Enzymotec's (ENZY) CEO Ariel Katz on Q1 2016 Results - Earnings Call Transcript

| About: Enzymotec Ltd. (ENZY)

Enzymotec Ltd. (NASDAQ:ENZY)

Q1 2016 Earnings Conference Call

May 19, 2016 8:30 AM ET

Executives

Tram Bui – Investor Relations

Ariel Katz – President and Chief Executive Officer

Oren Bryan – Vice President and Chief Financial Officer

Analysts

Jeff Schnell – Jefferies

John Gardner – Wells Fargo

Tram Bui

Good morning, everyone, and thank you for joining us today to review Enzymotec's Financial Results for the First Quarter Ended March 31, 2016. Representing the company today are Dr. Ariel Katz, President and Chief Executive Officer; and Mr. Oren Bryan, Vice President and Chief Financial Officer. Dr. Katz will begin with the business review and provide an update on the company's growth strategy. Mr. Bryan will then provide a review of the first quarter financial performance. Finally, we'll open the call for questions.

Before we begin, we'd like to remind you that during today's call management may make forward-looking statements. These statements may include management's beliefs and expectations about the company's future results. Please be aware that they are based on the information currently available to our management and on assumptions management believes are reasonable as of today's date. Such statements are not intended to be representations of future results and are subject to risks and uncertainties. Future results may differ materially from management's current expectations.

We also refer you to Enzymotec's first quarter earnings press release that was issued this morning, and the 2015 Annual Report on Form 20-F filed with the SEC on March 3, 2016 for more detailed information on the risks and uncertainties that could have an adverse bearing on the company's operating results, performance and financial conditions.

During the call today, management will also disclose certain non-GAAP financial measures which are used as supplemental measures of performance. The company believes these measures provide useful information for investors in evaluating its operations period-over-period. For each non-GAAP financial measure referenced on this call, the company has included a reconciliation of the non-GAAP financial measures to the most directly comparable GAAP financial measures in its earnings 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.

It is now my pleasure to turn the call over to Dr. Ariel Katz.

Ariel Katz

Thank you, Tram, and welcome everyone to Enzymotec’s first quarter 2016 earnings conference call. Enzymotec stands at the forefront of innovation within the medical nutrition industry with our leading lipids technology, as well as a wide breadth of complementary technologies, concentrating on diseases prevention, infant nutrition, and the dietary management of diseases with medical foods. Medical nutrition is the fast emerging as a living field in healthcare and it beginning to attract the attention of multinational corporations looking to enter to this market.

We believe that Enzymotec is uniquely positioned ahead of the curve with our noble technologies, products and established distribution channels everything that we are doing from a research and development perspective that blistering of our intellectual property portfolio. The investment in infrastructure and sales and marketing initiative is intended to lay the groundwork for our overall strategy design to place the company back on accelerated growth objective.

So we can talk about the medical nutrition industry, what we are referring to. Medical nutrition is a clinical application of the role of nutrients played in health and diseases state. It is not intended to treat diseases, but to manage the diseases and can be used either alone or in tandem with conventional drug therapeutic to help patients to achieve a better quality of life. Medical nutrition spends the entire human lifecycle from infancy to adulthood and it works in three major ways.

First, it ensures that the nutrition is integrated into disease prevention strategies. Second, there is a pediatric nutrition, which supports the health, development of infants. And finally, there is a clinical nutrition, which supports adult, who are undergoing medical treatment of diseases therapy. We believe that Enzymotec is well positioned in each of these markets with our tailor-made solution as industry began to govern more attention in the healthcare field.

With that said, I am very excited to be able to report the strong first quarter with almost 24% revenues growth year-over-year as well as sequential growth on both the top and the bottom line. VAYA Pharma also had record revenues of $3.1 million in the quarter. Overall, the company continued to operate efficiently with strong gross margin profile of almost 67%, which is an increase of almost 500 basis points year-over-year and 540 basis points sequentially.

Furthermore, we generated $3.3 million in operating cash flow this quarter and increased cash and cash equivalents, short-term bank deposits and short-term and long-term marketable securities on our balance sheet to almost $80 million. We have developed a roadmap to expand our business to new territories, continues to grow in our established market and enable us to pursue additional opportunities across all our business units, which we are designated to generate its faster growth and higher profitability for the company.

