Neptune Wellness Solutions Inc (NEPT) 2017 Q2 法說會逐字稿

(Spoken in French). Good afternoon, ladies and gentlemen. This is the operator. Welcome to the Neptune Wellness Solutions second-quarter 2016-2017 earnings conference call.

(Operator Instructions)

I would now like to turn the call over to Mario Paradis, CFO of Neptune. Mr. Paradis, you may begin your conference.

Thank you. Good afternoon, everyone, and thank you for joining us. As mentioned, the purpose of today's call is to review our results for the second quarter ended August 31, 2016. Joining me today is Mr. Jim Hamilton, our President and CEO. As usual, Jim will review Neptune's operational highlights, followed by a discussion of quarterly financial results by myself.

Before we begin, I'd like to remind you that all amounts are in Canadian dollars and today's remarks contain forward-looking information that represents 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 securities laws.

A number of assumptions were made by us in preparing these forward-looking statements, which are subject to risks. Results may differ materially, and details on these risks and assumptions can be found in our filings with the Canadian Securities Commission and with the Securities and Exchange Commission.

I'll now turn the call over to Jim.

Mario, thank you very much. Good afternoon, everybody, and, for those who are celebrating, a very happy holiday. We have a short PowerPoint presentation that can be found online both through Marketwired as well as our website under Investor Relations. And you can find that under neptunecorp.com.

Let's just begin. Our focus today, of course, is on the neutraceutical business. This is excepting Acasti.

Let me begin by saying that although there's a lot of work to be done, let me say we have done a lot. Neptune today is a very different company. It is much stronger than a year ago in really all dimensions -- the quality of the people, the quality of the products, the portfolio, quality of our customer relation, quality of results.

Let's just reflect a little bit on the second quarter. Revenues at CAD11.6 million. And compared to prior year that's 165% growth, with contributions coming from our turnkey solutions business, Biodroga.

Our first sales of our new product, MaxSimil, and solid specialty ingredient sales of krill oil, including some first sales to China. Also, sequentially, our third positive quarterly adjusted EBITDA of around CAD800,000. And this compares to a loss of CAD1.6 million a year ago. And we're maintaining our annual expectation of double-digit EBITDA margin for the fiscal year.

When you factor in some items such as depreciation, interest expense, et cetera, the loss was about CAD700,000, which compared to a loss of CAD1.9 million for the quarter prior year. Again, the variances reflect continued growth in volumes of our products, our solutions business. And, also, I would add, improvement of our operating efficiencies such as through our Project Turbo. Mario will touch on that in a minute.

I'd like to also call out an event subsequent to the quarter which is the settlement of our litigation with Aker Biomarine. This is a $6 million net settlement. Let me just maybe qualify that a little bit further. It reflects settlement of $10 million relative to a licensing of Neptune IP and $4 million going to Aker Biomarine, hence the net $6 million.

Let me just say that Aker is a great company. They're very well managed and a great innovative firm, too, that has invested a lot in innovation and in IP over the years. And cross-licensing some of their innovation will prove, I think, very helpful for the continued success of Neptune going forward, as will their licensing to our IP.

It also opens the door, I think, for a collaboration, which is important, collaboration on items of mutual interest such as regulatory affairs, communications, media things. And I'd like to say, too, that when you reflect to some of the time and attention and money by this company on this litigation, it will certainly free up a lot of that to focus on what we're really here for, which is growing the business and innovating.

Which leads to the next point, such as MaxSimil. Subsequent to the quarter we also expanded our distribution rights to MaxSimil to that global rights. We're very intrigued by this product. This product is novel and unique.

Just the quick primer there for everybody, in essence it's a more available and predigested form of omega-3. You would say -- why is that important. There's a large community, you could estimate up to 20% of our North American community, is challenged with digesting of omega-3 supplements. A most extreme case would be people, for example, with Crohn's disease. This gives consumers an opportunity who are otherwise challenged to supplement with omega-3s.

