Probi AB

STO:PROB

Earnings Call Transcript 2019-Q3

[Operator]

Hello, and welcome to Probi AB Q3 Report 2019 [Operator Instructions] Today, I'm pleased to present CEO, Tom Rönnlund; and CFO, Henrik Lundkvist. I'll now hand the word over to Tom Rönnlund. Please begin your meeting.

[Tom Rönnlund, Chief Executive Officer]

Good morning, everyone. Thank you for joining this call where we present the third quarter results and the first 9 months of 2019 for Probi AB. Please turn to Page #2. And please familiarize yourself with our safe harbor statement on Page #2, and please go to Page #3, which is overview of our agenda. As mentioned earlier, today, together with me here, I have Henrik Lundkvist,our CFO, and we will walk through executive overview of our first 9 months performance as well as a financial review element and a bit of perspective on our outlook as well as a Q&A session after the actual presentation. Please turn to Page #4. So in the third quarter, Probi had a sales of SEK 142 million, which was down compared to previous year, the same period for previous year, where -- which was earlier communicated to a large extent affected by dynamics in the U.S. market where Probi has its majority of sales. And looking at the 9-month period, as we also mentioned in the market message a week or so ago, we are at a slight growth in -- for the 9-month period ending in September. But currency adjusted, we are about flat. On the other side, our EBITDA for the 9-month period increased and adjusted for the currency effect -- sorry, the IFRS impact, we grew our EBITDA with about 8 or 9 -- SEK 9 million and that represent actually -- together with the IFRS impact, it's a growth of 17% versus previous year. We turn to Page #5. So as earlier mentioned, we are seeing a flattened to falling market growth in the dietary supplement segment of probiotics in the U.S. market, which is affecting us as well as others who are active in the market. But we also at the same time, are seeing a number of trends for the U.S. market, which are working in our favor. Many customers are looking at differentiating themselves in the marketplace as well as ensuring that their products are clinically effective and are delivering health benefits, actual health benefits for the consumers. These trends are working in Probi's favor from a perspective that many customers are interested in reformulations of their products, new launches, to introduce new offerings into the market as well as more differentiated offerings. There is also a trend of making sure that products are formulated and delivered with an end of shelf life contained -- containing probiotics, which are valid through the entire shelf life of the product. And these are elements where Probi is very strong or these are areas where Probi is very strong both from a clinically documented perspective as well as the ability to deliver products, which works for all the consumers.In the EMEA region, in the quarter, we saw falling sales versus last year mostly due to phasings of orders. But if we look at the 9-month period for the year, we are still in growth mode for the first 9 months for our EMEA region. APAC, as we have previously mentioned is a focus area for us for growing our presence as well as our sales. Throughout this year, we have not realized that so far, but we have at the same time made sure that we have increased our presence in the region with people who have joined with new resources from a commercial perspective, who have joined our organization through the last 12-month period. And we are seeing a strengthened pipeline in the region, which we hope will -- or are counting on that it will materialize through next year. At the same time also there are market trends in the region, particularly in China, where both sort of a cross-border e-commerce -- cross-border trade has had a downturn since a program by the government during the spring as well as a regulatory review, you could call it, in the Chinese market as well, which has hampered the -- temporarily hampered the introduction of new products into the market. At the same time, Probi is well positioned with our portfolio of well-documented products, and we see a strong interest for our products in the market as well and a growing pipeline, which we are working hard on executing for driving growth into the future there. If you then turn to Page #6 and these numbers, of course, from the different geographic regions are also reflected in -- when we're looking at the segmentation of our business into 2 business segments that we have been -- that we're reporting on, both for Consumer Healthcare as well as Functional Food. With Consumer Healthcare then for the year being slightly up, but currency adjusted then, virtually flat. And with Functional Food, year-on-year as well displaying a growth, but parts of that is as earlier communicated as well, driven by a onetime nonrecurring income earlier in this year. We are seeing opportunities in both areas. We are working on several new launches in multiple markets. We are addressing opportunities in new channels, in new sales channels as well where we're seeing interest -- strong interest for our products as well as making sure that we have the adequate amount of commercial resources to execute on the strategy that we have. We also within Functional Food, still being a relatively small business segment for Probi, we have refocused our team there on working solely on large accounts where we are seeing bigger opportunities than historically, and we are having advanced discussions in terms of opportunities for launching new products and projects in the field.If we turn to Page #7, a couple of comments on a few things happened in the quarter. We are very happy and proud together with one of our customers in the U.S. market being able to, as a first, include Probi Osteo, our concept for improved bone health into a consumer-oriented, on-the-go formulation in form of a beverage shot, which is an oat-based drink, which includes a clinically relevant dose of Probi Osteo, and this is being launched currently as we speak, introduced into the U.S. market. And it's an innovative way of leveraging Probi's unique science in the field. We have also in the quarter, together with a partner in the Australian market, been a part of the introduction of Probi Osteo as well as our FerroSorb concept for improved iron uptake in a major launch into the pharma -- sorry, into the Australian pharmacy channel, where products are right now being distributed to 1,000 pharmacies across the Australian market. And the partner in Australia is well equipped to work specifically with a clinical perspective and a medical marketing approach to introducing the product into the Australian market. Our earlier communicated launch of a new range of -- or an updated range of products in Swedish pharmacies is performing according to our launch plans, which we're satisfied with. And we also are planning for the next steps in terms of a Nordic expansion of these products as well. If we turn to Page #8. So in the quarter as well, we have also in one of our U.S. factories, initiated a manufacturing upgrade program, which includes a comprehensive effort or comprehensive program in upgrading our facility there with new equipment for targeting improved manufacturing efficiency. This will, of course, take some time as we are carefully planning this in order not to disturb any current production processes. It is being executed as we speak, and it is moving according to plan. We are looking at -- the reason for doing this is that we longer term see opportunities for gross margin improvement as well as quality upgrades to even further strengthen our competitiveness in the American market. So even despite that we see that the U.S. market for the moment is not growing as strongly as it has in the dietary supplement perspective, Probi is still a relatively small player in the U.S. market, and we are confident that we have great opportunities to continue to capture market share in that market; and therefore, also we need to ensure that our manufacturing facilities are well equipped to handle those opportunities as we move forward. We also in the quarter, had a publication of earlier presented data. It's a good development that it's actually now also published in a journal, which is an example of Probi's frontline research in the field of probiotics, where the results from the study on children genetically predisposed for gluten intolerance or also called celiac disease, where that randomized and double-blind placebo-controlled study show that Probi's probiotic concept in this area has a suppressing effect on celiac autoimmunity and thus may delay the onset of the actual disease. Very exciting data. Additional research is ongoing. And we will see in the future how that pans out. But it's a unique and innovative area, again, for use of probiotics. So if we turn to Page #9, we will hand over -- or I will hand over the word to Henrik Lundkvist, our CFO, for the financial review.

