Neptune Wellness Solutions Inc.
Q1 2018 Earnings Call Transcript

Published:

  • Operator:
    [Foreign Language] Good morning, ladies and gentlemen. This is the operator. Welcome to the Neptune Wellness Solutions First Quarter 2018 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. Mario Paradis, CFO of Neptune. Please go ahead, sir.
  • Mario Paradis:
    Thank you, operator. Good morning, everyone, and thank you for joining us. As mentioned, the purpose of today's call is to review our results for the first quarter results ended June 30, 2017. Joining me today is Mr. Jim Hamilton, our CEO. As usual, Jim will review Neptune's operational highlights followed by discussion on quarterly financial results by myself. Before we begin, I'd like to remind you that all amounts are in Canadian dollars unless specified, 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 statements, except as may be required by Canadian and U.S. securities laws. A number of assumptions were made by us in preparing these forward-looking statements which are subject to risks and 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. Now I'll turn the call to Jim.
  • Jim Hamilton:
    Mario, thank you very much, and good morning, everybody. Well, what a week. We've been very, very busy here. And for those who were not on the call last week or aware, I'm going to touch on elements of the transaction that we just completed, but for all I'm going to start also sharing some thoughts as we look more to the future. For those who are following, just on Page 4, our announcement last week that we did a transaction with Aker BioMarine to the tune of about US$34 million, and we will be exiting the bulk krill oil manufacturing. We have, as a consequence, a much, much stronger balance sheet with over $35 million asset, including debt repayment to a number of our people supporting us through loans. Transformative transaction allows for acceleration of repositioning into what we describe as much larger and more attractive growth markets. There were, however, a number of our employees affected. I am pleased to say though in that regard that one of our partners in the Green Valley Consortium, we've been working with, and we've been advised that approximately 20 people have already been placed and they're confident we can have all those employees placed shortly. So we feel very, very good about that. Moving to Page 5, just – it's important to reinforce what is not included in the transaction, and it's everything else. I mean, we have transferred elements of IP and we've transferred our commitment to close our krill oil manufacturing, but our Solutions Business, Biodroga, and all related assets including our product brands MaxSimil remain, the Sherbrooke site, all related equipment, our investment in Acasti, royalty streams, certain inventories, our brand. And moreover, I think as we look forward to that, we'll be partnering with Aker BioMarine in terms of our Solutions Business, and we had the Aker team in this – a couple of days ago. And it was a really, really constructive and creative session with an impressive crew. Moving to Page 6, just a little bit of a talk that we shared prior about yesterday and today. And I think it's important to reflect a little bit on the motivation for this. I think we've done a good job in terms of optimizing the krill operations both in terms of process, people, cost, quality, et cetera. But I think this market we believe strongly as a board, that this market is right for consolidation, and the choice is do you lead and be in front or are you a consequence of it. And it's a bold move but we choose to lead and we choose to be in front and hence we have made this decision now. We will remain active, as I mentioned, through our partnership with Aker in the soft gel business, supporting our Solutions Business. And by the way, we want to talk a little bit about that, on our Solutions Business, what we envision currently is that business will be double-digit growth as compared to prior fiscal year. Moreover, we're going to keep our web shop platform. And as I mentioned, we continue with our position with Acasti and we also have some opportunities for some earn outs down the road should they occur with Aker. Just looking at Page 7, and I just – we talk about Neptune's transformation. And I just want to spend a little bit of time on this what I call the first phase, and then let's focus on the future. But we've identified in our first phase these 4 key areas that we're focusing on, moving up the value chain, expanding our specialty portfolio, levering our IP and strengthening the krill oil franchise, and all of which, I think we've been very, very active on and moved this company forward. Most importantly, the acquisition of Biodroga. In our acquisition program, where we've defined clear criteria and have engaged quite deeply in some cases, especially a portfolio, in terms of the MaxSimil global license and development there, but more importantly launching a whole initiative, look at high-value unique extractions in the business and utilizing our facility. And we're very motivated as we've shared with our – with the cannabis oil market. IP resolutions and for those who have been here with this company for a while know that this has been a major focus, time consumer and eater of resources in terms of legal fees. And we are happy we've concluded all those. And most importantly, I think the strengthening of the krill oil franchise allowed for us to consummate a transaction at the values that we saw last week. Looking at Page 8, and I think the results of this is in the last 2 fiscal years, revenues have increased 182% and the adjusted EBITDA bottom line has moved by close to $29 million. But that's a little bit of the past, let's look forward. Page 9, and we talk about the focus for the future which remains absolutely consistent with what our mission has been and our defined focus, which is a combination of solutions, specialty ingredients and brands. No change there. And our investments going forward will be both in M&A and in innovation that support these sectors. And looking at Page 10, again one of the things that we wanted to reinforce with everybody to that we will be focused on sectors that are characterized by much larger size and by growth. And I think, when you look at the krill oil market, there's different estimates for this. We have characterized between USD 80 million and USD 100 million globally at the ingredient level. And that also assumes certain price assumptions. And I can tell you that given the supply dynamic that exists in