Neptune Wellness Solutions Inc (NEPT) 2015 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Neptune Technologies and Bioressources fourth-quarter 2015 earnings call.

(Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to turn the call over to Mr. John Ripplinger. Sir, please go ahead.

Thank you, Operator, and good morning, everybody, and thanks for joining us today. As mentioned, the purpose of today's call is to review our results for the fourth quarter and fiscal year ended February 28, 2015.

Joining me today are Jim Hamilton, Neptune's President and CEO; Pierre Lemieux, Chief Operating Officer, Acasti; and Leendert Staal, who's providing consulting services in connection with our Sherbrooke plant and, as announced yesterday, is also a Neptune Board nominee. Jim will review Neptune's operational and financial highlights, Leendert will provide a detailed update on our plant situation, and Pierre Lemieux will discuss Acasti's operating highlights. We'll then open up the lines for questions.

Before we begin, I'd like to remind you that today's remarks contain forward-looking information that represent our expectations as of today and, accordingly, are subject to change. We do not undertake any obligation to update any forward-looking statement except as may be required by Canadian and US security laws.

A number of assumptions were made by us in preparing these forward-looking statements which are subject to risks. Results may differ materially. Details on these risks and assumptions are in our filings with the Canadian Securities Commissions and the SEC.

With that, I'll turn the call over to Jim.

John, thank you very much and good morning, everybody. It's good to be here. I just wanted to share with you some opening comments and then will pass the gavel over here to Leendert and Pierre shortly.

Let me begin by just saying that our number one priority has been manufacturing. Our plant is the foundation that will be building our business and our primary objective is to ensure that we can optimize the output in a cost-effective manner. And I'm very pleased to report that we're making significant progress and are currently able to deliver a premium product to our customers.

By way of background, Neptune has modified its manufacturing process to improve product handling characteristics, or viscosity. Currently, we're running at an operating annualized capacity of 75 metric tons and working hard to keep that momentum, and expect to reach an effective capacity of 100 metric tons very shortly.

So we've got the right team in place addressing this challenge and are doing so, I believe, in a very timely manner. And as mentioned earlier, Leendert will participate in the call today and share with us a few more insights in regards to our manufacturing.

In addition, I'm very encouraged by our sales funnel. This is enabled, of course, by the performance we're seeing in manufacturing. Accordingly, we expect a significant improvement in our second-quarter revenues and beyond.

Based on these improving fundamentals, we believe cash levels should be sufficient to fund operations over the next 12 months. But let me add, we've made very reasonable assumptions here. It will be a challenge, nonetheless; and we need, as a team, management and the Board, to execute on all levels.

Turning to some intellectual property news, some of you may have read recently that the Australian patent office completed their review of our Australian composition patent, coming in favor of Neptune and triggering royal payments to us by Enzymotec. In their examination, the patent office found all Neptune claims patentable and, as you may recall, Enzymotec's royalty obligations in Australia were dependent upon outcome of this review.

I should add that re-examine of this patent has no impact on Neptune's license agreements with both Rimfrost and Aker.

Moving to our Board, yesterday we also announced a solid state of Director nominees for our upcoming annual meeting, along with the establishment of independent boards for both Neptune and for Acasti. Over the past year, we've seen significant strengthening of our leadership team and new director nominees. And I'm really, really happy with the business experience and perspectives they will bring.

Let me begin by Leendert Staal, a little bit of background. I've personally worked with Leendert for a number of years and have tremendous respect for him. He is a very seasoned and accomplished executive, strong record of value creation in the nutraceutical space, pharmaceutical space, and I would like to add, a big believer in omega-3s.

Most recently, he was CEO of the world's largest nutrition ingredient business, DSM. Just for reference, DSM is about a $6 billion turnover business globally, with sites really around the world and a tremendous leader in science. And Leendert, I would say, was instrumental in the investments DSM made in the omega-3s with Martek Bioscience and Ocean Nutrition, which I was very happy to work with him on, and also a consumer of krill himself. But I'll let Leendert speak to that in a moment.

Also joining us will be Katherine Crewe, a strong and provocative leader, I believe, and a track record for success both in manufacturing and business processes. Thirty years in the medical device, pharmaceutical manufacturing space, sales distribution spanning the globe, and previously worked at both Mallinckrodt and Cryocath Technologies. We're very happy to have Katherine join us.

And in addition, Francois Roy, extensive experience and executive in both the private and public sectors. Previously CFO with Telemedia and Executive Vice President at Quebecor, both very, very large corporations, and currently sits on the Board of Caisse Depot, which for reference is one of the larger asset management organizations at over CAD225 billion in management. So a tidy sum, at Caisse.

