Probi AB

STO:PROB

Earnings Call Transcript 2023-Q3

[Operator]

Welcome to the presentation of Probi Q3 report. [Operator Instructions]

Now I will hand the conference over to CEO, Anita Johansen; and CFO, Henrik Lundkvist. Please go ahead.

[Anita Johansen, executive]

Good morning. Welcome and thank you for dialing in to Probi's presentation of our Q3 results for 2023. With me, I have Henrik Lundkvist, the CFO of Probi. My name is Anita Johansen, and I'm the CEO of Probi. Please take a few moments to familiarize yourself with this statement. This is the agenda of our presentation today.

With today's Q3 report, I'm pleased to present both an increased net sales in the quarter, but also a new updated strategy and new financial targets. The net sales in the third quarter increased by 8%, 6% adjusted for currency effects, to SEK 156 million versus the last year's quarter, SEK 145 million. All regions showed growth compared to the previous year. The EBITDA margin decreased to 18% or 20% when we adjusted for items affecting the comparability.

We are now announcing our new strategy, we call it Probi Reinforced. It's a new 5-year business plan and a new financial target for 2024 to 2028. In the quarter, we also published our -- the results of our third clinical trial of HEAL9 strain, and it shows -- it strengthens the evidence of improved cognitive performance of this strain.

And because of that, we are now launching our new concept, Probi Sensia, which is based on HEAL9. In the quarter, we also had a publication of a new study in metabolic health that's just clear benefits of probiotics. And after the quarter, we announced a new CFO, Per Lindblad, who will start as CFO of Probi on November 1.

After an intensive work on evaluating our strategy, we can now present an updated strategy and new financial targets that will reinforce and strengthen Probi. Our strategic plan is to achieve sustainable and profitable growth, by striving for excellence in 4 key strategic focus areas.

The first strategic focus is Commercial Execution & Customer Centricity. By improving our customers' experience and extending our internal understanding of our customers, we will expand our global base of key account customers and we'll grow our position on our science-based products, and we will focus on Tier 1 markets.

The second strategic focus is Pioneering Science & Innovation. We will continue being first in probiotics by ensuring a continuous rate of market-relevant innovation, by enhancing speed to market and by continuously expanding our range of clinically documented probiotic offerings. We will also evaluate scientific benefits and growth potential of other biotics.

The third focus, Providing Differentiated Quality Solutions, it refers to our competitive edge of delivering products through the entire value chain from concentrated probiotic ingredients to finished consumer product. We will focus on a long-term improvement of the gross margins by optimizing our internal manufacturing processes. And through supply chain effectiveness, we will deliver better customer experience.

We will address the need for new production opportunities on contract manufacturing in growth regions, and optimize manufacturing footprint as business opportunities appear. All of these 3 focus areas will be reinforced by leveraging strategic external partnerships, international research collaborations and/or acquisitions within relevant health areas, geographies and segments.

The fourth focus and a foundation for successful implementation of the strategy is having People with a Shared Purpose and Passion for Probiotics. We aim to have a healthy and thriving organization driven by our shared purpose and our goal to provide probiotics for healthier lives and a healthier planet.

We have set new financial targets for the next 5 years, for 2024 to 2028. These targets are ambitious. We will strive for delivering a compound annual growth rate of 6% over the 5-year period. A growth target of 6% CAGR is above the market growth projections in our industry, which, based on our revenue in the different regions, would be closer to 3% to 4%.

With regards to our profitability, our new financial goal is to gradually increase our EBITDA to reach 25% or above in 2028. This will happen gradually over the years. Growth will come from new products and innovations, and from growing existing and getting new customers. By region, we expect the highest growth rate from APAC, followed by EMEA and then North America.

2024 will be a transition year with more modest expectation. It will take some time to increase our profitability, which we are doing with our remediation program in manufacturing. Also, our new innovations will contribute to our growth, but sales cycles may take months and sometimes years to implement in our customers' portfolios.

Growth is expected to come from new products and innovations. And one of the new innovations is our new offer, Probi Sensia, in the gut-brain area. In 2022, brain health was the fastest-growing category within the global dietary supplement market, and there is a high interest for brain health in especially younger audiences. And growth in this area is expected to continue according to Nutrition Business Journal.

Our new product is scientifically documented and we recently published the results of our third clinical study on our human strain in the mental health area. Our product, Probi Sensia, is proven to support brain health by significantly affecting cognition, mood, sleep and stress in healthy but moderately stressed adults. This product can be applied in different product formats, dietary supplements and functional foods and beverages.

As we speak, this week, we are launching our new product at Supply Side West in Las Vegas, and we are already in dialogue with interested customers in all regions.

Now I will hand over to Henrik for a financial review.

