Neptune Technologies & Bioresources' (NEPT) CEO Jim Hamilton on Q2 2017 Results - Earnings Call Transcript

| About: Neptune Technologies (NEPT)

Neptune Technologies & Bioresources, Inc. (NASDAQ:NEPT)

Q2 2017 Earnings Conference Call

October 12, 2016, 05:00 PM ET

Executives

Mario Paradis - VP and CFO

Jim Hamilton - President and CEO

Analysts

Doug Loe - Echelon Wealth Partners

Robin Cornwell - Catalyst Research

Operator

Good afternoon, ladies and gentlemen. This is the operator. Welcome to the Neptune Wellness Solutions Second Quarter 2016/2017 Earnings Conference Call.

[Operator Instructions]

I would now like to turn the call over to Mario Paradis, CFO of Neptune. Mr. Paradis, you may begin your conference.

Mario Paradis

Thank you. Good afternoon everyone and thank you for joining us.

As mentioned, the purpose of today's call is to review our results for the second quarter ended August 31, 2016.

Joining me today is Mr. Jim Hamilton, our President and CEO. As usual, Jim will review Neptune's operational highlights followed a discussion on quarterly financial results by myself.

Before we begin, I'd like to remind you that all amounts are in Canadian dollars, and today's remarks contain forward-looking information that represents our expectations as of today and accordingly are subject to change. We do not undertake any obligation to update any forward-looking statement except as maybe required by Canadian and U.S. securities law.

A number of assumptions were made by us in preparing these forward-looking statements, which are subject to risks. Results may differ materially and details on these risks and assumptions can be found in our filings with the Canadian Securities Commission and with the Securities and Exchange Commission.

I'll now turn the call over to Jim.

Jim Hamilton

Mario, thank you very much. Good afternoon everybody, and for those who are celebrating a very happy holiday.

We have a short PowerPoint presentation that can be found online both through MarketWire as well as our website under Investor Relations, and you can find that under neptunecorp.com.

So let's just begin. Our focus today of course is on the nutraceutical business. This is excepting Acasti.

And let me begin by saying that, although there's a lot of work to be done, let me say we have done a lot. Neptune today is a very, very different company. It is much stronger than a year ago in really all dimensions: the quality of the people, quality of the products, the portfolio, quality of our customer relations, and quality of results.

Let's just reflect a little bit on the second quarter. Revenues had CAD11.6 million, and compared to prior year that's 165% growth with contributions coming from our turnkey solutions business Biodroga. Our first sales of our new product MaxSimil and solid ingredient, specialty ingredient sales of Krill Oil, including some first sales to China.

Also, sequentially, our third positive quarterly adjusted EBITDA, around CAD800,000, and this compares to a loss of about CAD1.6 million a year ago, and we're maintaining our annual expectation of double-digit EBITDA margin for the fiscal year.

So when you factor in some items such as depreciation, interest expense, et cetera, the loss was about CAD700,000, which compared to a loss of about CAD1.9 million for the quarter prior year.

So again, the variances reflect continued growth in volumes of our products, our solutions business, and also I would add, improvement of our operating efficiencies such as through our Project Turbo, and Mario will touch on that in a minute.

I'd like to also call out an event subsequent to the quarter, which is the settlement of our litigation with Aker Biomarine. This is a USD6 million net settlement. And let me just maybe qualify that a little bit further. It reflects settlement of $10 million relative to licensing of Neptune IP and $4 million going to Aker Biomarine, hence the net $6 million.

Let me just say that Aker is a great company, they're very well-managed, and a great innovative firm too that has invested a lot in innovation and in IP over the years, and cross-licensing some of their innovation will prove I think very, very helpful for the continued success of Neptune going forward as will their licensing to our IP, and it also opens the door I think for a collaboration, which is important -- collaboration on items of mutual interests such as regulatory affairs, communications, and media things.

And I'd like to say too that, when you reflect to some of the time and attention and money by this company on this litigation, it will certainly free up a lot of that, to focus on what we're really here for, which is growing the business and innovating which leads to the next point such as MaxSimil. Subsequent to the quarter, we also expanded our distribution rights to MaxSimil to that global rights, and we're very, very intrigued by this product.

