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Enzymotec Ltd. (NASDAQ:ENZY)

Q1 2014 Earnings Conference Call

May 14, 2014 08:30 am ET

Executives

Ariel Katz – President & Chief Executive Officer

Oren Bryan – Vice President & Chief Financial Officer

John Mills – ICR (NYSE:IR)

Analysts

Scott Van Winkle – Canaccord Genuity

Brian Spillane – Bank of America / Merrill Lynch

John Bumgarner – Wells Fargo

Laurence Alexander – Jefferies & Co.

Rommel Dionisio – Wedbush Securities

Operator

Good day, ladies and gentlemen, and welcome to the Enzymotec Q1 2014 Earnings Conference Call. (Operator instructions.) As a reminder, this conference call is being recorded. I would now like to turn the call over to John Mills. Sir, you may begin.

John Mills

Great, thank you. Good morning, everyone. Thank you for joining us today to review Enzymotec’s Financial Results for Q1 Ended March 31, 2014. 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 star the call with a review of the key operating and financial achievements for the quarter and provide an update on their growth strategy. Then Mr. Bryan will discuss the Q1 2014 financial performance as well as the 2014 outlook. 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 statements may include management’s belief’s and expectations about the company’s future results. Please be aware they are based on the best available information to management and assumptions that management believes are reasonable as of today’s date. Such statements are not 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 all of you to Enzymotec’s Q1 Earnings press release and Annual Report on Form 20(f) for more detailed information on the risk facts and uncertainties that have a direct bearing on the company’s operating results, performance and financial conditions.

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

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

With that said I’ll now turn the call over to Dr. Ariel Katz. Go ahead, Ariel.

Ariel Katz

Thank you and welcome everyone to our Q1 2014 Earnings Conference Call. We are pleased with our start of 2014. Our team continues to execute on our strategic growth initiatives and leverage our core strength including infant nutrition, health and wellness., to generate solid Q1 net revenues growth, strong margin expansion and robust earnings.

We generated record Q1 operating cash and in January this year we repaid our long-term loan in full, and as a result we are free of interest-bearing debt. Specifically for Q1 we generated solid gross margin expansion of over 1400 basis points to 61.6% driven by a revenues increase of 43.3% in our Nutrition segment and 47.6% for our VAYA Pharma segment.

Net income was up 180% to $5.1 million and adjusted EBITDA grew 190.3% to $6.5 million. Oren Bryan, our CFO, will review the financials in greater details shortly.

We believe that we are well positioned for future profitability and growth as we continue to expand our customer base across our Nutrition and VAYA Pharma segments and further leverage our global infrastructure. Consumers globally are increasingly using our innovative proprietary lipid-based products to address their health and wellness needs.

Focusing on our two reportable business segments for a moment, our Nutrition segment and VAYA Pharma segment, both offer a variety of products that leverage our lipid-related expertise. In Q1 2014 the Nutrition and VAYA Pharma segment represented 94.5% and 5.5% of our total revenue respectively. Enzymotec’s success continues to be driven by our [class] of proprietary lipids technology and competitive advantage where created.

We remain focused on strategically working on clinical trials and gaining patents in key markets. We currently have [eight clinical trials] in process across various stages and additional clinical activities. This approach provides us with a key competitive advantage as we have accelerated our growth on the global level.

In addition as many of you know Enzymotec has over 150 patents and patent applications pending worldwide, including the filing of new patent applications in Q1. Our team will continue to expand our clinical validation over the coming years, reinforcing our current products and formulary indications. The potential market for both Nutrition and VAYA Pharma products is large and growing, and we will continue to invest in innovation to bring the highest quality nutritional ingredients to our customers.

Our Scientific Team remains committed to extending our intellectual property and delivering value to our customers around the world. In our Nutrition segment, customers of our infant nutrition product include some of the leading providers of infant formula in the world, and in Q1 we made progress with key new customers. INFAT, which is sold and marketed by Advanced Lipids – our joint venture with AAK – has also been achieving rapid penetration in the Chinese and other Asian markets. And we believe that we have a significant opportunity in other developing markets and developed markets such as North America and Europe.