[Henrik Lundkvist, executive]

Thank you, Anita, and good morning to everyone. So now I will walk you through the financial section of the report. We reported net sales of SEK 156 million or an increase of 8% in the third quarter. Adjusted for currencies, the growth was 6%. We are pleased to report growth in all 3 regions this quarter, with 3% growth in Americas, 22% growth in EMEA and 27% growth in APAC. Year-to-date, the report -- we reported a decline of 1% in net sales or minus 5%, adjusted for currencies.

Our reported EBITDA was 18% in this quarter and 19% for the first 9 months of the year. The EBITDA margin has been negatively affected by higher manufacturing costs during the year, which also was the case for the third quarter. Adjusted for costs affecting comparability, the EBITDA margin would be at 20% in the quarter and 22% for the first 9 months of the year.

If we look at the regional performance for the first 9 months of the year, Americas reported a growth of 1% or minus 5% currency adjusted. What we see is, in general, a cautious market where customers are ensuring they don't get too high stock levels, which results in lower order frequency from some customers.

In EMEA, we reported a decline of 21%. The sales in the region has been negatively affected by one of the largest customer that reduced their safety stock. We also had temporary lower sales in the Swedish market during the first half of the year, as we took over the distribution of the Probi brand. In Q3, we see a normalization of the order patterns, and we are starting to see the benefits from the new business model, with good growth in the quarter.

In APAC, we reported strong growth for the first 9 months of the year with growth of 27%, and sales for the first 9 months of the year was all-time high. Growth mainly came from Australia and China. We continue to be optimistic about this region based on our healthy customer pipeline.

And some short comments around the gross margins and for the different regions. In America, we have a lower gross margin compared to last year, mainly related to the challenges we have in manufacturing. In EMEA, we have slightly better margins compared to last year, which is due to us taking over the B2B business and cutting out the distributor there. And in APAC, it's more or less on par with last year.

And let's have a brief overview of our net income. Our reported net income was SEK 6 million, lower than last year. We had a positive volume effect from our increased sales, but this could not fully compensate the lower gross margin effect we had related to the higher manufacturing costs. Our operating expenses were more or less on par with last year, down SEK 1 million.

In the quarter, there was also a cost of approximately SEK 5 million affecting the comparison, where SEK 3 million was related to challenges in the manufacturing processes and the initiated remediation program, and SEK 2 million was related to recruitment cost for strategic positions. The financial result was better than last year due to higher interest rate, and the tax was lower as a result of a lower EBIT result. So net income for the period was SEK 6 million.

And then some comments to the cash flow for the first 9 months of the year. The gross operating cash flow amounted to SEK 89 million for the first 9 months of the year. We had a negative cash flow effect from higher working capital by SEK 37 million due to higher accounts receivable and inventory.

The inventory has increased partly as we have taken over the distribution in Sweden, but also as an increase connected to the remediation program as we -- yes, we keep higher stock levels to ensure we are able to meet our customer expectations. Accounts receivables was higher as large shipments were made late in the quarter, late in the third quarter here.

For the first 9 months, we paid taxes of an amount of SEK 14 million. The CapEx or investments, they were up at SEK 37 million, and the largest part was related to investments in our manufacturing sites in U.S., but we also invest in clinical trials, patents and IT.

We paid, in May, a dividend to our shareholders of SEK 15 million and the financing activities amounted to SEK 12 million, and that is mainly related to interest for lease obligations and -- payments and interest for 'lease obligations. To summarize, we have a strong cash position of SEK 301 million at the end of the quarter.

Our balance sheet continues to be very strong, and we have no external loans. The equity amounts to SEK 1.5 billion, with an equity ratio of 91%. Our strong balance sheet enable us to further invest in new projects and capabilities to continue to build our growth platform.

So to summarize the financial review, the reported numbers for the first 9 months of the year has been affected by a softer market, especially in Americas, but we are pleased to report growth in all regions in the third quarter.

The lower volumes, together with the challenges in manufacturing has, however, put some pressure on our profitability this year. So our earlier assessment made in Q2 remains, that our net sales will be approximately on par with last year and that our profitability will be lower than last year.

With that, I will hand over to Anita again.

[Anita Johansen, executive]

Thank you, Henrik. So Probi's mission and vision has not changed. We aim to continue to be first in probiotics, and we will deliver on our mission to provide probiotics for healthier lives and a healthier planet. Now we have clarity on our strategy and our financial targets for the coming 5-year period. We also have clear goals and objectives, and we know where to focus our efforts for the remainder of 2023 and onwards.