There was an announcement recently, I'm sure many of you saw, with one of our first customers, XYMOGEN, launching to their consumers and the practitioner channel, which we very much like. Where there is a conversation with consumers is where specialty products like MaxSimil can excel.

Just a further comment here, also, cash has grown to CAD7.1 million, up from CAD3.5 million as of February this year.

And turning to page 5, the ingredient business has improved versus prior year. One of the reasons for that would be a new form that we launched called NKO Omega+. This is 30% more omega in the krill products as compared to many out there on the market, which is really helpful for marketers, especially those who are on the shelf and competing against some private label brands. It helps differentiate it.

We're seeing very good traction with that product. And I would just add, too, that we've had our first sales of NKA -- this would be for animal nutrition -- which effectively is turning our byproduct, which we were spending approximately CAD800 a ton to dispose of a year ago at this time, into a revenue stream.

Moving to page 6, as I mentioned, Neptune today is a very different company. It's a growing nutrition products company, primarily focused business to business, turnkey solutions and specialty ingredients, and also with an endeavor in consumer brands with OCEAN O3 which we launched the latter half of last year.

But focusing on turnkey solutions, it's just over half of our business. And I will say that I'm increasingly optimistic about this business. I think it's the right kind of business at the right time.

Consumers today are just driving so much innovation. They're driving so much increased segmentation in the market. And the Biodroga team and our turnkey solutions business is right there to participate.

We are putting the plans in place to grow this business by 20% per year on average over the coming years. The limiting factor, we believe, is not demand here. We believe the limiting factor is our processes and our capacity. And we are investing in those processes and capacity, as we speak, and, again, anticipate that we can grow that business by approximately 20% per annum over the coming years.

Our growing portfolio of specialty ingredients, as I mentioned earlier, with products such as NKO Omega+ and MaxSimil and NKA, just below half of our revenue stream today. And we anticipate that we can grow this business double digit annually going forward.

Some comments on organic growth. Of course this excludes any ambitions relative to acquisitions, which we're very much motivated to do in the future.

Acquisitions, just turning to page 7, if they were in the field of any of the businesses we're in -- turnkey solutions, specialty ingredients and consumer brands, and ideally all three, but at least two -- we'd be very motivated because we like the synergies between these businesses. We like turnkey solutions as a great pathway to sell specialty ingredients. And it's a great radar for innovation.

Similarly, specialty ingredients is a great pathway to change our conversation with customers there, also an ability to drive innovation. And clearly and ultimately, I think, with consumer brands, we can look at that window as a way to commercialize our specialty ingredients and also capitalize on the efficiencies that our systems can deliver. So, all three creates, I think, a very compelling ecosystem and we're going to continue to drive along those three platforms.

So, with that, I would like to hand it over to Mario to talk a little bit more about the numbers and then we'll come to some kind of looking-ahead comments. So, Mario, please.

Thank you, Jim. I'd like to remind you that our results are in Canadian dollars and today's remarks may contain forward-looking statements. My comments today will focus on quarterly performance of our neutraceutical business unless otherwise indicated. Consolidated and second-quarter FY17 information can be found in our press release and in Neptune's consolidated financial statements and related MD&A, available on SEDAR, EDGAR, and under the investor section of Neptune website.

Turning to our neutraceutical results, I'm pleased to report that our revenue for the second quarter were CAD11.6 million, up by CAD7.2 million over last year, and up CAD0.2 million or 2% over the first quarter of this year. Our revenues include strong sales from our specialty ingredients business and the contribution from our recent acquisition of Biodroga for an amount of CAD5.7 million. We are also pleased with our ingredient krill business, which grew by CAD1.3 million, in comparison with last year, representing an increase of 32%.

Our quarterly gross margin as a percentage of sales also continued to improve compared with the same period last year. The gross margin on sales came in at 20%, up 6 points over the same quarter last year. The improvement in comparison with last year is being mainly driven by the contribution of Biodroga, higher sales volume in specialty ingredients, and by overall improved operating performance and efficiencies as a result of the Project Turbo.

