Neptune Wellness Solutions Inc.
Q2 2018 Earnings Call Transcript

Published: 15 Nov 2017

[Operator:]

[Foreign Language] Good afternoon, ladies and gentlemen. This is the operator. Welcome to the Neptune Wellness Solutions Second 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 Mario Paradis, Vice President and Chief Financial Officer. Mr. Paradis, you may begin your conference.

[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 second quarter results ended September 30, 2017. Joining me today is Jim Hamilton, our President and CEO. As usual, Jim will review Neptune’s operational highlights, followed by a 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 filing with the Securities Commission and with the Securities Exchange Commission, the SEC. I’ll now turn the call over to Jim.

[Jim Hamilton:]

Mario, thank you very much. Welcome everyone, those who have dialed in and those also on the – via the website. And for those who want to follow, there is a presentation that is posted in our Presentation section on our website. So just to start with a couple of comments relative to second quarter headlines. First and foremost, for those who attended the last call or had read the documents, the big news in the last quarter, of course, was our transaction with Aker BioMarine and the divestment of our krill oil business, our distribution and customers and manufacturing. Of course, the Sherbrooke site we have retained for our new business focus. Now the net gain of that was around $24 million. And pro forma cash after that transaction, around $32 million. We say pro forma cash because some of the debt repayment Mario made, there was – a couple days after the quarter closed. But $32 million, approximately, just a couple of days after the quarter, with a total debt repayment of just over $17 million. And the debt now is around – just below $5 million, $4.9 million. On the revenue side, revenues for nutraceutical business, $6.8 million. Of course, down from last year because, of course, the transaction with our krill business and divesting from krill sales. I would say that the krill volumes in the second quarter, there were some, smaller than the first quarter. But sequentially, the business and sales volumes was actually higher versus the first quarter, reflecting some good strength within our Solutions Business. And our objective remains double-digit growth in our Solutions Business versus prior year. And the net income and EBITDA, I’ll leave to Mario, who will get much detail on the numbers in just one moment. Just flipping pages over to Page 5. We moved and made a number of moves on our employee, creating our team, with Mike Timperio becoming the President of this business, along with Melody Harwood, the Scientific and Regulatory Leader. And subsequent to the second quarter, we also hired Eric Krudener, who we’ve appointed the Director of Product and Brand Development for our Cannabis business. And Eric’s job is – he’s based in Colorado and is deeply experienced in the sector, and his job is to help us accelerate and move forward with the right relationships, licensing and co-ventures with people to accelerate our brands in this business. A big news for us this week, of course, as we’ve approved an investment, capital investment, in our Cannabis business. Today, we’ve spent just two great days with the board here yesterday and today, looking at all of our business, but especially in our Cannabis business, with a detailed strategy, business plans, investments, ambitions, et cetera. And we will be sharing that in great detail with everybody, and so please come and attend our meeting on November 28 in New York City. I’m actually going to hit you with a couple of advertisements on that session, that’s just two weeks away from today. And we look forward to detailing out a lot more on the Cannabis business in particular at that point in time. Just moving to Page 7. The last call and at the Annual General Meeting, we discussed the consequences of the strategic review and exiting the legacy business of krill so we could focus on segments that are characterized by size and growth. And when you look at our nutrition solutions business in North America, we’ve identified that market potential at between U.S. $1 billion and U.S. $2 billion. And when you look at the legal cannabis business in Canada, the projections for that in the coming years is between $6 billion and $8 billion by a number of firms that are tracking the industry, whether it be investment banks, accounting firms, et cetera. And we like being in business characterized by size and by growth. And in doing so, consistent with what has always been our mission, and our mission, of course, is to lever our innovation and focus on great nutrition and wellness product solutions, and we see cannabis as being a great fit with this mission and a great foundation to feed into the ecosystem of, what we call, solutions, feed into our specialty ingredient platforms and feed into brands. Relative to some – a few more comments on the Sherbrooke site. As I mentioned, we’ve retained the site, and we’re very excited by this site. As I mentioned, the medical adult cannabis extraction markets present just a great opportunity and a great fit. And one of the things we like to say, it fits because it fits very much with the core competencies. Now when you think of cannabis, I’ll tell you one competence we don’t have is in cultivation, that we are not farmers. But we know extraction; we know the regulatory affairs; we know science; we know clinical research, we know how to build markets, and not just domestically, but globally; and we’re very, very excited by this business. We have a team of approximately 20 people working full-time on this, and we’re very, very happy about the investment that was approved by the board this week. And that capital investment will be largely focused on getting our site compliant with the very strict regulations in Canada to act in this business, so for example, securing the site with fencing, cameras, controlled access of storage vaults, et cetera. And again, we’ll be sharing much more on the strategy and expectations for this business with everybody when we’re together in two weeks’ time. Just moving to the next page about our Solutions Business. And we’ve mentioned this in the prior calls, we’ve done a tremendous amount of work about strengthening the capabilities and the processes in that business. Acquisitions remain on our target list. I will confess, we had been very much consumed with getting our Cannabis business and team moving as well as the – not only the strategy, but the capital investments required there; and as well as the divestiture, the exit with the Aker BioMarine team. But acquisition clearly remains on our agenda for nutrition. And as I mentioned earlier, we expect a double-digit growth in revenue for this business. And just one comment on MaxSimil, which has really been a star within our portfolio. And when we talk about MaxSimil, we often talk about it as an ingredient, but effectively, it’s a technology platform to aid the bioavailability and absorption of compounds. And we see this as a really exciting platform that we can apply to other products – in other products that we have in the portfolio, and you will hear more from us about that in the coming weeks and months. So with that, I’m going to pass it over to Mario to detail a little bit more on the numbers scenario.