First, we believe that Enzymotec is well positioned to advance up the value chain in infant formula markets with partnerships. Through the innovation and formulation of new clinically sound products, the camp found a research at our Human Milk Center, especially as the landscape remains competitive. Second, our bioactive division has been experienced strong demand for our PS products as we prepare to add new solutions and enhance our product portfolio in this division in order to further leverage our existing infrastructure and manufacturing capabilities to drive efficiency and growth.

Third, VAYA Pharma continues to post strong numbers as the sales reps increased their productivity and as the doctors continue to recognize the advantages to prescribing medical foods in this WellGen, Inc’s area. We expect VAYA to be one of the main drivers to our growth. And finally as we look for the opportunities to strategically invest our cash, our growth strategy includes among adding potential acquisitions that are complementary to our core business.

Let me start with the Infant Nutrition, market during the quarter we have continued to see steady growth as well as garner strong margins in the Infant Nutrition business against the backdrop of the industry that is currently experiencing overcapacity from the OEM’s. A shift to build to our share values retail stocks and the overall transition to the truly consumer product, these challenges help heightening the competitive landscape that the brand space will put Enzymotec in a strong position to develop key partnerships as such brand compete to repreciatethemselves from one another and maintain their market shares.

Based on the tools that we have such is our strong brand with InFat and the Human Milk Research Center we are developing a five plan - of five new innovative and tailor made solution some of which we are ready for commercialization with partners. We expect that this solution will enable the brand to lead the Infant Nutrition industry as well as solicit our own position in the market as an invaluable partner.

InFat is particular which is our legacy brand has become a tool for this brands for reinforcement generating more attention recently through the television and online channels. With our understanding of what the brands are facing in terms of competition and the solution that we can provide them. Our discussion with them continue to progress and we look forward to sharing more of details with you in the coming months.

Beyond our product offering we believe that there are tremendous opportunities to extend our geographic reach beyond China to expand it to the far East and Americas. For example the economic transition occurring in India and South America are analog to the changes that occur in China in recent decades.

The Infant Nutrition market in these countries although in their infancy are upswing driven by improving economics and more women gravitating to the workforce. This transitions are leading to more household with two working parents. Increase this possible income a new constraint on available time, which is beginning to propel sales of Infant Nutrition products forward and are expected to continue contributing to grow in the infant formula market.

A European based brand has recently launched the first infant formula containing InFat in North America market. And we will also start to commercial supply to two major U.S. based infant nutrition companies to launch product containing InFat in territories outside of U.S.

We believe that the commercial success in this territory may encourage them to launch product containing InFat in the U.S. as well. With a goal of entering the market in India, we’re beginning to build our infrastructure in the country and other potential medium term market for us is Mexico. We believe that our ingredients will allow us to form partnerships and will help to drive brands to the forefront and beginning to garner a strong consumers base by taking advantage of this consistent demands for well research safe and effective infant nutrition solution.

We also believe that there are opportunities in Vietnam, Indonesia and South America. And we continue to focus on exploring potential expansion on these geographies. As I have mentioned before our robust product portfolio led the ground work for the business activities that we’re pursuing. In the first quarter we were granted a U.S. patents for compositions and processes related to infant nutrition, we were also granted the new patents in China for InFat uses promoting the development of the beneficial of the gut flora and reducing crying duration.

These additions only fueled strengths our world intellectual property portfolio which is expensive in this enrich. I would like also to say this the International Chamber of Commerce tribunal has recently rejected AAK request for additional award and found that it has addressed all matters submitted in each February award.

And also has awarded certain costs to Enzymotec in connection with this latest request by AAK. And let me now transition to the bio-active division, in regard to the krill oil market overcapacity continue to challenge the market and the overall demand remains in general mainly in the United States and Australia. Even with slowdown of the market, we continue to operate superior product compare to our pills and are looking to pursue opportunities to extend this business to other countries, while the krill oil market does not represent a pillar to our growth it does contribute to our EBITDA.

