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Enzymotec Ltd. (NASDAQ:ENZY)

Q4 2013 Earnings Conference Call

February 13, 2014 08:30 AM ET

Executives

Dr. Ariel Katz - President and CEO

Oren Bryan - VP and CFO

Analysts

Scott Van Winkle - Canaccord Genuity

David Lee - Bank of America Merrill Lynch

Laurence Alexander - Jefferies & Co.

Operator

Good morning everyone and thank you for joining us today to review Enzymotec’s Financial Results for the Fourth Quarter and Fiscal Year Ended December 31, 2013. On the call today representing Enzymotec are Dr. Ariel Katz President and Chief Executive Officer; and Oren Bryan, Vice President and Chief Financial Officer. Dr. Katz will start the call with a review of key operating and financial achievements for the quarter and provide and update an update on their growth strategy. Then Mr. Bryan will discuss fourth quarter and fiscal year 2013 financial performance as well as our outlook for 2014.

Finally the Company will open the call for your questions.

Before we begin, we’d like to remind you that on today’s call management may make forward-looking statements. These may include management’s beliefs and expectations about the Company’s management future results. Please be aware they are based on the best available information from management and assumptions that management believed are reasonable as of today’s date.

Such statements are intended to be a representation of future results and are subject to risks and uncertainties. Future results may differ materially from management’s current expectations. We refer you all to Enzymotec’s final perspective from our detailed information on our risks and uncertainties that have a direct bearing on the Company’s operating results performance and financial condition.

On the call today management will also disclose their non-GAAP financial measures which are used as a supplemental measure of performance the Company believes these measures provide useful information for investors in evaluating their operations period-over-period. For each non-GAAP financial measure referenced this call, we have included a reconciliation table of the non-GAAP financial measures to the most directly comparable GAAP financial measures in the Company’s press release.

Please note that non-GAAP financial measures have limitations of analytical tools and should not be considered an isolation or the substitute for Enzymotec’s final results prepared in accordance with GAAP.

With that said I’d now like to turn the call over to Dr. Ariel Katz.

Dr. Ariel Katz

Thanks. Thank you for Flower and welcome everyone to our fourth quarter and fiscal 2013 end conference call. We are very pleased with our fourth quarter results which enabled us to report record net revenues profitability and cash flow from fiscal year 2013. Our team continued to execute on our growth opportunities within the global nutrition market specifically for the year we generated solid gross margin expansion of 290 basis point to 50.6 percentage revenue by robust revenues increase of 71.6 percentage of our Nutrition segment and 142.6% of our VAYA Pharma segment.

Net income was up 138.3% to 11.4 million and adjusted EBITDA grew 121.3% to $16.1 million. Oren Bryan our CFO will review our financial result in greater detail shortly.

We continue to see tremendous growth opportunities for our products in both new and existing markets. Consumers globally are increasingly using products containing our innovative proprietary lipid-based product to address their health and wellness needs. Focusing on our two reportable business segments for enrolment our nutrition segment and VAYA Pharma segment both offer a variety of products that leverage our lipid-related expertise.

The nutrition develop and manufacturing premium INFAT formula ingredients and bioactive value added ingredients. The VAYA Pharma segment focus on lipid-based branded medical good for dietary management of cardiovascular and neurological medical condition; available only under physician’s provision the United States which is currently the principle market for this segment.

For the fiscal year ended December 31, 2013 nutrition and VAYA Pharma segment represented 94.5% and 5.5% of our net revenues respectively. Throughout fiscal 2013 in particular in the fourth quarter our team executed our growth strategy to further strength our position as a global inventor of lipid-based technologies in either of our addressable markets.

One of the key growth strategies is to further focus on leveraging our current strengths in the areas of infant nutrition and consumers health and wellness help the consumers delivering end markets rapidly increase we believe that we have a positive momentum based on our business accomplished at the end of fiscal 2013 and the beginning of fiscal 2014 including the following; Enzymotec was granted patent by Canadian patent trademarks office and by U.S. patent trademark for us of INFAT which is a market and sold by advanced lipid our joint venture with AAK, the Canadian patent cover the use of lipid composition for promoting [intestine] development, maturation, adoption and depreciation.

