Neptune Wellness Solutions Inc.
Q4 2017 Earnings Call Transcript

Published: 8 Jun 2017

[Operator:]

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.

[Mario Paradis:]

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 results ended March 31, 2017. Joining me today is Jim Hamilton, President and CEO; and also Mr. Mr. Benoit Huart, Project Lead of our new project Green Valley that Jim will talk about in next 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 maybe 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. 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 Exchange Commission. I’ll now turn the call over to Jim.

[Jim Hamilton:]

Mario, thank you very, very much. Just some of the 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 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 is growing on the revenue side by three-fold, 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 was generated from operations, as well as 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 31st, which was our fifth consecutive quarter of positive EBITDA. And just some comments and you will 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’ve got a lot of comparisons around that. But going forward, we’ll be on the normal calendar quarter. And I just wanted to move over to page five now, and talk a little bit about our strategic focus. And 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 NKA Original in that 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'll 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 strategic focus, so just moving clockwise around 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 their solutions business. I'll tell there has been a lot of work done in terms of enhancing the operational capability of this business. I think at acquisition they respect to a certain degree of 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, which we have originally shifted more resources to the frontline there. And actually have been very, very fortunate to be supported in that process by industry expert and veteran and administration, 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 on that path. Just moving along the clock here little bit down to leveraging IP and technology globally; we completed our two resolutions of the IP challenges that this firm has faced; it's been a big management time burn and 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 ross 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 the 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 are technological customer relationships process capabilities, et cetera. And I think we're starting to see the results of those efforts, and a couple are here are listed with the launch of the new product, an ultra high mega plus, 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 they are 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’ve licensed in and acquired and have the global rights for, and we completed our license. We’ve also launched that product and we're very, very happy with some of the numbers we're starting to see generate. This is a specialty form, highly a 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 Canada space, looking at uniquely and specifically at oil extractions at 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 interesting and very, very special initiative we have underway. And just to 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 when you reflect for those who know this Company and its story, we have effectively been a new entrant with our plant coming online two and half years ago. And I think we’ve reestablished ourselves in the market; in fact, I think we have grown share in the market; I think we've achieved quite a bit in terms of project Turbo, which we've spoken about in past calls, delivering over $5 million of productivity gains over the last year or year and 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. And a very, very interesting relationship it's a JV as we've reported and communicated, is focused on developing domestic krill oil business in China, which is an undeveloped; although, they make a three businesses developing in China, krill today is underdeveloped portion of that market. But I think the opportunities with our relationship CMI potentially could be more. They are in a 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 and we are impressed to see very intimate and deep relationship they have with the Chinese government and our meetings with the Chinese government to learn 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 the one more thing 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 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 number of estimates in Canaccord, I think being one that that has this market growing retail, potentially almost three to four folds 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 or around just $6 billion at retail. So a market today around $500 million going into very, very large and interesting territory. And I think sort of an interesting comment of 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 great degree that market exist 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 a delivery formed thereof. And when you look at our competencies as a business, this is what we do. We do extractions 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 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 on last year, I think, it was early-May mid-May of a consortium in the regions, it's 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 sub-Neptune, because it was the technology, the intellectual properties 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 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 a development there and so much as it's less of a risk factor in the process has been slightly streamlined as well as more government resources are being applied to it. So that’s good news that 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 and then started the process. I am looking at Benoit, I think that was 1,000 pages that went in, and it is a major, major undertaking in terms of the compliance standpoint. Let me just say that I think it's around -- I'm looking at Benoit, 75% to 80% of the initial applications today have been rejected right at the first phase. And we're 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 the space that we can apply to this business going forward. So there’s been comments, I’d we pleased to come back that little bit later. But maybe we could stop there and I’ll jump over to Mario to talk number, which I know is his passion. So Mario may be you can take us from there.

[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 quarterly and annual performance for our nutraceutical business unless otherwise indicated. Consolidated fourth quarter and annual fiscal 2017 for the fourth 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 under the Investors Relation section on our Web site. I would 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 as 13 months. I’m now at page eight of the presentation. The first two columns are the statutory reporting quarters, while the third and four columns are for the three months period ended March '17 and '16. And I will discuss the financial results of these three months periods ended March '17 and comparison with March '16. 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 solutions business last year and to inventory filling with some large clients. This decrease was partially offset by growth in the specialty intergradient 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 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 the last year. During this quarter, we recorded $2 million of R&D tax credits that were applied against the income tax in order to bring income tax payable to zero. SG&A doubled $2.3 million during this quarter compared to $3.6 million last year. SG&A expenses decreased by $1.3 million over the last year, mainly due to decrease in total compensation, professional and legal fees and acquisition costs. Adjusted EBITDA for the quarter, excluding the settlement litigation, amounted with Enzymotec, continue to be in the 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, '17 that consider Neptune's revenue of $1.6 million or equivalent CAD2.2 million. Taking into account the conditions of the settlement, the IFRS rules considered this transaction as an equivalent of IP intellectual property sale. And it is a non-recurring event we 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 the 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 GAAP 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 31st in comparison with the same period last year as shown on page nine of the deck, and more specifically the third and fourth columns. Total revenue for the 12 month period ended March 31, '17 were $45.1 million, up by $18.5 million or 69% over last year. This increase is mainly related to the solution business or 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 continued 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 cost and better efficiencies from operation, partially offset by product review mix. In terms of dollars, we generated $11.3 million, a solid increase of $7.4 million over the last year. As indicated before, we recorded the $2 million R&D tax credits 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 adjusted by a decrease in some areas like total compensation, professional and legal fee, marketing expenses and acquisition costs. Adjusted EBITDA, excluding the settlement litigation with Aker Biomarine and Enzymotec was $4.1 million compared to a loss, 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 reduction of SG&A expense and the Biodroga acquisition. Coming back to the Aker Biomarine and Enzymotec settlement agreements, the combined amounts 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, the income taxes expense of 2.6 recorded for the year is a non-cash expense, and is completely offset by 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 repayments. And I now just want to turn the call over to Jim.