This product is novel and unique, and just a quick primer there for everybody, in essence, it's a more available and pre-digested form of Omega-3. And you would say, why is that important? Well, there's a large community, you could estimate up to 20% of our North American community that is challenged with digesting of Omega-3 supplements. Most extreme case would be people, for example, with Crohn's disease, and this gives consumers an opportunity that, who are otherwise challenged, to supplement with Omega-3's. And there was an announcement recently, I'm sure many of you saw, with one of our first customers, Xymogen, launching to their consumers and the practitioner channel, which we very much like where there is a conversation with consumers is where specialty products like MaxSimil can excel.

Just a further comment here. Also cash was grown to CAD7.1 million, up from CAD3.5 million as of February this year.

And then turning to Page 5, just the ingredient business has improved versus prior year. One of the reasons for that would be new form that we launched called NKO Omega Plus. This is 30% more Omega in the Krill products as compared to many out there on the market, which is really helpful for marketers, especially those who are on the shelf and competing against some private label brands, it helps differentiate. And we're seeing very, very good traction with that product.

And I would just add too that we've had our first sales of NKA. This would be for animal nutrition, which effectively is turning our byproduct, which we're spending approximately CAD800 a ton to dispose of a year ago at this time into revenue stream.

So, moving to Page 6, as I mentioned, Neptune today is a very, very different company. It's a growing nutrition products company, primarily focused business to business, turnkey solutions and specialty ingredients and also with an endeavor in consumer brands with OCEAN O3 which we launched the latter half of last year.

But focusing on turnkey solutions, it's just over half of our business. And I will say that I'm increasingly optimistic about this business. I think it's the right kind of business at the right time. Consumers today are just driving so much innovation. They're driving so much increased segmentation in the market, and the Biodroga team and our turnkey solutions business is right there to participate, and we are putting the plans to grow this business by 20% per year on average over the coming years.

The limiting factor, we believe is not demand here. We believe a limiting factor is our processes and our capacity, and we are investing in those processes and capacity as we speak, and again anticipate that we can grow that business by approximately 20% per annum over the coming years.

Our growing portfolio of specialty ingredients, as I mentioned earlier, with products such as NKO Omega Plus and MaxSimil and NKA, just below half of our revenue stream today, and we anticipate that we can grow this business double digit annually going forward.

So, some comments on organic growth. Of course, this excludes any ambitions relative to acquisitions, which we're very much motivated to do in the future.

And acquisitions, just page -- turning to Page 7, if they were in the field of any of the businesses we're in, turnkey solutions, specialty ingredients and consumer brands, and ideally all three, but at least two, we'd be very motivated, because we like the synergies between these businesses. We like turnkey solutions as a great pathway to sell specialty ingredients, and it's a great radar for innovation. Similarly, specialty ingredients is a great pathway to change the conversation of our conversation with customers there, and also an ability to drive innovation.

And clearly and ultimately, I think with consumer brands, we can look at that window as a way to commercialize our specialty ingredients, and also capitalize on the efficiencies that our systems can deliver. So all three, it creates I think a very, very compelling ecosystem, and we're going to continue to drive along those three platforms.

So with that, I would like to hand it over to Mario to talk a little bit more about the numbers, and then we'll come to some kind of looking-ahead comments. So, Mario, please.

Mario Paradis

I'd like to remind you that our results are in Canadian dollars and today's remarks may contain forward-looking statements. My comments today will focus on the quarterly performance for our nutraceutical business unless otherwise indicated.

Consolidated second quarter fiscal 2017 information can be found in our press release and in Neptune consolidated financial statements and related NDA, as well as [ph] on CEDAR, EDGAR and under Investor section on Neptune website.

So, turning to our nutraceutical results, I'm pleased to report that our revenue for the second quarter were CAD11.6 million, up by CAD7.2 million over last year, and up CAD0.2 million or 2% over the first quarter of this year. Our revenues include strong sales from our specialty ingredients business and the contribution from our recent acquisition of Biodroga for an amount of CAD5.7 million.

We are also pleased with our ingredient Krill business which grew by CAD1.3 million in comparison with last year, representing an increase of 32%. Our quarterly gross margin as a percentage of sales also continue to improve compared with the same period last year. The gross margin on sales came in at 20%, up 6 points over the same quarter last year. The improvement in comparison with last year is being mainly driven by the contribution of Biodroga, IO sales volume in specialty ingredients, and by overall improved operating performance and efficiencies as a result of the Project Turbo.

In terms of dollars, we generate CAD2.3 million, an increase of CAD1.7 million over last year.

