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Edited Transcript of CDXC earnings conference call or presentation 7-Aug-19 8:30pm GMT

Q2 2019 Chromadex Corp Earnings Call

Irvine Aug 16, 2019 (Thomson StreetEvents) -- Edited Transcript of Chromadex Corp earnings conference call or presentation Wednesday, August 7, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brianna Gerber

ChromaDex Corporation - Senior Director of FP&A and IR

* Frank Louis Jaksch

ChromaDex Corporation - Co-Founder & Executive Chairman

* Kevin M. Farr

ChromaDex Corporation - CFO

* Robert N. Fried

ChromaDex Corporation - CEO & Director

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Conference Call Participants

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* Destiny Alexandra Buch

Ladenburg Thalmann & Co. Inc., Research Division - Research Analyst

* Jeffrey Wallin Van Sinderen

B. Riley FBR, Inc., Research Division - Senior Analyst

* Raghuram Selvaraju

H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Healthcare Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to ChromaDex Corporation's Second Quarter 2019 Earnings Conference Call. My name is Cheryl, and I will be your conference operator today. (Operator Instructions) 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 2019. If you have not reviewed this information, both are available within the Investor Relation section of ChromaDex's website at www.chromadex.com. I would now like to turn the conference call over to Brianna Gerber, Senior Director of FP&A and Investor Relations.

Please go ahead, Mrs. Gerber.

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Brianna Gerber, ChromaDex Corporation - Senior Director of FP&A and IR [2]

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Thank you. Good afternoon, and welcome to ChromaDex Corporation's second quarter 2019 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 of 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, future investor interest and clinical trial studies that are subject to risks and uncertainties relating to ChromaDex's future business prospects and opportunities as well as anticipated results of operation.

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 annual report on Form 10-K and quarterly report on Form 10-Q, most recently filed with the SEC.

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 Relation 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.

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Robert N. Fried, ChromaDex Corporation - CEO & Director [3]

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Thank you, Brianna. Good afternoon, everyone, and thank you for joining our second quarter 2019 investor call.

It was another successful quarter for the company. We continued to advance our 3 core objectives: build TRU NIAGEN into a global brand; to own the science; and to focus on the fundamentals.

We again delivered strong sales growth, at 42% year-over-year and 10% sequentially, with TRU NIAGEN representing 79% of net sales in the quarter.

U.S. e-commerce retention rates improved compared to the first quarter. We drove continued global expansion with initial cross-border sales into China and Japan. We added new specialty retail partners in the U.S. and in Canada. We continue to build a solid foundation positioning us for more diversified growth in the TRU NIAGEN business.

This quarter, we took a public position on industry safety, compliance and efficacy. And I would like to thank those of you who reached out in support of my op-ed on this topic that ran in Nutritional Outlook in June. Science and regulatory compliance are imperative for consumer safety and the integrity of the dietary supplement industry in general. Yet, companies are not complying with the FDA's NDIN and GRAS status processes set forth by DSHEA in 1994.

Due to limited resources at the FDA, these rules are not being enforced consistently. 3 out of every 4 Americans take a dietary supplement and that number is growing. By 2023, the U.S. dietary supplements market will surpass $18 billion according to Euromonitor. People deserve to know that what they are ingesting is safe, that the health claims are validated by science and that what is written on the label is truly what is in the product.

This was an important mission for ChromaDex and for me personally and we will continue to champion the necessary regulatory changes required to protect consumer health and ensure that reputable companies have a level and fair playing field.

Before reviewing the quarterly results in more detail, I will now turn the call over to our Executive Chairman, Frank Jaksch for an update on recent developments in scientific research. Frank?

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Frank Louis Jaksch, ChromaDex Corporation - Co-Founder & Executive Chairman [4]

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Thank you, Rob. As Rob stated, one of our core objectives is to own the science, and we are committed to remaining a leader in NR and NAD research. We continue to build upon and protect our intellectual property and invest in quality research partnering with the world's leading scientists.

There are 32 ongoing, completed and published clinical trials currently registered in clinicaltrials.gov to investigate the pharmacokinetics and therapeutic effects of NR. This is 3 more than our last update. An additional 5 clinical trials are registered to test NR in combination with other ingredients for a total of 37.

