Niagen Bioscience, Inc. Q2 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to ChromaDex Corporation's Second Quarter 2020 Earnings Conference Call. My name is Josh, and I will be the conference operator today. At this time, all participants are in a listen-only mode. And as a reminder, this conference call is being recorded. This afternoon ChromaDex issued a news release announcing the company's financial results for the second quarter of 2020. If you have not reviewed this information both are available within the Investor Relations section of ChromaDex's website at www.chromadex.com. I would now like to turn the conference call over to Brianna Gerber, Vice President of FP&A and Investor Relations. Please go ahead, Ms. Gerber.

Thank you. Good afternoon and welcome to ChromaDex Corporation's second quarter 2020 results investor call. With us today are ChromaDex's Chief Executive Officer, Rob Fried; Founder and Executive Chairman, Frank Jaksch; and Chief Financial Officer, Kevin Farr. Today's conference call may include forward-looking statements, including statements related to ChromaDex's research and development and clinical trial plans and the timing and results of such trials; the timing of future regulatory filings; the expansion of the sale of TRU NIAGEN in new markets; future financial results; business development opportunities; future cash needs; ChromaDex's operating performance in the future and future investor interest that are subject to risks and uncertainties relating to ChromaDex's future business prospects and opportunities, as well as anticipated results of operations. Forward-looking statements represent only the company's estimates on the date of this conference call and are not intended to give any assurance as to actual future results. Because forward-looking statements relate to matters that have not yet occurred, these statements are inherently subject to risks and uncertainties. Many factors could cause ChromaDex's actual activities or results to differ materially from the activities and results anticipated in forward-looking statements. These risk factors include those contained in ChromaDex's Quarterly Report on Form 10-Q most recently filed with the SEC, including the effect of the COVID-19 pandemic on our business, results of operations, financial condition and cash flows. Please note that the company assumes no obligation to update any forward-looking statements after the date of this conference call to conform with the forward-looking statements, actual results or to changes in its expectations. In addition, certain of the financial information presented in this call references non-GAAP financial measures. The company's earnings presentation and earnings press release, which were issued this afternoon and are available on the company's website present reconciliations to the appropriate GAAP measures. Finally, this conference call is being recorded via webcast. The webcast will be available at the Investor Relations section of our website at www.chromadex.com. With that it's now my pleasure to turn the call over to our Chief Executive Officer, Rob Fried. Rob?

