Neptune Wellness Solutions Inc (NEPT) 2017 Q4 法說會逐字稿

(spoken in foreign language) Good afternoon, ladies and gentlemen, this is the operator. Welcome to the Neptune Wellness Solutions fourth quarter 2017 earnings conference call. At this time, all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions). I would now like to turn the call over to Mr. Paradis, CFO of Neptune. Mr. Paradis, you may begin your conference.

Thank you. Good morning, everyone and thank you for joining us. As mentioned, the purpose of today's call is to review our results for the fourth quarter and annual result ended March 31, 2017. Joining me today is Jim Hamilton, President and CEO; and also Mr. Benoit Huart, project lead of our new project, Green Valley, that Jim will talk about in a few minutes. As usual, Jim will review Neptune's operational highlights followed by a discussion on quarterly and annual 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, very much. Just some quick comments on my side about the fiscal year. I'll pass it back to Mario to get into much more detail on the numbers. And for those who are following, there is a deck that has been posted and I'm on page number four and I'd like to just begin by stating when you reflect back on the last year, revenues have more than doubled, in fact grew by 104% to close to [47 million and the adjusted EBITDA improved close to 9 million] on the year and actually when you reflect back even further over the last two years, this business has grown on the revenue side by threefold and the bottom line adjusted EBITDA by close to $30 million. So we're definitely moving in the right direction.

Strong cash balance at the end of the quarter of [8.8 million and 13 million] cash flow generated from operations as well as a portion of the IP settlements and much of that cash was used for actually a debt reduction. On the fourth quarter revenues, close to [12 million] for the four-month period ending March 31, which was our fifth consecutive quarter of positive EBITDA. And just some comments and you'll see the detail in a minute from Mario. We did change our fiscal year-end to land on the calendar quarter just because it's been a lot of complexity for people over the years to understand exact timing. So we got a lot of comparisons around that, but going forward, we'll be on the normal calendar quarter.

I just wanted to move over to page five now and talk a little bit about our strategic focus. First and foremost, what we've communicated is that we're a nutrition products company focused on wellness solutions and we're working to drive value through an integrated business model of turnkey solutions, specialty ingredients, and brands and when you look at this picture, two years ago, we had one item, one product, one leg of the stool, which was the NKO original in the specialty ingredient box and since that time, I think we've added quite a bit to the portfolio and we continue to work on more, which I will speak to just in a moment.

Just flipping on to page six and just some of the key activities in support of that mission and that strategic focus and just moving clockwise on this chart. One of the key umbrella themes has been expanding up the value chain and clearly the acquisition of Biodroga early last year was an important element of that getting us into the solutions business. I'll tell you there's been a lot of work done in terms of enhancing the operational capability of this business. I think at acquisition, they were at -- to a certain degree at their functional capacity. I think we've done a lot of process improvements and the last element of that integration has been on optimization of the sales team, of which we recently shifted more resources to the front line there and actually have been very, very fortunate to be supported in that process by industry expert and veteran in Jim Terry who is a senior executive at General Nutrition and has been with us the last couple of months supporting our sales development in that area. We're very, very excited to have Jim supporting us [with same]. Just another comment we've talked about also acquisitions and we've developed a strategy around acquisitions which we've mentioned. We've also been actively engaged there, nothing to report today, but we'll continue to do that and we're optimistic that we'll continue to progress down that path.

Just moving along the clock here a little bit down to leveraging IP and technology globally. We completed two resolutions of the IP challenges that this firm has faced. It's been a big management time burn and a legal resource burn over the years and we're very, very happy that we've resolved that and we've been very happy about the cross-license that we've been able to achieve to ensure freedom to operate going long-term. Expand Specialty portfolio into related spaces and what we mean by that is to work and to initiate the innovation process, which in fact we did with the development of a team over a year ago, to look at where we could innovate and develop our business in spaces we know that we can lever either a technological, customer relationships, process capabilities, et cetera.

And I think we're starting to see the results of those efforts and a couple are listed with the launch of a new product, an ultra-high Omega+ we call it, which was launched last year. NKA, this would be taking a byproduct from our krill oil processing and selling that into the aqua and feed businesses and it's going beyond the byproduct by the way in terms of sourcing similar products in the category to leave our relationships with those customers. MaxSimil, a brand new product that we licensed in and acquired and have the global rights for and we completed that license. We've also launched that product and we are very, very happy with some of the numbers we're starting to see generate. This is a specially form, highly bio-available form sold in specialty channels largely in United States right now, which we're getting some very interesting traction.

