Probi AB

STO:PROB

Earnings Call Transcript 2020-Q3

[Operator]

Hello, and welcome to the Probi AB Q3 Report 2020. [Operator Instructions]. Today, I am pleased to present the CEO, Tom Rönnlund; and CFO, Henrik Lundkvist. Please go ahead with your meeting.

[Tom Rönnlund, Chief Executive Officer]

Thank you very much, and a warm welcome to you dialing in here today to Probi's Q3 2020 Conference Call. As mentioned, Tom Rönnlund here, CEO; and Henrik Lundkvist, CFO, also in the room. Please turn to Page #2. And I encourage you to familiarize yourself with our safe harbor statement. Please turn to Page 3, which is the agenda for the day. So we will walk you through an executive overview of our third quarter results as well as dive a bit deeper into our financials for the quarter as well, and the first 9 months of the year. And then also conclude with a few remarks on the outlook for our company as we head closer into 2021 as well, as well as finishing off with a question-and-answer session. Please turn to Page #4. So the third quarter in 2020 for Probi is concluding one of our strongest quarters ever. Ourselves compared to previous year, Q3 in 2019 is up 38%, particularly driven by strong performance in the region Americas. We have also delivered a healthy EBITDA margin in the quarter. And while we had region Americas as our main growth driver in this particular quarter, we did see a somewhat weaker development in EMEA and APAC, partly affected by earlier stock buildup and some lingering COVID-19 pandemic impact as well. In the quarter as well, we have completed the search for a new Vice President for our research and development units and team. And welcome Mr. Peter Dybdahl Hede into our executive leadership team. And with this recruitment, we now have a complete leadership team in Probi as well, very satisfying for us. We're also in the quarter, very proud to have published in the medical journal, psychology and behavior. Our study on Probi's proprietary strain, L. plantarum HEAL9, where we, in a randomized, double-blind, placebo-controlled trial showed significant reduction in the pro-inflammatory markers, fractalkine and CD163 compared to placebo in this trial. These 2 inflammatory markers are coupled with acute stress in chronically stressed individuals and the results from this exploratory study is very encouraging and provides us pointers for further research and in the future as well, introduction of new products. In the quarter and throughout this year, societies around the world has been vastly affected by the COVID-19 pandemic. Positively, in one context, is that Probi operations have been maintained throughout this period. It's been a challenging period for our business. At the same time, our business have been performing well. Our teams are healthy -- safe and healthy, and we have been able to stay operational through these challenges. We do have certain customer dynamics affected by the pandemic but these, on an overall level, combined, poses limited effect on Probi as a company. Last night as well, we communicated that Probi has acquired a stake in Vital Nutrients Holdings as well as initiated a strategic partnership with that company, and we will get back to that a little bit later here in the presentation. So please turn to Page #5. As mentioned, we had a very strong quarter in terms of sales, were up 38% organically, admittedly against the relatively low compare in Q3 2019 and also combined with a positive one-off effect in region Americas in Q3 2020, related to a customer product range update. But even if we remove this positive one-off effect, we would be up -- we are up about 26%, 27% in the third quarter. Even more importantly, it's a longer-term trend. If we look at our year-to-date sales performance, where we have a growth in our sales of 16% versus last year, landing on SEK 532 million for the first 9 months of the year. And even with removing the one-off effect earlier mentioned here, our growth into this year for the first 9 months is -- equates to approximately 12% on a year-to-date basis, which is well above our long-term growth target, as communicated earlier, of more than 7%. Our EBITDA, is on par with previous year, both in the quarter as well as year-to-date. Even if OpEx grew, particularly in the third quarter, based mainly on team expansions and increased activity levels across our teams to maintain our growth trend. In a long-term perspective, as we also earlier communicated, we're working towards our long-term target of an EBITDA margin of above 29%. This year, we are not quite there yet. And as mentioned earlier in the year, we had an equipment malfunction, which affected our margins, particularly in the first quarter. But as you can see from the third quarter EBITDA margin, we are well underway of fulfilling this longer-term target as we move into the future. Please turn to Page #8. If we have a look at our regional sales development and gross profit development, we can start with region Americas. As mentioned, very strong growth in the third quarter here, with sales up approximately around 50% compared to previous year. And if we remove the one-off effect from here, we would still be up about 36% in the quarter specifically. This strong development is driven by a number of factors. One is that there is a strong demand in the U.S. market for dietary and nutritional supplements. Most likely, partly driven by the pandemic. We also have been engaged throughout this