Neptune Wellness Solutions Inc.
Q3 2020 Earnings Call Transcript

Published: 16 Feb 2021

[Operator:]

Ladies and gentlemen, thank you for standing by and welcome to the Neptune Wellness Solutions Incorporated Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your host Ms. Megan McCrae . Thank you. Please go ahead.

[Unidentified Company Representative:]

Good morning, everyone, and thank you for joining us. Yesterday afternoon we issued a press release, announcing our results for the third quarter of fiscal 2021. We also issued our management discussion and analysis and consolidated financial statements. These documents have been filed with the Canadian Securities and Regulatory Authorities of the U.S. Securities Commission and are available on the company's corporate website.

[Toni Rinow:]

Thank you and good morning. Neptune's fiscal third quarter results reflect the significant transformation taking place at the company. Several investments and changes are now in place that should drive an accelerated revenue growth beginning fiscal 2022 and have even more impact in fiscal 2023. The third quarter financials include the impact of shifting away from B2B extraction along with the COVID demand volatility and challenges in the global supply chain. We expect future quarters to show the benefit of the shift into branded consumer products and the resulting higher level of sustainable profitability and cash flow. Please allow me to provide you with an update on Neptune's transformation from B2B extraction to a fully integrated health and wellness company with a platform of innovative brands. Last quarter we outlined the four main steps of our transformation process

[Kelly Kosmin:]

Thank you Toni. I'm thrilled to be joining Neptune Wellness team as its General Counsel. I'd like to take this opportunity to discuss our recent acquisition of Sprout Brands and Morgan Stanley's relationship in more detail. Last week we announced our acquisition of Sprout Foods, a three-brand portfolio of organic, plant-based baby food and toddler snacks. Sprout is a great fit for Neptune as the products, people and corporate philosophy fit perfectly within the transformation we are undergoing. Sprout's three brands; Sprout, Nosh and NurturMe are disrupting the baby food market, which has historically been dominated by processed foods. With roughly $28 million in annual net revenues, Sprout already has a foothold in the organic baby food market. We see significant revenue and cost synergies with this acquisition. On the revenue side, we believe that our distribution network both in the U.S. and internationally can provide early additional distribution points for existing Sprout products. We also see opportunities for product expansion within Neptune's portfolio for example in our nutraceuticals business.

[Michael Cammarata:]

Thank you, Toni and Kelly, and good morning, everyone. I echo Kelly's sentiment on the Sprout's organic foods transaction and the relationship with Morgan Stanley. We expect the acquisition to have more value than it appears at first glance. We see Morgan Stanley as more than a new shareholder, but as a partner in our long-term growth strategy as we will be working together to identify future mergers and acquisitions opportunities. We see Sprout as a key part of our portfolio of innovative and disruptive brands in the plant based health and wellness area. Neptune is becoming a brand accelerator and we believe, we can continue to grow Sprout's brands with additional points of distribution and a larger product portfolio. We are excited to realize that the synergies that will come from having Sprout's and its three brands as part of Neptune. The acquisition of Sprout's comes after historical third quarter for Neptune as we move from B2B extraction to finished form, branded product revenues at our Sherbrooke facility. We now have the capability to produce multiple product lines at this facility. We are licensed from products from tinctures to distillate to CBD and gummies. Although, our revenues were impacted by the transition from extraction in the third quarter, this shift will lead to a higher and more sustainable margins and ability to create brand loyalty for our high-quality Cannabis products. As Toni mentioned, we are extremely pleased with the early success of Mood Ring in British Columbia.

[Operator:]

Your first question comes from the line of Aaron Grey with Alliance Global Partners. You may now ask your question.

[Aaron Grey:]

Hi. Good morning and thank you for the questions. So my first question is kind of regarding the hand sanitizers, some of the supply chain issues that you kind of mentioned during the quarter and specifically how it relates to the status of the $100 million of purchase orders that you had previously mentioned on the last call. So you had mentioned December kind of a delay to 4Q fiscal 2021 or beyond. It sounds like you're starting to see some improvement into 4Q and you mentioned to see more next quarter. But I just wanted to know if we can get some more clarity. You first put out the in December now. A couple of months removed from that. So I just want to get more color in terms of whether it was more related to kind of air versus now sea shipping? And with that kind of being two months removed kind of further color on changing the transition you've kind of seen up to-date to those kind of supplies being able to come in now and kind of get those sold. You mentioned shifting some supply as well within MD&A from Mexico too. So just any kind of incremental color you can give in terms of some of these supply chain issues, and how it relates to those purchase orders which you said are still in place, but also they mentioned there being some kind of issues with inventory and the repurchasing orders for those products as well. So kind of any incremental color you could give there would be helpful? Thanks.

