Neptune Wellness Solutions Inc. (NASDAQ:NEPT) Q3 2023 Earnings Call Transcript

Neptune Wellness Solutions Inc. (NASDAQ:NEPT) Q3 2023 Earnings Call Transcript March 31, 2023

Operator: Good morning, ladies and gentlemen, and welcome to the Neptune Wellness Solutions Inc. Third Quarter 2023 Earnings Conference Call. At this time all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. 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 Third 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 financial measures, specifically adjusted EBITDA to provide investors with a supplemental measure of our operating performance and thus highlighting trends in our core business that may not otherwise be apparent when relying solely on GAAP financial measures.

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, comparability may be limited. Non-GAAP measures should not be considered as a substitute for or in isolation for measures prepared in accordance with GAAP. Investors are encouraged to review our financial statements and disclosures 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 statements, except as may be required by Canadian and 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 would now like to turn the call over to Michael.

Michael Cammarata: Thank you, Valter, and hello, everyone. Today, we reported our fiscal third quarter 2023 results for the period ended December 31, 2022. In November, we completed the divestment of our cannabis business. Operating a business with such a highly controlled substance was prohibitively expensive from an administrative standpoint, and we are already seeing the benefits from this decision. The sale included the cannabis plant in Sherbrooke, Quebec and the cannabis brands, allowing us to gain significant cost savings and operational streamlining from redirected resources towards a simplified CPG forward corporate structure. This move also allows us to pursue relationships with investors, corporations and banks going forward, who have restrictions against working with cannabis-associated businesses, and we have already taken steps toward improving our capital position, which Ray will be speaking to you about shortly.

Neptune’s management team and Board continue to evaluate and pursue operational and structural efficiencies, all in our continued effort to maximize stakeholder value. As part of our ongoing cost saving and streamlining efforts, by the end of Q3, our headcount reduced by 66% year-to-date. These reductions have resulted in a cost savings of $6.6 million in annual salaries, a 46% reduction overall by the end of Q3. As well, management has asked the Board to revert back to its precannabis size and structure, which will also result in cost savings for the Company. Neptune is now a leading consumer packaged goods company with popular products that our retail partners and consumers are excited about. We have built a portfolio of good for you, good for the planet brands with evolving product lines and opportunities for further growth into the future.

Starting with Sprout, our leading organic children’s food and snack brand. This brand continues to outperform based on the KPIs we monitor closely. Not only achieving revenue growth for the comparable periods, but also distribution store count and fill rate, while also ramping up innovation and North American expansion in the third fiscal quarter. Sprout’s successful partnership with Walmart continues with sell-through of the half-pallet seasonal display reaching 75% in eight weeks. Sprout also continued its successful expansion into Canadian retailers, recently launching into Loblaws, the largest grocer in Canada. For total store count, Sprout distribution growth has reached nearly 28,000 doors in the United States and 1,350 doors in Canada, totaling 29,350 doors in North America.

If we quickly have a look at the Nielsen data from 13 weeks ending December 31, 2022, Sprout sales outperformed the category by showing growth of plus 12.6%. Sprout now has the two fastest-growing organic meal items nationally and the highest sales velocity in the segment. This growth was largely driven by the categories of toddler meals, snacks and CoComelon pouches. Our toddler snacks are growing 35.5%, which is above the category average. As well, our CoComelon partnership has proven highly incremental to our growth with our Yes, Yes Veggie becoming our number one selling pouch in our total pouch portfolio, Nielsen data last 13 weeks. Sprout’s strong fill rate of 85% for the third fiscal quarter was another key driver in its revenue growth.

And so far, our Q4 fill rate is 80.3%. Sprout now has a 90% footprint in the market with more doors to grow inside our existing footprint as we are only at a 5% share. We plan on expanding our market share by winning more shelf space and continued product innovation. Sprout PB &Yayz are our newest innovation that launched in Q3, which continues Sprout’s expansion of the snack category. The gluten-free, dairy-free and no sugar added formulation continues Sprout’s commitment towards great nutrition for kids. Their strong initial sales demonstrate the large addressable market opportunity that this category has for Sprout going forward as we continue to expand our offering. Big kid meals have continued to roll out during Q3, and we see huge potential for revenue growth outside of the baby food aisle.