Thank you, Brianna. Good afternoon everyone, and thank you for joining our second quarter 2020 investor call. ChromaDex had another strong quarter with total net sales of $15.3 million. Also we achieved the business goal of positive adjusted EBITDA, excluding total legal expense, of $525,000. Overall, sales increased 7% sequentially and 38% year-over-year. TRU NIAGEN net sales were $11.7 million, a 5% increase sequentially and a 34% increase year-over-year. As you know the Coronavirus and the economic downturn have created headwinds for many businesses, including ours. Our e-commerce business continued to perform well in this challenging environment; sales were roughly flat sequentially. Our retail business, including sales to Watsons and partners in new international markets, has been more impacted by the Coronavirus. But we remain focused on the terrific opportunities ahead. As just mentioned, adjusted EBITDA excluding total legal expense was a positive $525,000 in the second quarter. We benefited by our initiative to reduce costs when the Coronavirus hit, an objective that is still ongoing. Let's now discuss the three pillars to our business strategy: to build a global brand, to own the science and to focus on the fundamentals. First, the brand. Global TRU NIAGEN net sales represented 77% of the $15.3 million total net sales in the second quarter. International sales for TRU NIAGEN represented approximately 35% of total TRU NIAGEN sales. This includes sales to Watsons in Hong Kong and Singapore, cross-border sales in China, Japan and Europe, and sales to our partners in Australia, New Zealand, the UK and Canada. It also includes a $1.6 million purchase from Horizon's, who donated bottles of TRU NIAGEN to the health-care workers in Hong Kong hospitals. Sales to Watsons were $1.3 million in the second quarter, compared to $1.8 million in the first quarter. This included initial shipments of TRU NIAGEN beauty; sales in the base business excluding TRU NIAGEN beauty were roughly flat sequentially. Watsons business continued to be impacted by store closures and declines in Chinese tourism in the second quarter. TRU NIAGEN was a relative outperformer and their top performing supplement. In addition, Watsons is pleased with the early performance of TRU NIAGEN beauty, which launched in 230 stores in April. In addition, we introduced TRU NIAGEN beauty through cross-border sales in China as another test launch. E-commerce net sales were $8.1 million, a 24% increase year-over-year and slightly below the first quarter. The Coronavirus and economic downturn negatively impacted our U.S. e-commerce business in mid-March. We responded in April with new relevant marketing messaging, highlighting the importance of elevating NAD for cellular defense and resilience in the face of physiological stress. These efforts were successful and we'll be continuing. We sell cross-border in the UK, Japan, Korea, Germany, France, Italy, Spain, and China, which grew approximately 115% year-over-year. We launched on Tmall in China in the second quarter of 2019 and expanded distribution to JD.com and Kaola.com this quarter, with a successful June 18 mid-year shopping festival. Our marketing strategy is focused on in-channel advertising and influencers, as well as earned media. We have been selling on Amazon UK since June of 2018 and began expanding to other major European markets following EFSA approval. We received favorable press in Europe, including HELLO! Magazine and the July issue of French Vogue, which covered the growing trend behind NAD supplementation and mentioned TRU NIAGEN. Additionally, we are continuing to build our brand with strong global partnerships. As mentioned on the first quarter call, shipments for new market launches contributed to strong sales. Sales from these new launches were down sequentially in the second quarter; we had reorders from all our new partners and we believe in the long-term potential of these markets. I'll briefly recap each. In April, we launched TRU NIAGEN in over 200 Superdrug UK stores, as well as superdrug.com. Launch plans were scaled back and sales have been slower to ramp up due to the Coronavirus. To support the launch ChromaDex and Superdrug continue to collaborate on PR and influencer efforts, as well as in-store and digital promotions. We do not expect meaningful sales in the UK in 2020, but we see the UK as a growth market for TRU NIAGEN with the potential to expand into Superdrug's full 800 UK stores over time, if the test launch is successful. We launched TRU NIAGEN online in Australia in March with one of our proven distributors, Matakana Health Limited. They plan to expand into retail later this year. This approach follows their successful rollout of TRU NIAGEN in New Zealand, a small but steadily growing market for us. Matakana brings deep knowledge of the local markets, as well as the dietary supplement category and our science-based product. We believe TRU NIAGEN is positioned for strong growth in Australia in 2020 and beyond. Nestlé Health Science has shared with us that they plan to begin the marketing efforts to educate consumers on the importance of cellular nutrition very soon. Our work with Nestlé Health Science will allow them to bring products related to cellular health containing TRU NIAGEN to market later this year. Ultimately, the timing will be determined by Nestlé, but we are encouraged by their commitment and their