So on behalf of the Board and management team, I'd like to thank all our outgoing Board members for their years of service. And with that, I'd like to get back to focusing on our business and manufacturing in our Sherbrooke plant, and invite Leendert to say a few comments. Then I'll come back with some more business perspectives in a moment.

So Leendert, please. The floor is yours.

Thank you, Jim, and good morning, everyone. Let me start by saying I'm excited about joining Neptune's Board, and also I'm excited about the opportunities ahead.

Neptune has a strong foundation in science, intellectual property and entrepreneurship; but also, it has seen some temporary setbacks. So I ask the question, others may ask the question, why am I here? Let me tell you, it's, first and foremost, because I believe in Jim Hamilton. He took on the leadership of Neptune at a difficult time because he believed he could make a difference, and I wanted to support him in his mission.

Secondly, and already mentioned by Jim, I'm a very big believer in omega-3 and, more recently, in krill oil in particular. And yes, Jim, I take krill oil in the morning.

Good man.

Now, thirdly, when I look at Neptune, I see nothing that cannot be fixed. So in summary, I'm very excited.

Initially I was asked to assist Neptune with its production issues, and what I found was a state-of-the-art plant with built-in expansion capacity. I've been in the industry for many years and I've seen many plants, and I'm actually fairly impressed with what I've seen at Neptune.

Looking closer at production, let's start with some background information. As you are aware, upon completion of a ramp-up period, the Sherbrooke plant was operating at an annualized capacity of 150 metric tons and all production specifications were being met. However, soon we became aware of challenges relating to product handling characteristics, let's say viscosity, which were not in line with what customers were expecting and, frankly, not in line with what Neptune was expecting for a premium oil.

To address the issues, production was slowed in order to reprocess the oil to reduce its viscosity and enhance its product handling characteristics. At the same time, various studies were undertaken to determine the source of the viscosity issues and to identify a cost effective solution.

As part of the initial investigation, a detailed assessment was made looking at the differences between the original and the new plant, particularly where it may affect product quality. Of course, there are differences between old and new plant, such as design capacity, future expansion capabilities, and degree of automation; however, they were not enough to suggest that the new plant was the root cause of the production issues.

So as a result, we turned our attention to raw materials being used, frozen krill. Now frozen krill is a natural product with natural variability; actually, a surprisingly huge variability, depending on the season. Lipid concentrations and lipid compositions really strongly vary, depending on the season.

Now Neptune sources carefully, with strict quality guidelines during actual harvest, including onboard freezing and cold storage. Similarly, there are quality assurance procedures in place for subsequent shipping and long-term cold storage. Nevertheless, we have to conclude that frozen krill ages over time.

Neptune has considerable inventory of deep frozen krill, some dating back to the old plant, and it has become apparent that not all of it is suitable for use. And a write-down of certain aged non-usable inventory was incurred during the quarter.

Let me turn to production and to the link between production and krill characteristics. During normal operation, the process parameters are adjusted to address the natural variation of krill. However, with the current inventory, we need to make additional process modifications to control the oil viscosity so that it fully meets customers' expectations.

The process that we now have in place is robust, but does result in reduced plant output. We continue to work on this.

Going forward, we are confident that we will identify more efficient process conditions and that effective plant capacity will return to our original preliminary objective of 150 metric tons annually. On top of this, during our investigations, we have also identified a number of opportunities for future process improvements. These include debottlenecking and general cost reductions, which we are starting to address now.

In closing, I would like to highlight that we are currently producing and selling oil that fully meets customers' expectations. Let's also remind ourselves that production start-up issues are not uncommon. Fortunately, we have the right team, the right plant, and the right result.

And with that, I would like to turn the call back over to Jim for a discussion of Neptune's financial highlights. Jim?

Thank you very much, Leendert. I should probably add, as far as Leendert's resume, that he's actually a scientist with a PhD in Chemistry and his early phase of his career of highly, highly active in process research and operations.

What has been so helpful is not only Leendert's capabilities relative to our manufacturing challenges, but also his ability to tap into his network of subject experts globally that we've been able to bring to bear on this problem. And I think we've witnessed the success of that with the traction we're getting in the site right now. So Leendert, I thank you very much for that.

Turning to financials, I'd just like to remind everybody that our results are in Canadian dollars and these remarks contain forward-looking statements, as well as -- the ongoing issues at our Sherbrooke plant rendered, you'll realize that it's difficult to always have comparisons on year-end results. My comments today will focus mostly on the quarterly results of the Nutrition business. Consolidated and annual information can be found in the press releases, of course, and Neptune's consolidated financial statements, the related MD&A. And this is all available on the SEDAR and the EDGAR investor sections of the nutrition website.