In terms of dollars, we generated CAD2.3 million, an increase of CAD1.7 million over last year. When we compare sequentially with the first quarter of this year, the second-quarter margin was impacted by the usual Sherbrooke facility shutdown for vacation, plant maintenance, and some innovation and R&D testing, and, finally, by temporary operational issues with our acetone recycling project, which is part of our Turbo Project initiatives. As indicated, these issues were temporary and are now under control.

Considering our cost structure and fixed costs, these events had an impact of approximately CAD800,000 on our gross margins during the second quarter, of which approximately 50% could be considered as nonrecurring. In addition, Biodroga's product mix was favorable in the first quarter and returned to more normal levels in the second quarter. Going forward, we expect gross margins to be in the range of 30% in the upcoming quarters.

A few words on our Turbo Project, initiatives continue to drive operating performance and efficiencies, and we are expecting that our CAD5 million target will be achieved by the end of this fiscal year.

SG&A totaled CAD2.5 million during this quarter. This is slightly lower than last year with CAD2.8 million and lower than the first quarter of this year by CAD0.7 million. When compared with last year, the Biodroga acquisition increased the SG&A expenses but was more than offset by a reduction in marketing and administrative expenses, more specifically in lower compensation expenses as a result of Turbo Project.

Moving along, adjusted EBITDA continued to be in a positive territory for the third quarter in a row, with CAD0.8 million for the current quarter compared to a loss of CAD1.6 million in the second quarter last year, and an adjusted EBITDA of CAD1.1 million for the first quarter this year. The improvement versus last year was mainly related to additional sales from our turnkey solution business, continued improvement on gross margin from better operational efficiencies, and also from a slight reduction in SG&A.

On a sequential basis, the decline in adjusted EBITDA reflects lower gross margins, partially offset by a decline in SG&A expenses. We expect adjusted EBITDA in dollars and in percentage of sales to improve in the third quarter over the second quarter, mainly due to expected higher gross margins, as discussed earlier.

Our quarterly net loss also significantly decreased, coming in at a loss of CAD0.7 million versus a net loss of CAD1.9 million in the prior year. The improvement of CAD1.2 million over last year was primarily due to the same factor applying for adjusted EBITDA and also a foreign exchange gain of approximately CAD400,000 related to our debt denominated in British pounds.

Talking about our debt denominated in pounds, we entered during this quarter into a cross-currency swap in order to convert this debt into US dollars. So, interest expenses from the US dollar debt will partly act as a natural hedge against our revenue denominated in US dollars and the debt itself against our receivables in US dollars.

Turning to our liquidity, on a consolidated basis the Corporation had consolidated cash and short-term investment of CAD15.3 million as of the end of the second quarter. Of this amount, CAD7.1 million was for the neutraceutical segment, or Neptune, and CAD8.2 million was related to Acasti Pharma.

Neptune's quarterly cash balance on a standalone basis increased by CAD2.1 million from CAD5 million at the end of the first quarter. The operation, including working capital, generated CAD4.6 million during this quarter, less the finance cost of CAD0.5 million and debt repayment of CAD2 million.

Finally, in FY17, for the neutraceutical segment, we now expect revenues to be greater than CAD45 million, up from our previous number of CAD43 million, with a double-digit adjusted EBITDA margin.

I now turn the call over to Jim for closing remarks.

Great, Mario, thank you very much. As I mentioned before, Neptune is a very different business, much stronger business than a year ago. We are in the business of wellness solutions and we're going to keep working to drive growth by providing great wellness solutions that deliver health and well-being, with a particular focus on growth in our turnkey solutions business. And we're going to invest in scaling and the capabilities of the business and specialty ingredients in terms of continuing to lever our capabilities there, as well.

Ultimately, we're motivated to look at acquisitions that complement not only our solutions, specialty ingredients, perhaps also consumer brands. In the near term, we're also going to be looking at strengthening our cash position and optimizing our debt structure. And for FY17 for the nutrition segment we expect revenues now around the CAD45 million with double-digit EBITDA margin for the year.