effort. Persona Nutrition, a division of Nestlé Health Science and a leading personalized vitamin subscription program, launched TRU NIAGEN on their direct-to-consumer platform last quarter. TRU NIAGEN capsules are offered in Persona's monthly vitamin packs along with other high-quality science-based ingredients recommended by their panel of medical experts. We believe our partnership with Nestlé Health Science and Persona will help build awareness for TRU NIAGEN. Our second core objective is to own the science. We are confident in the science behind NIAGEN, which continues to be studied by leading institutions and universities around the world. We recently signed our 200th material transfer agreement through the ChromaDex External Research program, which has resulted in 60 published studies to date including 10 published clinical studies supporting the safety and efficacy of our patented ingredient NIAGEN. Several new studies have been registered and published since our last update, which Frank will summarize momentarily. All of our science on NR can be found on AboutNAD.com, which was re-launched this quarter to provide a better user experience. In April, we announced the first round of results from a combination tissue and in vitro study on COVID-19. As a reminder, there were two key findings from this preclinical study. First, the COVID-19 introduction to the studied cells caused an 80% reduction in NAD. And second, these infected cells specifically sought out nicotinamide riboside in an attempt to replenish NAD levels in the face of the viral infection. We recently announced the results of the second round of preclinical research by this group, including our Chief Scientific Officer, Dr. Charles Brenner. They found that NR inhibits replication of a form of Coronavirus, the virus that causes COVID-19 infection in mouse cells. This suggests that NR may have an antiviral effect that may support a cell's innate immune response to Coronaviruses and other viruses. Of course, human clinical research is still required. In addition, ChromaDex entered into a preclinical collaboration with the National Institute of Allergy and Infectious Diseases, NIAID, a division of the NIH, to assess the therapeutic potential of NIAGEN in COVID-19 animal models. This is a logical next step to assess whether increasing NAD levels within our supplementation benefits the innate immune response in a COVID-19 model of mice and hamsters. This joint study is designed to assess whether NR supplementation prior to infection can reduce progression of the infection either by limiting viral replication or by modulating the severe inflammatory response. We're proud to support NIAID as they work to help find answers to this global pandemic. Ultimately, clinical trials will be required to determine whether NIAGEN may have any impact or benefit on COVID-19 infection in humans. We will continue to share the findings of all our collaborative COVID-19 research when appropriate. We also continue to build upon and protect our intellectual property, which includes our ongoing litigation with Elysium Health. The Coronavirus outbreak has extended delays in California and New York and no trial dates have been set. In Delaware, the patent case is scheduled for trial in September of 2021, with a Markman Hearing in December of this year. We have seen Elysium's initial claim construction arguments and remain as confident as ever in the strength of our licensed patents. As I have repeatedly said, we are eager to get to trial and for the facts to be presented to a jury in all three cases. Our third strategic pillar is to focus on fundamentals. It is our mission to lead by example in this industry. In June Frank participated in the panel on master files for dietary supplements hosted by the American Conference Institute and the Council for Responsible Nutrition, and just this week he joined NIH for two roundtable discussions. In all three presentations, Frank championed the importance of greater transparency, compliance and enforcement in the dietary supplement industry to protect consumers. This is an important topic to all of us and essential to our commitment to science and to consumer safety. Quality control is a big part of that and in June our Longmont, Colorado lab received its ISO accreditation. This latest accreditation recognizes ChromaDex's consistency, meeting the highest international standards in quality control, which has been recognized by prestigious regulatory bodies around the world. Finally, our Chief Scientific Advisor, Dr. Charles Brenner received the 2020 National Scientific Achievement Award from the American Society for Nutrition for his outstanding research in the field of bioactive compounds for human health. In summary, we continue to deliver on our strategic objectives and successfully navigate these unprecedented times. I know there are many listening who believe that TRU NIAGEN has positively impacted your health and are eager for it to become a household name. So are we. We are working hard to spread the word globally, while staying true to our philosophy of responsible science-based marketing and communications. We clearly have the attention of the scientific community, who is increasingly studying this molecule, and we are investing alongside them to drive important research. And now I'll pass the call over to our Chairman, Frank Jaksch for an update on scientific research. Frank?