[Mario Paradis:]

Thank you, Jim, and 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 performance for our nutraceutical business, unless otherwise indicated. Consolidated second quarter fiscal 2018 information for the three months period can be found in our press release and in Neptune’s consolidated financial statements and the related MD&A available on SEDAR, EDGAR and in the Investor Section of 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 second quarter ended September 30, 2017, and the comparison period is for the three months period ended August 31, 2016. Financial information for the three months period ended September 30, 2016 will not be discussed, and there’s low – there are no significant factors, seasonal or otherwise, that would impact the comparability of information. Furthermore, in respect of the accounting treatment of the transaction with Aker BioMarine, we indicated during our last call that the transaction could be treated as a discontinued operation or a disposal of assets. After deeper analysis of this particular transaction, we concluded that under IFRS Accounting Standards, the transaction has to be registered as a sale of assets. Our external auditors review and agreed to this accounting treatment. Consequently, the krill oil operations before the transaction and during the transition period were and will be registered within our operations. So if we look at Page 10 of the presentation, total revenues for the second quarter were $6.8 million, down by $4.8 million or 41% over the three months period ended August 31, 2016. The revenue decline is mostly due to our exit of the krill oil manufacturing and distribution activities related to the divestiture to Aker BioMarine. We had some sale in the second quarter, derived from the krill business before the transaction date, amounting to $0.8 million. And we anticipate to still have some sales in the third quarter related to the manufacturing of clinical supply for our affiliate Acasti Pharma. Our Solution Business was favorable in comparison with last year and registered double-digit growth sequentially over the first quarter. Our quarterly gross margin as a percentage of sales improved compared with the same period last year. Gross margin on sale came in at 29%, up nine points over the quarter last year. The improvement was mainly driven by product revenue mix related to the Solution Business. In terms of dollar, we generated $2.1 million, including royalty revenues, a decrease of $0.5 million over last year. The total cost of sales presented in the financial statements includes an impairment loss of $1.7 million related to inventory of frozen krill that was not part of the transaction with Aker BioMarine. SG&A totaled $3 million during this quarter compared with $2.5 million last year. SG&A expenses increased by $0.5 million over last year, mainly due to an increase in total compensation, royalty and commission on some Solution Business sales and a provision for bad debt, amongst other things. Adjusted EBITDA for the quarter was negative at $0.2 million compared to a positive EBITDA of $0.8 million last year. The variation of $1 million versus last year is directly related to lower sales from our exit of the krill oil business and the corresponding lower gross margin in dollars and higher SG&A expenses. During the second quarter, following the sale of certain assets to Aker, we recorded a net gain on sale in the statement of earning for an amount of $23.9 million. The total transaction proceed was $43.1 million or U.S. $34 million. And after subtracting the net book value of assets sold, which consists mainly of intellectual property and inventory, the reorganization costs, the related transaction expenses went up with a net gain of $23.9 million. Our quarterly net income, after taking into consideration the net gain on sales and the financing expenses, was $20 million in comparison with a loss of $0.7 million last year. Turning now to our financial position. We are happy to report that we have a very healthy and strong balance sheet. As indicated on Page 11 of the presentation, as of September 30, 2017, on a pro forma basis, after considering the reimbursement of $2.4 million to the Federal Government on October 6, we have cash of $31.8 million and the remaining amount of debt of $4.9 million. The financing cost of this debt is approximately 5% annually. We used a portion of the transaction proceed to deleverage our balance sheet by reimbursing $17.2 million of long-term debt. Finally, following the confirmed capital investment of $5 million in the Cannabis business, the investment to support that business of $2 million to $3 million and sub debt repayment for the upcoming two quarters, we anticipate that our cash position should be in a range of $23 million to $24 million at the end of the fiscal year. Now I’ll turn the call to Jim.