We are very pleased with Sprout’s progress and the results achieved in the third fiscal quarter. Sprout continues to focus on scaling our offering into new product SKUs in a cost-efficient way to further increase our leadership in the organic food market. Sprout products are now available in all 50 U.S. states, Canada and shipping direct to consumers through the Sprout website. We have partnered with several major retailers, including Target, Walmart, leading supermarket chains and both of the largest national pharmacy chains in the U.S. We are also shipping direct to consumers through the Sprout Organics website. Turning now to Biodroga. For the first three quarters into the 2023 fiscal year, Biodroga has shown strong growth year-to-date across all key measures.

These positive numbers have resulted from launching products with both existing and new customers. In particular, our MaxSimil product line continues to show solid sales growth as Biodroga’s most popular product. Biodroga has worked closely with its customers, existing and new, to provide scientific materials to support consumer education on the health benefits of MaxSimil. We continue to innovate our product offering for customers, demonstrating the flexibility of Biodroga’s strategy to align with customer demands. For example, Biodroga launched a new roll-on product with an existing strategic customer in the third quarter. Customer retail and online sales for that product began in November. In addition, our marketing initiatives from the prior quarters being trade shows, website and social media presence have succeeded in bringing in new business to drive sales growth.

Biodroga remains focused on cutting costs where possible to mitigate supply chain challenges, which is flowing through to margin improvement and impacting customer retention. To counteract raw material pricing increases that are being felt across the industry, Biodroga has also implemented price increases where possible to mitigate increased supply chain costs. But with the objective of minimizing price increases to our customers, we have also aggressively bid to find alternate suppliers and manufacturers when raw material prices and toll prices become too high. Finally, we are continually expanding our manufacturing network to ensure we can pivot to alternate suppliers when needed and expand our offering based on customer market demand. Sales of our MaxSimil products are driven by two SKUs, MaxSimil 1,300 mg and MaxSimil 650 mg.

After launching these two products in 2019, demand stabilized to about 1.3 million units per month over the next two years. In 2022, building on the groundbreaking results of a clinical study showing MaxSimil’s significant superior absorption of omega-3, Biodroga and its customers continue to work at educating medical experts and patients about the benefits of MaxSimil versus standard fish oil. The study was published by the Journal of Nutrition in May 2021. These efforts have resulted in a 30% increase in average monthly sales for the year 2022 to 1.7 million units per month. In December, we further proved the credentials of MaxSimil’s technology with a study that showed Biodroga’s omega-3 supplements led to faster absorption of combined curcuminoids of 40% higher compared to other formulation.

That study was published by Nutrients in December 2022. As well, our pilot MaxSimil study has just been completed. The study showed that the group that’s supplemented with MaxSimil lutein appeared to experience a decrease in their eye prescription, while the placebo group experienced an increase in their eye prescription. The study also showed that MaxSimil lutein supplement helps maintain good cognitive health. The results indicate that the supplementation had significant impact on cognition when compared to the placebo. This study shows how powerful MaxSimil can be across a range of products, and we look forward to furthering our MaxSimil lutein trials to gain greater statistical power. In closing, I want to emphasize that we understand the challenges that have impacted our business over the past year.

We recognize that some changes have put pressure on our stakeholders, but we remain confident in our strategy and the direction we are headed. We are dedicated to delivering long-term value for all of our stakeholders and believe that our focus on our CPG brands, as evidenced by our strong Q3 results, is the right path forward. We are committed to continuing our efforts to streamline operations, manage expenses and expand our market share in the organic food and nutraceutical space despite the challenges of inflation and supply chain disruption. Thank you for your continued support. And now over to Ray for a deeper dive into our financial results. Ray?

Raymond Silcock: Thank you, Michael, and good afternoon, everyone. I am pleased to be able to report Neptune’s financial results for the third quarter of fiscal year ’23, the three-month period ending December 31, 2022. Except as otherwise stated, all numbers in today’s presentation are in U.S. dollars and U.S. GAAP. Firstly, I would like to apologize to our shareholders and other stakeholders for the delay in reporting our Q3 earnings. The transition from Canadian dollar financial — excuse me, functional currency to U.S. dollar functional currency, which we executed in the third quarter. Coming on top of our transition to U.S. dollars and U.S. GAAP earlier this fiscal year was the primary cause of these delays. As we go forward to the fiscal year-end close on March 31, we are bringing in additional accounting support, which will enable us to close on time in the future.

Turning to the numbers. Consolidated net sales for the third quarter totaled $12.2 million, down $2.5 million, a 17% decline as compared to the same period last year. This decrease was because we divested our cannabis business this quarter, and the impact was partially offset by growth in our remaining businesses. Excluding sales from the cannabis business in fiscal Q3 last year, this quarter’s net sales increased 8.1% over the prior year due to strength in those core businesses, Sprout and Biodroga. Year-to-date, net sales amounted to $40.5 million, up 8.6% versus prior year and up 19.7% when cannabis sales in both this year and last are excluded. Strong growth in Sprout sales, which were up 29.4% year-to-date, was the major driver of this accomplishment.