Thank you, Rob. As you heard Rob say, one of our core objectives is to own the science. We are committed to remaining a global scientific authority on NR and NAD research. We are also setting the standard for excellence in the industry with our commitment to science, safety and quality. I was very proud to represent ChromaDex in the dietary supplement industry as an innovative science-based responsible company at the conferences and panels that Rob mentioned earlier. Since our last call, publication of research on NR and NAD has continued to accelerate. There are 42 ongoing, completed or published clinical trials currently registered on clinicaltrials.gov to investigate the pharmacokinetics and therapeutic effects of NR. This is two more than our last update. An additional 10 clinical trials are registered to test NR in combination with other ingredients for a total of 52. We also reached a milestone of 200 signed research collaborations during the quarter, up by approximately five compared to our last update. As Rob said these collaborations have resulted in 60 publications to date, including 10 published human clinical trials. We recently announced the results of a preclinical study investigating the effects of NIAGEN supplementation in mice that have traits or behaviors associated with autism spectrum disorder. Specifically, they studied male mice that were missing a gene that's partially responsible for the production and release of oxytocin, which is essential for feelings of happiness and attachment. Researchers found that by elevating NAD levels in these mice, their social deficits, such as fearful and anxiety-like behavior, were corrected, allowing them to interact normally with other mice. The study was the first to evaluate NIAGEN in an autism mouse model, but it joins a growing body of preclinical data demonstrating that boosting NAD levels may have a positive effect on cognitive health. In addition, a preclinical study was published last month in the Journal of Translational Animal Science. In this study, the researchers examined the effects of in ovo or in-the-egg injection of nicotinamide riboside on pectoral muscle development and growth in chicks. They found that when injected into the yolk sac, pectoral muscle weight and length increased by 38% and 22% respectively. NR also increased width, depth and muscle fiber density by 9%, 11% and 45% respectively. The effects were significantly greater when injected into the yolk versus the egg white. As stated in the paper, it is unknown whether the increase in pectoral muscle weight due to the effect of NR will affect future chick growth and meat quality. However, according to the researchers, this effect could potentially impact poultry industry yields and product quality. This is an interesting study since it explores the impact of NR on a new addressable market. I'll briefly touch on a newly registered clinical study that was registered in June. This study was registered by McLean Hospital in collaboration with the National Institute on Aging to study the effects of NIAGEN on brain energy metabolism, oxidative stress and cognitive function in individuals with mild cognitive impairment and mild Alzheimer's disease. Fifty participants will be given 1,000 milligrams of NIAGEN over a 12-week period. Within the intrinsic capacity framework that I introduced last quarter, cognition-related studies account for roughly 15% of all ongoing research on NIAGEN. As Rob mentioned, we relaunched AboutNAD.com with the goal of making all the science on NR easily accessible. This new site has an option to filter the research by intrinsic capacity domain. In summary, ChromaDex is committed to remaining a leader in the NR, NAD and cellular health conversation. We will continue to defend our intellectual property around NR, while exploring the potential of next-generation NAD precursors, which are also protected by a strong and growing patent portfolio. We are thankful to our investors for putting their trust in this team to deliver on the opportunity in front of us. With that, I'll pass the call to Kevin Farr. Kevin?