In the near term, as I am sure many of you are aware, there have been recent Chinese regulation changes that require infant formula manufacturers to consolidate their production chain. As a result we expect certain changes to our supplier arrangement with customers in response to customer requests. The changes in Chinese regulation should not impact our 2014 revenues but we do expect that this will result in revenues being shifted from Q2 to the second half of the year. Oren will discuss our financial guidance in more detail shortly.

That said, we are still on track with our next generation of infant formula ingredients that are currently under development. These next generation infant ingredients target additional key lipids found in the human bloodstream in order to take (inaudible) to resemble the breast milk composition and aid functionality such as improved brain development.

Our dynamic manufacturing facility expansion commissioned at the end of 2013 continues to run as planned, as we successfully ran our krill oil extraction process. We also believe that having this process in-house will be more efficient due to the use of new technology and the sale of marketable byproducts of the krill oil extraction process that we didn’t have access to benefit from in the past, thereby also increasing our Nutrition segment revenues and gross profit margins long-term. In fact, we have started to see this impact in Q1 as we increased our gross margin of the Nutrition segment.

As we previously disclosed we plan to install new equipment to increase manufacturing capacity which will require a temporary shutdown in Q2. Oren will more fully discuss the impact of this in his remarks.

I also wanted to provide you with some updates on our joint venture agreement signed in December, 2013, with Polar Omega for formulation of Omega-PC, the new premium fish-based Omega-3 product which provides more complete nutrients and better delivery systems. We expect to commercially launch this product during Q2 2014.

We continue to believe that this JV provides both Enzymotec and Polar Omega with a (inaudible) product that is based on a combination of our scientific and intellectual process with Polar Omega, strengthened supply chain management and manufacturing. We believe that the existing Omega-3 market suffers from increased commercialization and lack of innovation, and Omega-PC is an innovative product in the Omega-3 category that brings a new benefit to our customers.

We also think that there are increasing opportunities for growth in new markets and as a result we have opened a new sales office in Turkey responsible for sales in Turkey and the Middle East. We plan to open additional sales offices in Australia and recruiting senior-level sales executives and regional sales managers in an effort to be closer to the market opportunities.

Focusing on our VAYA Pharma segment for a moment, our VAYA sales force in the United States ramped up to in Q1 2014 across the eight states where we currently market VAYA Pharma products. During 2014 we also plan to upgrade the operational system and the supply chain in the US. We believe that our sales force and updated infrastructure will help us to expand the position of our VAYA Pharma products given the [early] acceptance and adoption of our VAYA Pharma products by the medical community.

One good example of such adoption is the conference presentation on efficacy of Vayarin that was evaluated in 380 patients diagnosed with an ADHD behavioral rating. The study was led to testing and conducted independently by Texas (Inaudible) at the University of Texas without Enzymotec sponsorship. The results of this study demonstrated an association between Vaya-immune and behavioral improvement in most of the patients. In addition, 80% of the patients in the study wished to continue using Vayarin after a three-month period.

Our team is seeing a positive response from our targeted educational activities and product awareness has grown, and we’ve slowly begun to see more sales associated with the medical goods segment. In addition we are on track to conduct additional clinical trials to reinforce the science behind our VAYA Pharma products and to enhance the market opportunity for our VAYA Pharma products.

We continued our discussion with health insurance providers to get additional coverage of our VAYA Pharma products by demonstrating both cost-effectiveness and benefit for patient. Going forward, we also plan to grow our VAYA Pharma sales out of the United States through additional strategic partnerships.

As previously announced at the end of April we signed a final settlement and license agreement with Neptune and Acasti Pharma. As a result the related US Settlement Court action and the International Trade Commission investigation will be terminated. According to the terms of the agreement, Enzymotec receives worldwide nonexclusive license to the entire 348 patent family for as long as any patent in the family exists and until all our relevant current product as well as future anticipated product under development.

We are very pleased with the terms of this agreement as we have previously stated, and believe that the end result was in the best interest of Enzymotec. Importantly it did not have a marked effect on our Q1 results and we don’t expect them to have a material impact on our results of operation and financial position.