Gross profit for the third quarter of fiscal year ’23 amounted to $1.88 million as compared to $1.65 million for the same period last year, while consolidated gross margins improved to 15.1% as compared to 11.3% last year. The major steps we have taken to refocus our cost and operating structure and become a pure-play CPG company have translated into margin growth, and we expect to see a positive impact on sales and earnings as we continue to scale our businesses and hopefully add new partnerships. Looking now at Sprout, our organic children’s food brand, in more detail. Net sales for Sprout totaled $8.4 million in Q3, an increase of 18% over the same period last year. Year-to-date, Sprout’s net sales are up 23% as compared to the first nine months of last year.

The primary driving factors of this growth was Sprout’s diversification into new products, primarily up-age meals, i.e., meals for older children, expansion of Sprout’s distribution footprint at Walmart and a price increase in November. Sprout reported gross margin of 5.7% for the third fiscal quarter, up 8.9 percentage points as compared to the negative margin of 3.2% we recorded last year. Gross margins have continued to improve each quarter in the current fiscal year, driven by higher sales volume and by price increases. Sprout continues to deliver versus a year ago, too, with increased market share, improved net sales and higher margins as compared to the same period last year. Now to Biodroga, our nutraceutical co-manufacturing business.

Biodroga’s Q3 net sales totaled USD 3.6 million, a decrease of 11% as compared to the same period last year. Year-to-date in fiscal ’23, however, net sales increased 6% versus the same period last year to $11.8 million. Q3’s net sales decrease was mainly from customer-related timing and from supply chain issues. Biodroga has implemented price increases to mitigate higher supply chain and raw material costs, and the gross margins remained strong at 31%, up from 28.7% in the last sequential quarter. So turning back to the total P&L. Consolidated SG&A for the quarter amounted to $8.7 million as compared to $18.4 million for the same period the prior year, a reduction of $9.7 million or 52%. This reduction came primarily from headcount reductions in Sprout and corporate as well as from the removal of the overhead cost in the cannabis business that we sold last November.

Year-to-date SG&A of $35.2 million was $14.7 million lower than for the same period last year, primarily for the same reasons. We have been focused on streamlining our operating expenses. And in the first nine months this year, we have reduced our overall headcount by approximately 66%. Q3 net loss of $497,000, contrast to a net loss of $16.8 million in the same quarter last year, an improvement of $16.6 million for the quarter. This sharp improvement was primarily due to the $9.6 million reduction in SG&A that we talked about earlier, but also from the $7.4 million gain in the value of derivatives, principally warrants issued in connection with new debt in the quarter. This came from the decline in our share price since the warrants were granted.

Year-to-date, our net loss amounted to $44.3 million, an improvement from the $47.8 million loss for the prior year. Diluted earnings per share attributable to equity holders was $0.06 per share in the third quarter, bringing the year-to-date figure to a loss of $4.04 a share. Note 13 of the financial statements explains the way in which our EPS is calculated in more detail. Consolidated adjusted EBITDA loss for the third quarter is $4 million as compared to a $14.2 million loss for the same quarter last year, an improvement of $10.2 million. This was mainly the result of significantly improved net earnings and that gain on the fair market value of derivatives we talked about before. For the year-to-date, the consolidated adjusted EBITDA amounted to a loss of $29 million as compared to a loss of $40.5 million last year, an $11.5 million improvement, much of which occurred in the third quarter.

Turning now to the balance sheet. We ended the quarter with $3.4 million of cash on hand and with trade and other receivables of $4.9 million. Net current assets amount to $63 million, including inventories of $16 million. Our current liabilities of $47.3 million includes loans and borrowings of $15.9 million. During the quarter, we took some actions to restructure our operations and improve our working capital position. As we’ve mentioned already, on November 9, 2022, we announced the complete divestment of our cannabis business for CAD 5.15 million in a cash sale. This was a significant milestone as the sale of our cannabis assets will enable us to realize significant cost savings and operational streamlining from redirected resources as well as a simplified corporate structure.