year in product range upgrade program with one of our major customers, which is also positively affecting our growth. But we have as well, added a number of new customers to our portfolio, who quickly have grown into fairly considerable size in our portfolio and holds a good promise as well for continued growth opportunities for Probi in the region Americas. Also very encouraging is that our focus on what we call our premium products has also had a very positive growth development in the U.S. market. So all these factors together have combined delivered a very strong performance in region Americas. And on a year-to-date level, for the first 9 months in the year, our sales growth is about 20% and in this region. So very encouraging signs that we are on the right track in the U.S. to continue to expand our business and serve even more customers. If we turn to region EMEA, as you can see, the development in the quarter is not very satisfying. This has been affected by -- partly on the COVID-19 pandemic, where some of our customers are dependent on meeting health care practitioners, doctors, pharmacies, et cetera, in their sales processes. And these have been hampered, of course, through societal lockdowns as well as other measures taken by both individuals and societies in relation to the pandemic, which has made it difficult for some of our customers to be as successful as they've been in the past in selling their products. We've also been affected in the EMEA by a reclassification of royalty sales -- from royalty sales over to product sales as well as a portion of sales moving to the U.S. Underlying in region EMEA, we are seeing positive signs with both acquired new customers as well as exciting new customer dialogues for potential future launches, which fills us with confidence that we, moving forward, should be able to have a positive development in region EMEA. Of course, taking into account whatever effect the second and third wave of the COVID-19 pandemic might have. But we are seeing encouraging signs that for Probi's sake, we hopefully should be able to return to growth also in this region. And as you can also notice here from a gross profit perspective, the reclassification here of earlier royalty sales over to product sales as well as shift of certain sales over the U.S. have affected the gross margin negatively. If we turn to our region APAC, here we have a quite weak quarter where we're 14% down versus previous year. If we look at the period for the first 9 months of the year, we're up 13.5% for the first 9 months this year compared to 2019. Still, this is on low levels, and we have much higher ambitions in this region as well. This year, we do have lingering effects of the COVID-19 pandemic, similar dynamics, as earlier mentioned, for EMEA, where some of our customers have had difficult times of reaching out to people who are recommending their products to consumers as well as those customers of ours who mainly have their sales through the pharmacy channel, where societal lockdowns and precautions taken in these countries have led to weakened demand in these channels. We are still filled with confidence and optimism about the growth prospects that this region holds. And we are also taking measures in this region to ensure that we've got the right team and the right resources and the right amount of resources here to be able to drive further growth as we move forward. Please turn to Page #9. Last night, as mentioned, we did announce that we have invested $6 million into the holding company or the company group Vital Nutrient Holdings. It's a portfolio company of North Castle Partners, a U.S.-based private equity company. And Vital Nutrient Holdings is focused on supplying dietary supplements of high-quality with a scientific foundation, sold primarily through health care practitioner network as well as established e-commerce marketplaces such as Amazon and others. More importantly, for Probi here is the partnership and collaboration opportunities that this investment allows. Vital Nutrients consists -- has today 3 brands: one which is Vital Nutrients, another one being Bariatric Fusion and then also recently acquired Hyperbiotics. Probi has had a long-standing relationship with Hyperbiotics in the U.S. and in international markets. And through this investment and the addition of Hyperbiotics to this group of companies, it represents to Probi an exciting partnership and collaboration opportunity. We have close access to a number of exciting brands which share many of the interesting characteristics that Probi holds high, like scientific foundation as well as working with health care practitioners as well as representation in important e-commerce channels. We also see opportunities for research and development and product development in a joint fashion that can then also strengthen Probi's growth prospects for the future across this portfolio of brands as well as, of course, securing a very long-term supply agreement with Hyperbiotics as well. We also see additional opportunities for collaboration here in terms of possibilities for production, collaboration, leveraging Probi's existing facilities. And the investment as such, will be reported as a financial investment in Probi's balance sheet and Probi will be the second largest shareholder in Vital Nutrients Holdings. Please turn to the next page, please, where I will be handing over to Mr. Henrik Lundkvist for the financial review section.