And with that, we'd be pleased to open it up to any questions.

(Operator Instructions)

Your first question comes from the line of Doug Loe of Echelon Wealth Partners. Please go ahead.

Yes, thanks very much and congratulations on the quarter and thanks for the granularity on the quarter. Mario, I just wanted to start with revenue allocation. Thanks for providing the granularity on Biodroga versus krill-related revenues. It's basically what I calculated, then you stated the numbers explicitly, so thanks for that.

Just wondered if there was any revenue reallocation that would have led to any perceptions of Biodroga sequential softness down to CAD5.7 million in the quarter versus our calculation for krill oil revenue being basically at the same number, which is a little bit more than what we were looking for. I just wondered if Biodroga, krill or omega-3 related revenue has now been reallocated into krill related revenue. That's the first question.

Second of all, maybe a question for Jim, I was just wondering if post quarter you had that solid patent cross-licensing agreement with Aker which did lead to some cash flowing from Neptune back to Aker. Just wondering if you could provide any insights as to what Aker's patent portfolio provides for you and how you might be able to leverage that in future product development opportunities. I understand what your IP entails as it relates to their ability to operate in the US and elsewhere, but just wonder if you could maybe reflect on what specifically comes back to you on the IP side.

And then, thirdly, thanks again for indicating that you still are on pace to achieve annual EBITDA cost savings of CAD5 million that should be fully realized by end of year on an annualized basis. I assume that that doesn't include any reduction in legal expenses related to settling your patent litigation with Aker. Just wondering if you might be able to quantify what additional savings or reduction in legal expenses might introduce into future quarterly EBITDA. And I'll leave it there. Thanks.

Boy, Doug, that's -- (laughter). Mario, do you want to start?

Thank you, Doug. As for Biodroga, it's true that sequentially it's a reduction compared to the first quarter. But, again, Biodroga's business is not a straight line business along with four quarters. So, there could be some bump here and there between quarters.

And when we compare with the same period last year, Biodroga effectively grew. So we're not worried about that. It's also related to pipeline filling, inventory filling of our customer. The third quarter we had a good start and it will be stabilized over the upcoming quarters.

Maybe we could take these one by one and I could just add to that, Doug. I think we're about half a year into Biodroga being part of Neptune. And what is very normal -- in fact, we had this discussion at the Board today -- is a certain element of distraction and integration.

I would I say that we were ahead of the curve on a lot of our expectations in terms of the integration, and in terms of customer retention. Again, we feel this business is immensely scalable and we would not put out our predictions in terms of how we can grow this going forward. Our limiting capability here is people and process and we're investing in that right now. We feel very good about this business.

Great.

You want to take number two, Mario?

Turbo?

Let me -- on Aker. We can't get into a lot of detail in terms of what specifically was and was not licensed and for how long, Doug. But let me just say that Aker has invested in a lot of innovation over the years.

Our primary motivation here is freedom to operate and to stop litigation and stop the conflict where we could, as I said earlier, build a platform where the companies could collaborate for the better of the industry and not be challenging one another on individual items of specific IP. So, I can't get into the detail but let's just say that it clears any potential conflict for us in the foreseeable future and we feel very good about that.

Okay. Maybe, specifically, what I was wondering about, without asking it explicitly, was whether there was any obligation on their side or perhaps with their US partner, Reckitt Benckiser, on perhaps infusing a bit more capital into promoting MegaRed or Superba, just as a way to bolster the profile for krill oil as an omega-3 category. I suspect -- again, I don't know whether you can comment on that -- but that was just a thought I had that the obligation for you back to them might be, as reflected in your cash payment.

Let's just say that it clears the air and creates, I think, an atmosphere that is conducive to those kinds of conversations as an industry, and we feel good about that going forward.

Okay. Thanks.

And the third one, Doug, we're not totally finished with our litigation. As you may know, Aker was with Enzymotec for that court case. Our intention is to restart discussion with Enzymotec.