When we compare sequentially with the first quarter this year, the second quarter margin was impacted by the usual Sherbrooke facility shutdown for vacation, plant maintenance, and some innovation and R&D testing, and finally, by temporary operational issues with our asset-owned recycling project which is part of our Turbo project initiative. As indicated, these issues were temporary and are now under control.

Considering our cost structure and fixed costs, these events had an impact of approximately CAD800,000 on our gross margins during the second quarter, of which approximately 50% could be considered as non-recurring.

In addition, Biodroga's product mix was favorable in the first quarter and returned to a more normal levels in the second quarter. Going forward, we expect gross margins to be in the range of 30% in the upcoming quarters.

A few words on our Turbo project. Initiatives continue to drive operating performance and efficiencies, and we are expecting that our CAD5 million target will be achieved by the end of this fiscal year.

SG&A totaled CAD2.5 million during this quarter. This is slightly lower than last year with CAD2.8 million and lower than the first quarter of this year by CAD0.7 million. When compared with last year, the Biodroga acquisition increased the SG&A expenses but was more than offset by a reduction in marketing and administrative expenses, more specifically in lower compensation expenses, as a result of Turbo Project.

Moving along, adjusted EBITDA continued to be in a positive territory for the third -- for the second quarter -- excuse me, for the third quarter in a row, with CAD0.8 million for the current quarter, compared to a loss of CAD1.6 million in the second quarter last year and an adjusted EBITDA of CAD1.1 million for the first quarter this year. The improvement versus last year was mainly related to additional sales from our turnkey solution business, continued improvement on gross margin from better operational efficiencies, and also from a slight reduction in SG&A.

On a sequential basis, the decline is adjusted EBITDA reflects lower gross margins, partially offset by a decline in SG&A expenses. We expect adjusted EBITDA in dollars and in percentage of sales to improve in the third quarter over the second quarter, mainly due to expected higher gross margins as discussed earlier.

Our quarterly net loss also significantly decreased, coming in at a loss of CAD0.7 million versus a net loss of CAD1.9 million in the prior year. The improvement of CAD1.2 million over last year was primarily due to the same factors outlined for adjusted EBITDA and also a foreign exchange gain of approximately CAD400,000 related to our debt denominated in British pounds.

Talking about our debt denominated in pounds, we entered during this quarter into a cross-currency swap in order to convert this debt into U.S. dollar. So interest expenses from the U.S. dollar debt will partly act as a natural hedge against our revenue denominated in U.S. dollars and the debt itself against our receivable in U.S. dollar.

Turning to our liquidity. On a consolidated basis, the corporation has consolidated cash and short-term investments of CAD15.3 million as of the end of the second quarter. Of this amount, CAD7.1 million was for the nutraceutical segment, or Neptune, and CAD8.2 million was related to Acasti Pharma. Neptune's quarterly cash balance on a standalone basis increased by CAD2.1 million from CAD5 million at the end of first quarter. The operation including working capital generated CAD4.6 million during this quarter, less the finance cost of CAD0.5 million and debt repayment of CAD2 million.

Finally, in fiscal 2017, for the nutraceutical segment, we're now expecting annual revenues to be greater than CAD45 million, up from our previous number of CAD43 million, with a double-digit adjusted EBITDA margin.

I'll now turn the call over to Jim for closing remarks.

Jim Hamilton

Great. Mario, thank you very much.

As I mentioned before, Neptune is a very, very different business, much stronger business than a year ago. We are in the business of wellness solutions and we're going to keep working to drive growth by providing great wellness solutions that deliver health and well-being, with a particular focus on growth on our turnkey solutions business, and we're going to invest in scaling and the capabilities of the business, and specialty ingredients, in terms of considering to lever our capabilities there as well. And ultimately, we're motivated to look at acquisitions that complement not only our solutions, specialty ingredients, but perhaps also consumer brands.

In the near term, we're also going to be looking at strengthening our position, our cash position, and optimizing our debt structure. And for fiscal 2017, for the nutrition segment, we expect revenues now around the CAD45 million, with double-digit EBITDA margin for the year.

And with that, we'd be pleased to open it up to any questions.

Question-and-Answer Session

Operator

[Operator Instructions]

Your first question comes from the line of Doug Loe of Echelon Wealth Partners. Please go ahead.

Doug Loe - Echelon Wealth Partners

Yeah. Thanks very much, and congratulations on the quarter, and thanks for the granularity on the quarter.