And part of our innovation process, we've also initiated a project in the medical cannabis space looking at uniquely and specifically at oil extractions and levering our capabilities there combined with the capabilities we have through our solutions business of application and specialty delivery forms. I just want to park that for a moment because I want to come back to that in a minute because that's an interesting and a very, very special initiative we have underway. And just conclude with some comments on this page relative to strengthening our krill oil franchise. Krill is a major portion of our business, it's about half of our business today and you reflect for those who know this company and its story, we effectively have been a new entrant with our plant coming online 2, 2.5 years ago and I think we've re-established ourselves in the market, in fact, I think we've grown share in the market.

I think we've achieved quite a bit in terms of our Project Turbo, which we've spoken about in past calls delivering I think over a $5 million of productivity gains over the last year, year and a half. We've been working and looking for market growth in developing nations and China has been a focus for us and we are pleased to accomplish the approval of being able to import products into China, not everybody can do that. And consistent with that and to further develop, we announced not so long ago a joint venture signed with a firm in China called CMI.

A very, very interesting relationship, the JV as we've reported and communicated, is focused on developing the domestic krill oil business in China, which is undeveloped although, the omega-3 business is developing in China, krill to date is underdeveloped a portion of that market, but I think the opportunities with our relationship with CMI potentially could be more. They are in the process -- in fact I was just there a number of weeks ago visiting with them, they have one of the largest new harvesting vessels under construction right now, we're impressed to see. We're impressed to see very intimate and deep relationship they have with the Chinese government and our meetings with the Chinese government to learn of their commitment to this sector.

We like the opportunity in terms of being able to further expand our NKA aqua business through this relationship. We also like the potential of the raw material sourcing possibilities with this relationship. So it's a new and young relationship in terms of not only developing -- working to develop the domestic Chinese business, but also looking to expand that to a broader capability.

Having said that, I think one of the things that is important and you've seen in comments here and with some of the other providers in this industry, I think it's an industry characterized by abundant supply right now. I think it's a dynamic industry and I think it also has the potential for consolidation over the next [while] and I think it's going to be a very, very interesting space to track as we go forward.

I just wanted to flip now to page seven and touch a little bit more detail on this initiative in terms of the medical cannabis oil extraction. Now as I mentioned before, we've had an innovation process going on for some time here to look at how we could expand into related spaces and this is a related space that we find very, very attractive. If you look at the box on the top right and these are some estimates from our friends at Canaccord, but approximately the business is estimated around [500 million] purely in the medical space in Canada currently and there are a number of estimates and Canaccord I think being one that has this market growing retail of potentially almost three to four-fold up to $1.5 billion to $2 billion. What's more is there is some legislation pending in this country to legalize the recreational sector that many have estimated at [around 6 billion at retail, so a market today around 500 million] going into very, very large and interesting territory. And I think what's sort of an interesting comment one of our colleagues had mentioned to me is when you look at the recreational side at least, it's not as if this is a new market that needs to develop, to a great degree, that market exists today, it's just a question of getting it out of the dark and into the legal channels. So it's a very, very interesting market first and foremost.

Number two is, we believe that this market will develop to a great degree in oil and extracted specialty oils and that delivery forms there -- and when you look at our competencies as a business, this is what we do. We do extraction of oils and delivery mechanisms thereof. So we have a combination in terms of adjacent spaces that we like and adjacent competencies that we can apply to this industry. So we are actively looking at this. We have realigned our management and as we mentioned earlier, Benoit who is both a biochemist and a IP lawyer by training is taking this initiative on full-time to lead this process, he and many in our organization to actively pursue this as a project.

Parallel with this, you may have seen an announcement and I think it was early May, mid-May of a consortium in the regions, a combination of local government, the local university, ourselves, and an aspiring grower to work and collaborate in terms of developing this business on a regional basis. Just an interesting footnote, the University of Sherbrooke, for those who know Neptune have been in this business that was also the genesis of Neptune because it was the technology, the intellectual property that was developed at that University that was the founding of this business in the krill oil business. So it's interesting history there.