[Henrik Lundkvist, Chief Financial Officer]

Good morning, everyone. So we are now moving into the financial review. So please turn to Page #10. In the sales page, we can see that net sales went from SEK 441 million to SEK 460 million, or up 4% if we compare the first 9 months of '19 with '18. If we remove the favorable exchange rate effect, the organic growth was 0 as earlier explained. In the condensed P&L, it's visible that EBITDA for the first 9 months was SEK 130 million or SEK 19 million higher compared to last year. Adjusted for IFRS 16 effects related to leasing, EBITDA would have been SEK 119 million with an EBITDA margin of 25.9%. The improved EBITDA and EBITDA margin is an effect of the revenue growth. The reported EBITDA margin for the third quarter was 32.1% or adjusted for IFRS 16, 29.5%, which is a healthy margin, well above our long-term goal. EBIT was SEK 7 million higher compared to the first 9 months last year, which is an increase of 9%. Net income increased by 15% and since the number of shares is unchanged, this also means that earnings per share improved with the same percentage rate as the net income. Now turning to Page 11. Net income for the first 9 months was SEK 60 million, which is SEK 8 million higher than last year. EBIT was SEK 7 million higher as a result of the revenue growth. Our reduced interest expenses are visible in the bridge and improved the net income by SEK 2 million, and the income tax was SEK 1 million higher as a result of higher operational result. Now turning to Page 12 to have a look at the cash flow. In the liquidity bridge, we can see that the gross operating cash flow amounted to SEK 133 million during the first 9 months, which demonstrates a solid business model. The CapEx in the bridge is mainly connected to the upgrade program of our manufacturing site in Redmond, U.S., but also connected to investments in our R&D program. The cash flow from financing activities consist mainly of redemption of borrowings. And during the third quarter, we made another redemption of SEK 20 million. This means the total redemption of borrowings for the first 9 months amounted to SEK 119 million. To summarize, we are pleased with the cash generation during the first 9 months of the year, and we have almost been able to maintain the cash level from the beginning of the year even if we have repaid SEK 119 million to the bank.Now turning to Page 13 to have a closer look at the balance sheet. I will make a couple of comments on individual balance sheet items. The increased goodwill is a translation effect from a stronger U.S. dollar, so there is no underlying movement on that one. Property, plant and equipment increased due to implementation of IFRS 16, where the opening balance for the year increased by SEK 72 million, and at the same time the liabilities increased by SEK 71 million, split on both current and noncurrent liabilities. Inventory was temporarily higher at the end of September, but this was compensated by a lower trade receivables. Looking at the liability side, we can see that we have now fully repaid all our borrowings. At the same time, we have maintained a flexible financing, which can be utilized when needed. The rest of the balance sheet items have limited movements compared to the end of last year. To summarize, we have a strong balance sheet with an equity of SEK 1.2 billion and equity ratio of 89%, which means we have a very solid platform going forward. Now turning to Page 14 and handing over to Tom again.