The U.S. patent cover the [indiscernible] increasing bone strengths to the infant who is in risk of impaired bone strengths, we believe that this patent in Canada and U.S validated our growing recognition of international market and provide our infant nutrition product with the potential to outpace industry growth. Our scientific team remains committed to expanding our intellectual property and delivering value to customers around the world.

At the end of fiscal year 2013 we completed our Migdal Ha'Emeq manufacturing facility expansion and a successful operating run of our new cream extraction process which was in line with our expected the timeline. This manufacturing expansion enables as to turn krill meal into crude krill oil in-house and expand our capacity to capture future sales growth opportunities. We also believe that having this process in-house will be more efficient due to the use of the new technologies and the sale of multiple byproduct of krill oil extraction process from which we did in benefit in the past, thereby also increasing our nutrition segment revenues and gross profit margins long-term.

Enzymotec also granted a patent by US Patent and trademark office for one of our lipid preparation use methods. Specifically, the patent covers a method for enhancing dietary calcium absorption, bone formation and bone mass maximization in non-infant children or adults by administrating routinely a dietary supplement or food article that comprises the lipid preparation of the invention. The potential market for such product is large and growing and we will continue to invest in innovation to bring the highest quality nutritional ingredient to our customers. Enzymotec has been granted over 70 patents and has application for about 80 additional patents pending worldwide and our team will continue to expand our clinical validation over the coming years.

Our K-REAL krill oil received the New Food Raw Material certification in China. This was an exciting and important milestone for Enzymotec. While we already have a strong presence in China through INFAT, we believe that China represents a tremendous growth opportunity for us with our K- REAL krill oil given that the vast proportion of the population is increasingly consuming premium health and wellness product. In addition, we believe that this certification further demonstrates our international regulatory capabilities. At the end of 2013 we signed a term sheet of settlement with Neptune. As a result, the ongoing US International Trade Commission investigation brought against Enzymotec by Neptune is currently stayed. Today, we were not able to finalize the settlement agreement.

On February 11, 2014 we and Neptune informed the ITC that we would like to request mediation and we will be filing a motion for additional six-week day stay of the ITC processing. We don’t know whether this matter will be settled through mediation or otherwise whatever the ITC proceeding will be recommends. We also recently signed a joint-venture agreement with Polar Omega for commercialization of Omega PC. The new premium fish-based omega product, Polar Omega, is a Danish company specializing in production of marine phospholipids form for several fish sources. Further, Omega PC is wild fish cold extract containing omega fatty acids bounded to the phospholipids and triglycerides to better preserve the natural nutrient found in fish and enhance their both impact on general health.

We believe that this JV strategically combines our scientific and intellectual forces with Polar Omega's strength in the supply chain management, manufacturing by establishing strategic partnership between two significant players in the global omega-3 market from Israel and Denmark. This will take us one step further towards creating a new gold standard for fish oil. We believe that the existing omega-3 market suffers from increased commoditization and lack of innovation. And Omega PC is an innovative product in the omega-3 category that brings new benefits to consumers. And finally to round out our recent business highlights, to start with fiscal 2014, we expanded our VAYA sales force in the U.S. with 12 new reps across three new geographies including Chicago Colorado and Washington DC area. With this expansion, we currently market VAYA Pharma products in eight states in United States. This is in line with our plan to expand the distribution of our VAYA Pharma products giving the early acceptance to the adoption of our VAYA products by the medical community. With this planned sales force expansion, we will engage in targeted educational activities to increase product awareness and to grow our medical food segment. Also we plan to conduct additional clinical trials and studies to reinforce the science behind our VAYA Pharma product and to enhance the market opportunity of our VAYA Pharma product. Based on our data as of the first quarter of 2013 approximately 30% of the sales of our VAYA Pharma product in United States received some form of reimbursement from the sales party base. We continue our discussion with both public, Medicaid and private health insurance providers to gain additional coverage for our VAYA Pharma product by demonstrating both cost effectiveness and benefit for the patient. Going forward, we also plan to grow our VAYA Pharma sales outside the United States to additional strategic partnerships such as the relations we have developed with Teva Pharmaceutical in Israel Daewon Pharmaceutical in South Korea, Daiichi Sankyo Pharmaceutical in Brazil and PFM Medical in Singapore.