By divesting the cannabis assets, we have also been able to build better relationships with investors, other corporations and banks, many of whom have restrictions against working with companies that own and/or operate cannabis businesses. This has already proved fruitful. We were able to close on a debt financing deal of $4 million and up to $5 million accounts receivable factoring facility in Sprouts and equity financing amounting to approximately $6 million. These were significant achievements that, combined with the cannabis asset sale proceeds, provided us with a much needed liquidity. Our Q3 results demonstrate our commitment to executing on our strategic plan and becoming a CPG company. The sale of the cannabis business has enabled us to focus on our core growth drivers, Sprout, in particular, which is a vertical that can be scaled from revenue and streamlined for improved margins.

The cannabis business represented an untenable regulatory environment that was built on the expectation of deregulation. And by divesting this business, we have removed some of the obstacles in our path to profitability. The numbers presented today at the start of the narrative, we anticipate, will prove out our business and financial strategy in the years to come. We currently still expect Sprout to achieve breakeven EBITDA by the end of fiscal ’24. With that, operator, please, could you open the line for questions?

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Q&A Session

Operator: Your first question comes from Aaron Grey, Alliance Global Partners.

Aaron Grey: So first question for me. I just want to talk about Sprout business and some of the additional distribution points. Could you talk about potential impact you can expect fiscal 4Q versus fiscal 1Q of 2024? Any additional color on the additional doors you expect to have, how many SKUs will be showing through them and how to expect that to flow through the top line would be helpful.

Michael Cammarata: We expect, obviously, the increase in our Walmart distribution to start rolling in, in Q4. We went from only around 900 stores to over 2,000 stores. And we’ve also started rolling out the innovations at the end of Q3 that is starting to be picked up by the fleet. So that will be continually growth.

Aaron Grey: Okay. All right. Great. And last quarter, you talked about some stock issues. I might have missed this in the early part of the call. I came on a bit late, but were you able to amend those stock issues in the quarter? And then were you able to improve those fill rates that you kind of mentioned in the last quarter? Could you provide any update on those fill rate numbers and how they’ve improved?

Michael Cammarata: Yes. So we’re in and around an 80% fill rate right now. We’re still striving to increase that. Obviously, our goal is to get in eventually into the 90s and hopefully the high 90s. We did have some supply-related issues with the ingredients providers that does fluctuate on our ability and production. But we, as you can see, have ramped up inventory, and we’ve been working with our supply chain to be able to accomplish the launches of the retailers and expansions.

Aaron Grey: Okay. Great. And then in terms of the innovation, just curious, as you think about how many SKUs you can have at potential retailers, how do you balance between keeping your core products on and then adding on new SKUs? And then any update in terms of how some of the CoComelon SKUs might be outperforming in any combined marketing tactics with CoComelon and Sprout?

Michael Cammarata: Yes. So our first goal was to make sure that we got the footprint in. Now we’ve started expanding doors. So as we’ve mentioned, we’re around like 5% of the potential of what doors and retailers that we’re in. And we do — right now, our focus has been really on scaling in a couple of areas, our up-age meals, which started to roll out, our toddler meals, which are performing very well, as well as expanding our footprint on our existing core SKUs. We are trying to streamline it in a way that we’re focusing on SKUs that drive the highest revenue while also positive to our gross profit margin. So we have prioritized it based on our supply chain and margins on the SKUs that we’re entering into. And we’ve also looked at reducing SKUs that may not be picked up in the fleet that don’t have the potential to grow as fast.

CoComelon has been very key to our partnerships because it’s opened up doors and the velocities. Like the only other peer in our space has like a Sesame Street license. And CoComelon has already shown that it’s performing way better than the Sesame Street license. And so we are expanding that. Our up-age meals is something that we’re really focused on because it gives us a lot of opportunity. Currently, if you look at the baby food aisle in most grocery stores, you’ll see about 50% of it being organic. With up-age meals, only about 10% of it is organic. So we are able to get in and partner with these retailers to really expand the footprint, and that’s where we’re starting to roll out our up-age meals, which are also a much higher-margin product.

Aaron Grey: Okay. All right. Great. That was helpful. And then lastly, maybe more a question for Ray. Some gross margin improvement that we talked about in the prepared remarks, how best to think about the gross margin in the near to medium term?

Raymond Silcock: We continue to see margin improvement, and we’re still seeing the effect of pricing that we’ve taken on both Sprout and Biodroga. So I think we see continued growth in the margin. And we’re very — as Michael said, the mix of products in Sprout is shifting to be slightly more margin accretive. And the same is true in Biodroga, too. The MaxSimil product lines are significantly more profitable on the gross margin level than the other lines that Biodroga makes and sells.

Operator: Thank you. There are no further questions at this time. Ladies and gentlemen, we thank you for your participation, and we ask that you please disconnect your lines at this time.

Valter Pinto: Thanks, everyone.