that business now, those assumptions may be on the high side. We are more intrigued by participating in markets characterized by the billions and that are growing. And that is where we will increasingly put our time and attention. Just looking at Page 11, just a few comments on acquisitions. Mario – I'm looking at Mario right now. Well, you and I have been on the road a few times over the last months, but we are very attracted by industry segments that we can expand. At least 2 of the 3 solutions, special ingredients and brands, with EBITDA in line with high single-digit, and able to leverage the cash position and projected EBITDA to add through – that we now have and along with potential partners. And I will tell you, I think the appetite for partners to work with us in acquisitions will be much, much enhanced with this recent transaction, which excites us very, very much. I just wanted to talk through the following slide, which we also shared last week but I wanted to focus on 2 elements, the 2 bottom bullets here, which is our Solutions Business where we've done a ton of work in terms of process and focus. Again, we envision right now double-digit organic growth on that business for this fiscal year. And also, we're very, very motivated and intrigued by the technology platform that this could enable us in terms of looking at unique extractions and this nexus of these high-value unique extractions with these application forms are very, very intriguing for us. And I'll use an example, MaxSimil which is a unique product form, we deliver through the Biodroga solutions platform to create much more value. And we would like to do that increasingly with our business as we innovate going forward. A few thoughts on Page 13, in terms of what I referred to on these high-growth segments, and we want to, like I say, lever our scientific and innovative expertise. We believe we have a core competence there when it comes to extraction quality, regulatory affairs, et cetera. We're looking at a number of unique high-value extractions. But clearly, the medical cannabis market is one that is very much high on our radar right now. We have approximately 20 people that will be dedicated to this project. Now not all have been full-time assigned to it. I will tell you as we wind down krill operations increasingly, we'll be shifting resources over to that project. Also we had a very good engagement with our board here yesterday just in terms of the project timelines, regulatory pathways and full support from the board to continue. It's interesting, just a little bit of color there for everybody, it's very, very interesting that because of this krill oil transaction with Aker, what it has done is enabled us to utilize new and different space and equipment within the site which could help us accelerate some of those developments which we are just articulating as we speak now. And you'll see much more news from us in the coming months on that project. Just shifting over to Page 14, I'll just kick it over to Mario right now briefly to touch on some of the numbers for the last quarter.
  • Mario Paradis:
    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 the quarterly performance of our nutritional – nutraceutical business unless otherwise indicated. Consolidated first quarter fiscal 2018 for the 3 months period information can be found in our press release and in Neptune's consolidated financial statements and related MD&A available on CEDAR, EDGAR and in the Investors section of Neptune's website. I'd like to remind you that – excuse me, that as previously announced, our fiscal year-end has been changed from February to March. Consequently, the first quarter is ending on June 30, 2017, and the comparison period is for the 3 months period ended May 31, 2016. Financial information for the 3 months period ended June 30, 2016, will not be discussed as there are no significant factors seasonal or otherwise that would impact the comparability of information. So I'm now on the Page 14 of the presentation. And again, my discussion will focus only on the nutraceutical segment. Total revenue for the first quarter was $6.3 million, down by $4.8 million or 42% over the 3 months period ended May 31, 2016. The revenue decline is mostly due to the nonrecurring of a large order last year causing a significant reduction in krill volume and also to a decrease in the Solutions Business in comparison with last year, which is primarily related to inventory management of some large clients and timing of some purchase orders. Our quarterly gross margin as a percentage of sales improved compared with the same period last year. Gross margin on sales came at 35%, up 5 points over the same quarter last year. The improvement was mainly driven by product revenue mix and better efficiencies in operations. In dollar terms, gross margin were $2.4 million including royalty revenues, a decrease of $1.2 million over last year. SG&A totaled $2.8 million during this quarter compared with $3.2 million last year. SG&A expenses decreased by $0.4 million over last year, mainly due to a decrease in different items like compensation, professional and legal fees, and marketing amongst other things. Adjusted EBITDA for the quarter was $0.6 million compared to $1.1 million last year. The reduction of $0.5 million versus last year is directly related to lower sales and related lower gross margin contribution, partly offset by lower SG&A expenses. Our quarterly net loss was down slightly with an amount of $1.2 million. This is mainly related to a reduction of $0.5 million in the finance cost, which include a gain on the relative financial instrument of $160,000 during the quarter ended June 17. In respect of the accounting presentation following last week announced transaction with Aker BioMarine, we are actually assessing if we should consider the dissolution and manufacturing of krill oil as a discontinued operation or it should be considered as a disposal of assets. The accounting treatment will be determined for the next quarter financial results. Turning now to our financial position. As of June 30, 2017, we have cash of $4.5 million and debt – total debt of $21.7 million. On a pro forma basis considering the cash received from the transaction discussed earlier, the reimbursement of debt for an amount of $11.1 million and the estimated transaction and reorg expenses of approximately $3 million, our cash position is approximately at $36 million. The remaining debt would be $10.6 million, with a working capital pro forma of $51.2 million. I'll now turn the call over to Jim for closing remarks.
