Neptune Wellness Solutions Inc. (NASDAQ:NEPT) Q2 2023 Earnings Call Transcript

Neptune Wellness Solutions Inc. (NASDAQ:NEPT) Q2 2023 Earnings Call Transcript December 16, 2022

Operator: Good evening, ladies and gentlemen, and welcome to the Neptune Wellness Solutions Inc. Second Quarter 2023 Earnings Call. At this time all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. . This call is being recorded on Friday, December 16, 2022. I would now like to turn the conference over to Valter Pinto, Managing Director, KCSA. Please go ahead.

Valter Pinto: Thank you, operator, and hello, everyone. Thank you for joining us today for the Neptune Wellness Solutions fiscal second quarter 2023 earnings conference call. With me today are Michael Cammarata, President and Chief Executive Officer; and Raymond Silcock, Chief Financial Officer. All amounts discussed today are in U.S. dollars, and our remarks may contain forward-looking information representing our expectations as of today and may be subject to change. Today’s conference call contains non-GAAP measures, specifically adjusted EBITDA to provide investors with supplemental measure of our ongoing performance and thus highlight trends in our core business that may not otherwise be apparent when relying solely on GAAP financial measures.

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Management also uses adjusted EBITDA in order to facilitate operating performance comparisons from period to period, prepare annual operating budgets and assess our ability to meet our capital expenditure and working capital requirements. Adjusted EBITDA is not a recognized, defined or standardized measure under GAAP. Our definition of adjusted EBITDA will likely differ from that used by other companies, including our peers, and therefore, comparably may be limited. Non-GAAP measures should not be considered a substitute or in isolation for measures prepared in accordance with GAAP. Investors are encouraged to review our financial statements and disclosures and in their entirety and are cautioned not to put undue reliance on non-GAAP measures and view them in conjunction with the most comparable GAAP financial measures.

We do not undertake any obligation to update any forward-looking statement except as may be required by Canadian U.S. securities laws. Assumptions were made in preparing these forward-looking statements, which are subject to risks as laid out in our public filings found on SEDAR and EDGAR. I’d now like to turn the call over to Michael.

Michael Cammarata: Thank you, Valter, and hello, everyone. Today, we reported our fiscal second quarter 2023 results for the period ended September 30, 2022. During our fiscal second quarter of 2023, we experienced continued growth, mainly driven by our organic baby and toddler food brand, Sprout. These results demonstrate that our strategy to focus on consumer packaged goods is yielding financial benefit and we are confident that this trend will continue. Because of our hard work over the last few years, we are now a leading consumer packaged goods company with a portfolio of good for you and good for the planet consumer-branded products. Sprout Organics is a top 5 organic baby food brand that is currently outperforming the category in sales growth.

We have recently made a successful expansion out of the baby aisle into a new product category, Toddler Meals, Biodroga is also performing well with new product offerings and new client relationships. I will go into both of these as well as operational highlights right now. Let’s start with our organic children’s food and snack brand, Sprout. According to Nielsen data, Sprout is the fastest-growing brand out of the top 5 brands in the organic shelf stable baby food category, growing 26% in the last year outpacing Gerber Organics and Happy Baby Organics. Nielsen data last 52 weeks, week ending October 8, 2022. Specifically, within the latest quarter, updated Nielsen data shows that Sprout sales grew 18.6% versus 10.7% for the overall category.

Nielsen data last 13 weeks, week ending October 8, 2022. Our CoComelon partnership has proven highly incremental to the category. CoComelon snacks are turning 79% above the category average, in the last 13 weeks. Pouches are selling 40% above the category average of all pouches. Nielsen data last 13 weeks, week ending October 8, 2022. Sprout has the 3 fastest-growing organic meal items nationally and the highest velocity in the segment. Nielsen data last 13 weeks, week ending October 8, 2022. While we experienced quarter-over-quarter sales growth, our everyday fill rate fell to 57% in Q2 due to supply chain challenges. Our biggest supply challenges were our Stage 3 pouches and Toddler meals and our waffle supplier, which experienced a fire at the facility and unexpectedly caused out of stocks.