So we are very, very excited by the potential of this business and we're working very, very aggressively to move forward here. I think it's important to note that this is not a business that we will see tomorrow. There is a significant amount of work to be done both in terms of the compliance regulatory as well as modifications of some of our site going forward. I think when you look -- and it's also a very dynamic situation. I think when you look, for example, legislatively, we would say that was a major risk factor even a short number of weeks ago in terms of what the timeline for that would be. It appears that there has been quite a bit of development there and so much as it's less of a risk factor in that the process has been slightly streamlined as well as more government resources are being applied to it. So that's good news that takes some of the timeline risk out of this for us, but it's one that we're very excited by -- we think levers and fits very well with our mission, it fits very well with our ambition to grow in adjacent spaces. And we have submitted our initial application in the start of the process. I'm looking at Benoit, I think that was 1,000 pages that went in and it is a major, major undertaking in terms of a compliance standpoint. Let me just say that I think it's around -- I'm looking at Benoit, 75% to 80% of the initial applications to date have been rejected right at the first phase and we are very happy to say that our application was not rejected, but in fact was accepted within weeks of submission, which I think is symptomatic of the competencies we have in this space that we can apply to this business going forward. So with those comments, I'd be pleased to come back to that a little bit later, but maybe we could stop there and I'll jump over to Mario to talk numbers, which I know is his passion. So Mario, maybe you can take us from there.

Thank you, Jim. Good afternoon again everyone. 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 the quarterly and annual performance for our nutraceutical business, unless otherwise indicated. Consolidated fourth quarter and annual fiscal 2017 for the four months and 13 months periods information can be found in our press release and in Neptune's consolidated financial statements and related MD&A available on SEDAR and also on EDGAR and on under the investor relations section on our website.

I'd like to remind you that as previously announced, our fiscal year-end has been changed from February to March. Consequently, the fourth quarter is a period of four months and the fiscal year has 13 months. I'm now at the page eight of the presentation. The first two columns are the statutory reporting quarters while the third and fourth columns are for the three months period ended March 2017 and 2016 and I will discuss the financial results of these three months period ended March 2017 and comparison with March 2016.

Total revenues for the fourth quarter were $11 million, down by $2 million or 15% over last year. The revenue decline is mostly due to a very strong performance of the solution business last year and [to inventory] filling with some large clients. This decrease was partially offset by growth in the specialty ingredient business. Our quarterly gross margin as a percentage of sales also continued to improve compared to the same period last year. Gross margin on sales came at 27%, up 2 points over the same quarter last year. The improvement was mainly driven by product revenue mix with higher sales volume in specialty business and in terms of dollars, we generated $2.9 million, a decrease of $200,000 over last year.

During this quarter, we recorded $2 million of R&D tax credit that were applied against the income tax in order to bring income tax payable to zero. SG&A totaled $2.3 million during this quarter compared to $3.6 million last year. SG&A expense has decreased by [1.3 million] over last year mainly due to a decrease in total compensation, professional and legal fees, and acquisition costs. Adjusted EBITDA for the quarter excluding the settlement litigation amount with Enzymotec continue to be in positive territory with a fifth quarter in a row with [1.6 million compared to 1.1 million] last year. This improvement of $0.5 million versus last year is directly related to lower SG&A expenses. Coming back to the Enzymotec settlement agreement, as you may recall, we announced that we concluded an agreement on March 31, 2017, that's translated in Neptune's revenue of USD1.6 million or an equivalent of CAD2.2 million.

Taking into account the conditions of the settlement, the IFRS rules consider this transaction as an equivalent of an IP intellectual property sale. As it is a non-recurring event, we've decided to record it under other income in the statement of earnings. The income taxes expenses of [2.5 million] is a non-cash expense as it is completely offset by the R&D tax credits and a recovery of withholding taxes on royalty settlement payment. Our quarterly net income slightly increased by [0.4 million to reach 1.5 million in comparison with 1.1 million] last year. This quarter included an amount of [2.2 million] related to the IP litigation settlement. And last year, we recorded [2 million] tax recovery as deferred income tax assets on tax losses.

Now let's take a moment to look at our financial results for the 12-month period ended March 31 in comparison with the same period last year as shown on page nine of the deck and more specifically the third and the fourth columns. Total revenue for the 12-month period ended March 31, 2017 were [45.1 million, up by 18.5 million] or 69% over last year. This increase is mainly related to the solutions business, our Biodroga acquisition considering the consolidation of only 12 weeks of revenues last year as well as the good performance of our specialty ingredient business, which achieved over 30% growth compared to last year. Our annual gross margin as a percentage of sales also continue to improve compared with the same period last year. The gross margin on sales came in at 26%, up 11 points over the same period last year. This improvement is mainly driven by a reduction of production costs and better efficiencies from operation partly offset by product review mix. In terms of dollars, we generated an [11.3 million, a solid increase of 7.4 million] over last year.