[Henrik Lundkvist, Chief Financial Officer]

Good morning, everyone. I will now walk you through the financial section. Please turn to Page #9. As earlier mentioned, our net sales grew by 38% compared to last year. Adjusted for currency effects, the sales growth was 43%. If we excluded the one-off effect of SEK 50 million, from the product updates related to large U.S. customer, together with the currency effects, the growth rate would have been 32%. We should also remember that the comparison quarter was relatively weak, as Tom earlier pointed out. But nevertheless, we are very pleased with the sales in this quarter. Our EBITDA increased by 35%, up to SEK 61.5 million, mainly due to higher sales volumes in Americas. This gave us an EBITDA margin of 31.6%, which was in level with last year and a level that we are pleased to be at. EBIT was SEK 44.1 million, which was 65% higher than last year, and net income and earnings per share was 53% higher than last year. Now turning to Page 10. Net income for the third quarter increased by SEK 11 million and ended at SEK 33 million. The increased net income is mainly a result of higher sales volume. Our operating expenses were SEK 7 million higher due to higher activities in R&D projects, strengthened sales organization and increased business development activities. And obviously, the income taxes increased as an effect of the strong results. Now turning to Page 11. For the first 9 months of the year, the gross operating cash flow amounted to SEK 152 million. We had a negative working capital effect due to the inventory buildup in connection with the launch of an updated product range for a large U.S. customer. We expect the number of days on hand to go down a bit when we have improved the processes, but this is still relatively new to us here. Our trade receivables were also affected by large shipments in Q3 that will be collected during Q4. The tax payment has been higher this year, but it's only related to timing effects. CapEx is mainly related to the upgrade program of our manufacturing site in Redmond, U.S., amounting to approximately SEK 23 million, but it's also connected to further investments in clinical trials and patents amounting to SEK 7 million. The cash flow from financing activities includes a dividend payment of SEK 11 million based on the decision at the AGM in May. The remaining SEK 12 million are related to payments and interest for lease obligations. To summarize, our cash generation for the first 9 months of the year is temporarily affected by an increased working capital, but we expect to have a strong operating cash flow going forward. Now turning to Page 12. We continue to have a very strong balance sheet and no external loans. Our equity amounts to SEK 1.2 billion, with an equity ratio of 92%. This means that we are well equipped to continue to evaluate interesting business development projects so we can grow our company, not only organic but also through collaborations and different types of partnerships. Now turning to Page 13, and handing over to Tom again.

[Tom Rönnlund, Chief Executive Officer]

Thank you, Henrik. And then let's turn to Page #14. So concluding a strong third quarter with great achievements by our entire team staying operational and in challenging circumstances and driving exciting product development concept projects as well as new customer projects across the Board in our company is creating a strong foundation for us to be able to deliver on our long-term financial goals as well as on our strategic ambitions. We stayed the course in terms of focus on growing ourselves. Our ambition is to be a growth company with a focus on scientifically validated products, strong market presence and higher market share in key markets. We are on the way to do this. We are not yet all there. Of course, there's still a lot to be done, but we have encouraging development as we speak. We are growing ourselves in the world's largest probiotic market in the U.S. and we're also growing our most scientifically validated product types there. We're working with strategic partnerships as well to drive expansion into new areas and to provide stronger foundation for Probi's growth as well. The earlier announced collaboration and joint venture in VivaPro as well as the yesterday announced strategic collaboration with Vital Nutrients are examples of that. We also continue to invest in our team across our sites and across the world to be able to fuel this growth. We also continue to be focused on leading the way in probiotic innovation and science. We're investing in new clinical studies and research partnerships and we are consistently delivering exciting innovation and scientific validation also into new, exciting potential future product areas. We also remain committed of ensuring that we have an organization characterized by manufacturing excellence. Our manufacturing upgrade program in the U.S. is well underway. It has been a challenging task to proceed with this, of course, under the ongoing pandemic but the team has pulled together in a fantastic way, and we are well underway and will conclude the first section or the majority of the manufacturing upgrade program through the later month in this year and the first months next year, which we are doing to strengthen our competitiveness with the ambition to grow our margin over time. All these components combined, creates a strong foundation for Probi to continue to be first in probiotics as well as grow our company towards the long-term objective of doubling our company in size. Thank you. So with that, if we turn to Page 15, we will open up for question and answers.