  • Jim Hamilton:
    Yes, thank you very much, Mario. I just want to say that our next phase is underway as we speak. I had the benefit of spending some time with one of our major investors and board members, who looked at me last night and smiled and he said, "Jim, we are so pleased that we are able to consummate this transaction, but we got to get moving. Like, what's next?" In fact, the initial call from him was I think 24 hours after we announced the deal. And we had the 24-hour notice to breathe and catch our breath before we have to go forward, and clearly it's an exciting journey but one will need to move quickly on. And I think that this transaction allows us the flexibility to accelerate that. We have done 2 transactions, when you look at January last year with Biodroga, and again, just last week with Aker, and I think this will allow us to accelerate that process, which is good news. We see what will remain in the krill business, yes. I think it's going to be an interesting upside possibility for our Solutions Business. And also we maintain our investment with Acasti Pharma as we speak. Our Solutions Business, as we said earlier, we expect to grow double-digit. And our activity at the Sherbrooke site will be viewed as we say an investment to support unique, high-value extractions and clearly medical cannabis is top of our agenda right now. We're working very, very hard on that right now. And what is also, I think, valuable and powerful for us as a team is that our management attention aligned with some of the encouragement from the board numbers I mentioned earlier is absolutely fully focused on these growth opportunities going forward. So watch this space for more news in the coming months. I think it's a very, very exciting time. And with that, we can open it up to questions, please.
  • Operator:
    Thank you. [Foreign Language] [Operator Instructions] Your first question comes from the line of Travis Brown from Seeking Alpha. Please go ahead.
  • Travis Brown:
    Hello everyone. It’s a pleasure to be on the call with you. Neptune has been a company I've covered multiple times at Seeking Alpha, and also as a shareholder I remain bullish. I have two questions I'd like to list. First, knowing how much work Neptune has put into patent defending and crafting good settlements, one of them being with Aker. Is new Aker partnership a sign of more aggressive competition versus Enzymotec or others in the space? And second question I had is the company's stock price has stayed a long time in this value territory without any new or large exciting buys by major institutions, I should say, that move that price per share upward. Are there any early indicators that sentiment will change as Neptune shifts from – or into the priority of Canada's medicinal cannabis oil versus the former krill oil?
  • Jim Hamilton:
    Okay. Travis, thank you very much for the question. I think – to the first comment, I think the space, as I mentioned earlier, is characterized by an abundant capacity. And in such cases where there is abundant capacity and growth is not keeping up with that, it's ripe for consolidation. More importantly, it's ripe for price pressure. I think unless you're very well positioned with a fully integrated operation, you'll be under pressure. And we have chosen to be in front of that and reposition this business in more attractive markets. I think for others in this space, I would be very, very careful, unless they have the right partnerships and the right alignments, I think they would be exposed. I think Aker is a good company. I think Aker is very, very focused on this space and will be one of the winners in this space going forward. Your question on stock price, as a second thought, is very, very interesting. I have spoken with a tremendous number of investors in the last days around this transaction. And I would say that there has been a very strong endorsement. I think large, sophisticated and institutional investors understand the dynamic of market's characterizes I described, They are very, I would say, pleased to see us take the lead in this process. And I think they are very excited by the possibilities. I think when you look at the stock price to, and I have heard this opinion from many and I know everyone has to make their own conclusion, but we have one large investor that likes to paint the picture, and adding up the various components of this business and when you do and you just look at the asset values, you very quickly get to the current market cap. And we don't apply really any value for the upside potential, such as cannabis license and/or accretive acquisition that we are now capable of doing. So I think the future for the stock actually has never been brighter. And we feel very good about the future in that regard.