Thank you, Frank. Let's look at our financial results for the second quarter of 2020, which reflected continued progress against our key financial objectives and strong underlying business performance. The underlying business is measured by adjusted EBITDA, excluding total legal expense, which achieved breakeven with the second quarter profit of $525,000. This was a $0.8 million improvement sequentially and a $2.6 million improvement year-over-year. Compared to the first quarter of 2020, we delivered strong sequential top line growth, higher gross margins, slightly higher advertising expense as a percentage of net sales, and lower general and administrative expenses primarily driven by lower severance and restructuring charges related to cost savings initiatives and lower legal expense. These results reflect strong operational and financial discipline, which have allowed us to navigate the challenging macroeconomic environment very well. We ended the quarter with $18.9 million in cash, including the $5 million common stock raised in the second quarter from existing strategic investors. While there was not an immediate need for additional capital, we believe it was prudent given the economic uncertainty. We have additional flexibility with our $7 million line of credit, which we have not accessed. In addition, we filed a $125 million shelf registration. The company has no present plans to issue securities under the registration statement. However, we believe it's prudent to have the shelf registration in place as a matter of good corporate governance. It provides financial flexibility to access the capital markets to respond to future financing and business opportunities. Moving to the second quarter results, for the three months ended June 30, 2020 ChromaDex reported net sales of $15.3 million, up 7% compared to $14.3 million in the first quarter of 2020. Year-over-year net sales were up 38%, compared to the second quarter of 2019. TRU NIAGEN net sales were up 5% sequentially and grew by 34% year-over-year with growth driven by U.S. e-commerce, a $1.6 million purchase by Horizon's, who donated TRU NIAGEN to health-care workers at Hong Kong hospitals, and international cross-border launches year-over-year. Watson sales remained solid at $1.3 million in the second quarter but, as expected, were down versus the first quarter, which included the initial shipments of TRU NIAGEN beauty. We are encouraged by improving trends in consumer takeaway in the second quarter from Watsons and expect shipping to more closely align with sell-through in the third quarter. However, with the recent rise in COVID-19 cases in Hong Kong, this is a risk. Total NIAGEN-related net sales were up 5% sequentially and 40% year-over-year. This included a small shipment to Nestlé, which resulted in recognition of a portion of the $4 million upfront payment in our revenues in the second quarter. We have experienced strong demand for NIAGEN from other customers, but these sales can fluctuate and we expect lower NIAGEN ingredient sales in the second half of the year. Turning to the rest of the P&L, on a sequential basis our gross margin was up 150 basis points from 57.9% in the first quarter of 2020 to 59.4% in the second quarter of 2020. Year-over-year gross margins increased by 310 basis points to 59.4%, compared to 56.3% in the second quarter of 2019. Product cost savings initiatives and overall scale in our supply chain drove the improvement in gross margins. While we originally expected supply chain cost savings to be reflected in our gross margins later in the year, a portion of this savings was realized in the form of a rebate for prior year efficiency initiatives, which was recorded in the second quarter. This resulted in a one-time benefit of approximately 110 basis points in the second quarter. We believe product cost savings initiatives, as well as favorable mix from growing TRU NIAGEN consumer product sales, represent a tailwind to gross margins in 2020. On a sequential basis, our total operating expenses for the second quarter of 2020 were $12.8 million, down $1.4 million compared to the first quarter of 2020. Our selling and marketing expenses were up $0.5 million to $5 million in the second quarter of 2020, compared to $4.4 million in the first quarter of 2020. As a percentage of net sales this expenditure was up 140 basis points in the second quarter versus the first quarter. We continue to monitor daily e-commerce metrics, such as consumer acquisition cost, to adjust messaging and spending, which is increasingly important in this fluid environment. We also invested in PR to support our launch events with Superdrug in the UK, as well as Matakana in Australia during the second quarter. As reported, G&A expense was down $2 million to $6.9 million in the second quarter of 2020 versus $8.8 million in the first quarter of 2020. This included $1.8 million of legal fees and $0.3 million of severance and restructuring expenses in the current quarter. Excluding legal fees, severance, restructuring and equity compensation expense, second quarter 2020 G&A expense was lower by $0.6 million versus first quarter 2020 comparable G&A expense. Legal expense was down $0.5 million compared to the first quarter of 2020. We incurred legal expenses through our ongoing investments in the Delaware patent infringement case as we prepare for the claims construction Markman Hearing in December 2020 and trial in September 2021. We also incurred expenses related to discovery in the New York litigation. We expect legal expense to begin to ramp up in the third quarter, driven by the New York and Delaware litigation. For the second quarter of 2020, our operating loss was $3.7 million versus $5.9 million in the first quarter of 2020. The net loss attributable to common shareholders for the second quarter of 2020 was $3.7 million or a loss of $0.06 per share, as compared to a net loss of $5.9 million or a loss of $0.10 per share for the first quarter of 2020. As we said, we believe it's important to focus on sequential trends in our business to demonstrate progress towards cash flow breakeven. To help investors better gauge the underlying financial performance of our business, in the second quarter of 2019 we introduced a new non-GAAP measure, adjusted EBITDA, excluding total legal expense. ChromaDex defines adjusted EBITDA, excluding total legal expense, as net income or loss, which is adjusted for income tax, interest, depreciation, amortization, non-cash stock compensation costs, bad debt expense related to Elysium, severance and restructuring expenses and total legal spending. We have included a reconciliation to the appropriate GAAP measures in our earnings release slides. As I previously highlighted, adjusted EBITDA excluding total legal expense improved by $0.8 million to a profit of $0.5 million in the second quarter of 2020, compared to a loss of $0.3 million in the first quarter of 2020. Year-over-year, we delivered a $2.6 million improvement in the second quarter of 2020 versus a $2.1 million loss in the second quarter of 2019. The improvement in the second quarter of 2020 was primarily driven by higher gross margins, higher sales and lower general and administrative expenses. Moving to the balance sheet and cash flow, we ended the second quarter of 2020 with cash of $18.9 million, up $5.3 million versus the first quarter of 2020. In the second quarter of 2020, our net cash used in operations was $1.6 million versus $5.2 million in the first quarter of 2020. The sequential improvement in this quarter was driven by a lower net loss and a reduction in our working capital investment. To date, we've successfully navigated the business during the COVID-19 pandemic managing our working capital. At this time, we do not expect any supply chain disruption from Coronavirus and have implemented risk assessment strategies to manage this going forward. As it relates to our 2020 full-year outlook, we expect to deliver continued top-line growth, including growth in our e-commerce business, which experienced a temporary slowdown in growth in the second quarter due to the macroeconomic impact of the Coronavirus. We continue to expect gross margin expansion, due to favorable mix from our growing e-commerce business, the product design changes implemented late 2019 and additional supply chain cost savings initiatives, which we implemented beginning in the first quarter of 2020. We continue to expect an increase in selling and marketing expense of $3 million to $5 million, including investments in brand awareness and investments in new market launches, including cross-border platforms in China. We expect continued improvement in selling and marketing expenses as a percentage of net sales, driven by strong sales from returning customers and scale in our business. Lastly, we continue to expect that G&A excluding severance and restructuring expenses and legal expense will be up by $1 million to $2 million year-over-year comparable to 2019 G&A expense excluding the Elysium-related bad debt expense in 2019. Adjusted EBITDA excluding total legal expense remains a key metric. We expect a significant improvement for full-year 2020 versus full-year 2019, but there may be quarter-to-quarter fluctuations driven by the timing of our marketing campaigns and R&D investments. We continue to believe that we can achieve cash flow breakeven with $17 million to $19 million of quarterly revenues if the litigation ends and legal costs decline. Total quarterly operating expenses will likely be higher in the near-term, driven by higher litigation. As a result we need sales of approximately $19 million and gross margins at slightly better than 60% to achieve this. We believe we'll deliver higher gross margins as we execute on supply chain cost savings initiatives. We'll continue to manage all levers of the P&L to deliver on this important objective. In summary, we continue to deliver consistent top line growth, while demonstrating operational and financial discipline. I'm very proud of how the entire ChromaDex team has executed in this challenging macroeconomic environment. Operator, we're now ready to take questions.