Finally, we will continue to focus on innovation and introduce new product onto that in both of our business segment. We plan to launch two new products in the next 12 months and have a pipeline of more than 10 additional products including new users and applications for existing product in various stages of development. Some of these products address new medical indication or provide new dietary or medical benefit while others provide different levels or consideration of active ingredients and offering through secondary characteristics.

In closing, Enzymotec has established strong aided value ingredient we recognize clinical validation which position us well for further development of customers’ relation and expansion of our global footprint. We are very proud of our accomplishments for fiscal year 2013. Looking forward, we believe that our proprietary lipid-based technology focus on consumers’ needs, solid reputation in large and growing nutrition market and our innovative product portfolio further enhances Enzymotec competitive strengths and position us for continued profitable growth.

With that I would like to turn the call over to Oren.

Oren Bryan

Thank you, Ariel. Before I start let me remind you of some important information with regards to how we present our financial results. Under U.S. GAAP we are required to account for the results of operations of Advance Lipids; our 50 own joint venture, using the equity method. This means that we recognize our share in the net results of Advance Lipids as a share of profit of an equity industry. Accordingly the revenue recognized from the arrangement are the amounts we charge to our joint venture partner or our direct cost of production plus our share of the joint venture for these.

To provide investors with a better understanding of our performance and for the purposes of segment reporting under U.S. GAAP which require presentation on the same basis provided to and utilized by our management to analyze the relevant segments result of operation we account for the results of operations of Advance Lipids using the proportionate consolidation method. Under the proportionate consideration method we recognize our proportionate share 50% of the gross revenues of Advance Lipids and record our proportionate share of the joint venture’s cost of production in our statement of operations.

And now let me discuss our financial achievements for the three months and fiscal year ended December 31, 2013. Based on the proportionate consolidation method, our net revenues for the fourth quarter of 2013 increased 69.5% to $24.1 million from $14.2 million for the fourth quarter of 2012. On a sequential basis, net revenues increased 7.1% from $22.5 million for the third quarter of 2013. Based on the equity method of accounting our net revenues for the fourth quarter of 2013 increased 59% to $18.5 million from $11.6 million for the fourth quarter of 2012. On a sequential basis our net revenues increased 4.3% from $17.8 million for the third quarter of 2013.

Our strong top line performance during the quarter was driven by robust performance in both nutrition and VAYA Pharma segments.

Gross margin for the fourth quarter of 2013 increased 540 basis points to 58.4% from 53% for the fourth quarter of 2012. Primarily due to an increase in the volume of sales of our higher margin product as well as improvements in production efficiency and leveraging our fixed production cost. Generation and administrative expenses increased to $3.8 million from $1 million in the fourth quarter of 2012 and from $2.2 million in the third quarter of 2013. Primarily due to the patent related legal expenses and due to the bonuses granted to certain employees in connection with our initial public offering in October 2013 as well as share-based compensation expenses mainly related to the IPO.

Out net income for the fourth quarter of 2013 increased 56.7% to $3.4 million, or $0.15 per diluted share, based on a weighted average of 23.4 million shares from $2.2 million, or $0.09 per diluted share, based on a weighted average of 4.8 million shares for the fourth quarter last year. The weighted average number of shares in the fourth quarter of 2013 includes 18.4 million ordinary shares issued in the beginning of October 2013 as a result of; one, the conversion of all previously outstanding preferred shares into ordinary shares; two, ordinary shares issued following the exercise of preferred share warrants and subsequent conversion; and two, the ordinary shares issued in the IPO.

Net income for the fourth quarter of 2013 includes approximately $2.2 million of IPO-related expenses. These expenses include the bonuses granted in connection with the IPO share-based compensation expense mainly related to the execution of the IPO and interest expenses related to the early repayment of long-term bank debt in the first quarter of 2014 from the IPO proceeds, excluding these items net income for the fourth quarter of 2014 would have $5.6 million or $0.24 per diluted share.

Adjusted EBITDA for the fourth quarter of 2013 increased 144.6% to $6.3 million from $2.6 million in the fourth quarter of 2012; on a sequential basis, adjusted EBITDA was up 62.6% from $3.9 million in the third quarter of 2013.