We want to come back to delivering sustainable and profitable growth, and we will deliver on our goals through a systematic focus on our strategic focus areas. One, we will ensure our entire organization puts the customer at heart, and we will focus on our commercial execution. Two, we will continue to bring new and market-relevant innovations to the market, supported by good clinical science.

And three, we will focus on being excellent in providing our customers the differentiated quality solution they need, while improving our profitability and gross margins by optimizing our manufacturing and supply chain processes. And four is the foundation for any successful, sustainable organization, it's by driving capable and resilient organization, and we will ensure to nurture, support and develop our people.

This concludes our presentation of our interim report and our updated strategy. Now there is time for questions, and I'll hand over to the operator.

[Operator]

[Operator Instructions] The next question comes from Mattias Vadsten from SEB.

[Mattias Vadsten, analyst]

Good to see updated targets. If you could just help me understand maybe the growth in detail. I think you mentioned 3% to 4% growth for the market. So yes, which would be the main areas for growth where you're present today? And maybe if you could share some words on potential new areas to add for sort of additional growth. That's the first question.

[Anita Johansen, executive]

Thank you for that, Mattias. So I can say when we look at the projected growth from external sources, we see strong growth in APAC, obviously, and moderate growth in the U.S. And this is also what we have in our assumptions. But we do have higher expectations than what is projected based on our new products and the customer projects we have ongoing already. So -- but we expect the growth to be highest in APAC and specifically in China.

I did mention briefly Tier 1 markets. And of course, Tier 1 markets for us is still North America, it's the U.S. In EMEA, it's definitely Sweden, maybe a few more markets. And in APAC, it's China, Korea and Taiwan.

[Mattias Vadsten, analyst]

And then you mentioned 2024 will be a transition year. But on the other hand, the comparison base should be relatively easier. So the question is do you expect sort of growth to resume for next year? Or could you share any comments or thoughts around 2024, that would be helpful.

[Anita Johansen, executive]

Henrik, do you want to answer that question?

[Henrik Lundkvist, executive]

Yes. So yes, on a profitability level, we don't expect big steps during next year. We need to reinvest the money, so to say, in stronger capability, things that we've already done this year, which also will have a full year effect next year. But we do expect to see some growth. But the financial target is then set to 2028, and the exact relation between the different year, we do not communicate.

But it will be a transition year. We will work a lot on the manufacturing program, making sure that we can leverage from the new manufacturing platform we have in place, so -- to then gradually improve our profitability in terms of gross margin. But we know that we also need to invest some money in the other parts of the organization to deliver this plan.

[Mattias Vadsten, analyst]

Good. And in terms of gross margin in Americas, yes, if you could just share a few more words. Because as I say, it's sort of a further deterioration versus Q2 maybe, or at least marginally. So if you could help me understand that. And when do you expect a more normalized gross margin again? Should that be 2025 or even 2026? Or how do you see it? .

[Henrik Lundkvist, executive]

So Anita, if I should start on that one. So as earlier discussed, next year, the transition year, of course there should be gradual improvements. But that is difficult to say what will happen in the first and the second and the third quarter, but we expect to see a gradual improvement of the gross margin effect. But next year, we need next year to fix this. And why is that then? Yes, of course, because it takes time. This is live bacteria that we are working with, and we need to have real-time data on the bacteria, making sure that we have the quality that we would like to have on our products here.

And right now, as we have discussed earlier, we do purchase some material instead of making it in-house. And of course, we would like to convert that in a balanced way [ or the ] next way, converting back to us making more of the material, which also will have a gross margin impact. So difficult to say, Mattias, but next year will be the transition year, but with gradual improvements.

[Operator]

The next question comes Sten Gustafsson from ABG Sundal Collier.

[Sten Gustafsson, analyst]

I have a few and maybe we should take them one by one. So the first one is I noticed that you removed the outlook for 2023 or the commentary regarding 2023 in your CEO letter, and I was wondering if you could perhaps provide us some guidance on what you expect for the remainder of 2023?

[Anita Johansen, executive]

Henrik, I...

[Henrik Lundkvist, executive]

Maybe just to address -- yes. Sorry, go ahead, Anita.

[Anita Johansen, executive]

Go ahead. Sorry, you can start.

[Henrik Lundkvist, executive]

Okay. It was actually mentioned in the CEO letter that we have the same statement or the same view on the full year as we communicated back in July in connection with the Q2 report. What that means is that we will -- we expect to be in level -- approximately be in level with sales last year. And that also means that we expect to have a lower profitability, a lower EBITDA margin compared to last year. So that's still valid. The comment from Q2 is still valid.

[Sten Gustafsson, analyst]

Sorry for -- I guess, I read it too quickly. And then regarding the remediation work. And I guess you talked about this earlier, but there's no clear or communicated time line when that work will be done. Is that correct? Or that will be sometime during 2024?