In closing, Enzymotec has established strong added value ingredients with recognized clinical validation which positions us well for future development and continued customer relationship growth and expansion of our products’ value and expansion of our global footprint. While we are pleased with the start of fiscal 2014 we expect to face a particularly challenging Q2 based on the few market dynamics that I mentioned and that Oren will discuss in more detail with our guidance.

Importantly we believe that these headwinds will mainly impact us in Q2 and remain optimistic in our outlook for the second half of the year due to improved supply/demand economics across our business units. Notwithstanding our outlook for Q2 we believe Enzymotec is well positioned for future growth in revenues and profits. As we continue to expand our customer base across our Nutrition and VAYA Pharma segment and further leverage our infrastructures in order to capitalize on growth opportunities in front of us.

We believe that our proprietary lipid-based technology focused on consumer needs, solid reputation in the large and growing nutrition market, and our innovative product portfolio further enhance Enzymotec’s competitive strength and position us for profitable growth in the long term.

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

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 US GAAP we are required to account for the results of preparation for Advanced Lipids, our 50%-owned joint venture using the equity method. This means that we recognize our share in the net results of Advanced Lipids as a share of profits of an equity in this (inaudible).

Accordingly, the revenues recognized from the arrangement are the amount we charged to our joint venture partner (inaudible) cost of production – not our share of the joint venture profit. To provide investors with a better understanding of our performance and for the purposes of segment reporting under US GAAP, this requires presentation on the same basis provided to and utilized by our management to analyze the relevant segment results of operation.

We account for the results of operation of Advanced Lipids using this proportionate consolidation method. Under the proportionate consolidation method we recognize our proportionate share of 50% of the gross revenues of Advanced 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 Q1 ended March 31, 2014. Based on the proportionate consolidated method our net revenues for Q1 2014 increased 43.5% to $23.7 million from $16.5 million for Q1 2013.

Based on the equity method of accounting, our net revenues for Q1 2014 increased 29.1% to $17.9 million from $13.8 million for Q1 2013. Our increased revenue performance was driven by robust performance in both the Nutrition and VAYA Pharma segments.

Gross margin for Q1 2014 increased over 1400 basis points to 60.6% room 47.3% from Q1 2013 primarily due to an increase in the volume of sales of higher-margin products as well as improvements in production efficiency and the operation of the new extraction facility; and also leveraging of fixed production costs.

Selling and marketing expenses increased to $2.3 million from $1.6 million in Q1 2013 and from $1.8 million in Q4 2013 primarily due to the license amortization expenses related to the settlement and license agreement signed with Neptune and as a result of building the sales force of VAYA USA in order to expand sales to additional states.

General and administrative expenses increased to $2.2 million from $1.1 million in Q1 2013. The increase was primarily due to expenses related to the secondary offering in February, 2014, and due to the patent-related legal expenses.

Our net income for Q1 2014 increased by 118% to $5.1 million or $0.22 per diluted share based on a weighted average of 23.3 million shares from $2.3 million or $0.12 per diluted share based on a weighted average of 3.8 million shares for Q1 last year.

Non-GAAP net income for Q1 2014 increased 135.3% to $5.6 million or $0.24 per diluted share from $2.4 million or $0.12 per diluted share for Q1 last year. The adjusted EBITDA for Q1 2014 increased 119.3% to $6.5 million from $3.0 million for Q1 last year.

Now moving to the balance sheet, as of March 31, 2014, we have $74.4 million in cash and cash equivalents, $19.8 million in other working capital items, and no debt. We also generated a record of $4.8 million in cash from operating activities during the three months ended March 31, 2014.

Finally I will provide you all with some context around our outlook for Q2 2014 and an update on our guidance for the full year 2014. As Ariel mentioned and as has been related in today’s earnings press release, Q2 net revenues and earnings are expected to be equal to or lower to Q2 2013.

As we previously disclosed, in Q2 we plan to install new equipment to increase manufacturing capacity which will require temporary shutdown interruptions. Additionally, recent changes in Chinese regulations require infant formula manufacturers to make certain changes to their production chain. As a result, changes may be required to supply arrangements in response to customer’s [wishes]. We believe this will result in revenues being shifted from Q2 to the second half of the year.