[Tom Rönnlund, Chief Executive Officer]

Thank you, Henrik. And please turn to Page 15, which is the last slide of the presentation. So despite that the third quarter was not as strong as previous year as well as that we this year are not predicting to deliver on our long-term ambition of growing faster than the global probiotic market, we feel very confident for the future for Probi. The probiotic market remains very attractive. Probi is well positioned in this field with a broad product portfolio, vertical integration with the ability to quickly and swiftly act on customer requirements and customer needs. We have a scientifically-validated portfolio where we continue to invest heavily in research and development, both on our existing offerings, but also for the future in terms of new and innovative ways of using probiotic. And based on these elements, we are confident that moving into next year, we will be able to return back to our long-term growth ambitions in terms of growing faster than the market and also maintaining a strong financial position as well from the perspective of strong balance sheet as well as a healthy cash flow for the company. The -- even despite that we have repaid significant amount of bank loans through this year, we are maintaining a healthy cash reserve also for investments into partnerships and projects that can drive additional growth for our company. Our strategy remains focused on ensuring that our scientifically-validated offerings are getting a bigger, sort of larger share of the global market. And we clearly see that we have the ability to differentiate ourselves versus competition in these areas, both on research that has been carried out in the past and that is part of our scientific heritage and assets, but also with the new and innovative concepts that we are bringing to the market. Geographic expansion still is on the agenda. Doesn't necessarily have to mean that we're moving into additional geographies or countries, but rather getting a larger share of markets where we are smaller today. And with the strength in commercial resources throughout this year, we are seeing a buildup of a healthy pipeline in this perspective and that we are working very hard on executing with speed as we move into next year as well. The lead times in certain of these customer projects are long, but we also feel confident at the same time that based on our assets, we have great opportunities of winning in those areas. We're also making, as mentioned, investments into our production facilities in order to strengthen both our gross margins in a longer term perspective as well as our competitiveness in the market. So with that, we conclude the actual presentation and open up for questions. Well, sorry, yes, let's go to Page 16 first and just provide you with an outlook for our financial calendar moving forward. But with that, we would like to open up the call for questions.

[Operator]

[Operator Instructions] Our first question is from Mattias Vadsten from SEB.

[Mattias Vadsten, Analyst]

I have a couple of questions actually. So on the North American market, you said that your strength in U.S. commercial resources has the ability to grow your market share there. So I would appreciate some flavor here and sort of the key improvements from your side in practice.

[Tom Rönnlund, Chief Executive Officer]

Okay. So when it comes to the U.S. market, we have added additional resources to have a greater -- a closer presence to the customers across the country, which has also increased our reach in terms of number of accounts that we can address. So in terms of number of sales resources being deployed into the market, that has increased since before. Also we have also added more scientifically-oriented sales support as well in order to make sure that we have a sufficient scientific backing in our sales processes. And we are seeing that this is giving us initial positive results, and we hope that those elements will continue to deliver as well. Furthermore, we're also as I mentioned, targeting additional channels where Probi historically has not been very strong in the U.S. market and where we also are engaged in a number of projects in terms of entering into -- for us, earlier, should I say, well, not very well developed sales channels. So those are our some of the main initiatives.

[Mattias Vadsten, Analyst]

Very helpful. So if I may, also it would be interesting to hear sort of your view on the overall North American probiotics market. Do you view this as a temporary downturn? Or should we sort of expect it to [ recur ] in the coming quarters? So -- and also what do you think is the main driver for the overall weakness in the region?