On the other hand, the demand of our PS line of products remain high while sport nutrition represents a growing market PS, as a potential to extend additional sub specialty such functional food and beverage. Let me remind you that we also appear in a variety of grades and firms, such companies powder flew the prescription in all of which create opportunities for new product. As we prepare to add new solution to the bioactive division, we look further – forward to further leveraging our sales infrastructure manufacturing capabilities. Our goal is to be able to offer complete range of products and solution to our customer.

Overall, we have a very strong platform in the bioactive division, beyond just our close relation with our customers. We have both intellectual capabilities, highly efficient expanded manufacturing facilities and an extremely strong infrastructure, which includes office and sales representatives in Europe, Australia, China, India, Singapore and the United States.

And now moving on VAYA Pharma. As I mentioned in my opening remarks, VAYA generated record revenues of $3.1 million this quarter and we remain excited about the perspectives of this business. The sales out in the U.S., which includes IMS data and our online sales channel increased 47% this quarter year-over-year. We have continued to successfully direct a higher number of prescriptions to our online pharmacy and in conjunction with our call centers have been seen a raise in refill rates and compliance. The expanded salesforce now stand at 56 people reaching a total of 29 states, compared to 45 sales reps in 2016 with 23 states at the beginning of the year.

We have designed an expansion plan based on our external big data analysis and now we’re looking ahead, we plan to increase our salesforce to 65 to 80 reps by the first quarter of 2017. We will also begin reaching out to the targeted doctors in the area not covered by our reps, using a sales party’s direct marketing program, starting at the end of the second quarter. Over the last quarter, we have seen upswing in the salesforce productive, which is inline with our expectation and we expect productivity to continue increasing.

The team is working with more tools and better support systems that is contributing to their success. For example, they have medical years on their disposal as well as more marketing that has helped the sales process. Also as we published more papers, we are gaining more support from the doctors. Furthermore, we have continued to lay the groundwork to expand VAYA to new territories around the world. With our expansion in Singapore doing well, VAYA is exploring additional territories in which to launch.

On the clinical front, we recently reported exciting results from the preclinical study of InCog, our innovative lipid composition for cognitive functioning. InCog was found to significantly enhance brain development in preterm piglets. And as you may remember we also have a number of trials assuming such as 24 months, multicenter clinical trials for Vayacog to evaluate its long-term efficacy in patients with Mild Cognitive Impairment, as well as trials in children with autism, in adult with ADHD, and in ADHD children with epilepsy. We look forward to keeping you update on the trial results as we complete these studies.

And finally, as we explore, grow opportunities includes potential acquisitions to supplement our growth, Enzymotec is committed to our history of effective, efficiency and conserve activity. The clinical nutrition segment remains ripe for consolidation and we have identified several target of interest, but we will not deplete our balance sheet and resources if we cannot get scaling the business. We will only consider transactions that fit into our core competency as we have strong infrastructure from which we can leverage our intellectual property and manufacturing capacity. We need critical mass and we always be price conscious for any further transaction.

So let me conclude by saying that we continue to build upon our team’s strategy with a clear roadmap designed to help and put Enzymotec back on track for accelerated growth by taking advantages of our fruitful solution, infrastructure as well as of knowledge.

In the infant nutrition, we are developing a pipeline of products available for partnering that will allow brands to repreciate themselves in a competitive marketplace. Beyond our product offering, we have targeted specific reasons for expansion and we have started laying the initial groundwork by establishing our presence in IP. We have a strong foundation in the bioactive division with sales presence and manufacturing capabilities, where a more robust product offering will leverage our infrastructure.

VAYA Pharma serves as another growth engine that continues to expand as we make measurement, investment to reap that benefit. We look forward to coming months as we turn our focus to forming additional partnership, expanding our operations to new territories and believe that our investments across our business unit will come to fruition.

And now, I would like to hand the call over to Oren to discuss the financials.

Oren Bryan

Thank you, Ariel. Before I start, let me remind you of some important information with respect to how we present our financial results. The company accounts for the results of operations of Advanced Lipids, the Company's 50% owned joint venture, utilizing the equity method of accounting as required by U.S. GAAP. We recognize two sources of income from the JV arrangement.