Finally, the recent weakness in the Omega-3 market had a negative impact combined with weather conditions in the US at the beginning of 2014 which resulted in delayed renewal orders from krill oil customers in the United States and additional market factors negatively impacted the Australian krill oil market. This is expected to be partially offset by increased demand from emerging territories such as Europe and the Far East in the second half of 2014.

Based on these variables I just described we have updated our fiscal 2014 guidance as follows: we expect net revenues based on the equity method of accounting of $68 million to $85 million, an increase of 5% to 31% over fiscal year 2013. We expect net revenues based on the proportionate consolidation method of $90 million to $110 million, an increase of 12% to 36% over fiscal year 2013.

We expect non-GAAP net income of $15 million to $22 million, an increase of 9% to 60% over fiscal year 2013, and we expect non-GAAP diluted earnings per share of $0.64 to $0.94. As a reminder, 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 the 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 an annualized basis given the inherent variability in our business associated with our strong growth.

With that we would like to take your questions. I will now turn the call back to the operator who will give instructions on how to queue up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator instructions.) And the first question is from Scott Van Winkle of Canaccord Genuity. Your line is open.

Scott Van Winkle – Canaccord Genuity

Hi, thanks. So starting with that Q2 guidance, Oren – if you expanded on this then I missed it and I apologized. To see revenues relatively flat year-over-year, given the gross margin gains you’ve had to date we’d still probably expect to see earnings relatively flat year-over-year in Q2, wouldn’t we?

Oren Bryan

As I said we expect Q2 to be equal or lower than the top line and bottom line of Q2 2013. You are right that the gross margin has increased compared to Q2 2013 but also we have increased our operational expenses throughout the last year.

Scott Van Winkle – Canaccord Genuity

Okay. And then as you go through the shutdown and install the new equipment, as we come out of that into the back half of the year what’s the margin implication? Obviously you’re going to have capacity for more sales – is this going to be margin accretive coming out of the new equipment?

Oren Bryan

The new equipment that we’re going to install in Q2 2014 is actually an increase of capacity. The effect on gross margin will be when we generate more revenues. There is nowhere an incremental increase from that capacity as we just did have with the extraction facility which we operated in the beginning of the year and had an incremental increase in our gross margin because of the new technology and the ability to sell the byproducts.

Scott Van Winkle – Canaccord Genuity

Thanks. And then moving on to the broader Omega-3 market, we’ve seen the fish oil side of the industry really weak since I’d say last July or August when that prostate study came out talking about fish oil. And it didn’t seem like krill oil really saw the same type of pressure. Has that changed more recently or has it just kind of been building? I know the fish oil market is even weaker today than it was say three or four months ago.

Ariel Katz

I will say that the area of the krill market, what we see is a little bit decrease in the United States and in Australia which were the traditional markets but we see a new development for krill markets in the markets where there was none, which is mainly the European market and the Far East. But you are right – a big shift of the Omega market started with the publication of (Inaudible) [Cancer postrata], and if you remember part of the negative publication were around the oxidation. And I do believe that actually Omega-3s that are in phospholipids create an opportunity to regain this market because they are much more stable.

Scott Van Winkle – Canaccord Genuity

Okay, okay. And then lastly you talked about the increase in the sales force at VAYA. I would have thought revenue would have been a little stronger in VAYA in Q1 with the incremental states and the investment in the salespeople, which I think came on right at the beginning of January. Are you expecting a payback to build in the incremental markets or can you give us an idea of how much adding Chicago and Denver and the incremental states that were added, how much that contributed to revenue in the quarter?

Oren Bryan

First of all I have to clarify that in the VAYA Pharma there are two different [channels], which is sell-out and sell-in. Sell-out is everything usually is in line. Sell-out is the [work center] selling to the pharmacies and to the patient and sell-in is when we shift to the [work centers] which are our customers.

So in Q1 there was some changes between different [work centers], which means different [work centers] taking different retail channels. And there are [work centers] that are buying products for one quarter in advance and there are [work centers] that buy on a weekly base – it depends on their system.