As indicated before, we recorded [2 million] R&D tax credit that were applied against the income tax, in order to bring the income tax payable to zero. Selling, general and administrative SG&A totaled [12.9 million during the 12 months period compared with 11.8 million] last year. SG&A expense increased by [1.1 million] over last year despite additional SG&A expenses related to the Biodroga acquisition, partly offset by a decrease in some areas like total compensation, professionals and legal fees, marketing expenses, and acquisition costs.

Adjusted EBITDA excluding the settlement litigation with Aker Biomarine and Enzymotec was [4.1 million compared to a non-IFRS loss of 3.8 million] last year. This represents a huge improvement of [7.9 million] directly related to the increase of the gross margin and the reduction of SG&A expenses and the Biodroga acquisition.

Coming back to the Aker Biomarine and Enzymotec settlement agreements, the combined amount reached [15.3 million less related legal fee of 1.5 million] and were recorded in other income. As indicated before, the settlement amounts are not included in the adjusted EBITDA. As also indicated earlier, income taxes expense of [2.6 million] recorded for the year is a non-cash expense and is completely offset R&D tax credit and a recovery of withholding taxes.

The annual net income increased significantly by [16.2 million to reach 10.1 million in comparison with a net loss of 6.1 million] last year. This net income increase is mainly related to EBITDA improvement and the royalty settlement agreements.

Turning now to our liquidity, the cash position of the Nutraceutical segment was [8.8 million at the end of the year and total debt was 22.9 million]. Our operations during the year included working capital and other revenues generated [13 million with 4.8 million being used for debt repayment]. I now just want to turn the call over to Jim.

Hey Mario, thank you very, very much. Just a couple of comments in terms of looking ahead, I mean clearly we're going to continue our focus on delivering great wellness solutions via an integrated model especially ingredients, turnkey solutions, and brands and along with that, and then part of our innovation process clearly is to look at executing against this medical cannabis oil extraction business. We think it just absolutely fits with wellness and it fits with our competencies and we're looking and working very, very hard on that.

On the acquisition front, as we mentioned before, in terms of our three boxes of ingredients, solutions, and brands, we find businesses have at least two of those boxes that we can check we're interested and we continue that dialog and we like also and are working to develop further our relationships in China. Last element is I think in terms of our debt structure and balance sheet, we'll continue to work to optimize that as we progress. Maybe one last comment here is just on Acasti, we haven't talked about Acasti. For those who are investing and have seen their recent releases, I'm glad for that. For those who are Neptune shareholders and [haven't] been tracking that, don't forget that we own 34%, 35% of Acasti and we're very, very jazzed by the progress that team is making in moving this business forward and we feel very, very good about their progress. So with that said, I'm looking at Mario and Benoit, I think that concludes our formal comments and we'd be very open to any questions from those listening.

(Operator Instructions) Doug Loe, Echelon Wealth Partners.

Mario, maybe just a quick question for you just on the financials, I'm just having a look at slide eight here in your slide deck and I see that your four month period EBITDA for the March-end period was [900,000] as you indicated in the press release, but for the calendar quarter ended March it was [1.6 million], so it's quite a bit higher. If you've addressed this in your commentary, sorry if I missed it, that clearly implies that you had quite a substantial EBITDA loss in December. So I'm just wondering what that was specifically pertaining to.

So the main explanation Doug is first we remove the month of December. So as you can appreciate, so December was not a good month. So we shut down the plant for vacations and it was planned and also the month following the quarter, sometimes in our krill business, it's softer and at the same time, we have a softer month in the solution business. So all these three reasons explain why December was not a real good month and just due to the fact that we removed that month from the quarter of three months ending in March, that's the reality.