First, we recognized revenue for the enzymes sold by us to AAK upon the sale of the final InFat product by Advanced Lipids to its customers. Accordingly, the revenues recognized from the arrangement are the amounts the Company charged to its joint venture partner, or the Company's direct costs of production plus an agreed-upon margin defined in the joint venture agreement. For the three month periods ended March 31, 2016 and 2015, sales of the enzymes to the joint venture partner amounted to $4.2 million and $2.9 million respectively.

Second, we also record our share of Advanced Lipids profits under the equity method of accounting. The Advanced Lipids profits that are shared between us and AAK are the profits that Advanced Lipids earned for its distribution activity.

To provide investors with a better understanding of our performance and for the purposes of segment reporting under U.S. GAAP, which requires presentation on the same basis provided and utilized by management to analyze the relevant segments results of operation, we account for the arrangement with AAK and the results of operations of Advanced Lipids using the proportionate consolidation method. Under the proportionate consolidation method, we recognize our proportionate share which is 50% of the revenues of Advance Lipids and record our proportionate share 50% of the overall joint venture cost of production in other operating expenses in our income statement.

And now let me discuss our financial results for the first quarter ended December 31, 2016. For the first quarter of 2016 net revenues increased 23.6% to $14 million from $11.3 million for the first quarter of 2015. For the first quarter of 2016 based on the proportionate consolidation methods that we used for segment reporting net revenues increased 19.5% to $17.1 million from $14.4 million for the first quarter of 2015.

The increase was primarily due to an increase of $1.4 million in InFat sales based on the proportionate consolidation method, an increase of $1 million in sales of VAYA product and an increase of $700 million in sales of PS product, partially offset by decreased sales of krill product of $300,000.

Gross margin for the first quarter of 2016 increased 480 basis points to 66.8% from 62% for the first quarter of 2015 primarily due to a change in product mix.

Research and development expenses for the first quarter of 2016 increased 34.3% to $1.9 million from $1.4 million in the first quarter of 2015, primarily due to an increase of $400,000 of expenses in respect of VAYA Pharma clinical trials.

Selling and marketing expenses for the first quarter of 2016 increased 78.2% and 18% to $4.3 million from $2.4 million in the first quarter of 2015, and from $3.7 million in the fourth quarter of 2015, respectively, primarily related to an expansion in VAYA Pharma's sales force, infrastructure and related marketing activities in the United States.

General and administrative expenses for the first quarter of 2016 increased 16.6% to $1.8 million from $1.5 million in the first quarter of 2015, primarily due to an increase in salaries and share-based compensation expenses of $300,000.

Adjusted EBITDA for the first quarter of 2016 increased 2.2% to $2.74 million from $2.68 million for the first quarter of 2015. The increase was driven by increase in the adjusted EBITDA of the Nutrition segment of $1.2 million as a result of increased revenues and increased gross profit margin and partially offset by a decrease in the adjusted EBITDA of the VAYA Pharma segment of $1.1 million as a result of increased operating expenses partially offset by increased revenues. Net income for the first quarter of 2016 decreased $1.4 million or $0.06 per diluted share from $1.7 million or $0.08 per diluted share for the first quarter last year. The decrease was primarily as a result of increased selling and marketing expenses an increase in research and development expenses mainly in the VAYA Pharma segment as well as an increase of $300,000 in share-based compensation expense, partially offset by the increase in net revenues and gross profit margin in both segments.

Non-GAAP net income for the first quarter of 2016 totaled $2.1 million, or $0.09 per diluted share, equal to the first quarter of 2015.

And finally, we would like to reiterate the guidance for the full year. We expect net revenues based on the proportionate consolidation method of between $68 million and $78 million, net revenues based on the equity method of accounting of between $56 million and $64 million, non-GAAP net income of between $6 million and $7 million a non-GAAP diluted earnings per share of between $0.25 and $0.30.

With those comments complete, operator, please open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Laurence Alexander from Jefferies. Your line is open.

Jeff Schnell

Hi, this is Jeff Schnell on for Laurence. Couple of questions, does the ICC rejection now put an end to all the litigation brought on by AAK or is there some outstanding and can you talk about how this may have effected the relationship or is everything as it was in the beginning?