Now, I will focus on a few fiscal year 2013 financial highlight. For the year ended December 31, 2013 based on the proportionate consolidation method, net revenues increased 74.4% to $80.6 million from $46.2 million for the year ended December 31, 2012.

Based on the equity method accounting, net revenues for the year ended December 31, 2013 increased 71.6% to $65 million from $37.9 million for the year ended December 31, 2012. For fiscal year 2013, net income was $11.4 million or $0.53 per diluted share based on a weighted average of 9.3 million shares compare to $4.8 million or $0.28 per diluted share based on the weight average of 3.5 million share for the year ended December 31, 2012, an increase of 138.3%.

Net income for fiscal year 2013 includes approximately $2.4 million of IPO related expenses as explained before excluding this item net income for fiscal year 2013 would have been $13.8 million or $0.79 per diluted share. Adjusted EBITDA for fiscal year 2013 was $16.1 million compared to $7.3 million for the year ended December 31, 2012.

Now moving to the balance sheet. As of December 31, 2013, we had $74.4 million in cash and cash equivalents, $20.7 million in other working capital items and $4.2 million in debt. We also generated $7.4 million in cash from operating activities during the year ended December 31, 2013. On October 2, 2013, we closed our initial public offering in the United States and our ordinary shares were listed on the NASDAQ Global Select Market. After deducting the underwriting discount and the offering expenses, the net proceeds from the offering amounted to $62.8 million.

As we’ve previously communicated, we may use the net proceeds to meet our anticipated increased working capital requirement resulting from the expected growth in our business and for other general corporate purposes. We may also use a portion of our net proceeds to fund the construction of an additional manufacturing facility that we intend to build. In January 2014, we used $4.4 million of the net proceeds to pay the remaining balance of an existing long-term facility including early repayment fees.

Finally, I will provide you all with our guidance for fiscal year 2014. As Ariel mentioned, we expect net revenues to continue to grow on a sequential basis throughout the year, however the second half of the year will contribute the majority of the growth in revenues as the new manufacturing capacity becomes available, thus we expect net revenues based on the equity method of accounting to be between $88 million and $95 million, an increase of 35% to 46%. We expect net revenues based on the proportionated consolidation method to be between $110 million to $120 million, an increase of 36% to 49% and we expect non-GAAP net income of $18 million to $22 million over non-GAAP diluted earnings per share of $0.70 to $0.87, an increase of 31% to 60%. Non-GAAP net income represents net income excluding share based compensation expenses and other unusual income or expenses. Non-GAAP diluted earnings per share is diluted earnings per share based on non-GAAP net income. Please note, we will continue to provide you with an update on our annual guidance each quarter as we believe it is best to review our results on in, in an annualized basis given the inherent variability in our business associated with our strong growth, with that review we would like to take your question, I would like to turn it back to the operator who will give the instructions on how to queue up for questions.

Question-and-Answer Session

Operator

Thank you, (Operator Instructions) we will now take our first question from Scott Van Winkle from Canaccord Genuity, please go ahead, sir.

Scott Van Winkle - Canaccord Genuity

Thank you very much, congratulations on the results, the first question, the new facility you’re discussing is, did you expect a year ago to be putting on a second facility, you had the largest expansion on your existing facility. Now a new facility that, did you expect this or is this a result of sales and kind of visibility on growth coming in ahead of your expectations.

Ariel Katz

You know, the new facility that we recently announced and completion started to operate by the end of 2013 was related to the Krill extraction in order to increase the capacity, to address our needs and to improve the gross profit. On top of that we announced that we’re doing additional step of expansion in the plan and expand the plan to address our needs which we will take a couple of months to install additional equipment in the current plan. And we disclosed during the road shows and the prospectus we planned to build a new plant that will be probably in 2015, by the end of 2015 or beginning of 2016.

Scott Van Winkle - Canaccord Genuity

Okay, so the incremental facility isn’t what’s bringing on extra capacity later this year, that’s from the existing facility where you’re adding equipment.

Ariel Katz

Yes, and we expected to increase all the line of our product, we expected to see their capacity increase, in the second half of the year and therefore as Oren mentioned we probably will see the second part of the year with higher sales.