[Operator]

[Operator Instructions] The first question comes from Rickard Anderkrans.

[Rickard Anderkrans, Analyst]

So first of all, looking at the roughly SEK 15 million stock buildup here in the U.S. in the quarter, can you say anything on how long you expect this stock to last, i.e., how should we think about potential follow-up orders in Q4? Or should we perhaps think of it more of a 2021 type of refill in that sense?

[Tom Rönnlund, Chief Executive Officer]

If you look at the current inventory level, that is a bit high, I would say, or looking at the number of days, it's currently a bit high, and that should go down a bit. But at the same time, our volumes are picking up here. So in absolute numbers, the number might be more flattish, so to say, but the number of stock terms should increase here.

[Rickard Anderkrans, Analyst]

Okay. Okay. So maybe we should think about the one-off from the customer expanding its product line here in the U.S., we should think about that revenue might be -- might not be recurring in the next quarter, at least in terms of [indiscernible]

[Tom Rönnlund, Chief Executive Officer]

That is, correct. That is correct.

[Rickard Anderkrans, Analyst]

Great. And looking at the weaker development in APAC, could you add some details on what drove the decline? You mentioned the pharmacy lockdowns and perhaps if you could more specifically also tell us what efforts you're putting in to shift the trend we see in Asia?

[Tom Rönnlund, Chief Executive Officer]

So I think the region and our customer base have been affected by the lockdown for sure. We have the majority of our customers in China, South Korea and Australia and then also to some extent in some other markets as well. But in these markets, the COVID effects have been quite pronounced, particularly for the type of customers that we're working with, where many are dependent on sales by our pharmacies as well as driving demand for their products through personal visits with pharmacists as well as different types of health care practitioners. So these elements have driven a weaker demand for us with those customers. We have also experienced a bit of a slowdown in introduction of new products as well in the midst of the pandemic. And any delay there will also cause, of course, some ripple effects on us as well. We are seeing signs that, that is picking up a bit in speed, but it will take us some time to actually get back to a stronger growth momentum in the region. In terms of activities that we're undergoing there, we have made changes to the leadership in the region. We are adding additional resources as -- we have added and will add additional resources to make sure that we are well equipped to handle the great interest that our products are having in the region, but also overlooking or sort of reevaluating certain elements of the strategy in the region with regards to the mix between distributors and direct sales, et cetera. So it's a multifaceted sort of approach to address what we see as a -- well, not satisfactory growth at this point in time.

[Rickard Anderkrans, Analyst]

Great. Great. And just looking at briefly at Vital Holdings here. How should we think about their current mix of probiotics? They seem to have quite a lot of different areas going on in terms of supplements. So it would be interesting to hear their current mix. And yes, maybe a bit more flavor on their positioning there.

[Tom Rönnlund, Chief Executive Officer]

Yes. The recent addition of the company Hyperbiotics into the number of brands in this company, in Vital Nutrients, is mainly based and focused on probiotics. So that, of course, adds to the brand lineup. At the same time, these companies have slightly different -- well, both branding and positioning in the market as well as different customer segments. So what is exciting here is, of course, to cross fertilize across this group. There are certain areas in which the portfolio companies are not working or are working, which is not of interest to Probi but provided the profile of their brands as well as the customer segments that they're working with, there is interesting opportunities for cross fertilization and joint projects as well in identifying new and exciting product concept across these brands.

[Rickard Anderkrans, Analyst]

And it sounds like Vital Nutrients might be a bit of higher-margin products. Is that correctly assessed?

[Tom Rönnlund, Chief Executive Officer]

Potentially, yes.