With ingredients already back in stock, we are catching up on this as is evident in our October fill rate, which is back up to 81%. Sprout continued to roll out new SKUs during the second quarter, further increasing our opportunity for revenue growth. Last quarter, we announced the addition of a new display featuring the CoComelon co-branded product at 2,500 Walmart doors in August and September, which was a major contributor to an approximate 31% increase in net sales for the first half of this year versus the same time period during the prior year. We are gearing up for distribution expansion in Q4 as we are doubling our SKU count and more than doubling our door count from 900 to 2,300 doors with a major retailer, Sprout’s distribution growth in terms of store count has reached nearly 28,000 doors.

We are now available in 90% of the market partnering with leading retailers, Target, Walmart major supermarket chains and both of the largest national pharmacy chains in the United States. We are also shipping direct to consumers through the Sprout website. Sprout is now available in all 50 states and continues to expand in Canada. In Q2, Sprout expanded beyond the baby food aisle, and continues to show upward trends, strengthening our potential to disrupt growing addressable markets. For the first time, since Sprout’s inception, they will now be able to extend its customer lifetime value providing healthy, organic and convenient options as children grow. The launch of our new big kids meals, a line of organic heat and serve bowls for children 4 and older is a key milestone toward the company’s plan of extended market penetration beyond the baby aisle.

The launch includes 4 flavors, each with a full serving of veggies and represents our potential to disrupt a retail category, more than double the size of the baby food category. Big kid meals have already begun shipping to retailers, and we expect to report revenue growth in upcoming fiscal quarterly reports. The second fiscal quarter of 2023 saw a continuation of Sprout’s growth path with several exciting milestones and sales levels achieved. The Sprout brand recorded $8.4 million in revenue in Q2 of fiscal 2023, outperforming Q2 and fiscal 2022 by 19%. We saw improvements while pulling back on promotions. The first half year-over-year trade rate was reduced by 10 points. We made significant improvements in gross margin this quarter and expect fluctuation in future quarters as we progress towards our plan of 22% in 2024, largely driven by the following 4 key drivers: one, improvement of the distribution and warehousing costs as a result of the move to a full turnkey model as well as improved logistics cost management.

Two, continued price increases effective November 1, 2022. Three, an improved product mix. Four, the realization of certain volume discounts with the level of sales increasing. As well we are gearing up for distribution expansion in Q4 as we are doubling our SKU count in more than doubling our door count from 900 to 2,300 doors with a major retailer. A key element of Sprouts strategy focuses on accessing the growing organic food and beverage market with Nielsen estimating market size of $124 billion and $21 billion for beverages and cereal, respectively. We continue to seek relevant opportunities to launch new products into categories where we see the most potential. Our expertise and partnerships with retail leaders gives us the foundational position toward becoming a leader in the organic food sector and beyond.

We are focused on scaling the Sprout business in a cost-efficient way while also growing and innovating within the organic food market. I am very proud of the momentum the Sprout team has continued over the second quarter and we look forward to continuing this through fiscal 2023. Turning now to personal care and beauty and Biodroga. Steps we have taken over the past year to increase product lines and grow sales leads have continued to translate to positive sales in the second quarter that we expect to continue through fiscal 2023. This was achieved by amplifying Biodroga’s brand presence through trade show attendance, implementing effective marketing strategies and our launching of a successful new website in prior quarters. We have continued to innovate and grow Biodroga’s product lines for both existing and new customers, which will further drive revenue going forward.

Our MaxSimil Omega-3 products have also maintained significant popularity and customer demand with a new customer secured in the second quarter for a whole new portfolio of products to be launched shortly. Biodroga also continues to undertake clinical studies to further build the credentials of our MaxSimil technology, which we believe is an incredibly strong asset for the company. MaxSimil is a game-changing piece of biotechnology that will help grow Biodroga and increase its market presence long term. MaxSimil’s technology has been successful in making fish oil 3.5 times more absorbable than standard fish oil, and we hope that with our ongoing studies, we will be able to expand MaxSimil into more nutraceutical products. We’re tremendously excited for what’s ahead for Biodroga and look forward to seeing continued growth from them.