Mario, I just wanted to start with revenue allocation. Thanks for providing the granularity on Biodroga versus Krill-related revenues. It's basically what I calculated, and you stated the numbers explicitly, so, thanks for that.

Just wondered if there was any sort of revenue reallocation that would have led to any perceptions of Biodroga sequential softness down to CAD5.7 million in the quarter versus our calculation for Krill Oil revenue being basically at the same number, which is a little bit more than what we were looking for. I just wondered if Biodroga, Krill, or Omega-3 related revenue has now been allocated into Krill-related revenue, so that's the first question.

Second of all, maybe a question for Jim. I was just wondering if, you know, post quarter you had that solid patent cross-licensing agreement with Aker which did lead to some cash flowing from Neptune back to Aker, I was just wondering if you could provide any insights as to what Aker's patent portfolio provides for you and how you might be able to leverage that in future product development opportunities. I mean I understand what your IP entails as it relates to their ability to operate in the U.S. and elsewhere, but just wondering if you could maybe reflect on what specifically comes back to you on the IP side.

And then thirdly, thanks again for indicating that you still are on pace to achieve annual EBITDA cost savings of CAD5 million that should be fully realized by end of year on an annualized basis. I assume that that doesn't include any reduction in legal expenses related to settling your patent litigation with Aker. I was just wondering if you might be able to quantify what additional savings and reduction in legal expenses might introduce into future quarterly EBITDA. And I'll leave it there, thanks.

Jim Hamilton

All right, Doug. That's all?

Mario, do you want to start, and I can --

Mario Paradis

Yes, okay, I'll start. Thank you, Doug.

So as for Biodroga, it's true that sequentially it's a reduction compared with the first quarter, but again Biodroga's business is not a straight-line business along with the four quarters. So there could be some bump here and there between quarters, and when we compare with the same period last year, Biodroga effectively grew. So we're not worried about that, so we're all -- it's also related to pipeline filling, inventory filling of the -- of our customer. So the third quarter, we have a good start and it will be stabilized over the upcoming quarters.

Jim Hamilton

I mean, maybe we could take this one by one and I could just add to that, Doug. Look, I think we're about half a year into the Biodroga being part of Neptune. And what is very, very normal, in fact we had this discussion at the Board today, what is very normal is a certain element of distraction and integration.

I would say that we were ahead of the curve on a lot of our expectations in terms of the integration and in terms of customer retention. And again, we feel this business is immensely scalable and we would not put out our predictions in terms of how we can grow this going forward.

Our limiting capability here is people and process, and we're investing that right now. We feel very good about this business.

Doug Loe - Echelon Wealth Partners

Great.

Jim Hamilton

You want to take number two, Mario, or?

Mario Paradis

Number two -- I'll take --

Jim Hamilton

Let me -- on the Aker. Yeah, look, we can't get into a lot of detail in terms of what specifically was and was not licensed and for how long, Doug. But let me just say that Aker has invested in a lot of innovations over the years. And our primary motivation here is freedom to operate and to stop litigation and stop the conflict where we could As I said earlier, build a platform where the companies could collaborate for the better of the industry and not be challenging one another on individual items of specific IP.

So, I can't get into the detail, but let's just say that it clears any potential conflict for us in the foreseeable future. We feel very good about that.

Doug Loe - Echelon Wealth Partners

Okay. Maybe specifically what I was sort of wondering about without asking it explicitly was whether there was any obligation on their side or perhaps with their U.S. partner, Reckitt Benckiser on perhaps infusing a bit more capital into promoting MegaRed or Superba just as a way to kind of bolster the profile for Krill Oil as an Omega-3 category, or I suspect that -- yeah, I don't know whether you can't comment on that, but that was just sort of a thought I had that might have been with the obligation back to you, might -- the obligation for you back to them might be on -- as reflected in your cash payment.

Jim Hamilton

Yeah. Let's just say that it clears the air and creates I think an atmosphere that is conducive to those kinds of conversations as an industry, and we feel good about that going forward.

Doug Loe - Echelon Wealth Partners

Okay. Thanks.

Mario Paradis

And the third one, Doug, we're not totally finished with our litigation. As you may know, Aker was with Enzymotec for that court case. So we -- our intention is to restart discussion with Enzymotec. And if we're unable to settle before, so we will have this, still this court case by the end of this year. So it's really difficult to put in numbers as to what is our expectations in terms of reduction of legal fee. But certainly there will be a reduction.