If we're not able to settle before, we will have still this court case by the end of this year. So, it's very difficult to put in numbers what is our expectation in terms of reduction of legal fee, but certainly there will be a reduction.

That's good stuff. Thanks, guys.

(Operator Instructions)

Your next question comes from the line of Robin Cornwell of Catalyst Research. Please go ahead.

Hi. Good afternoon and congratulations on your many successes in the quarter. Two questions quickly for Mario. I know everyone's -- at least my clients -- are very interested in the production level of NKO. Can you give us some idea what level of production you're at?

Again, we already confirmed earlier that our plant demonstrated the capacity to manufacture 160 tons a year. But now we have reduced that pace because the demand is not there.

We do not want to confirm on which pace we are, but let's say that we are actually manufacturing what we are selling. And just a good allocation of our money right now. And we are confident to increase our demand and, of course, we have some room to come back to the 160 ton.

I think I'd just add to that, Mario, that we are seeing an increase in volume sales as compared to prior year, helped in part through innovative new products like Omega+. The facility is not running at full capacity right now. We would love to fill it with demand with krill.

But, more importantly, and as I've mentioned in prior calls, we're also working -- and this was some of the work we were doing in the summer -- to look at alternate compounds that we could use the site to manufacture. Ultimately I'm happiest when we have a mixed use, highly utilized facility, and we're motivated to do that. But it's not going to happen tomorrow. We're going to have a lot of work there to do to pull that off.

That's interesting. It leads me to another question I have on China. You mentioned sales but we discussed it last quarter, as well. Has there been any additional sales since in the quarter or further penetration into the Chinese market?

Absolutely. We recorded our first sales there in the second quarter, as well as in the third quarter. I think that the interesting thing about China is we see it really as white space, as an opportunity to grow. If you look at the omega-3 category in general in China it's on fire and so we're very optimistic.

And only two Western countries can export material into China, and that would be from a facility such as ours in Canada or New Zealand. We're working hard in China to find the right method there to rapidly commercialize, and we hope to talk about more of that in the near future, Robin.

Okay. Back to the Aker transaction, now you have a working relationship because you both have, as you say, different products and different patents, et cetera, that you can work with. Does this agreement allow Neptune to have direct transactions or discussions with Reckitt's and possibly even shift, even though a shift has a long, fairly negative history? Is there any possibility of getting sales from Reckitt's?

Let me just say, we don't like to talk about individual customers publicly because the relationships are confidential. I would add, though, that we know Reckitt Benckiser shift people very well. I think they're very committed to the space and spend literally tens of millions of dollars in promotion and development of the market globally. We see their continued commitment there and we're going to work hard to be a good partner for them going forward.

And, finally, your expanded distribution rights for MaxSimil, this implies that you've had some fairly obvious success with it. Is this the case? And have you been highly encouraged that you'll be successful with MaxSimil?

Robin, I hope so. It always remains to be seen. I think here's the great news. The great news is our interface is primarily with the innovative companies in this space, and this radar system is bringing us ideas such as MaxSimil. That's the great news.

How well it commercializes, let's see. This is a novel compound and this industry is calling for differentiation and innovation, rapidly. It's a compound and it's a science that is young but is absolutely resonating in the conversations that I've been witness to. So, we're going to see where this goes. It is a differentiated product.

I don't envision this product being necessarily competing in the bargain basement, Dollarama or Walmart shops, but I do see it where there is an engagement with the consumer through practitioners, through doctors, through health food stores. Where there's a conversation, and when you have a person that is challenged with some digestive issues, price is not the issue. And it's going to be a product they're going to embrace.

So, let's see. We're jazzed by it. And we're going to work to commercialize this not only locally, but globally.

Okay. Thanks very much.

There are no further questions at this time. I will turn the call back over to the presenters.

Thanks, everybody, for your attention and support. We're going to continue to transform Neptune into a great nutrition products business, focused on wellness solutions. Mario, thanks for all your support, too, today.

Thank you.

This concludes today's conference call. You may now disconnect.