Our consumer personal care brand, Forest Remedies, also continued its path of growth during the second quarter. Product launches of Forest Remedies into large retail chains nationwide have translated to positive sales growth, which we expect to continue through fiscal 2023, in particular, launches into Sprouts, farmers markets, Fresh Time and a large pharmacy chain in prior quarters have translated to week-over-week growth and strong customer demand. In addition, Neptune is working on the development of innovative new SKUs in the product pipeline for Forest Remedies. For example, we are planning to launch Forest Remedies multi Omega kid gummies early next year, the formulation for which has already been developed. While we continue to experience sector-wide supply chain issues over Biodroga and Forest Remedies, we have been aggressive in implementing streamlining and efficiencies to mitigate these challenges and ensure cost saving.

Biodroga continues to expand its manufacturing network by developing strong partnerships across North America. And during Q2, Biodroga launched its first product from a new softgel manufacturer in the U.S. Product quality remains a key pillar for Biodroga, so the selections of new co manufacturers are carefully managed by our quality team. To conclude, Neptune made significant progress over the second fiscal quarter to execute on its consumer packaged goods growth strategy and improve our path to profitability. Our progress has been demonstrated by sales growth across both our organic foods and beverages and personal care and beauty. We are well placed for growth and believe these decisions are in the best interest of Neptune and its stakeholders.

Thank you to all our teams at Neptune, as well as our stakeholders. The last few years have been hard on us all, but finally, there’s a light at the end of the tunnel. By exiting cost-intensive businesses that were championed by our prior Boards and leadership, we are now finally able to say that we believe we will be on the path to profitability quicker, slimming down, starting to simplify the organization and focusing on consumer packaged goods is the company’s future. I will now pass the call over to our Chief Financial Officer, Raymond Silcock, to discuss our financial results in more detail. Ray has had a successful career improving sales and profit performance for leading public and private equity-owned companies, including Campbell Soup and Diamond Foods.

We are pleased to have him join us. Ray?

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Raymond Silcock: Thank you, Michael, and good afternoon, everyone. I am pleased today to present Neptune’s financial results for our fiscal second quarter of 2023. The three-month period ended September 30, 2022. All amounts are in U.S. dollars. First of all, I’d like to sincerely apologize to all our shareholders and to our other stakeholders for the delay in reporting earnings this quarter. The delays were largely as a result of complications from our transition last year and from Canadian to U.S. dollar reporting as well as from our onboarding and new finance and accounting team this quarter, including myself. Turning now to the results for Q2. Revenue for our second quarter totaled $12 million, a decrease of 4% from the same quarter last year despite the adverse impact on net sales of our existing the cannabis business.

The cannabis divestiture resulted in a reduction of net sales of $600,000 in Q2 as compared to the same quarter last year. This decrease was more than offset by increased net sales from the key growth segment of our business, organic foods and beverages growth we expect to see for the rest of fiscal year ’23. Consolidated gross margins in Q2 improved by 18.6 basis points to 9.2% of net sales for the second quarter as compared to a negative 9.4% of net sales during the same quarter prior year. This improvement reflects that Q2 last year included the impact of a $3 million impairment to cannabis inventory as well as the effects of steps that were taken over the past year towards becoming a pure-play CPG company, which have translated into margin growth in organic foods and beverages, where our principal brand is Sprout.

On Sprout, we expect to see a continued favorable impact on both revenue and margin as we scale our co-manufacturing and retail partnerships there. Sprout and organic children’s food brand accounted for $8.4 million or 70% of the total $12 million of Neptune revenue in Q2. The principal driver of Sprouts growth in Q2 was in Walmart displays, which we secured in 2,500 Walmart locations last — this past quarter. Moving now to Biodroga. Biodroga’s Q2 net sales were down $900,000 from the same quarter last year, adversely impacted by shipping delays. Gross margins of 29% compared to 30% for Q2 last year. And finally, cannabis. The sale of the cannabis assets for $3.8 million was completed on November 9, 2022. Q2 cannabis revenue was $55,000, a decline of $1.1 million as compared to the same period last year, while gross margin improved $420,000 to a loss of $780,000 versus a loss of $1.2 million in the same period last year.