Doug Loe - Echelon Wealth Partners

That's good stuff. Thanks guys.

Jim Hamilton

Thanks, Doug.

Operator

[Operator Instructions]

Your next question comes from the line of Robin Cornwell of Catalyst Research. Please go ahead.

Robin Cornwell - Catalyst Research

Hi. Good afternoon and congratulations on your many successes in the quarter. Two questions quickly for Mario.

I know everyone's, at least my clients, are very interested in the production level of NKO. Can you give us some idea where, what level production you're at?

Mario Paradis

Yeah, again, we already confirmed earlier that our plant demonstrated the capacity to manufacture 160 tons a year, but now we have reduced that pace because the demand is not there, so we do not want to confirm on which phase we are. But let's say that we are actually manufacturing what we are selling. So it's just a good allocation of our money right now and we are confident to increase our demand and of course we have some room to come back to the 160 tons.

Jim Hamilton

Yeah, I think I'd just add to that, Mario, that we are seeing an increase in volume sales as compared to prior year, helped in part through innovative products like Omega Plus. The facility is not running at full capacity right now. We would love to fill up with demand with Krill. But more importantly, and as I've mentioned in prior calls, we're also working, and this was some of the work we're doing in the summer, is to look at alternate compounds that we could use and decide to manufacture.

Ultimately I'm happiest when we have a mixed-use highly-utilized facility, and we're motivated to do that. But it's not going to happen tomorrow. We're going to have a lot of work there to do to pull that off.

Robin Cornwell - Catalyst Research

Well, that's interesting. That kind of leads me to another question I have on China. You mentioned sales. But we discussed it last quarter as well. Has there been any additional sales since in the quarter or further penetration into the Chinese market?

Jim Hamilton

Absolutely. And we've recorded our first sales there in the second quarter as well as in the third quarter.

I think that the interesting thing about China is we see it really as white space, as an opportunity to grow. If you look at the Omega-3 category in general in China, it's on fire. And so we're very optimistic. And only two countries can export material, western countries, can export material into China, and that would be from a facility such as ours in Canada or New Zealand. We're working hard in China to find the right method there to rapidly commercialize and we hope to talk about more of that in the near future, Robin.

Robin Cornwell - Catalyst Research

Okay. And back to the Aker transaction, you've, you know, now you have a working relationship, because you both have I guess, as you say, different products and different patents, et cetera, that you can work with. Does this agreement allow Neptune to have direct transactions or discussions with Reckitt, possibly even Schiff [ph], even though Schiff [ph] has a long fairly negative history, but is there any possibility of getting sales from Reckitt?

Jim Hamilton

Well, let me say, we don't like to talk about individual customers publicly because the relationships are confidential. I would add though that we're -- we know Reckitt Benckiser's people very, very well. I think they're very committed to the space and spent literally tens of millions of dollars in promotion and development of the market globally. We don't -- we see their continued commitment there, and we're going to work hard to be a good partner for them going forward.

Robin Cornwell - Catalyst Research

And I guess finally, the -- your expanded distribution rates for MaxSimil. This kind of implies that you've had some fairly obvious success with it. Is this the case and have you been highly encouraged that you'll be successful with MaxSimil?

Jim Hamilton

You know, Robin, I hope so. I mean it always remains to be seen. I think here's the great news. I mean the great news is, because we're - our interface is primarily with the innovative companies in the space, and this radar system is bringing us ideas such as MaxSimil, that's the great news. How well it commercializes, let's see. But, you know, this is a novel compound and this industry is calling for differentiation and innovation rapidly, and it's a compound and it's a science that is young but is absolutely resonating in the conversations that I've been witness to. And so we're going to see where this goes. It is a differentiated product.

I don't envision that this product being necessarily competing in the bargain basement, you know, Dollarama or Walmart shops, but I do see it, whether it's an engagement with the consumer through practitioners, you know, through doctors, through health food store, because where there's a conversation and when you have a person that is challenged with some digestive issues, you know, price is not the issue. And it's going to be a product they're going to embrace.

So let's see. We're jazzed by it and we're going to work to commercialize this not only locally but globally.

Robin Cornwell - Catalyst Research

Okay. Thanks very much.

Operator

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

Jim Hamilton

Well, good. Just thanks everybody for your attention and support. And we're going to continue to transform Neptune into a great nutrition products business focused on wellness solutions. And Mario, thanks for all your support too today.

Mario Paradis

Thank you.

Operator

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

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