So turning to results, revenues for the third quarter were CAD3.8 million. This was up from CAD3.5 million the prior year. And revenues for the current quarter are and will be impacted by viscosity issues that we've identified. The consolidated gross margin as a percentage of revenues was 26% for the quarter, up from 20%. The adjusted margin for the current quarter excludes certain costs included in cost of goods related to manufacturing issues of CAD2 million and CAD4 million for an impairment of inventory.

The viscosity issue at the plant has been linked to some of the krill inventory in stock and, therefore, it was necessary to take the write-down on certain of this inventory. And it's important to say that we do not anticipate further needs for inventory write-downs at this time, given our very extensive work that we're doing in the site right now.

Moving over to Nutraceutical, adjusted EBITDA was negative CAD7.4 million for the quarter, compared to negative CAD1.5 million the prior period. Year-over-year declines in adjusted EBITDA was largely due to higher cost of goods described earlier, along with lower income from royalty settlements.

As to the Nutraceutical net loss, Neptune recorded a quarterly net loss of about CAD8.6 million versus a net loss of CAD1.3 million in the prior year. The higher net loss is due to the same factors outlined in EBITDA, as well as the prior year Neptune received insurance recoveries related to the 2012 plant incident. This was partially offset by a decrease in stock-based compensation expenses. By the second quarter, however, we do expect significant sales increases linked to our improved plant performance and product availability.

Switching to liquidity, the corporation has consolidated cash and short-term investments of CAD27.6 million as of February. CAD9.2 million of this, Neptune, and CAD18.4 million on the books of Acasti.

Let me just say, before I hand over to Pierre, that in the last few months much has been done to strengthen Neptune, both for today and the future. I'm pleased with the positive momentum, especially that we're seeing in the plant, and I'm very, very pleased with what we're seeing develop in our sales pipeline. And as I mentioned earlier, the consequence, we're expecting stronger sales in the second quarter ending August 31.

There are no shortage of challenges here, as Leendert touched on and I knew this would be the case in joining this company. But like Leendert said, none of this is not beyond fixability and we're working hard to do that now. I'm very excited by this -- I'm very excited by the team we're building here and I'm very, very excited by the capabilities that we're bringing online with some of our new Board members. So, so far, we are making progress.

With that, I'd like to pass it over to Pierre Lemieux for some comments on Acasti, and then we will open it up for questions. So Pierre, take it away.

Thank you, Jim, and good morning, everyone. As announced yesterday, Acasti continues to focus, of course, on the clinical development of CaPre. Following receipt of data for our Phase I PK study and Phase II clinical trials, COLT and TRIFECTA, we provided the data package to the US Food and Drug Administration, so called FDA, to receive direction and confirmation on our requirements for our pivotal Phase III trial. The trial is to be pursued, of course, under an amended IND application.

Acasti is now corresponding with FDA to determine next steps in the clinical development of CaPre and obtain the required authorization to proceed with such steps, including initiating a Phase III clinical trial. Such correspondence is meant to allow the FDA to provide feedback on Acasti's submission and to answer specific questions on such filings. Prior to a final response from the FDA, any exchange with them can take the form of a written correspondence, discussions, and potentially face-to-face meetings.

The Company is working to respond to FDA feedback and we'll be working with them to determine resolution and direction needed to advance to a Phase III trial. As mentioned in our last quarterly call, I would like to highlight that developing a new drug candidate is a long-term commitment that is not without challenges and constraints. Moving from the clinical testing stage to marketplace will require that safety and efficacy is confirmed. We still need to meet a number of material clinical and regulatory milestones ahead.

That said, with a strong management team and experts in the field, along with an impressive slate of Director nominees, including two new candidates for election at our next annual meeting, we are well equipped to continue with our clinical development plans. The new Director nominees include Dr. Roderick Carter, MD, who is a physician with significant experience developing and commercializing nutraceuticals and pharmaceutical products and successfully led clinical research and business development strategies for cardiovascular and inflammation-related disease. Notably, Dr. Carter was Vice President, Clinical Development at Reliant Pharmaceuticals, which developed the omega-3 cardiovascular drug called Lovaza, which is today a wholly-owned subsidiary of Glaxo.

Our other Board nominee is well known to all of us, Jim Hamilton. In addition to Neptune's ownership in Acasti, we have close ties through the associated benefits krill oil brings for both nutraceuticals and pharmaceutical applications. And we look forward to Jim's participation, of course.