Over 70% of U.S. studies that are in progress or being planned, focus on neurological and cardiovascular areas, with other key areas being obesity and aging. We finished the quarter with more than 170 signed research collaborations, roughly the same as last quarter.

In June, we celebrated the success of our external science partners, educated the research community about NIAGEN and generated new interest in our collaborative research projects at the FASEB NAD Metabolism and Signaling Conference.

Rob will share more about this conference later, but I wanted to say what an honor it was to be surrounded by so many experts in their respective fields who are advancing this important area of research.

One notable theme was the importance of NAD to key cellular repair enzymes, which has been getting a lot of attention. Among those presenting the research in this area was Dr. Carles Cantó with a presentation entitled Exploring the Physiological Roles and Limitations of NAD Precursors. His preclinical research demonstrated that the key enzymes and pathways which utilize NR to produce NAD become especially critical when cells are faced with metabolic stress, which we believe will translate more broadly into conditions of aging.

This builds upon previous preclinical research showing that the NR pathway gets turned up in response to certain conditions of metabolic stress.

Broadly speaking, the research presented at the conference further supported what makes us so confident in the importance of NR and the value of being an integral part of this research community.

As I mentioned in our last update, beyond our own research and thought leadership on NR and NAD, we are excited about investment communities' tremendous interest surrounding the science of aging as well as the quality of science that has been published on healthy aging broadly. I'll highlight one example.

A study published in Biochemical and Biophysical Research Communications provided a new link between NAD and senescence, one of the 9 hallmarks of aging I discussed last quarter. The study used a combination of isolated human and mouse cells. Previous work suggested that increasing activity of an NAD-consuming enzyme, CD38, may be partially responsible for declining NAD levels observed with age. The new study reported that senescent cells do not have increased CD38 activity, but it is increased in nonsenescent cells through an inflammatory response.

NAD, mitochondrial dysfunction and senescence have recently generated a lot of buzz amongst the 9 hallmarks of aging. So having any be linked to the senescence story reinforces the opportunity we have with NIAGEN. Along those lines, while we continue to follow the science around aging closely, we remain focused on NR and other NAD precursors. Strategically, this includes not only clinical studies but broadening our patent portfolio.

In January, we were granted a U.S. patent, which includes additional methods for increasing intracellular NAD or NADH by delivering new analogues of NR and new derivatives of nicotinic acid.

And in July, our own clinical study on the safety of sustained NIAGEN supplementation was published in Scientific Reports. This marks the fifth published human clinical study on NR, but it is the first clinical trial to measure both the kinetics and dose-dependent effects of chronic NIAGEN supplementation.

132 healthy overweight adults completed the trial. It was randomized, double-blind and placebo-controlled with 4 parallel arms. An important takeaway was that there was a dose response when measured at 100, 300 and 1,000 milligrams per day in study participants. On average, the study's participants consuming 300 milligrams per day, our current recommended dose for TRU NIAGEN, experienced a statistically significant 51% increase in whole blood NAD within 2 weeks, which was maintained over the remainder of 8 weeks. The increase was 22% at 100 milligrams and 142% at 1,000 milligrams. All doses were also well tolerated with no attributable adverse side effects. This is an important study for ChromaDex and the results further support the safety and efficacy of our product.

Along those lines, in June, we were proud to be recognized by NutraIngredients-USA as the winner of the Ingredient of the Year for Healthy Aging Category. The judges acknowledged our commitment to quality clinical research and regulatory compliance. They heralded NIAGEN as a breakthrough ingredient and believe it delivers the promise of addressing a true mechanism of cellular aging, whereas other products might focus on symptoms of aging.

Lastly, here are 3 important highlights related to new clinical studies since we last spoke. First, in May, a new study was registered by Helsinki University, one of the world's top research universities, to investigate the effects of NR on mitochondrial dysfunction and chronic metabolic diseases in twin pairs.