[Anita Johansen, executive]

It is correct that we did not communicate a clear time line. It is going to be a gradual improvement, so to speak. As Henrik tried to explain already, we are improving our processes in our manufacturing, meaning we are working with the live bacteria and we need to see the data, how they perform over time, before we put them back into our products. So it will be gradual and it will be at least towards the end of 2024 before we start seeing those improvements come back to us.

[Sten Gustafsson, analyst]

Okay. Got you. And on the gross margin, now that you have changed or taken out the distribution in -- or you're doing it yourself, the B2C business in Sweden, and we saw the uptick in the gross margin, is that the new level we should expect going forward then for Europe?

[Henrik Lundkvist, executive]

Yes. So if nothing else changes kind of, which is one assumption to be made there, I think, yes, we should be able to see margin more in these regions. But then we are dependent on customer mix and product mix as well, so of course, there could be new business coming in with a different margin profile affecting that number.

But in general, there should be an uptick since we are, as you said, cutting out the distributor. What we instead need to do is invest in marketing. So we do have a higher sales and marketing expense this year because of that. So we're kind of rebalancing or moving cost in the P&L to be below the gross margin there.

[Sten Gustafsson, analyst]

My last question is regarding the price sensitivity. I got the impression that earlier there was some price pressure and customers going to sort of lower value products, is -- I guess, mainly in the U.S. But is that pattern still valid? Or has that changed in the market?

[Henrik Lundkvist, executive]

So I can start on that one and, Anita, maybe you can jump in. Because I think what we saw in the second quarter was -- yes, there were some signals from the market. We could definitely see customers ordering less. That has kind of bounced back a bit in the third quarter. Now I'm mainly talking about the U.S., which is good, but it's also a very short trend. So I don't think -- I think it's a bit too early to evaluate that situation.

But what we can see is that the orders came in again in the third quarter, which I think is great news, of course, for us as well. So not sure long term what that actually will mean to us, but we do see a healthy order intake again.

[Anita Johansen, executive]

And maybe I can add. So of course, and I think that is -- I don't think, I know, it's part of our strategy is to sell more of our clinically backed or scientifically backed probiotics. So -- and those products, when we are able to sell those products, they are more premium priced. But also when the customers implement them in their portfolio, they usually stay with us for a long time. It's harder for them to change to something only because of price because it's a different offer. We actually have the science. So this is, of course, part of our strategy, is to make sure we increase the ratio of our clinically documented strains.

[Sten Gustafsson, analyst]

You mentioned earlier that there was some earlier destocking, but it's now back to normal in EMEA. Was that also the case in the U.S.? Or do you think that inventory levels are back to normal again? Or have we seen a restocking boost during Q3? Or do you think now we're sort of at a normalized level, whatever that is?

[Henrik Lundkvist, executive]

Sten, yes, so I understand your question there. You're talking about the customers' inventory levels now?

[Sten Gustafsson, analyst]

Yes, yes.

[Henrik Lundkvist, executive]

Yes. Okay. So I think there are a couple of different events here. So the one in EMEA, there were actually -- the B2C business. There, we had an impact of the pharmacies stocking up, while the distribution -- or the old distributor sold out their inventories.

And what that meant to us was that we didn't get a lot of sales in the second quarter even if we took over the distribution in April. So there, we had a negative impact during the second quarter. That came back in the third quarter, and now we can expect normalized sales levels going forward regarding the B2C business, because now they need to buy from us, so to say.

There was also a second event in EMEA, one of the largest customers in that region that overstocked a bit last year. Because of all the supply chain issues around the world, I think they had a strategy to make sure that they kept some more inventory compared to the past. So we did get a good effect during last year with that specific customer. They have then ordered much lower or lower levels compared to 2022, and that is visible in our EMEA numbers.

And then the third comment then around Americas because that is also -- we do see customers being more cautious on cash flow, making sure that they trim their inventory. So we have seen lower order volumes in general over the year. So even if they used to buy for 100, they potentially placed the same orders, but now it's only for like 95, if that is a proper way to describe it.

[Sten Gustafsson, analyst]

No, that's good. Very clear. And I guess then going forward, the change in order pattern will have less of an impact going forward since this has now been in effect for a year?

[Henrik Lundkvist, executive]

Yes, that is correct.

[Operator]

[Operator Instructions] There are no more questions at this time. So I hand the conference back to the speakers for any written questions or closing comments.

[Anita Johansen, executive]

Thank you. So this concludes our Q3 financial reporting. Our next financial report and call will be the year-end report on January 26 next year. But we will also be presenting on ABG Investor Day in Stockholm on November 22, so we hope to see some of you there.

Thank you for listening, and have a good day.