coolers, dehumidifiers, icemakers, are those still the growth drivers as you saw in the second quarter and maybe you can give some details around SKUs that have been introduced, recently that are beginning to drive growth or drive growth in the next quarter or two?

Yaniv Sarig

We don't disclose specific information but obviously for competitive reasons right. But we're excited in general about the new prospect that we have in the pipeline across many different categories, as you know the seasonality in our business and that’s obviously going to continue to happen. But overall what we're seeing in the pipeline has become [Technical Difficulty] as well trending in the right direction and very exciting. We can’t obviously exactly talk about what are the next products we’re going to launch.

Brian Kinstlinger

For the 20 SKUs that you gave us a little bit of guidance for the second half of the year. With the increased capital from the IPO, I think one of the key stories is your ability to get from say two to four SKUs per month to where I think you communicated much higher. So can you talk about as you exit this year, what you think that your capacity looks like as you head into next year?

Fabrice Hamaide

So, we’re continuing to -- the big element to actually drive new products for us is not the number of opportunities because the platform allows us to actually identify a very large number of opportunities every month. It’s to actually increase our capacity on the sourcing QA and QC side, so, provides significant floors on that front. We have recruited a new GM in China for example who comes from the sourcing world and are increasing capacity on that front. Of course it’s -- that part is people driven though very inexpensive, so it takes a little bit more time to scale than just software basis. But as we said I mean we’re trying to actually -- we’re really launching approximately 20 products in the next -- in this second half, probably tilted towards Q4 than Q3. And we’re still trying to actually essentially increase our capacity to on limited levels, I mean a very long time what we’re trying to get to is 20, 30 new products a month.

The opportunities in the market support us to be able to actually have that capacity. So, actually what we’re trying to get and we’re trying to scale there as fast as we can, right. Exactly at what pace, it depends on how quickly we can recruit product sources, test engineers, add-on, that extra capacity but we’re making significant progress there, obviously, right. And we’re going from 11 new products in the first half to 20 new products in the second half. So, that already is a doubling of the capacity there.

Brian Kinstlinger

Great. Last question I have obviously President Trump today twitted about 10% tariffs and I know you’ve repaired your long inventory last quarter. Were you communicating your still long inventory with the outlook in the second half of the year being much stronger? Or do you have a little bit more to go on the inventory side?

Fabrice Hamaide

So, we have a little bit more to go, but what is interesting is on the tariff situation, I mean they’re going -- the products that are not subject to tariff today in our product line up or essentially our environmental appliances including dehumidifiers and window ACs and the tariffs themselves would actually come in play, with that tweet they do come into it after the seasonality year is over essentially or towards the end of the seasonality. So, the impact for us from a working capital and inventory position is quite a nil.

Operator

[Operator Instructions]. Your next question comes from the line of [Elia Gorzawski] from National Securities. Your line is open.

Unidentified Analyst

Thanks. I wanted to kind of -- first of all, I don’t think I have an answer from either of you guys on a previous question about the SaaS revenues in the quarter, the actual dollar amount?

Fabrice Hamaide

$0.4 million, sorry we didn’t -- you’re right.

Unidentified Analyst

$0.4 million, okay. Next. So looking at the revenues in the quarter when without going into the specifics of which products they are, what can you tell us about the concentration of those 250 SKUs in terms of kind of additional color? Is there -- is 20% of the SKUs contributing 80% of the revenues or kind of just want to understand what if any kind of product concentration there is?

Fabrice Hamaide

Sure, as you know we have 250 products, we have a product that were launched already in 2015, at the time where our working capital means were not what they are today and therefore we’re going after smaller product opportunities and smaller SKU values right. So we carry a lot of products that have small revenue contribution. Overall what I can tell you without giving too much specifics is, our top 40 products represent close to 88% of our revenue in the quarter -- in H1 I am sorry. It changes of course quarter-by-quarter because of the seasonality of some products. You would have more long tail products in Q4 and more environmental products which have higher SKU price, and therefore, revenue contribution in end of Q2 and Q3 right. If we keep on launching new products, all the new products get diluted even more, further, little by little, more and more.

Unidentified Analyst

And then also looking at expenses, are the Q2 expenses sort of the baseline what we should model going forward in terms of your quarterly expenses, you spent something like I don’t know $18 million or so on operating expenses?

Fabrice Hamaide

So remember that the significant portion of our operating expenses are variable in particular, in the sales and distribution components. When you look at the total spend in the quarter on the sales and distribution, they represent -- let me get back to the exact number here, we’re at 38.9% of gross sales, right. In that you have both the fulfillment costs which is a variable cost and -- linked to sales and the selling fees related to the marketplace which are also variable components. Our actual fixed cost in that is 4.3% of gross sales, the rest is viable. So the expense levels will actually fluctuate based on the revenue directly and that percentage of the variable cost can fluctuate as well quarter-over-quarter depending on the product mix and how much of our revenue goes into our own fulfillment flow through our third-party fulfillment providers and what percentage of our product sales go through FBA for example.

Unidentified Analyst

Okay. But from a percentage perspective is this the right baseline?

Fabrice Hamaide

Again the percentage itself can actually change. So some products that you sell today like dehumidifiers are sold and distributed, fulfilled actually through the third-party fulfillment platforms, whereas an alarm clock which is sold heavily in Q4, for example, is actually fulfilled through FBA and doesn’t have the same percentage of fulfillment costs. You to remember that we manage the business on a net margin basis, right. So the ones that have a higher fulfillment costs will have a higher gross margin and ones that have a lower fulfillment cost can afford to actually have a lower gross margin.

Operator

I’m showing no further question at this time. I would now like to turn the conference back to Mr. Brendon Frey.

Brendon Frey

Thanks everyone for joining. Fabrice, Yaniv, we appreciate you joining today. And we’ll see you again on the next call. Thank you. Take care.

Operator

Ladies and gentlemen, this concludes the conference call. Thank you all for your participation. And have a wonderful day. You may all disconnect.