[Tom Rönnlund, Chief Executive Officer]

Good question. And unfortunately, I can't see into the future. But still, it's a -- I think, looking at it for the past sort of 3 quarters, 4 quarters, if we look at the market data that we have available, there are a couple of things we believe at least, there are experts forecasting markets as well. But what we believe is affecting the situation is the element of consumer confusion to a sense in terms of the probiotic segment in the U.S. market. It's a crowded market space with lots of various types of offering to the consumer, and not always very well differentiated. So as well as the presence in the market of products, which necessarily doesn't deliver the clinical benefit. So those 2 things, consumer confusion combined with various products which not necessarily are formulated to deliver a true clinical benefit, that can, of course, cause consumers to, okay, I don't really know what to use. And when I purchase an article, I might end up with something that doesn't really make a difference for me. So I think that or we believe that, that is one element there. And in that respect, we actually feel quite confident that, that is working in our favor from the perspective that we have strong science and well-validated products not only from a scientific point of view, but also from a consumer point of view that the consumers, when they are using Probi's product that they actually feel the difference and stay loyal in that respect. So it's difficult to say in terms of sort of the future prospects for the U.S. market, but at the same time, we believe that the position or opportunity for Probi is still very positive in that environment.

[Mattias Vadsten, Analyst]

If I can move on to China perhaps then, so the increased regulatory reviews of the probiotics market and so more -- in fact, if I can understand, how is this affecting the launch climate? And what type of regulations are we talking about? And also some...

[Tom Rönnlund, Chief Executive Officer]

Yes, the main element of that wasn't really related originally to probiotics. It was actually a bit of a focus from the Chinese authorities on supplement in -- dietary supplements in general where claims were made by companies, which weren't supported. So the government launched a program to address that during the spring really which, of course, sent some ripple-effect through the industry as there was a heightened focus on ensuring that your product actually delivers what you're saying about them to the consumers. But at the same time, we are seeing signs that, that sort of the, should I say, effect of that is wearing off and the probiotic market in itself -- I don't know for supplements in general, but the probiotics market in itself is, again, on a growth track and there's a very strong interest from a consumer point of view in strong offerings in this field. So we do expect that the Chinese market, for sure, will be a growth driver and engine moving forward. Probi's exposure into that market is not huge as you can see from our overall numbers, obviously, with the region. But with our increased presence and the work we're doing there, we feel that, that provides us a good opportunity for future growth.

[Mattias Vadsten, Analyst]

And then lastly, I guess, a quick question on EMEA actually. So is it possible for you to quantify the order phasing effect for Q3?

[Tom Rönnlund, Chief Executive Officer]

We haven't done that basically, but -- and I think for our business, it's important to look at the longer-term trends. Indeed, we will have variances between quarters. So I think it's -- I think we should look at it towards the end of the year rather and see how we're performing there.

[Mattias Vadsten, Analyst]

So we should view it as it hasn't weakened since H1 because you're still up in H1 in the EMEA. So you haven't seen a, sort of, underlying downturn for you yet in the EMEA.

[Tom Rönnlund, Chief Executive Officer]

And EMEA is many markets for us, of course, in that sense. So it's a little bit hard to give a simple answer to a short question, but I would say, I mean for EMEA, we've had a good growth trend into this year. We have added new customers. We are also making entrances into markets where we haven't been before. So even though individual quarters might be up and down a little bit depending on certain customers' ordering patterns, I would say we still feel that, that also EMEA, even though the regulatory climate is different, still represent a growth opportunity for us because our share in that market outside of Sweden is relatively small or very small actually. So we do see opportunities there.

[Mattias Vadsten, Analyst]

So my last question is really on -- a bit broader, if it's okay. So your strategic direction here in terms of branding, are you trying to position sort of unitary Probi brand on products to a larger extent? Or are you, sort of, satisfied with the current setup? I mean you guys have been here for 9 months now, so it will be interesting just to hear you put some flavor on that.

[Tom Rönnlund, Chief Executive Officer]

It's a good question. And of course, Probi's business model has been in place for quite many years. I mean if we look at our portfolio offerings, we have since the acquisition in the U.S. a few years back, broadened it with additional types, really, of offerings compared to what Probi historically has had. And the branding aspect has only really been prevalent in the Swedish market, but there is, of course, an element of actually creating a customer stickiness in terms of having your brand or your IP as a part of the customers' offering. We are working with this because in our quite wide customer portfolio, there are different opportunities for doing this with different types of offerings. We also believe that it is a strength to actually be able to leverage the heritage and the strength of the brand and the scientific sort of backing and assets behind that. And therefore, we are evaluating that on a customer-by-customer basis because it depends a little bit on the type of offerings that the customer is putting into the market. So I'm not saying that's going to be unified approach, but it's definitely something that is on our agenda as well to ensure that we leverage our brand.