  • Travis Brown:
    Yes. Thank you.
  • Jim Hamilton:
    Hey, Travis, thank you so much for the question.
  • Operator:
    Your next question comes from the line of Doug Loe from Echelon Wealth Partners. Please go ahead.
  • Doug Loe:
    Yeah. Thanks very much, and good morning gentlemen. Three things, and I'll just kind of talk through them one at a time here. Two are just kind of logistical questions for Mario. So it's great that you paid down your debt post quarter-end down to about $10.6 million. Just wondered – and the effective interest rate that we infer from your Q1 financials, the last quarter would have been a little bit north of 10%. Just wondering what the interest rate we should ascribe to residual debt that you're going to carry into Q2?
  • Mario Paradis:
    Yeah, we actually keep the federal government debt. We're in discussion with them to see if they want to stay and support our future. So we'll probably take a decision shortly on that, but the remaining debt as is, the interest rate will probably be around 5%, 5.5%.
  • Jim Hamilton:
    I think you’ve heard the financial – the federal that is 0.
  • Mario Paradis:
    Yes, it's 0 interest rate, yes.
  • Doug Loe:
    Perfect. That's great feedback. And then secondly, again, just kind of a housekeeping item here. What proportion of your EBITDA is going to be ascribed to any expenses that you are incurring in Sherbrooke while you're ramping up activities on medical cannabis production? Your EBITDA on a Biodroga specific basis, I mean, the margin around 9.5% would have been a little bit lower than what Biodroga was doing on a trailing basis prior to the acquisition. So I assume the delta is some modest R&D expenses at Sherbrooke. Can you kind of quantify those for us, so that we can kind of model it going forward?
  • Mario Paradis:
    Yes. So for the second quarter, Doug, we will – we need to continue to manufacture some goods. We – as part of the transaction, we committed to finalize some manufacturing finished goods. But starting in October and with the as is situation, we've done – in fact, we projected that our, let's call our burn would probably be slightly below $1 million a quarter. So that's our best guess for now. And after the second quarter when everything is settled in terms of manufacturing, the second portion of the layoff will be done during September for our employee Sherbrooke facility. And we'll have a clear more visibility at that time.
  • Doug Loe:
    Okay, that's great feedback on that. And then, Jim, just kind of referring back to Slide 11 where you're making it clear that you plan on being acquisitive going forward, and that's good to hear. A lot of obvious motherhood statements on that slide, but we're just – I'm kind of interested in the IRR threshold. Because I mean you could put any number you like on that slide as an objective, but I was just wondering if that return level is indicative of opportunities that you're seeing or – as opposed to just a target that you're hoping to kind of establish for potential products for sale, your vendors just kind of knowing what your investment criteria are. And then sort of Part B to that question, I'm just wondering if there are any interesting geographies that you're looking at in terms of market opportunities as you build out new product portfolio with Biodroga? And I'll leave it there.
  • Mario Paradis:
    So maybe, Doug, I'll start with some of the criteria there. So the IRR of 20% is – again, based on my past experience is kind of a rule of thumb, and minimum to reach. But most importantly, is – any acquisition will need to be accretive for shareholders and that's what we are looking. The other criteria is more to give you a perspective of what kind of targets we are looking, and I would just – maybe, Jim, if you want to follow on the targets that we have look at in the past.
  • Jim Hamilton:
    Yean, look, as we've said many times, we talk about solutions, brands and ingredients. We very much like companies that we've engaged with and seen and targeted that have at least 2 of the 3. We like the nexus especially of ingredients and solutions. And we like even the opportunity to take that further into marketing brands, which I think will be increasingly an opportunity in what is becoming more and more a fragmented market I say, we mentioned going from 5 TV channels to cable to streaming the consumers, just fragmenting immensely. So we are looking at companies that have at least two of those three. Again, our geography will be North America.
  • Doug Loe:
    Perfect. Thanks Jim.
  • Jim Hamilton:
    Doug, thank you sir.
  • Operator:
    There are no further questions at this time. I'll turn the call back over to the presenters.
  • Jim Hamilton:
    Well, great. Thank you very much everybody for listening. It's been a busy time for us. We are very, very happy about this recent transaction, and we are very, very happy about the opportunities that it brings both from an M&A and innovation perspective. And that's where we are focused full time going forward. And as I mentioned earlier, watch this space for more news in the coming months' recordings. Thank you very much for everyone's attention. Have a great summer.
  • Operator:
    This concludes today's conference call. You may now disconnect. [Foreign Language]