Your first question comes from Jeff Vansen Sinderen with B. Riley & Co. Please go ahead.

First, let me say congratulations on the strong results, especially with the pandemic background. Can you speak a little more about the project with Fauci's lab? How that came about, maybe you can touch on your thinking around cellular strength and cellular protection, and potential immunity enhancement from TRU NIAGEN. And I guess what other studies are you watching most closely that are currently ongoing?

Yes, I'll begin the answer to that and then I'll pass it over to Frank to contribute as well. Before I do, I want to quickly say that there is a website called raisingnad.com, which compiled and submitted a very impressive list of investor questions. We want you to know that we've read them all and some are fairly technical. We plan to answer many of these questions and post our answers on our Investor Relations website. In response to your question on the Fauci lab, they saw the initial data that was published on bioRxiv that showed that there was an 80% decline in NAD when the Coronavirus attached to the cell. They found that very interesting. Obviously, they are particularly interested in the cytokine storm and how the reduction in IL-6 inflammation marker might impact cytokine storm. There's a connection between one of the original co-founders of ChromaDex and a member of that Fauci team in the Colorado lab. I'll pass it over to Frank now if you want him to elaborate a little more.

Yes, so the researcher who is doing the study had been studying energy metabolism in mitochondria as a contributor to Coronavirus, and picked up on the initial bioRxiv study that showed the decline of NAD and the potential to rescue that as a way to help. That's exactly what they're going to be studying in a two-stage mouse and hamster model. Mice cannot naturally become infected by Coronavirus, so they have to produce specific mice that can be infected, and they were successfully able to do that. We'll be looking at that model where the mice will be dosed prior to becoming infected, so we'll see the effect of dosing before infection and the impact afterwards as well. In the hamster model, hamsters do become infected without modifications. Their hypothesis is that dosing will have a significant impact on repairing NAD and on not only controlling the virus itself—meaning replication of the virus—but also on survivability and recovery of the animals. That's the core of it: whether repairing the NAD pool will affect replication and inflammatory response and recovery.

No, that's really helpful. And then I guess I wanted to get your sense of which studies—this is a terrific study—but which other studies you're most focused on?

There are a number of important conversations happening between ChromaDex and other research entities that we have not yet announced and are still exploring. We are excited about the possibilities.

Just one other comment: it's good that we'll have animal model studies in place prior to evaluating other studies as well. It's a responsible way of approaching this research.

Absolutely. And then, if we could just turn to Nestlé for a moment, any more color you can give us on your work with Nestlé? How that's evolving? And then what we should look for with Nestlé as a partner this year?

We speak with Nestlé frequently, and we're very excited about what they're doing and they're very excited about NIAGEN and their business plans. But they, like everybody else, have been impacted by Coronavirus. They initially planned to begin their marketing in June and they moved it to July; the product launch was planned for September and shifted. The marketing launch hasn't commenced yet, although they assure us that it's imminent. We expect the product launch to be slightly delayed but not significantly delayed. They are thinking long-term and have many facets of their organization working on it. Ultimately it will be up to Nestlé when and how they proceed. We like what they're doing and what they see, but we don't have much beyond that public information.

Okay, that's helpful. And then if I could just squeeze one more in on your marketing plans. I know you've evolved those. Maybe you can touch on how you're changing them for the second half around anti-aging versus cellular protection and what we should anticipate near-term?

The market for dietary supplements has been interesting over the last few months. Sales of immunity-based supplements have been doing extremely well. Sales of supplements that are not immune-based have been challenged. Another phenomenon is that e-commerce in general has been doing well, while retail has experienced headwinds. TRU NIAGEN is predominantly an e-commerce product, but our international strategy has a significant retail component as well. TRU NIAGEN is known as an anti-aging supplement and in the last year also as a fitness supplement, but not broadly as an immune-based supplement. We understand the science behind nicotinamide riboside well and believe there may be benefits to cellular health when a virus attaches to a cell. We immediately began preclinical studies—first in vitro, then animal models, then human clinical studies—to verify these hypotheses. We believe there could be therapeutic and perhaps prophylactic benefits, but we need to prove that scientifically. There is sufficient science to support messaging like cell defense, cellular health, and cellular protection. In addition to launching studies, we pivoted our marketing somewhat away from just fitness and anti-aging toward cell resilience, cell defense, and cell strength. Ultimately, TRU NIAGEN remains an anti-aging supplement, but we see important sub-cohorts: fitness, immunity, and others. Currently, a lot of our time and attention is on the concept of cellular defense and resilience. That message is working, so we plan to continue. Of course, nobody knows how the pandemic will evolve worldwide, but long-term we expect consumer sensitivity to immunity and cellular health to be an important part of our narrative.

Okay, that's helpful. Thanks for taking my questions and best of luck.

Thank you.

Thanks, Jeff.

Your next question comes from Brian Nagel with Oppenheimer. Please go ahead.

Hi, good afternoon.

Hey, Brian.

Thank you for taking my questions. My first question, a bit of a follow-up to the last question. You discussed headwinds to TRU NIAGEN sales given COVID-19 in the U.S. and elsewhere. Can you elaborate on what that headwind is? Is it due to stores being closed, primarily overseas? Is it a function of general economic malaise where consumers are trimming budgets? As these headwinds have started to abate in the U.S. and elsewhere, have you seen improving demand trends for TRU NIAGEN?