[Jim Hamilton:]

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. The integrated model, especially ingredients, turnkey solutions and brands and along with that in part of our innovation process clearly is to look at executing against this medical cannabis oil extraction business. We think it's just absolutely fits with wellness and it fits with our competencies, and we're looking and working very hard on that. On the acquisition front, as we mentioned before, in terms of our three boxes of ingredient, solutions and brands and refine business that 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. And wonder when that last settlement is I think in terms of our debt structure, and balance sheet will continue to work to optimize that as we progress. May be one last comment here is just on cash. We haven’t talked about the Acasti, for those who are investing and have seen the recent releases, I'm glad for that for those who are Neptune’s shareholders, and having 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’ll be very open to any questions from those listening.

[Operator:]

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

[Doug Loe:]

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

[Mario Paradis:]

So the main explanation Doug is first we removed 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 some times in our krill business it's softer krill business it's softer. And at the same time, we have a softer month in the solutions business. So all these three reasons explain why December was another real good month. And just to the fact that we removed that month from the quarter of three months ending in March that’s the reality.

[Jim Hamilton:]

Yes, I think, Doug, it’s a interesting question. I mean, by the way, it's like you are seeing 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 is for me is a couple of things, One is, directionally, this business is not the same business it was a year ago or two years ago. I mean the business is effectively doubled and the bottom line is 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 had and anticipated in our solutions business that were very customer specific issues, but nothing that we’re too concerned about. So overall we’re very, very pleased with the year, and we feel very good about where we’re moving. I think part of our ambitions here is -- and one friend talks about tools on the -- or blades on stool. This business basically had one leg on the stool couple of years ago. And we are adding and continue to add legs to this 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.

[Doug Loe:]

And then second, if I can just maybe just shift sideways a little bit to your recently announced initiatives in cannabis oil extraction. I mean certainly looks like a positive exploratory move for. You leveraged your expertise in krill oil extraction into tracking other oil from other bio-materials, which cannabis is an obvious next evolution for you. Maybe just couple of question there; one, just wondering how much R&D or validating efforts you’ve done to this point, maybe specially if you’ve explored whether acetone or supercritical CO2 extraction actually works within your facility at creating high purity oil and do whatever -- what extent it retain it's cannabinoid like activity. Just whatever comments you can make there on 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 just wondering if that individuals, it's all relevant to driving initiatives forward, and may be Part B to that question is just what any commercial alliances or any discussions with any of the LPs in Canada you've undertaken and where those discussions might have proceeded to this point? And I’ll leave it there. Thanks.

[Jim Hamilton:]

Well, 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 analysts there is participating and listening. And I had opportunity to chat with Matt and those who haven’t seen, and 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 drive plant and smoking of about, it's going to be an highly refined unique oil extractions that will be placed in to a delivery forum, that is go specific. And it's interesting if you read Matt's paper just so how this is a very, very interesting wide space that it's just not fully occupied. So the growth will to a great degree be in this space, and is not adequately served today. Now in Matt's paper, he is predicting that that will be about 40% of the total market, and there is others out there that say it could be larger. I think there is some places in the United States, geographically, that the proportion is long or largely for who knows; but I think it's going to be at least that it just 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 had inspected by the Federal Government. We have physical plants and equipment in terms of buildings and walls and 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 an investing. But I think most importantly for me is there is a macro infrastructure of competence and hardware that we can bring to bear this process that will hopefully help us sell fast track. Now, a question we all can get and I'm sure there is 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 sometime, is a long time, right, Benoit a year or even before of the legislators and the inspectors could get to the legislature. But the compliance people inspectors could get there. I think that risk factor is publicly much, much less now. And the constraint on us as we perceive down this path will be mostly our sales in terms of our ability to detailed 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 will keep you posted Doug as we progress down this path. But it's -- we’ve shifted our resources, we put senior leadership on it and we’re moving aggressively down this path.

[Operator:]

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

[Jim Hamilton:]

Well, just on behalf of Mario and Benoit who are 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 and 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.

[Operator:]

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