Together with the other Board nominees, they are well-positioned to help support management in its growth initiatives. With that, I will turn the call back over to John. Thank you.

Well, thanks, Pierre. This ends our formal remarks for today. I'd like to now turn the call back over to the operator for the Q&A portion of the call. Operator?

(Operator Instructions)

Rick Schottenfeld, Coyote Capital.

Hello, guys. I got two questions. The first one is -- and I might've missed the very beginning of the call. If you said this, I apologize. But in terms of the write-down of the frozen krill that wasn't usable, is there a possibility for insurance claims against that as it went bad because the plant had blown up and was no longer usable?

Rick, it's Jim, and thanks for the question. The answer to that is absolutely yes. It's on our list and we're now developing that right now. So we're looking into that, as we speak.

And then also in terms of sales momentum, can you talk a little bit about what's going on in your order pipeline?

Yes. Thank you, Rick, again. I'm very, very encouraged there. And it's really two components. One component is some tremendous traction that we're getting with some major marketers in this area. And we're looking forward to starting commencing a new relationship in that regard.

Number two would be the reality of our inability in past to deliver quality product on time. I've essentially taken the position with some of our key relationships, and these are -- many of them are personal friends of mine -- to say, you know what, we're not ready for you today. When we are ready, we will come back.

And the answer I've got from some of those friends is, when you're ready, Jim, the doors will be open. And those conversations are now beginning. So I'm confident that we'll be able to deliver on a much more robust second-quarter sales number than we've been able to deliver, given availability and viscosity issues have passed.

All right. Thank you.

Doug Loe, Euro Pacific.

Thanks very much and good morning, gentlemen. Thanks for the update on the business and your Board reconfiguration for both firms. Just a couple of things from me.

So first of all, appreciate the feedback on what some of the challenges might have been on the biophysical properties of oil that you've been manufacturing at the new facility. Would not have guessed a priori that alterations of frozen starting material would have been the problem, though. So without getting too technical for the general audience, I'd just be interested on how that could conceivably be one of the possible reasons for why that was giving you some challenges on end product. So that's the first thing.

And then, second of all, just reflecting on some general macroeconomic parameters in the overall industry, just noting from one of your peers, Aker, as an example, that their krill oil Superba production has been generally flat over the last three or four quarters. And I don't mean for this question to be necessarily Aker specific, but just wondering to what extent you might see that as reflecting on overall global krill oil demand and just what sort of trends you're seeing on how phospholipid ester formulations and krill oil-derived product specifically is gaining traction in the marketplace, and how specifically you believe that it can be positioned to capture the growing market share in the overall omega-3 space? Just a general comment on macro market parameters would be helpful there. And I'll leave it there. Thanks.

Doug, both great questions. I would look to Leendert to comment firstly on the inventory.

Happily do so. I understand your question; a surprise that there is a link between krill characteristics and product quality. If you have been in this industry for a period of time, then you know this is not a surprise. It is actually -- what to me was a surprise to see the huge variability in the characteristics of an oil depending on seasonality. It's well known and adjustments are being made. And if I say on a day-to-day basis, I'm probably overstating it somewhat, but adjustments are made depending on the lipid composition that exist in the krill.

Now those lipid compositions can also show some variability, depending on aging, and have similar impact. Now that was indeed somewhat surprising. And without then going too technical, I have not only that I want to be not too technical, but also you probably appreciate that there is maybe opportunities for intellectual property here. Definitely, this is something that we are not ready to talk about today.

Doug, Jim, just on the market -- and this is where ultimately this organization and our investors should be focused upon. This market, depending on the estimates you look at, from past experience and external sources is anywhere between CAD1.5 billion and CAN1.7 billion in total. This would be the, call it, the DHA EPA space. This business, I'll call it krill; total market is about 7% of the value, probably mid-single digits.

I think the challenge for this organization, and others in this business, is to find ways to make sure that krill has its rightful place within the total omega-3 category. And that's what we'll definitely be focused upon.

We also have to execute on the ground level and that is making sure that we have our fair share of the existing total market. And that's also our thing. So two things: we got to execute at the customer level to make sure that we've got our rightful share and then, ultimately, we need to grow into the bigger omega-3 space.

Okay. That's helpful. Thanks, Jim.

(Operator Instructions)

Larry Palmer, Sun Life Financial. I apologize; it looks like he did remove himself from the queue. And at this time, I'm showing no further questions.

Okay, Operator. Thank you very much. I believe that ends our call for the day, then. Thank you, everybody, for joining us. Have a good day.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may now disconnect. Everyone have a great day.