So I would say that in Q1 although we present it as flat or lower, if you’re looking at our sales out we continue to increase our sales in VAYA as we made before. And the reason is the shift between different [work centers] and the way that they’re buying materials.

Regarding the new reps, indeed we recruited new reps. We still have not seen any material sales from this team but we recruited them in the beginning of January – usually it will take one month of training. We have training in the office and then we have training in the field, and then they just started making introductions to working on verbalized messages, etc. So we expect that early in Q2 we will start to see some contribution from this team.

Scott Van Winkle – Canaccord Genuity

Perfect, perfect. Thank you very much.

Operator

Thank you. And the next question is from Brian Spillane of Bank of America. Your line is open.

Brian Spillane – Bank of America / Merrill Lynch

Good morning. So a couple of questions: first, can you expand a little bit on how the weather affected Omega-3 in Q1? Is it just that you’re going to have some orders that you’ll ship later in the year? Just if you can expand upon that a little bit.

Ariel Katz

What we have heard from our customers is that the shutdown creates a lower demand in the retail and there were many shutdowns because of the weather of the United States that had [local impacts] and real impacts. And what happened is they’re used to some level of sales, and whenever you keep some stock on the quarterly level or monthly level of course when they have some reduction immediately it impacts the following quarter.

So what we expect to see in Q1, late in Q1 was a little bit lower sales in the retail channel that keep a little bit higher stock in our customers but they continued to sell. So we’ll see probably a catch-up in Q3.

Brian Spillane – Bank of America / Merrill Lynch

Okay, alright. And then Chinese regulations, could you expand upon that in terms of just what changes infant formula manufacturers actually have to make and what specifically the impact is on your business?

Ariel Katz

The Chinese regulation is new so actually just in the last I would say couple of weeks it came clear. The Chinese regulation, the new changes in the Chinese regulation is that it’s now allowed to have a request to consolidate for quality control the production. So if in the past program a Chinese infant formula could operate one OEM, and if he doesn’t have enough capacity he can operate an additional OEM as a subcontractor of the OEM. This is not allowed anymore.

So they request that there will now be one OEM in the chain in this respect, and since the business has grown dramatically the Chinese [past] companies have more than one OEM in the chain. So they request consolidation. So it is not expected to impact our 2014 because our agreements are not with the OEMs – our agreements are with the infant formula producers. But they need to shift into consolidating their production, so sometimes they will request to expand the capacity; sometimes they will request to move from one OEM to the other OEM, and this is the change.

So in Q2 they organized all the OEMs and therefore we will see a slowdown during Q2, and expect that there will be a catch-up in Q3 and Q4.

Brian Spillane – Bank of America / Merrill Lynch

Okay, so you think that process of changing the OEMs should only take one quarter? Or is there a chance that that will go on for multiple quarters?

Ariel Katz

I don’t think it will take more than one quarter because what happened with the infant formula, it is going down with the stock level. And you know, the shelf life of infant formula is very limited so actually there is working capital [risk] on that. And they have to fix it as soon as possible in order to maintain their sales.

Brian Spillane – Bank of America / Merrill Lynch

Okay, and then if you could within the Nutrition segment could you give us some color in terms of just the sales performance in your infant formula ingredients business versus the krill business? I’m just trying to get an understanding of magnitude in terms of the growth in each one of those businesses.

Oren Bryan

I cannot disclose the breakdown between the products of the Nutrition segment but what you can see is that our proportionate consolidated method has increased more than the equity method. This means because of the accounting where you count revenue’s impact in the equity method only on the gross profit of it, you can understand that the majority of the increase was from the infant nutrition. More than that I cannot really comment on the breakdown specifically.

Brian Spillane – Bank of America / Merrill Lynch

And infant nutrition, just where do you stand now in terms of the plans that you have to increase penetration – to have the products become, INFAT I guess specifically, become more widely adopted? We’ve heard from some of the manufacturers that one sticking point is still some skepticism on the efficacy claims. Can you just talk about where you stand now versus what your plans were six months ago in terms of getting new business signed up?