[Michael Cammarata:]

Yes, I'll take that. It's Michael Cammarata. So the purchase orders are not related to hand sanitizers, the $100-plus million purchase order. So that's coming up with a different product line. Regarding hand sanitizer, specifically, we did have to shift out some of our international inventory to domestically made -- US made products for some of our retailers, and we did see that there is a switch in demand on the consumer side. So they're normalizing their levels at retailer. So the unique thing that we were able to do was actually be able to develop a US made high quality product that actually doesn't leave that sticky feeling or anything along those lines. So our product is superior and been getting great reviews. And we've had a lot of success with sustaining retail distribution in the hand sanitizer market and having opportunities to pick up additional distribution points. So our hand sanitizers have evolved to our latest formulation. We are also introducing Dr. Jane Goodall's natural plant-based hand sanitizers. That will be rolling out to retail. So we feel that we have a competitive edge both on the product formulation with Dr. Jane Goodall's plant-based natural product that's entering the market for hand sanitizers. And then our Neptune brand hand sanitizers, which we've moved to a US made and manufactured. And we've also lowered the cost of the manufacturing to be very highly competitive in the hand sanitizer market and to be able to retain margin. When it shifts to the $100-plus million purchase orders that we discussed, the international supply chain issues that we've seen was twofold. One, when air freighting product the cost would normally be around $200,000 to $300,000 and accelerated to over $1.3 million. We are competing with product launches with Apple and others and Microsoft internationally at the end of our year -- our calendar year. And then it shifted to us moving to containers and shipping it across the seas, those products for those purchase orders. Then we saw a shortage -- global shortage of containers. So we've had twofold hit us with fulfilling those, but we're committed to focusing on the profitability and not just rushing in orders to make timelines. We want to build a sustainable long-term business and we want to grow our profit margins. And also we've been looking at our P&L to even give more transparency and we've been working with our accounting teams and even the former CFO of Unilever to be able to monetize our P&L to be able to -- of North America, but monetize our P&L to be able to better reflect true direct cost to what it costs us to make the products. So the investors can see more along the lines of what the gross profit margin is in each sale. So regarding the hand sanitizers, we've switched out of any supply that was international to domestically made in the US. We are working with our retailers not only on our Neptune brand, but our Dr. Jane Goodall hand sanitizers that's launching. Both have higher qualities and competing heavily with brands that have been in that industry for a long time. And then internationally regarding the backfill purchase orders that we have, we are putting things on cargo ships. We had a little bit of issues with getting containers. We're starting to see improvements in the global supply chain. A lot of the components for those products come from overseas. And we expect to start seeing improvements -- modest ones in Q4 and then expanding obviously in Q1. I think I got all the questions on there.

[Aaron Grey:]

No. Thanks, Michael. I appreciate the commentary there and details. So second question for me. Congrats on the Sprout acquisition. So kind of mentioned a little bit of detail there on the potential kind of synergies you guys see particularly on the top line. Related to that in terms of the points of distribution, could you provide kind of some timing in terms of how you expect to be able to realize some of these synergies? And more color specifically in terms of the points of distribution you expect to be realized through the acquisition and how you guys look to leverage your own kind of distribution platform related to that?