[Jim Hamilton:]

Yes. Thanks, Mario. Just a couple of looking-ahead comments at some – at risk of being a little bit repetitive here, but look, we have moved from a industry segment that could be characterized globally at maybe between $80 million and $100 million so we can more – better focus on market segments characterized in the billions. And doing so by not doing something completely different, but doing so, building on the foundations that this business was built on, competences and regulatory affairs, science by extraction, distribution and building markets. And as Mario said, we have a solid balance sheet. I don’t know if it’s ever been in better shape, Mario. And we are moving not only supporting our existing nutrition business but into a new business called Cannabis, and doing so with a differentiated approach. A differentiated approach where we will not be cultivators, but rather we will be using our competences to extract and excel in totally a new category for this business, and again, a business characterized in the billions over the coming years. And we’re very, very happy with the board endorsement of the detailed plans. The first public element of that plan includes the capital investment approval, which we are moving immediately upon in terms of modifying our plan to be in a compliance with the Canadian regulations. Of course, this compliance for security, et cetera, is a necessary element of the licensing process. If your plant is not compliant with those rules, you do not get a license. So it’s a parallel process, this investment and the licensing process, but we will detail those time lines when we share more detail about that when we’re together in two weeks. Solutions business, we like, and we like the progress there. Again, our objective that we’re on track to deliver on is a double-digit growth. And again, last time I’ll advertise that this one is our – a time in two weeks from now where we will detail much more in terms of what we think will be a differentiated positioning in this business, where we think the trends and the conditions are highly conducive to our entry in what would be a very, very large and attractive market segment called cannabis. So with that, we would welcome any conversation, either now or with your calls and letters subsequent to this call.

[Operator:]

[Operator Instructions] Your first question comes from Doug Loe with Echelon Wealth Partners. Please go ahead.

[Doug Loe:]

Yes. Thanks very much. Good afternoon, gentlemen. I don’t want to jump too far ahead here on the cannabis opportunity, mindful that you’ll be going over a lot of the strategic details in a couple of weeks, but maybe, Jim, just reflecting on the fact that when you sort of made us aware of this opportunity, either last conference call or the one before, it was still under active consideration and not a guarantee that you would’ve reached this point strategically. So just – maybe just give us a sense of what key learning sort of came to bear during your diligence on this opportunity in the intervening months? Just any macro factors where you saw that Neptune could provide a differentiated product to the market or manufacturing efficiencies or maybe any new market macro factors? Just things that you might have learned over your diligence period here that turned this into the opportunity that you’d think you’re justifying going forward with. And I’ll leave it there.

[Jim Hamilton:]

Doug, thank you for the question, and it’s a – potentially a very, very long answer. But really, the process began quite some time after I arrived and Mario arrived, where not only were we working hard to get the performance of the business in the plant and the krill business delivering, but a strategic review about the opportunity that this facility and the krill business presented long term. And we like the facility, we like the capabilities of the facility, but we didn’t like the dynamics that were happening long term in the krill and the prospects for us delivering value. And so we had a team together looking at other products, compounds, segments, that we could utilize and capitalize in this market. And I think we’ve talked about that and hinted at that in many prior calls over the last a year or two. Clearly, one of the opportunities identified over a year ago was the cannabis opportunity because it absolutely fit with our belief in the wellness sector. Remember, it’s interesting when you start to really understand the market people, I think, their history and their prejudices around the psychoactive properties. But the truth of the matter is, when you look at the consumer market data, more than half of the consumption is often for wellness, things like pain management, sleep, et cetera. And so we like the fit with our mandate under wellness, we like the fit with our competences. Some people say, oh, jeez, you’re not cultivators, and we have no intent, as I mentioned, to be a – we don’t have competence in cultivation. But when you look at this market and many example markets around the world, more than half is now presenting itself as extract – based upon extracted oils and delivery systems, which is exactly what we do. We extract oils, and we’ve managed to formulate things into delivery systems. It’s absolutely consistent with our regulatory competences. It’s interesting when you talk to people in this industry how complex they find the regulatory process. It is a complicated process, but it’s not something that is completely foreign to us. I think if you were in the business of flower growing or tomatoes, it may seem odd or new, but it’s something within our strike zone. So we started to formulate the license preparation process probably about this time last year. And I think the application, Mario, was over 1,000 pages in the end that was submitted. It’s a very, very detailed progress. It was formally submitted in April of this year, and we are working closely with the process and the people involved in the process, federally here, to make sure that it moves in an effective way. It is a parallel process, as I mentioned before, that you have to also, as you go through the steps, make sure that you are doing so and can demonstrate and prove that you have facilities and processes that are consistent with their license. So a long answer, Doug. But in the end, it’s – the genesis of this was probably about two years ago, and probably in a more detailed way, about a year ago. And we’re working very, very hard to be in this business as soon as we can. And again, that – those specific time lines, we’ll be sharing with people in two weeks’ time in our presentation specific to this roadmap, as we’re calling our roadmap for this business in two weeks’ time.