Exiting the cannabis business was a significant milestone for Neptune as divesting the cannabis assets has freed us to pursue relationships with investors, corporations and banks who have restrictions against working with companies that own and/or operate cannabis businesses. Even more importantly, it maintains our focus on our growth business, Sprout as well as on our Canadian business Biodroga. Additionally, the sale of cannabis assets has helped us realize significant cost savings and will enable us to streamline our business model and enable simplification of our corporate structure. Year-to-date fiscal year ’23, Neptune net sales of $28.3 million, up $5.7 million versus the same period last year, an increase of 25%. Gross margin year-to-date amounted to a loss of $1.8 million compared to a loss of $3.5 million for the same period last year.

Excluding this year’s cannabis — this year’s first quarter cannabis inventory impairment charge of $3.1 million, gross margin for fiscal year ’23 year-to-date would have been a $1.3 million profit. This compares excluding last year’s $3 million inventory impairment charge on cannabis, to a loss of $500,000, excluding the impairment in fiscal year ’22. Moving on to Sprout. Net sales for the first half of FY ’23 increased by $3.9 million compared to the same period in the prior year, an increase of 30.5%. This was largely driven by our diversifying into new product categories, in particular, to what we call Up-age Meals, meals for older kids by expanding our distribution with footprint — excuse me, by expanding our distribution footprint with Walmart and also from increased prices.

These factors all contributed towards market share growth, higher sales revenue and margin improvement as compared to the same period last year. Gross margins have already improved sequentially quarter-over-quarter in fiscal year ’23 driven by higher sales volume and increased selling prices, and we expect further gross margin improvement for Sprouts in 2023 from the 4 key drivers that Michael enumerated in his remarks. We anticipate that these drivers will lead to a Sprout gross margin of 22% by the end of fiscal ’24. Biodroga net sales year-to-date totaled $8.2 million, an increase of 13.7% compared to the same period last year, while gross margin of $2.0 million in Q2 was up from $1.9 million last year. The percentage margin for Biodroga expanded from 31.6% year-to-date fiscal ’23 — sorry, expanded to 31.6% fiscal ’23 from 26.2% last year.

In the second quarter, SG&A expenses were $15.9 million compared to $15.4 million for the same period last year. This is primarily as a result of severance payments, mainly in the cannabis business and other costs related to our restructuring implemented over the past year. Net loss of $37.3 million in the second quarter was primarily due to an impairment charge in Q2 of $24.7 million, $10.2 million of this was in Sprout trade names and goodwill and $14.5 million was related to the cannabis assets we sold. In addition, we had a change in the fair value of derivatives, which cost $7.3 million, offset by a gain of $3.1 million in foreign currency adjustments. This compares to a net loss of $12.1 million for the same quarter last year. We have also continued to take action to manage operating expenses, cost cuts across the businesses and at corporate, have reduced the company’s headcount from 170 to 56, a payroll reduction of $7.6 million or 49%.

In fact, since completing our strategic review last year, we have reduced our total admin pet spend by an approximately $18 million on an annualized basis. We continue to evaluate additional steps to manage all our expenses appropriately, and we expect Sprout to have positive EBITDA by the end of fiscal 2025. Turning now to our balance sheet. Neptune ended the quarter with $1.4 million in cash on hand. Today, our cash on hand amounts for $3.5 million. In July, Neptune entered into an amendment and expansion of Sprout secured promissory notes, led by a $3 million investment from Morgan Stanley. This amendment expanded the notes by $15 million from $22.5 million to a possible maximum of $37.5 million and signified confidence in Neptune’s strategic shift towards becoming a pure-play CPG company as well as Sprouts growth trajectory.

The funds from the expanded facility are intended to be used for general Sprout working capital and the repayment of certain outstanding obligations. In addition, Sprout introduced — excuse me, Sprouts issued promissory notes amounting to $775,000 to other investors since July 2022. And in October of this year, Neptune raised $6 million in gross proceeds in a successful public offering of the company’s equity. To sum up, we are pleased with the year-to-date progress on our core brands, Sprout and Biodroga, increased revenue, better gross margins and lower costs, a pattern we expect to continue through the rest of this year. We are now directing all our focus and resources to becoming a CPG company and look forward to seeing this improvement as we advance into the next fiscal year, fiscal 2024.

With that, operator, I’d like to open the call for questions, please.

Q&A Session

Operator: Thank you, sir. . Your first question will come from Aaron Grey of AGP. Please go ahead.