[Michael Cammarata:]

Yes. So I think we're already starting to see and we've been working on a plan that maximizes the synergies before the -- between both entities. The couple of parts of the synergies. One is on a cost basis. We're looking to -- as a portfolio of three brands to synergize all three of their supply chains to improve gross profit margin, to give us an extremely good positioning on that. With the distribution, we've had success internationally expanding distribution for them that will start taking place in upcoming quarters with onboarding additional international customers. And then domestically, they will be rolling out chain-wide to Target over 1200 stores eight SKUs in upcoming months. So we've seen domestic success in distribution. We're adding international distribution. We have a great team in our health and wellness division as we've had to build our global supply chain through the COVID times. That comes over from Walmart. So we've been definitely thoroughly looking at how the opportunities are. They do have a great reputation and been strong in the domestic distribution. So adding Target was definitely something that we're really excited about. And then internationally expanding the footprint overseas, the products will be shown at the Dubai Food Show coming up as well. And we are working actively on completing the registrations in over 20 countries. So that's something that you'll see in international growth from. You'll see domestic growth in the US distribution. And also within Canadian, we're onboarding a Canadian retailer grocery store as well. So you're going to see growth simultaneously domestically and internationally, and also cost synergies for the three brand portfolios. And we're really good that Morgan Stanley and the management stayed on, to support the growth and been working with us on the plan and we're really excited to bring it to fruition and really starts our footprint in the plant-based foods area and we expect a lot of product innovations. It will also be very supportive to our nutraceutical business. As I talked about a little bit, we're looking for synergies on vitamins and expansions. And there is a heavy interest in kid’s vitamins and other products. So you expect to see line synergies between our nutraceutical side on the product development area as well.

[Aaron Grey:]

Okay. Thanks for the color. Thank you. And if I could just squeeze in one more. You mentioned that, you expect further M&A. So just any kind of color on potential targets and synergies that you would expect there too would be similar along the lines of just saw with Sprouts kind of in those help to modify products that are kind of smaller and growing can benefit from your distribution platform? Or any kind of color in terms of different verticals or a supply chain you'd expect for the M&A to occur would be helpful? Thanks.

[Michael Cammarata:]

Yes. We're looking heavily in plant-based arena, Personal Care, Home Care, Households and then obviously plant-based foods. And so -- and also tactical infrastructure support, because as we've started -- as our brand is starting to go to distribution and scaling we want to be able to continue to be able to support our brands from e-commerce to all the way into international and domestic North America focused growth. So when I looked at brands, it's really looking for brands that of purpose that fit within our values. We are obviously trying to set our ESG strategy very in line with our consumers. And I think that the brands that we're looking at and opportunities that we see are really some brands that are historical and some brands that have the momentum and that align with our philosophies. So we're definitely looking the cross-category, because we have a platform that we've built out over the last year and half that can support a lot of brands and distribution globally and domestically. And we've made a lot of optimizations in our supply chain both having domestic supply chain and focus in North America, but also in international supply chain. So we want brands that will be synergistic that will add to our gross profit margin and our top line and bottom lines.

[Aaron Grey:]

Great. Thanks for the color. And I’ll pass it along.

[Operator:]

Your next question comes from the line of Gerald Pascarelli with Cowen. You may now ask your question.

[Gerald Pascarelli:]

Hi. Good morning. Thanks very much for taking the questions. So just going back to the purchase orders, specifically related to 3Q on the shift or on the delay in revenue recognition. Can you quantify what you believe the impact was to your 3Q revenue specifically as it relates to the purchase orders? Thank you.

[Michael Cammarata:]

Toni?

[Toni Rinow:]

Sure. Can you hear me well, hopefully? So we -- these purchase orders that we had announced throughout Q3 and that Michael just mentioned are not related to hand sanitizers. They are all intact. So we are currently negotiating with suppliers to deliver these products to our different clients. It is difficult to say, how much they are on a quarter-by-quarter basis, because these are long-term purchase orders. We believe that we are going to fulfill them as soon as those international trade challenges are being resolved. Our goal is to transport profitable merchandise and to make these business lines -- gross margin profitable. And in Q3 that was just not possible for those international challenges. So we believe that those purchase orders they will unfold over the next quarters as those supply chain challenges are easing up and they stay to be all intact and they are related to different Neptune Innovation products.

[Michael Cammarata:]

And I'd also want to add too, we've been very fortunate that one of our CPG partners Unilever has entered into that category, and we'll be supporting manufacturing in that effort. So we do see that some of our synergies with our CPG partners have helped us broaden our supply base for those particular products that we are launching.