Oren Bryan

The ICC first issued – ended their award in the March or in February rejecting on AAK’s claims among other things and AAK decided to ask for additional award which was also rejected this month. We hope that put an end, we don’t see a way that it doesn’t put an end to this field. However, as you can see in our report and the report that we issued today and also reported that AAK issued before us, that the InFat business and the operation of the joint venture is going well, the InFat sales increase, the margin increase, and therefore we hope that together we – that this together would be end of the dispute, will also contribute to the future.

Jeff Schnell

And then on the InFat formula market, can you talk a little bit more about how Enzymotec can generate more value for the technology like will these products that you're going to – that you have in the pipeline compete directly with InFat or will they be targeted for different regions or markets? And do you expect to do solely through partnerships or do you plan to vertically integrate it all?

Oren Bryan

The first answer is that we are not planning to compete with InFat ingredient that has its own benefit and create the value for the brand. But we – as I mentioned today in our call, we have five new ingredients that part of them are ready for commercialization. And we – our plan is to be part to go-forward and having some integration on the brands with our VAYA. And as I said, we have progress, discussion in this respect about this model and hopefully by the coming months we will be able to share more information on that. But if you are in general taking InFat as an example, the brands in the world were built around the InFat were about $2.2 billion. Our process ingredient supply are very, very low, and we believe the values that we create which is very unique should bring us more revenues and more profit from what we bring to the brand.

Jeff Schnell

Thank you. And then lastly if I can, can you talk about how you think about allocating R&D dollars to the nutrition business, specifically Krill or PS. What is the criteria you look at? And as it stands, which areas have the most demand pull compared to the areas you're seeing the longest – long-term health impact? Thank you.

Oren Bryan

Most of the R&D of the company is going to be a pharma segment and not to be a nutrition segment. We also spend invest R&D expenses in infant nutrition. So in terms of – as you know in that area I just replied to your previous question, so we're not – let's say a small portion of our R&D goes to the bio-active division which is the PS field that you asked. We do some research and develop – mainly the development of the product to new grade, new implications as for our customers.

Maybe I will add that medical nutrition become very, very important part of the business and many multinational companies either announced or exploring ways to penetrate it. And for us medical nutrition cover infant formula, medical food, and clinical nutrition. And we believe that we are ahead of the market and our investments in the R&D aim to continue to keep our competitive edge in the market and believe in terms of products and technologies in this area.

Jeff Schnell

Great, thanks very much.

Operator

Thank you. Our next question comes from the line of John L. Gardner from Wells Fargo. Your line is open.

John Gardner

Thanks, good morning. Ariel, I’d like to ask in terms of VAYA business, what percentage of sales there is now being derived from the online pharmacy?

Ariel Katz

I’d say something between 30% to 40%.

John Gardner

Okay, okay. And then in the nutrition business, can you speak a little bit about to the drivers of the increase in gross margin there this quarter?

Ariel Katz

Yes. So the gross margins of the company not only of the nutrition business – of the nutrition division increased as we report and this is result of the better mix. And when I’m speaking about better mix I mean that when we sale more VAYA products with 80% gross margin, we of course have better gross margin on the consolidated in financial statement. But also remember that increase the volume of sales of InFat when accounting by the equity method which carries higher gross margin of course improves our mix and improves our gross margin.

To add to that – to thing we reported last quarter, we completed the expansion of our manufacturing plant in Israel and these resulted better processes and more efficiency and better allocation of fixed cost that also contribute to a better gross margins in the nutrition segment.

John Gardner

Okay, understood. And then just last question for me, in terms of just the InFat being commercialized in North America, can you maybe just speak about it again, make sure I understood that correctly.

Ariel Katz

What I mentioned in my call, there is – this first product that contains InFat was launched in United States and it is currently in the market in United States. And it is launched by a European company that brought these products from the Europe to United States. If you want, I can send you information via the web, it is public domain information. And the second, I mentioned that there are two American-based companies that both InFat had launched outside of United States. And we believe that they will be encouraged with the results and we’ll bring it also in the future to United States.

John Gardner

Great, thank you.

Operator

Thank you. [Operator Instructions] I’d now like to turn the call back over to management for closing remarks.

Ariel Katz

Thank you very – everyone for your participation in question and for your support. We look forward to updating you on our progress in our second quarter 2016 earnings call in the coming month. Have a great day. Thanks.

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