Doug, it's an interesting question I mean, and by the way, it's like you're sitting on our Board because we had a heavy discussion on the month-to-month and day-by-day on the business with the Board. I think what's important for me is a couple of things. One is directionally that this business is not the same business it was a year ago or two years ago. I mean the business has effectively doubled and the bottom line has dramatically improved. When you look at the fourth quarter business, I think our ingredient business was quite steady for the quarter. I think we took a few bumps that we hadn't anticipated in our solutions business that were very customer-specific issues, but nothing that we're too concerned about. So overall we are very, very pleased with the year and we feel very good about where we're moving. I think part of our ambition here is and one friend talks about stools or legs on the stool, this business basically had one leg on the stool a couple of years ago and we are adding and continue to add legs to the stool and the more legs that we can add, the more diversified this business and probably the less volatility that we're going to see in future. So we have added a lot of legs and we're going to continue to work to do that.

Understood, thanks for that color. And then the second if I could just maybe shift sideways a little bit to your recently announced initiatives in cannabis oil extraction. I mean, it certainly looks like a positive exploratory move for you to leverage your expertise in krill oil extraction into extracting other oils from other biomaterials of which cannabis is an obvious next evolution for you. Maybe just like a couple of questions there, one, just wondering how much R&D or validating efforts you've done to this point, maybe specifically if you've explored whether acetone or supercritical CO2 extraction actually works within your facility at creating high purity oil and whatever or what extent it retains its cannabinoid-like activity. Just whatever comments you can make there on the R&D progress on that front would be helpful.

And then second of all, I mean, you obviously have a conspicuous member of the medical marijuana cannabis space on your Board and was just wondering if that individual is at all relevant to driving your initiatives forward here and maybe part B to that question is just what -- any commercial alliances or any discussions with any of the LPs in Canada you have undertaken and where those discussions might have proceeded to this point and I'll leave it there, thanks.

That's a very, very interesting question. I'm looking at Benoit, but maybe I'll kind of get started here. I had the pleasure and I see on the Board here that Matt at Canaccord is one of the analyst there is participating and listening and I had an opportunity to chat with Matt and those who haven't seen it, Matt produced a very, very compelling and interesting paper on the entire space and what I think is interesting for me is when you look at this business today, it's already large, but the growth in this business will mostly not be a dry plant [and smoking up about], it's going to be in highly-refined unique oil extractions that will be placed into a delivery form that is dose specific and it's interesting if you read Matt's paper just how this is a very, very interesting white space that is just not fully occupied.

So the growth will to a great degree be in this space and it's not adequately served today. Now in Matt's paper, he is predicting that will be about 40% of the total market and there's others out there, let's say, it could be larger. I think there are some places in United States, geographically that the proportion is [largely 40%], who knows, but I think it's going to be at least that as this becomes more mainstream. In terms of the equipment and I think what's important for us is an organization to communicate is we have infrastructure and we have competence in this space.

So we are not a greenfield site or greenfield company that is brand new. We understand the regulatory process, we already get inspected by the federal government. We have physical plant and equipment in terms of buildings and walls in energy and safety communities et cetera. Now in terms of the equipment, the equipment will need to be dedicated from a legislative standpoint. So there will be an element of equipment that will need to be installed, that will be dedicated to this, and there will be an element of security that needs to be added to our site in terms of -- it's a high level of security required. So there are some elements that will be unique to this business that will need to add and invest in, but I think most importantly for me, there's a macro infrastructure of competence and the hardware that we can bring to bear this process that will hopefully help us fast track this.

Now the question we often get and I'm sure there's many that are more expert than I and Benoit and I debate this and we debate this with others, just how long does this take. As I touched on earlier, I think the legislative process was really a wild card and I understand from some in the industry that they would build infrastructure and then have to wait sometimes, it's a long time, right, Benoit a year even before the legislators and inspectors could get to -- not legislators, but the compliance people -- inspectors could get there. I think that risk factor is probably much, much less now and the constraint on us as we proceed down this path will be mostly ourselves in terms of our ability to [detail engineer] and investments going forward. So it's to be determined and we have to see how it goes. I would say, it's no less than 12 months and it could easily be 18 months this process, but we'll keep you posted, Doug, as we progress down this path, but we've shifted our resources, we put senior leadership on it and we're moving aggressively down this path.

(Operator Instructions) And there are no further questions at this time. I turn the call back over to the presenters.

Well, just on behalf of Mario and Benoit who were joining me in the room, just thank you for your attention. We continue to work hard to move this business forward. I think if you reflect on the last one or two years, we've absolutely moved in the right direction and we're going to continue to work hard to continue that pace forward. So thank you everyone for listening and your support.

And this concludes today's conference call. You may now disconnect.