[Gerald Pascarelli:]

Got it. Thanks very much. So it's mid-February we're -- I guess halfway through fiscal -- through your fiscal 4Q. Not looking for guidance or anything like that, but if there's any kind of color you can offer just in terms of how your revenues are trending quarter-to-date maybe relative to the previous quarter maybe year-over-year? Any broad color you can provide there would be helpful? Thank you.

[Toni Rinow:]

Sure. So yes and you know for the reasons that we have seen in the past that we are not providing a guidance because even though the year-over-year growth is there, but from a quarter-to-quarter perspective revenue growth can be much more scattered. So -- but just in order to give you an idea of overall trend, we -- I believe that in this quarter Q3 we have gone through the dip and we're now moving back up. So yes, I think that's a fair first statement to say that we have moved through the more difficult time for us and moving back up. And I think what we can also see is that we will -- we will increase in Q4. And year-over-year I think you have seen that we are kind of close to doubling revenues fiscal year-over-year after nine months. And I think that trend certainly continues.

[Michael Cammarata:]

And I'll add too that we also -- one other thing on the Sprout's brand, we've actually had very good talks with Tesco. So you'll -- on the international footprint. So that would be another distribution point to the earlier question.

[Gerald Pascarelli:]

Got it. Thanks Michael, thanks Toni. Just last one for me. This is on SG&A. Obviously it was inflated this quarter due to the one-off big depreciation and amortization, but excluding that from an absolute dollar perspective it did go down sequentially. So I guess as we look at the SG&A line, I know that there was a 25% headcount reduction. Is that fully baked into that adjusted number which according to my math, it's about $17.5 million for the quarter? Or is there more -- white powder in terms of how you can leverage your SG&A line going forward as we look out to fiscal '22? Thanks.

[Toni Rinow:]

Yes. So in Q3 as you say most of the SG&A and the measures we have taken are fully baked in. So yes, we have a couple of non-cash that we have identified in the EBITDA adjustment in SG&A and some accelerated depreciation. So mostly the SG&A, yes it went down because we -- as you all know we are managing our cost -- internal cost structure extremely carefully. And that will continue to go on because our goal is still to work ourselves over the next fiscal years to EBITDA positive. So most of that indeed was baked in for Q3.

[Michael Cammarata:]

And I'll even add to that. It's definitely -- we're looking to -- on a year-over-year basis to obviously grow top line and also improve cost. And I think we're on the trajectory to do that.

[Gerald Pascarelli:]

Thanks very much. I will hop back into the queue.

[Operator:]

Your next question comes from the line of John Chu with Desjardins Capital Markets. You can now ask your question.

[John Chu:]

Hi good morning. My first question is just on the hand sanitizer outlook. You talked about oversaturation impacting demand. But I was also under the impression you're expanding into Costco's West Coast and U.S. Midwest retail outlet there. So can you maybe just talk about whether or not you did expand into that or whether or not that did not happen and that also contributed to the decline in the hand sanitizer revenue?

[Michael Cammarata:]

Yes. I think there's two parts to that. We have a great relationship with Costco and we'll be launching products with them and working with them on new product lines. When it comes to the particular hand sanitizers, they had -- some retailers not just Costco, but other retailers had to move out of different brands and it takes some time to sell off. So for instance, some retailers had 18 other brands. And then the retailers have cut it down to three or less and we've been made the cuts, but we're not going to be able to see the growth until they move through 18 other brands worth of hand sanitizers. The good thing that we have noticed on the different distribution points that we're in is that our brand is performing much better than the peers and competing with some of the biggest brands in hand sanitizer. We have seen some of the big competitors in hand sanitizers actually lose money to try and win back real estate from us. And we're committed to profitability and focusing and developing long-term relationships with not only the consumers, but our retail distribution partners. And so we do feel that we're in a good position and we're starting to see good movement obviously, because of our sales data on our particular brand but also real estate to start to open up. I think Q4 would be more like a stabilization side, but across the board. But I think as we move into Q1 and Q2, we should start to see the uptick and hand sanitizes as a business unit. And I think that's something that Neptune has done very good over the last year is to have multiple product lines. And to be able to adapt with demand on the consumers, but also be able to hold our product lines to the highest standard and also work with global and domestic supply chain that's seeing improved gross profit margins to be highly competitive against some of the biggest brands in the world.