Yes, we have seen an improving demand trend for TRU NIAGEN domestically and abroad. In the middle of the quarter we saw significant improvement in Watsons sell-through; May and June were stronger and continued to show strength. We're confident Watsons is coming back. Initially the downturn was caused by store closures and lack of foot traffic rather than lack of consumer demand. Hong Kong has seen a recent resurgence, so there is some uncertainty, but we remain highly confident in Hong Kong performance. For our U.S. e-commerce business, we saw a fairly dramatic impact in March, but we recovered in the middle of the quarter and finished fairly strong. We have confidence in continued growth in e-commerce and in Watsons.

Okay. My follow-up regarding marketing: for those who follow ChromaDex and TRU NIAGEN closely and watch the science, what are you waiting for from the science or studies to give you conviction or leeway to lean more into marketing about potential benefits of TRU NIAGEN as a supplement?

We take pride in being fundamentally sound and conservative in our approach—financially, operationally and in marketing. We have strong relationships with regulatory bodies because we follow the rules. In the U.S., you cannot mention a disease unless you are an approved drug; at best for a dietary supplement you make structure–function claims. To make structure–function claims, you typically need clinical studies, generally more than one. We see other companies leaning into health claims without sufficient evidence; that is not our approach. We license patents, pay royalties, and are conservative about claims. This takes more time, which can frustrate investors who want faster results, but we are building a company meant to last. We prefer the brick-by-brick approach.

I appreciate the color. Thank you very much.

Thanks, Brian.

Thanks, Brian.

Your next question comes from Jeffrey Cohen. Please provide your company name and ask your question.

Hi, this is Destiny on for Jeff. I want to echo the congratulations on a nice quarter. My question is around health care practitioners. Are you able to have any insight into how they're coping with various restrictions that may have been placed on them? Do you think some customers who were getting NIAGEN through practitioners have transitioned to your e-commerce channel in order to continually receive NIAGEN?

That's an interesting question. You can market more aggressively to health care practitioners than to consumers. Practitioners can be presented preclinical and animal data to evaluate and interpret the evidence for patients. Our connections to health care practitioners are strategic and a growing part of our business, both in the sports community and among nutritionists, nurse practitioners, chiropractors and physicians. Many consumers are introduced to TRU NIAGEN by their health care practitioner; some practitioners resell the product to patients after purchasing wholesale bottles from ChromaDex and some simply recommend it. We do see many of those consumers transition to becoming direct-to-consumer e-commerce customers.

Okay, very interesting. I appreciate that. I also heard a brief mention of R&D investments. Any high-level color you can give on what you're working on?

Our R&D investments span supply chain and manufacturing improvements to reduce cost, research efforts to support stronger claims and deeper understanding of the molecule, and product development to offer other ways to present nicotinamide riboside to consumers—powders, foods, beverages, formulations, and combinations with other ingredients targeted at sub-markets. All of these are part of our R&D pipeline.

Okay, thank you. Frank, you've been busy at conferences and roundtables. Anything coming up we should be aware of?

I've been spending time on FDA-related regulatory topics and advocating for better enforcement of existing regulations. The discussions have been about the FDA doing its job to enforce regulations within the space more effectively. I'll continue to advocate on that topic because it's important for ChromaDex and for the industry.

Your next question comes from Mitch Pinheiro with Sturdivant & Co. Please go ahead.

Yes, good afternoon. Following up on your cautious approach to marketing about viruses and NAD, when do you think you'll have the ability to more directly address viruses and related aspects to NAD? Is this a year out, two years out, six months out? I'm curious about a realistic timeline.

When you conduct human clinical studies, there's no way to know the results in advance. Preclinical studies indicate what you might expect, but clinical studies involve many variables and are harder to control. It could be a few months; theoretically it could be weeks, though that's unlikely. It might be as much as a year depending on when studies are completed and what the results say. We need completed, robust clinical data before making more direct claims.

It's hard to sell a product without being able to tell people why they need to take it more directly. Speaking of marketing, you noted selling and marketing will be up $3 million to $5 million for the year and was up $1 million in the first half, which suggests acceleration in the second half. What gives you the confidence to accelerate marketing when e-commerce was flat sequentially in the quarter?

E-commerce was flat sequentially for the quarter, but the first half of the quarter was down significantly and then it recovered. We look at trends and are seeing strength and rebound. We know the product, retention metrics, and that customers who stick with TRU NIAGEN for a couple months tend to remain long-term. We monitor numerous e-commerce metrics that indicate the business will be around and growing. Short-term disruptions like the pandemic can affect quarter-to-quarter performance, but long-term we expect growth.