Scott Van Winkle - Canaccord Genuity

Sorry, I was confusing the two. Second the bioactive side if the nutrition segment, looks like it was down a little but sequentially after taking out the INFAT revenue. I know normally there’s not much growth in the Q4 but did that surprise you at all or is that a reflection of tougher omega-3 market today.

Oren Bryan

Thanks, Scott, actually we have showed increase in all our revenues in all our products, ending the two segments that are operating in, so we did show an increase also in the krill as well as the INFAT as well as in other products that we have in the bioactive ingredients.

Scott Van Winkle - Canaccord Genuity

Okay, great and then last question, with the further stay of the mediation with Neptune, what happens to legal expenses in the first quarter of a, maybe certainly down from Q4, but do they still stay up as you’re going through the process.

Ariel Katz

At least in……

Oren Bryan

Okay, as Ariel just mentioned, we are in the process now, we’re starting a 60 days, additional 60 days of stay to conduct mediation will also be, will actually result whether the legal expenses will continue to be a burden Enzymotec or not. If the mediation will be successful than of course the legal expenses will reduce significantly compared to the last two quarters.

Scott Van Winkle - Canaccord Genuity

Great and then if you could, you mentioned the VAYA sales force the incremental 12 salespeople, what was the total, what’s the current total now.

Ariel Katz

Currently we have 29 reps total and we’re not expected dramatically we’ll better our expenses. So we have increased our sales force and this was also expressed in the call, in the beginning of first quarter of 2014 we increased it by 12 in additional reps, and this will be reflected of course in Q1 but it’s not significant.

Operator

We will now take our next question from Brian Slan of Bank of America - Merrill Lynch.

David Lee - Bank of America Merrill Lynch

Hi, this is David Lee actually, standing in for Brian. Thanks for taking the question. My question specifically is on INFAT. I was hoping that you could provide an update on the adoption of INFAT, can you give us any more detail around the progress of additional manufacturers adopting the use of the ingredient.

Ariel Katz

You know, we see continuous growth and interest, unfortunately due to confidentiality with companies, you know we cannot disclose the names but I would say in general that we feel on track with what we have spoken when we went to the IPO and we see that the acceptance of the products continue. And this is reflected in Q4 results as you calculate and see that they will have increase of INFAT in Q4 ’14.

Operator

(Operator Instructions) Our next question from John [indiscernible] from Wells Fargo, please go ahead.

Unidentified analyst

Good morning, thanks for the question. Only two questions, and first off here looks like in the nutrition segment the gross margin there was a little bit higher sequentially, is that a good run rate for that business in 2014 or what’s kind of driving the gross margins there.

Ariel Katz

You are right, John and thanks for the question, it is indeed correct that our gross margins in the nutrition segment are very high this quarter, I will first explain why and then I will give you the answer for the second part for 2014. So, there’re multiple reasons for this growth, high gross margin in the nutrition segment. First is the higher volume of sales of INFAT, which in relation to other nutrition product carries a higher gross margin than the other nutrition products, and this is a more meaningful in the equity method of course, second is improvements in production efficiency and leveraging of fixed cost production cost, and the third reason I would say, that is the quality and the mix of raw material that we sold as you already know that our, the level of oils that we find in the krill meal that we saw it impact our gross product profit as higher quality of krill meals results greater yield and less processing and therefore higher gross margin. Regarding the first quarter of 2014 we believe that the gross margins will in the short term increase as just we explained that we expanded our Migdal Ha'Emeq facility to enable us to extract krill oil ourselves using an advanced technology equipment and our proprietary processes and we expect a higher production yield than we are producing, we were producing the krill meal, the extraction in India before and we expect also that we believe that we will be able to sell many of the marketable byproducts of the krill oil extraction process that we currently cannot sell which we believe will increase the net revenues and the gross profit in the short term. Is that answering your question, John?

Unidentified analyst

Yes, it was very helpful, thank you, and just as follow up, Ariel thinking about the viral moving into the phase three process, any news there, or expectations near term for that technology.