Another clinical study was registered in May by Radboud University in the Netherlands. This study will investigate the effects of NR on the disease course of patients with ataxia or A-T, a rare genetic neurodegenerative disorder. According to the study description, A-T is caused by mutations in the ATM gene. The ATM protein plays a pivotal role in more than 100 different biochemical processes, among which, cellular energy metabolism, cell signaling and DNA repair. Studies have shown that NAD deficiency plays a role in disease mechanisms underlying DNA repair disorders such as A-T. ChromaDex previously supported a collaboration with NIH on the use of NR for ataxia in a mouse model, and we are pleased to see additional research in this orphan disease.

And just last week, a third clinical study entitled Nicotinamide Riboside Supplementation for Treating Arterial Stiffness and Elevated Systolic Blood Pressure in Patients with Moderate to Severe CKD was registered by Dr. Michel Chonchol from the University of Colorado. This study will measure the effects of NR on arterial stiffness and other measures of cardiovascular health in patients with chronic kidney disease or CKD.

A clinical study published in 2018 observed a trend towards decreasing arterial stiffness in healthy, middle-aged and older adults taking 1,000 milligrams of NR per day for 6 weeks. At least 2 other clinical trials are currently registered to measure the effects of NR on arterial stiffness and blood pressure in different populations, highlighting the growing interest of the research community in this area.

In summary, this quarter reflected momentum behind the science of NR, NAD and the 9 hallmarks of aging broadly. We believe ChromaDex is well positioned to capture the market opportunity ahead of us as the leader in NAD and cellular health space and look forward to sharing further updates on future calls.

With that, I'll pass the call back to Rob Fried. Rob?

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Robert N. Fried, ChromaDex Corporation - CEO & Director [5]

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Thank you, Frank. As I mentioned upfront, we made progress across each of our core objectives in the second quarter. First, we've continued to build TRU NIAGEN into a global brand. The company delivered $11.1 million in total net sales, a 10% increase sequentially and a 42% increase year-over-year.

TRU NIAGEN net sales were $8.7 million, a 17% increase sequentially and a 134% increase year over year. e-commerce net sales were $6.5 million, a 10% increase sequentially and an 88% increase year-over-year.

For the third consecutive quarter, we delivered this growth against a backdrop of improved marketing efficiency as higher sales from returning customers represented the primary driver of growth. We are very encouraged by the loyalty of our returning TRU NIAGEN customers but have not yet reached the tipping point of awareness for our brand and NAD in general. This continues to be an important priority for us.

Each quarter, we continue to refine our marketing messaging as well as test new campaigns, all grounded in a solid foundation of science. This quarter, we launched our True Believer campaign, featuring respected influencers and celebrities. These individuals have been following the science of NAD and are among the early adopters of TRU NIAGEN.

Our first True Believer was Strauss Zelnick, CEO of Take-Two Communications and ZelnickMedia. We have since expanded this to include Dr. Roger Kornberg, a Novel Prize winner on our SAB and Dr. Alyssa Dweck, a practicing gynecologist who was voted top doctor in New York Magazine and in Westchester County.

Also, Gabrielle Reece, a former professional beach volleyball player, a health and fitness expert and NIKE's first female spokesperson. Of course, Adam Vinatieri, the 46-year old placekicker for the Indianapolis Colts with 5 Super Bowl appearances; and Hall of Famer football star, Shannon Sharpe.

Like many of you listening today, they are all loyal TRU NIAGEN consumers who believe our product has positively impacted their health.

On our last call, we discussed our new marketing campaigns featuring Shannon Sharpe, which targeted fitness-oriented consumers. Based on the success of these campaigns, we expanded with tests in radio and television in the second quarter.

Beyond direct-to-consumer marketing, we continue to build relationships with professional athletes and sports teams. We began to see sales in our sports business grow in the second quarter versus the first quarter. We are in the early stages of building this business but we have heard from a number of athletes, trainers and coaches who are interested in the research on nicotinamide riboside.

As I said, while new campaigns and testing of existing campaigns and new channels help us optimize our marketing spend, this spending and this testing can lead to quarter-to-quarter fluctuations in overall efficiency. Testing is an important element of any e-commerce business. We will continue to optimize our marketing spending as a percentage of net sales driven by lower customer acquisition costs over time.