[Doug Loe:]

Great color. Thanks, Jim.

[Operator:]

[Operator Instructions] Your next question comes from Bob Johnson with [indiscernible] Research.

[Unidentified Analyst:]

I wonder if you could give us a little background as to others who may have this capability of extraction. I hear what you’re saying about not wanting to be cultivators, but it sounds as though the extraction is a more sophisticated approach, perhaps. And are there others who can do this? Are there only a few? Are there many? Where do you fit into the picture with your particular expertise?

[Jim Hamilton:]

Thank you, Bob, for the question. And it’s a great question, I would say. It is rapidly rising on the radar of people in this industry. I think when you – and I’ve met and talked with so many of them, as had the rest of our team has over the last year. I think people realize that if they’re going to be successful in this business, they have to have this capability. And in fact, some of the dialogue we’ve had with people that have visited us as well, they look at our capabilities and our operations and say, my God, it’s going to take us at least two years to get to what we see here. And so it’s not just facilities and hardware, it’s actually about people and processes as well. That is not easily acquired. So I think it’s on the radar of people. I think when you look around the United States and Canada, typically what you see is the initiation of this work, the start of this work in some cases, not all. And I would say it’s characterized by extremely small scale. One particular producer said something interesting to me though, Bob, I think he said, you know I’ve spent my life, my recent life at least, working on understanding cultivation and installing cultivation and raising money for cultivation. My God, I don’t know if I have the energy or the bandwidth to figure out this side of the equation. So I think some will be in the business, Bob. I think some will invest in this business. And a few may be successful. But we – our view is not all and many will not.

[Unidentified Analyst:]

When you see companies like Budwieser getting involved, that’s a dramatically different picture than we’ve seen in the past. And clearly, what’s going on in Canada is way ahead of the U.S. But maybe we’ll be getting there in time. But it seems to me that the upside of this potential is a subdued word might be pretty damn impressive. Another word could be monumental. And I wonder could you give us any flavor between those two as to how you all in the Board are looking at this?

[Jim Hamilton:]

Yes, Bob, absolutely. And we’ll share some of this in more detail as I mentioned in a couple of weeks. But when you look at this opportunity, we tend to utilize the context of Canada. But when you look at this opportunity, we tend to utilize the context of Canada. But when you look globally, Canada may be more developed than other countries in this regard. But we see this, it really is a global phenomenon that we see a lot of opportunity. We also see, when you speak of the wellness, I mean, Budweiser in alcohol community is one, maybe more towards the THC side of things and the wellbeing, if you will. But when you look at the CBD side of the equation around sleep and pain management, et cetera, we see that’s also going mainstream. And we sometimes think of beer. But Bob, I think we also have to think about the pain management and chronic pain management potential, and multinationals and consumer brands looking to differentiate and add SKUs to their business as well. So we think this is a very, very attractive business. And the analogy for me, being a long-term nutrition products’ person, it’s a kin to the nutrition products industry of many, many years ago. And I think it’s the genesis of something really, really attractive. But look, let’s just take one statistic. Just look at the Canadian estimates done by so many people in terms of penetration by consumers. And you get these estimates between $6 billion and $8 billion. If we’re even in a single-digit market share, we have a very attractive business.

[Unidentified Analyst:]

Well, sounds great. Good luck. We will be looking forward to seeing you.

[Jim Hamilton:]

Thank you very much.

[Operator:]

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

[Jim Hamilton:]

Well, thank you very much for everyone that’s listening in today. We appreciate the questions. We appreciate the listening and the support. And we look forward to talking again in two short weeks’ time. So please come see us in New York on 8

[Operator:]

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