[Rickard Anderkrans, Analyst]

Great. And just as a final question in -- for the U.S. now. What trends are you seeing there in the U.S.? Would be interesting to hear a bit more info on the underlying trends in the U.S. in terms of where you have seen the growth pickup. You mentioned there was some new customers. Are there any specific sales channels that stands out? Or is there any particular trend that you've been noticing? And perhaps how we should think about that going into the next quarter as well?

[Tom Rönnlund, Chief Executive Officer]

Yes. I think for us, the -- particularly when it comes to new customers, I think it's customer-focused on e-commerce marketplaces. But those, I would say, have performed the best or have had sort of the greatest increases or the greatest order flow. But also in other customers who are working across multiple sales channels, where we have been able to identify exciting product concepts have also performed well. So it's not -- unfortunately, I cannot answer it just with one simple answer there. So it's a mix, I would say for Probi. It has been an opportunity for us through the hard work of our U.S. team to be able to attract new segments of customers where we've been able to find the right product solutions for them, which then have caught on in the market so far. So -- and of course, starting to work with some of these bigger customers also provides opportunities for further growth moving forward. And also, of course, line extensions and expanding the collaboration. Our efforts in identifying new customers has in no way slowed down. We still believe that we are very well positioned in the market to do that. But we have then experienced good growth with new customers as well as in our existing customer base. I think the U.S. market is probably growing a bit more than what was expected -- well, perhaps a year ago, most likely partly, which we've talked about before as well, partly driven by the COVID pandemic. So there is currently a strong sentiment in the market in terms of demand. And then as always, it's, of course, important to position yourself as an attractive supplier with good quality products, which are backed by science, and that is Probi's sweet spot that we believe.

[Operator]

Next question comes from Mattias Vadsten from SEB.

[Mattias Vadsten, Analyst]

Mattias Vadsten from SEB. Congrats to a great quarter here in Q3. My first question is in terms of the positive effect from the American customers product update program. What is the drop-through to EBITDA here? Is it fair to assume that the margin of this was in line with your target, I mean, in the ballpark of 29%? Or how should we think about that?

[Tom Rönnlund, Chief Executive Officer]

Yes. I would say that's a fair assumption.

[Mattias Vadsten, Analyst]

And my next question would be, I mean, what can you say about potential for continued negative impact on COVID-19 going into Q4 here in APAC and EMEA? And more specifically, perhaps, is there a risk that the negative effect from stocking effects from earlier this year will also -- I mean, partly last into Q4? What can you comment about that?

[Tom Rönnlund, Chief Executive Officer]

I think as mentioned for EMEA and APAC, the -- it's a bit of a mixed bag, I would say, in terms of signals. We have some customers who are actually coming back. Sort of, okay -- resuming demand, resuming demand, I should be saying. Whilst others are still in a difficult situation. For EMEA, in particular, I think from our perspective, we have some exciting developments with customers ongoing. So -- with new launches with expansions, so we're quite confident that moving forward, we will have a positive development. Of course, a bit difficult to judge right now, as everybody has seen the sort of the development in many countries right now is really not going the right way in terms of COVID-19. And therefore, it's a bit difficult to call. But I think we should be expecting a fairly stable development in EMEA for the latter part of this year. With regards to APAC, a similar position, I would say, where we will continue to be affected by the challenges that some of our customers have in reaching their customers in their in turn as well as, of course, as we are rebuilding and redesigning our efforts in that region as well, there will be probably a bit of a lag before we can start to generate growth there as well. So for -- I would say that for APAC and which also then constitutes a fairly small part of our overall portfolio, it will take us a bit of time into next year before we feel confident that we should be able to return to growth.

[Mattias Vadsten, Analyst]

That's very helpful. I guess my other questions were answered before. So that was all from me. And congrats once again.

[Operator]

We have no more question for the moment. [Operator Instructions] .

[Tom Rönnlund, Chief Executive Officer]

Yes, and please, before you leave, please familiarize yourself on the last page as well. If we could flip to that with our financial calendar as well. Looking forward to see you or speak to you all then as well. Thank you for attending the call this morning.

[Operator]

Thank you, ladies and gentlemen, this concludes the conference call. Thank you all for your participation. You may now disconnect.