Our global expansion continued in the second quarter with cross-border launches in China and in Japan. These are soft launches, which we expect to build slowly over time. Consumers in these markets have a strong culture of health and wellness through dietary supplementation, and we look forward to updating you on our progress.

Our Canadian launch continues to steadily build momentum with continued sales to our partners Fullscript Canada, WELL Health and Showcase as well as ongoing e-commerce sales on our proprietary truniagen.com site as well as Amazon.ca.

In addition, we recently announced a distribution agreement with Whole Foods in Canada to test sales in their 7 Ontario-based stores. Whole Foods' dedication to bringing innovative quality health and wellness products to its consumers make it a natural partner for ChromaDex as we continue our retail expansion in Canada.

Watsons' sales exceeded our expectations in the second quarter and are tracking ahead of their purchase commitments for the year as they experienced strong sell-through in Hong Kong, driven by a celebrity video post that went viral. This was complemented by an enhanced in-store presence at Watsons, including new planogram space and prominent signage for TRU NIAGEN. We were very pleased with the acceleration of sell-through in the first half of the year, which drove additional orders in the second quarter to meet that expected demand.

Sell-through in Singapore is still not reflective of the market's potential, and we view this as an opportunity. We're partnering with Watsons to execute a more concentrated PR and marketing effort. These initiatives were complemented by recent discussions with the Health Science Authority where we presented new lifestyle messaging for TRU NIAGEN, which is supported by our existing health claims.

Much like our support of the U.S. FDA, the HSA in Singapore interaction has been positive when presenting the depth of science to support our claims.

As a reminder, Watsons has higher purchase commitments through 2021 and the recent progress in both Hong Kong and Singapore is encouraging.

Another notable update on the regulatory front was the release of EFSA's draft opinion of NIAGEN as a novel food ingredient for use in supplements at a 300-milligram per day dose. This is a critical first step to marketing TRU NIAGEN in Europe.

The next step is for the European Commission to draft legislation that is informed by the member states. While there is more work to do. I am extremely proud of the teams for this important accomplishment, which was a key priority for us in 2019 and a major milestone for the company.

As most of you know, we announced a global supply and license agreement for TRU NIAGEN with Nestlé Health Science last December. Nestlé continues to be a good partner as we learn more about their 2020 commercialization plans and premarket testing, began a greater appreciation of their global capabilities in both areas.

A key milestone that must be met in 2019, unless Nestlé chooses to extend the deadline, is the technical feasibility requirement, which relates to stability in the ready-to-drink format. We have a highly capable R&D team who is performing the appropriate research in this area. The science is ongoing and inconclusive, so I cannot currently predict when we will solve this. But I am confident that we will get there.

The cellular health benefits of TRU NIAGEN are aligned with Nestlé's stated mission to improve consumers' health with the power of nutrition, and they are passionate about adding our ingredient to their portfolio. We believe this will substantially advance their already strong market position and raise overall awareness for TRU NIAGEN and NAD.

Our second core objective is to own the science as there were several important updates since we last spoke. We added to our intellectual property portfolio with more than 20 owned and licensed global patents or patents pending. This includes the new patent that Frank highlighted for additional methods of increasing NAD, which demonstrates our leadership in the NAD precursor space beyond nicotinamide riboside.

The lead composition of matter patents around nicotinamide riboside are exclusively licensed from Dartmouth College. As you are aware, Dartmouth and ChromaDex filed a patent infringement complaint in the United States District Court of Delaware against Elysium Health. No court date has yet been set. We look forward to that day. Also, Elysium was unsuccessful in its challenge of both patents in the IPR and has appealed a part of the PTAB's decision.

Beyond our own and licensed portfolio, W.R. Grace, who supplies ChromaDex with NR exclusively, was issued 2 crystal morphology patents earlier this year. These patents further strengthen our position around the manufacturing distribution of NR and expose the vulnerabilities of companies who infringe on the patents of others.

In contrast to those who infringe on the IP of legitimate companies, and this represents the research, we continue to invest in quality research and partner with the world's leading scientists to uncover the full potential of this extraordinary molecule.