Ariel Katz

Yes, you know the FDA initially granted our request for an end of phase 2 meeting, however prior to the date of the meeting the FDA issued written comments on our submission, based on these written comments and telephone conference we had with FDA representative, we believe that the FDA would be willing to grant an SPA for proposal Phase 3 clinical study if we propose a mode of development plan than the one that we originally proposed including a more extensive phase 3 clinical trial. The total time in the course associated with the revised development plan are significantly lower than those that practically required for the development of prescription drug which we believe reflect our ability to be cost-effective and efficiently development prescription drug. Nevertheless, in light of the FDA expanded requirements for the investigational program and crowded market for hypertriglyceridemia treatments, we are currently evaluating our next steps in reconsidering the coast and the benefit of this specific project and how to handle the segment in the future.

Operator

Our next question is from Laurence Alexander of Jefferies, please go ahead.

Laurence Alexander - Jefferies & Co

So a couple of different things. First, on INFAT, can you talk a little bit about what you are seeing in the opportunities to pick up market share as competitor long-term agreements roll over. At least the first few agreements look like they have already rolled over without any shift in market share, but I wonder if you can just give your perspective on what is happening there?

Ariel Katz

Okay so first of all, for the future growth, we seek two main domains of continuing to increase the business. One is infant formula is divided to premium products and nonpremium products. So definitely we have started to see the movement from those who launched the product only at the beginning, on premium products to nonpremium products and, expand the use of the INFAT and become standard. And the second is in the areas for countries that have not incorporated as a main innovative product, we see possibilities that they will incorporate the product and we will expand the use of INFAT behind the current customers' markets that we currently operated or sales. Regarding the contracts that we have in our -- with our customers, we feel confident. We are striving all the time to bring more value and it seems that this is very stable contracts.

Laurence Alexander - Jefferies & Co

And are you seeing any sort of adverse pricing behavior by your competitors as they try and maintain their market positions or are they maintaining discipline?

Ariel Katz

As we presented in the past, we never consider ourselves just selling ingredients. We consider our selling product is a part of food services and our strategy is a company is always to bring more value to our customers and whenever you bring more value to the customers we always feel less pressure over the prices. So this is the area that we believe that our values are unique from the position that we are from or scientific background and therefore, I would not say that we feel strong pressure.

Laurence Alexander - Jefferies & Co

And then some of the companies have talked about the need for the industry to shift towards a higher potency or a more concentrated formulation, almost pharmaceutical grade, even in the consumer markets. That should work to your advantage, is that right or am I missing sort of how that will play out?

Oren Bryan

I would say what you say is true, but is general to all that nutrition market. And we believe that in the future the nutrition market in terms of quality and we’ll have much more regulation and as a company that is operated on pharmaceutical standards with GMP is a big advantage for us in the short and in the long-term.

Laurence Alexander - Jefferies & Co

And then on the nutrition margins, it sounds as if you were pointing towards margins expanding from the current level over the course of the year. Could you get above 35% margins for the year?

Ariel Katz

Can we get about what?

Laurence Alexander - Jefferies & Co

Sorry, 35% margins, can you get like 200 or 300 basis points higher from Q4 levels for all of 2014?

Oren Bryan

It's too informative question. We think in the long term that margin will be improved. In the short term, I already answered that we feel that or we believe that in the short term the gross margins of the Nutrition will increase as a result of starting to use the new expansion facility for the krill.

Laurence Alexander - Jefferies & Co

Okay. And then just one last one, if I may. With the krill harvest equipment, I guess there has been some discussion in the trade press of processing and trying to extract the krill -- extract the purity oils on the ships rather than doing it as a two-stage process. Would that have any -- if the industry does move in that direction, would that lead to any cost savings for you?

Ariel Katz

I would say that, as we said before in terms of securing the raw materials we're taking a lot of actions. We still have not published but in general I would say that we're making progress and we feel all track with our plans.

Operator

(Operator Instructions) As there are no further questions I will now hand you back to the management for any additional and closing remarks.

Ariel Katz

So thank you everyone for participating in today's call. We are very pleased with our record financial performance in fiscal 2013, but most importantly we believe the fiscal 2014 will be another strong year or sales and earnings growth will execute on our long-term growth strategies. We look forward to updating up on our progress on our first quarter 2014 earnings call in the coming months. Thanks very much.

Operator

Thank you.

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