Ariel Katz

I would say that we are more confident than in the past that we are on track with it, and we see the movement. We see the movement from companies that used to use the product in the premium brands moving to the main channels of the brand, and we have as I mentioned in my press release, we’ve had some serious discussion with new key players on adopting the [OPO] as the main innovative product in their formulas.

And on top of this, if you see those companies – speaking on the infant formula companies – those who have adopted the INFAT for example as their premium product, they’re performing extremely well. So it’s a public domain for information, companies like Wyatt, Lumina, you can see the publication of (inaudible), you can see the Lumina doing very well from Wyatt. You can see that [Balstein] is doing very well, you can see that [Deanmade] is doing very well. And these companies you know have INFAT or OPO-structured (inaudible) as I would say the main product which you can see from the publication of the public domain information.

So I would say that the combination of those who incorporated it have had great success, the scientific publications we’ve had give us confidence; the movement from the premium products to the mainstream and the serious discussions that we’ve had with other key players to incorporate it. So I would say we remain confident and we believe that we still have a lot of market share to capture.

Brian Spillane – Bank of America / Merrill Lynch

Alright, thank you.

Operator

Thank you, and the next question is from John Bumgarner of Wells Fargo. Your line is open.

John Bumgarner – Wells Fargo

Good morning, thanks for the questions. Ariel, any update on the FDA process with Vayarol?

Ariel Katz

Yes. We had the discussion with the FDA regarding the Vayarol after we submitted the IND and scheduled the end of Phase II meeting where the FDA asked us to arrange it in a phone call. I would say that our assumption is that we will be able to grow the test up to Phase III and getting SBA at a very low cost. I think we have been able to prove that and what the FDA requests from us is not substantially incurring additional work to prepare, is not substantial cost and is not something that has a risk, not a gain.

However, because we have seen recently a lot of trends in the specific triglyceride market which includes you know [Lovaza ]became generic, [Entera, Amalin], so we believe this is a very crowded market and we believe that we have to use our platform and our ability or the fact that we have been able to prove that we have a test to cut the cost and going direct up to late stages in the development, to go to and to invest in the efforts of the product in the users that have much more attractive business. This is what we plan to do.

John Bumgarner – Wells Fargo

Okay. And then Oren, in terms of the final settlement agreement with Neptune, the press release had mentioned that no future royalty payments would be paid in North America unless that interparty review is unfavorable to you; then in Australia unless the reexamination of the patent by the IP Office there is unfavorable to you. So I guess do you have a timeframe for when you think maybe a decision from the interparty review could be expected, and then what sort of timeframe can investors expect in terms of a reexamination in Australia? I’m just trying to get some clarity there in terms of the risk.

Ariel Katz

Okay. So if you don’t mind I will answer this. The first one regarding the United States, it’s in the public domain that the initial response from the Patent Office regarding the reexamination that was based on 351 was that all the claims are non-valid, this is the initial [reaction], and two of them are not possible or did not have substantial data behind it. So I would say in general the initial statement from the Patent Office is that the patent probably won’t survive and this is all in the public domain.

And the process usually takes I don’t know, one half year or something like that before the final decision but it was similar to 348 – the first decision was to reject and the final decision was to reject. So it’s a high likelihood that the claims will not survive, the claims that are in the reexamination.

Regarding Australia, it’s a much longer process because Neptune still didn’t gain any patents and there is no official announcement about patents in Australia. And we don’t know what are the claims and we don’t know if they did claim on what we would do as a reexamination, even with (inaudible). So we believe this is a long process that will probably take all of year.

John Bumgarner – Wells Fargo

Okay, thanks Ariel.

Operator

Thank you. The next question is from Laurence Alexander of Jefferies. Your line is open.

Laurence Alexander – Jefferies & Co.

Good morning, two quick questions. First on the VAYA sales force, can you give an update on the number of salespeople and the number of states that you’re selling in?

Ariel Katz

We are selling in eight states but in part of the states we [concentrate] in cities, like Chicago as a city. So we have basically eight states. We have currently 26 reps in the field and among them twelve basically are new reps. So we expect that they will start to have real sales or initiate after the training period in Q2.