[John Chu:]

Okay. So as a follow-up, you recently got some approval on the disinfectant wipe side. What's the timing for that? And is there any risk that by the time you're trying to get your market out to the retail market that you could see an uptick in a more oversaturated market similar to what we saw in the hand sanitizer side?

[Michael Cammarata:]

So when it comes to disinfectant surface wipes, they're regulated by the EPA in the states in different bodies across different countries, the barrier to entry is much harder similar to our Cannabis business, right? The licenses that we've had to attain and get take years and months and require a lot of work to you. The EPA is very similar, when it comes to licenses in the US and the different bodies in Canada and other countries. The format that we have on wipes is going to be a lot of B2B businesses as well. So they're more contract oriented. So commitments that are longer term. And we're even seeing that across some of our other portfolio products in our health and wellness space. That we're negotiating on contracts that could last for three years four years and that are very unique to us. So it's not as easy for other like brands that came in during a pandemic time, but didn't focus on quality. They're still sitting on shelves or are products that are focused on quality sold out and the retailers are moving out of those products. When it comes to wipes, those are heavily geared to a lot of B2B customers, so government and businesses and such and different territories with a high standard of licensing and requirements. So I think that the wipes are uniquely positioned for a longer term stable business and growth because of contract base, not necessarily all just retail focused and there's not a lot of competitive brands in that space.

[John Chu:]

Okay. That's helpful. And then maybe just a last question on the Mood Ring launch. I don't see any products listed in OCS yet and maybe give us a sense on when you think you might be entering Québec with that product brand as well?

[Michael Cammarata:]

I think we have a press release coming out pretty shortly. And Toni can talk about that.

[Toni Rinow:]

Yes, yes. Good question. So we are in very close conversations with SGDC. They like very much what we do. We have a new brand that we're going to announce very, very shortly. So you should stay tuned. And essentially, what they told us is that whatever you produce we take. So they're looking for good products for high-quality products. Our launch in the rest of Canada was extremely successful. The products are very high-quality for hashish. We had coverage like this is the best hashish out there. So we are looking very -- we're looking forward very much to Québec and it should be coming very, very shortly. So just stay tuned on that one.

[Michael Cammarata:]

And I'll add that, that was a unique and larger unique situation, because it's how we're -- like in the US, we're working with the retailers to develop brands, partner with them and to bring brands and collaborate with them when we launch new brands. To get faster distribution and more points and more support. But in Canada we actually -- in this scenario, we created a brand with a territory to launch and we're really excited about it. So yes, it's not going to be listed on the Mood Ring. It will be listed on the brand network that we're going to be launch -- announcing with that territory shortly.

[John Chu:]

Okay. Thanks. I’ll get back in the queue.

[Operator:]

Your next question comes from the line of Doug Miehm with RBC Capital Markets. You now ask your question.

[Doug Miehm:]

Yes. Good morning. A couple of questions. Starting with the US opportunity. I know Michael that you walked through what Senator Schumer and Booker talked about recently and I hope to see that news soon. But maybe you can give us a little bit more information on your thinking with respect to the US opportunity and especially in light of the fact that you did write-down the SugarLeaf assets again. Just compare and contrast what you've done there?

[Michael Cammarata:]

Yes. So actually the write-down is in correlation with us making transition in the US. So the goodwill and impairment on that accountant but Toni can maybe add more color after I speak. But is -- when it was written was tied to specifically hemp extraction, right? So as we're making the shift like we did in Canada to go from just extraction to finished form. It obviously had an effect on the goodwill and the impairments. So as we're looking at SugarLeaf Labs facility and focusing more on our finished form products to be ready for any shift and beyond extraction because we give much more value when we can control the whole quality process from extraction to the finished form. And we're seeing that with the reviews that we're getting in Canada and the quality scores like our distillates, like our teams that we've been working on -- in Canada on. Our distillates yielding more than -- almost 98% to almost 99%. So we're in a very good situation with quality and experience. So as we're looking at that facility in the US that we have, particularly the one that relates to the impairment, we were looking at broadening the uses of that facility to finished form and to -- from extraction all the way to packaging. And because we made -- we're making these changes with the business model in that area to move away from extraction to finish one product or branded revenues, as we're launching brands both in Canada and the US, that was something that triggered because of how it was written prior and the acquisition and a goodwill was tied to pacifically hemp for extraction for particular customers. So as we changed the model, we're focusing on Fortune 100 customers and we're focused on Fortune 500 customers and we're focused on making finished form not just doing extraction for farmers. So that is -- that had to play into it. And if Toni wants to add any more to that, she can.