[Mattias Vadsten, Analyst]

Very helpful. So the last one is very, very quick. So the employee-related provision of SEK 4.5 million, just trying to compare sort of the correct EBIT, the comparison quarter last year. So the SEK 4.5 million, was that attributable to Q3? Or was it Q1 last year?

[Henrik Lundkvist, Chief Financial Officer]

You should really see that as, yes, the first 9 months, so to say. But it wasn't in the third quarter. It was early in the year. So in the comparison, you should really take them out.

[Mattias Vadsten, Analyst]

Yes, but if I look at Q3 isolated, so then I should use the EBITDA at SEK 38 million as a comparable figure?

[Henrik Lundkvist, Chief Financial Officer]

You should take them out. If you look at the first 9 months, you should adjust the SEK 4.5 million right because that was a onetime thing last year.

[Mattias Vadsten, Analyst]

Absolutely. But it isn't for Q3 last year, so if I look at Q3 isolated...

[Henrik Lundkvist, Chief Financial Officer]

There is no impact from those SEK 4.5 million. It's early in the year.

[Operator]

[Operator Instructions] Our next question is from Rickard Anderkrans from ABG Sundal Collier.

[Rickard Anderkrans, Analyst]

So just going through some questions here quickly. You mentioned that you see major opportunities for Probi to return to growth next year. Could you add some flavor on what drivers we should look out for in terms of specific markets and segments? And is the market -- the global market still growing roughly 7% per year?

[Tom Rönnlund, Chief Executive Officer]

So if we look at the global market first, the available data that we have currently, which basically runs through the first half of the year, I would say it's probably slightly lower than 7% on the available data that we have, which -- so it's probably slightly behind or lower than 7%. And if we look at the specific growth opportunities that we see for next year, they are actually spread through the geographies, but of course, the magnitude varies depending on customer sizes, the market sizes obviously. But we do see an opportunity to have a stronger year in the U.S. even though that the actual, this year's performance is a tougher one for us in the current market climate. Of course, that demand, strong focus on execution and making sure that we turn the opportunities into sales, but that I would say would be one of the larger drivers there in that. And then in a smaller scale, but of course, working off a smaller base, we also see that our efforts and focus in the APAC region should start to pay off through next year as well.

[Rickard Anderkrans, Analyst]

Perfect, perfect. So looking at this quarter specifically, you showed really strong cost control across the board. Are these sustainable levels going forward? Are there any sort of, would you call it, a bit of a one-off in that sense?

[Henrik Lundkvist, Chief Financial Officer]

So looking at the operating expenses in the first quarter, they are a bit affected by vacations, less during the vacation months being both in July, August, so to say, looking at the global group here. We have spent a bit less on marketing, for instance, and some other things. So I would expect a bit higher going forward. It's been a vacation period, yes.

[Tom Rönnlund, Chief Executive Officer]

We are -- I mean provided that we are seeing a slump in our growth here during the second half as communicated, we still see opportunity. So we also believe it's the right thing to continue to make sure that we have the resources for expansion and additional new business.

[Rickard Anderkrans, Analyst]

Interesting. So looking at that, you have a very strong balance sheet at the moment obviously. What can we expect in terms of capital allocation going forward? Would an acquisition make sense? Or are you prioritizing internal efficiencies and improvements?

[Tom Rönnlund, Chief Executive Officer]

We are continuously working on a number of projects within the business development area, and we hope to be able to come back to that through next year.

[Rickard Anderkrans, Analyst]

Excellent. So just a final question. Could you provide any sort of guidance in terms of the efficiency program in the U.S. in terms of savings we can expect? Or perhaps a gross margin target?

[Tom Rönnlund, Chief Executive Officer]

We prefer not to at this moment in time. It's still early on and it's a complex process to install these machinery with full ongoing manufacturing as well at the same time, as we do not wish to interrupt that in any way. And as I said, it's according to plan and it is targeting a longer-term gross margin improvement opportunity there. So the quantification of that, we would like to come back to that at a later point.

[Operator]

And as there are no further questions at this point, I will hand the word back to the speakers for any final comments.

[Tom Rönnlund, Chief Executive Officer]

Okay. So thank you very much for your attention this morning, and we wish you a great weekend. And hope to speak to you, again, on the 11th of February next year. Thank you.

[Operator]

This now concludes our conference call. Thank you all for attending. You may now disconnect your lines.