Aaron Grey: Good evening and thank you for the questions. So first one for me. I believe you guys said in the prepared remarks, there was some impact just in terms of supply with — I think you said some waffles and the toddler on the Sprout side. So can you talk about maybe how much of an impact that might have had in the sales during the quarter? And then just maybe just give us some more detail on the impact and confirm that, that’s now been resolved? Thank you.

Michael Cammarata: Hey, Aaron, it’s Michael Cammarata. The impact, we had a fill rate of 57% for the quarter of the potential orders. So obviously, there was — if you minus out the 1.2, 1.3 of Walmart, you can see the core impact it had on the core sales. We are since back up to over an 81% fill rate and with the goal of getting up to over 90%.

Aaron Grey: Okay. That’s helpful. Sounds like you guys got some extra distribution coming online in 4Q with retail going from 900 to, I think, 2,000 or more. So can we confirm that, that Sprout organic distribution now being at 90% that takes into account that incrementally have coming on — I’m sorry, in calendar 4Q, not your fiscal Q. But can you confirm that, that includes 2,000 and 90%? And then as we then move forward into the incremental quarters now that you have the broader distribution of the 90%, is it then more about getting more SKUs within the existing doors? Or how do we then think about those incremental growth opportunities for Sprouts?

Michael Cammarata: Yes. So with that retailer, particularly the resets are in March, so we would ship out in February, and that would be the uptick, which is in our Q4.

Aaron Grey: Okay. In your Q4. And then — and how do we think that gets you to 90%, right? So then thereafter? How do you think about more longer-term growth opportunities for Sprout?

Michael Cammarata: Yes. So the growth opportunities, obviously, we’re heavily focused on increasing our velocities and our SKU expansion. So with our Up-age Meals, those are starting to roll out to our core distribution. So that’s something that beyond our core SKUs, the Up-age Meals, we expect to roll into the existing distribution. It’s already started shipping and will start ramping up early next year. And then on top of that, beyond the Up-age Meals, we have additional distribution that’s coming online for additional retailers. Obviously, our white space that we have is in Albertsons and Whole Foods.

Aaron Grey: Okay. Great. Thanks, Michael. Any update in terms of the partnership with CoComelon and maybe how some of the CoComelon and co-branded products might be outperforming, maybe some co-marketing, you might — I know there’s some potential for that. So any update in terms of that CoComelon partnership?

Michael Cammarata: Yes. So CoComelon, we haven’t even deployed yet marketing into the YouTube channel yet, which has over 115 million subscribers. We are expanding our relationship with them and with an addition of additional products, including the snacks that we announced going into our distribution. So the partnership we’re seeing that there’s an uplift of over 70% on the SKUs when adding the CoComelon. So we’re seeing that we’re performing very well against our peers who have different licenses. So CoComelon is proven in retail to increase distribution and have an uplift that is greater than 70%. We are expanding the relationship and the product offerings with them. And then we do plan to expand the relationship and how we market with them as well as starting to eventually work with them on the YouTube channel and integrating additional content as the SKUs roll out to our distribution.

Aaron Grey: Okay. Great. Thank you for that. And then last one for me, and then I’ll go ahead and jump back into the queue. Just talking about the target, this might be more for Raymond here, the target of the profitability by end of fiscal year 2025 on EBITDA. First of all, could you just confirm the EBITDA for the quarter that you guys had roughly here? I didn’t see that in the PR. And then as we look to that in the fiscal year 2025, can you talk about maybe some underlying sales or gross margin assumptions that might be needed in order to reach that profitability target? Thank you.

Raymond Silcock: Yes, this is Ray. I — we’ll be releasing our Q with EBITDA detail in it on Monday, but I’m not ready to answer the EBITDA question right now just because we didn’t include that in our press release. So with respect to the question about profitability in ’25, yes, we have expectations. But right now, we’re guiding totally to our expectation of profitability in ’25. And at some future date, we might be willing to give more detail. But right now, we’re just sticking with the fact that we expect to be profitable and not the full details of sales and earnings and so forth.

Aaron Grey: Okay, alright. Well thanks very much for the color and answering the question. I’ll get back into the queue.

Operator: . As there are no further questions, this will conclude the conference call for this afternoon. Neptune would like to thank everybody for participating, and we ask you to kindly disconnect your lines.

Michael Cammarata: Thanks, everyone.