[Toni Rinow:]

Yes. I think Michael you sort of -- you said it perfectly well. I don't think there was much to add at this point unless there is a more specific question.

[Doug Miehm:]

Okay. No that's fine. I think you did a great job answering that.

[Toni Rinow:]

Yes.

[Doug Miehm:]

The second question and maybe this has just been a mischaracterization and this is probably a question for Kelly. With respect to Sprout Foods and the MD&A, it appears that the company has been included in a US house subcommittee investigation on heavy metals. And one of the things that we saw in the Reuters article last night was that, I guess yourselves and two other companies refused to cooperate with the investigation. Is this a mischaracterization on inflammatory or something else or is it an accurate representation of what's going on there?

[Kelly Kosmin:]

Yes. Thank you for the question. This is Kelly. So I'll start by saying that it's an inaccurate representation prior to Neptune's acquisition of Sprout. Sprout had gone through at least two changes in leadership, and all of these activities that you're reading about currently in the news, actually occurred -- started back in 2019, early 2020. And at that time, it was a voluntary -- it was a lobbyist group and advocacy group for baby food. And some companies chose to participate and basically submit in information concerning their product lines. And those companies that chose to participate ended up getting smeared in the press for their participation. The leadership at Sprout back at the time, none of whom are still currently with the company, thought the more prudent approach would be to just lay low and not get caught up in this press campaign. So, as part -- so, saying that they refuse to comply is an interpretation of they chose not to participate. Because it would appear that no good deed would go unturned in this situation. So as part of our due diligence of our Sprout acquisitions we are aware of this issue. We recognize that it's an issue that actually occurs in the entire food chain. It's not simply limited to baby food products. And we are going to take the position and have been in discussions with Sprout and outside parties that we are going to be a partner in the industry. We will cooperate with the commission inquiry, and we want to be involved in a positive solution to this issue throughout the industry. So, we will be actively participating and partnering with others in the industry to find solutions.

[Michael Cammarata:]

Yes. And I don't like to even add like this is what Neptune health and wellness is about. We're going into the plant-based area, because we want to raise the standards. The fact that in baby food particularly was one area, but the whole US supply chain, everything from your pickles to other products has heavy metals into it, and what we're trying to do is not just to meet or exceed the FDA requirements but actually bring a new standard at a much higher level. So whether it’d be cannabis in Canada with us introducing MaxSimil, which is our IP that is very unique and people typically tie it to omega-3s and krill oil. But MaxSimil, actually is an enzyme that bypasses a digestive system and maintains that ingredient at a much higher level, so it goes directly into your system. So in a cannabis use, if you put MaxSimil with CBD or THC, it's an onset within two minutes versus people having an edible and laying 30 minutes not feeling anything and having too many edibles and ending up causing havoc on a health system. So, we have IP that's very unique to us that can make products safer like we're doing in Canada, that we'll be introducing MaxSimil with some of our products. We have a clinical study going on right now. And so the opportunity here for Neptune to really disrupt the CPG industry, has never been greater. And I think that when you look at Sprout's and it's been around for a long time and has very loyal customers and a good distribution platform and meet or exceeds. And the fact that Morgan Stanley is our partner and work with us on the strategic planning of Sprout and its distribution and its changes, and even in our growth opportunities and synergies of other products that we'll launching. I think we're very uniquely positioned to not only meet or exceed requirements in the territories we operate. We're going to be very active in raising the bar not only for plant-based foods, and the -- specifically in the US raising the bar across the whole US supply chain. So I think that that's something that we have an opportunity to raise the bar in the standards and really connect with our consumers and that's the type of brands that we're looking at that have the same philosophy as us.

[Doug Miehm:]

Okay, very good to know. Thanks, Michael, Kelly.

[Operator:]

Thank you, presenters, and thank you ladies and gentlemen, for joining us today. That concludes the Neptune Wellness Solutions Inc. third quarter earnings conference call. You may now disconnect.