A follow-up: in the e-commerce channel was new customer growth sequentially weaker, or were retention rates lower? Any color would be helpful.

At the beginning of the quarter we saw, for the first time, an actual reduction in retention rates in March and headwinds in new customer acquisition. By the end of the quarter retention rates returned to healthy levels and new customer acquisition improved as well.

Okay, thank you.

Sure.

Thanks, Mitch.

Your next question comes from JP Mark with Farmhouse Equity Research. Please go ahead.

Hi, good afternoon and congratulations also on positive adjusted EBITDA.

Thank you.

Regarding that measure, legal is obviously the big variable. I heard it was down sequentially but may ramp back up as you go into another phase. Is that correct?

Yes, that's correct. We expect legal expense to increase in the third quarter due to the litigation in Delaware and New York.

By the end of next year do you believe the legal expense moderates after resolution?

It's hard to predict the magnitude and timing of legal spending, but the Delaware case scheduled for September 2021 is the most important. We hope that once we get to trial that spending will moderate afterward.

Okay, great. My last question is about gross margin. The press release talks about a 110 basis points benefit related to prior year initiatives recorded this quarter. I also heard gross margin is still improving. Are you optimistic you get to 60%+ gross margins over the next few quarters?

From a timing perspective, we implemented a design change in Q4 2019 moving to a one-bottle configuration, which reduced bottle, packaging and shipping costs. Those benefits continue to show improvement versus last year. We also made supply chain improvements in Q1 2020 that we expected to hit in the second half of the year; some came through in Q2, with additional benefits in Q3 and Q4. We have highlighted about $2 million of additional savings based on what we've implemented already, and most of that would show up in 2021. So we expect gross margins to expand over time and believe reaching above 60% is achievable as these initiatives take full effect.

Okay, great. Thank you very much.

Your next question comes from Raghuram Selvaraju with H.C. Wainwright. Please go ahead.

Good afternoon. I have two questions. First, how has FDA regulation of nutraceuticals evolved recently and how has that impacted you? Second, regarding the autism mouse model study, were the researchers planning to replicate this in female mice as well as males?

I wouldn't say FDA regulations have changed recently; the core regulations date back to the Dietary Supplement Health and Education Act and related guidance over the years. The core elements are good manufacturing practices and new dietary ingredient (NDI) notifications. The bigger issue is enforcement. Responsible companies like ChromaDex spend money and follow the rules, but some companies do not. The inconsistency in enforcement can disadvantage responsible operators. We advocate for better enforcement so that companies that follow the rules receive the benefit of doing so.

Regarding the autism study, were female mice studied or are there plans to do so?

They specifically studied a male mouse model in that study, likely because it was easier to replicate the phenotype. I don't know if they plan to test female mice. More hopeful next steps would be that successful preclinical studies like this transition into human clinical trials rather than only additional mouse models. We hope researchers will pursue further investigation in clinical settings.

Thank you very much.

Sure, thank you.

Thank you.

Your next question comes from Matt Dhane. Please provide your company and ask your question.

Hi, this is Matt Dhane from Tieton Capital Management. I wanted to delve into the COVID-19 studies referenced on the call. You mentioned animal studies and the NIH collaboration. How much effort is being done around human studies? Is that developing? Are people looking at it? Is there informal research in hospitals or otherwise that might be publishable?

We haven't announced any human studies yet, but we are having discussions with numerous researchers.

Is there anything informal that's being done—hospital observations or early work—that you're aware of that might be publishable?

We are aware of various efforts taking place, but none that we've announced publicly or are ready to discuss in detail.

I also wanted to ask about China. You added two additional partners this quarter. How is the China market developing for you?

China is definitely growing. There is surging interest and we see it as an opportunity and intend to invest more in it.

Is it material at this point?

I wouldn't say it's material yet. We do not yet have blue-hat approval to sell in China; it's still a cross-border business. We work on it every day.

Do you have any sense when you might get blue-hat approval?

No, we cannot provide any indication of timing. Rules for blue-hat approval were established within the last year and things are changing rapidly. There is significant interest, but we cannot give a timeline.

Okay, sounds good. Thank you.

Sure.

Thanks, Matt.

Thanks, Matt.

That is all the time we have for questions. I'll turn the call back to Brianna Gerber for closing remarks.

Thank you, Josh. There will be a replay of this call beginning at 4:30 p.m. Pacific Time today. The replay number is 1-800-585-8367 and the conference ID is 1563949. Thank you everyone for joining us today and for your continued support of ChromaDex.

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.