Laurence Alexander – Jefferies & Co.

And secondly, can you give an update on your view of the stability or the likely prospects for the medical food regulations in the US, and also any other countries where the similar regulatory category might be created in 2014/2015?

Ariel Katz

Yes. First of all regarding the United States, you know we believe this is in real need of dietary management. And I would say that even those companies that wrote warning letters, we have not seen them stopped from action or acting in the market. So it’s not public information how they settled with the FDA but at least we see that even after the warning they continued to operate in the field. And so we believe that this is quite stable.

The second issue regarding the rest of the world we’re even much more encouraged because we see more and more countries adopting the medical foods. So for example in Australia since 2014 they adapted new categories, new regulatory categories which is the medical food which is new. We have seen in China that they are now currently going to adopt a new category of medical food. So the trend or the category that was established in the beginning in the United States, we have seen more and more countries adopting this category.

Laurence Alexander – Jefferies & Co.

And then lastly you mentioned earlier that with the new capacity that you have brought on stream, that it would affect your incremental margins. Can you give a sense for what you think your incremental margins might be as you bring the production in-house?

Oren Bryan

Yeah. Hi Laurence, it’s Oren. This is maybe an opportunity to say again that the right way to analyze our report is to do that on the basis of the proportionate consolidation method, since using the equity method with the joint venture accounting for the product INFAT has like a 95% gross margin – therefore you need to eliminate it.

So using the proportionate consolidation method you will see that we have increased our gross margin in the Nutrition segment by 1.0% over the last quarter, Q4 2013, from 44.6% to 45.6%. So we had an incremental increase of 1.0% or 100 basis points in our gross margin in the Nutrition. This can be representative of incremental gross margin because as a result of the new extraction facility but you should remember that during Q1 which was the first quarter that we used this extraction facility we were still using the other operation that we have in India. Therefore the full outcome of this extraction facility has not yet been shown in the Q1 results.

Laurence Alexander – Jefferies & Co.

Thank you.

Operator

Thank you. And the next question is from Rommel Dionisio from Wedbush Securities. Your line is open.

Rommel Dionisio – Wedbush Securities

Thank you, good morning. Along the production capacity expansion, between that and the extraction facility I wondered if you could quantify just on a percentage basis or perhaps on a dollar revenue basis how much more your capacity would be higher once this is complete than where it was say six months ago?

Ariel Katz

What we are putting today is we are putting some more manufacturing capacity in our current manufacturing plant. This would allow us to increase our capacity for all of our products. The answer to your question is very difficult because it depends on the needs of what we produce in these new machines that we are putting inside. If we sell it as a VAYA product therefore it’s a huge increase in capacity; if we sell those as ingredients for the value-added it’s a different answer.

So but what we said is that with that expansion we believe that we will be able to execute our financial plans for the rest of 2014 and 2015 and we will start building the new facility next year that will support our more traditional goal from 2016 going forward.

Rommel Dionisio – Wedbush Securities

Okay, and just a follow-up one if I may. On the Polar Omega business do you guys have some customers lined up? And just with regards to your revised 2014 guidance, would that include some meaningful impact from Polar Omega?

Ariel Katz

Polar Omega in our plans was not planned to be something material in our plans for 2014. And we said in our disclosures and press releases that our plan is to commercialize in 2014, to commercialize – to bring this product to commercial levels. And we repeat it now in the earnings release, that we expect to have commercial sales of this product in Q2 which is in line with our previous releases.

Rommel Dionisio – Wedbush Securities

Okay, thank you very much.

Operator

Thank you. And there are no further questions in queue at this time. I’ll turn the call back over to management for closing remarks.

Ariel Katz

Okay, so thank you everyone for your participation and questions. We look forward to updating you on our progress on our Q2 2014 Earnings Call in the coming months. And have a great day.

Operator

Thank you. Ladies and gentlemen, this concludes today’s program. You may now disconnect, good day.

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Source: Enzymotec's (ENZY) CEO Ariel Katz on Q1 2014 Results - Earnings Call Transcript
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