For instance, in June, ChromaDex sponsored an offside event at FASEB NAD+ Metabolism and Signaling Conference in Dublin, Ireland. This conference attracts the world's leading experts in aging research with those specializing in drugs and nutritional interventions that interface with the science of NAD. Dr. Charles Brenner, our Chief Scientific Adviser and Discoverer of NR as an NAD precursor, co-hosted the event with our CSO, Dr. Matthew Roberts. The discussion featured other luminaries in the field such as Dr. Carles Cantó from the Nestlé Institute of Health Sciences and Dr. Myron and Dr. Elaine Jacobsen.

We continue to seek out the best scientific minds in academia, and in July, we appointed Scripps Research Professor of molecular medicine and renowned cancer researcher, Dr. Bruni Felding, to our Scientific Advisory Board. Dr. Felding and her team of scientists at Scripps have conducted an impressive body of research, including a preclinical study showing that increasing NAD with the B3 vitamin nicotinamide prevented breast cancer development in mice. The preclinical research findings in the areas of mechanisms and inhibition of tumor metastasis have been published in dozens of journals, including Cancer Cell, Journal Molecular Biology and the Journal of Neuro-Oncology. We've already learned so much from Dr. Felding about NAD precursors and the possibilities of breast cancer prevention and treatment. We very much look forward to partnering with her to further advance this important field of research.

Furthermore, as Frank discussed, our fifth clinical trial was published last month in Scientific Reports, demonstrating our continued investment in safety and science-based claims. This was an important study to further validate the safety of NR for sustained use and provides key data points to support international regulatory submissions.

By expanding our community of scientific advisers, our clinical and preclinical research and our leadership within the scientific community, we deliver on our goal of owning the science.

Lastly, we continue to focus on the fundamentals, build a world-class team with greater depth and brand reputation, communication, science, regulatory and sales. 2 strategic hires joined us this very week. Megan Jordan is our Chief Communications Officer and the Senior Vice President of Global Corporate Affairs, a member of the executive leadership team and reports directly to me. Megan leads our global communications, social media, corporate social responsibility and thought leadership functions. It's a new function for us, and it's very important as we build our global brand reputation and raise awareness for TRU NIAGEN. Megan brings decades of experience to her role, having worked in-house for Herbalife Nutrition, Southern California Edison and Kaiser Permanente and with agency clients including Nestlé, General Motors, Hilton and Philips. She has been heading communications for us since February as a consultant, so this is a seamless transition.

And I'm also pleased to introduce Dr. Andrew Shao as our new Vice President of Scientific and Regulatory Affairs, reporting to Dr. Matthew Roberts, our Chief Scientific Officer.

Regulatory compliance is an area we continue to champion within the industry as I mentioned in my opening comments, but it is also something we prioritize internally, and Dr. Shao is an important addition to our team. He is highly regarded within the industry, having led similar functions for the Council for Responsible Nutrition, Herbalife Nutrition and Amway's Nutrilite, among others. Dr. Shao has published more than 60 articles, and serves on the Editorial Board of various peer-reviewed publications including the Journal for the International Society of Sports Nutrition, the Journal of Dietary Supplements and Advances in Nutrition. He'll play an important role as we seek regulatory approval in new markets, as we leverage our science to educate consumers and thought leaders.

These new executives are joining the company at an exciting time in our history as we build momentum behind our brand and our science. I am proud of the work our team has accomplished and of the company we keep in terms of our scientific advisers, our business partners and you, our excellent investors.

We are steadily building a global network that strives to improve the lives of people worldwide through our product and our science. We take the trust that you and they put in ChromaDex and our products very seriously.

We will continue to invest in and leverage the growing body of science on nicotinamide riboside to help consumers better understand its impact on their lives.

We are grateful to our investors for helping spread awareness of our consumer product TRU NIAGEN as well as the investment opportunity in ChromaDex.

Now I will pass the call over to our CFO, Kevin Farr, who will provide more detail about our financial results, which demonstrate our continued focus on the fundamentals. Kevin?

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Kevin M. Farr, ChromaDex Corporation - CFO [6]

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Thank you, Rob. Let's take a look at our financial results for the second quarter of 2019, which reflects continued progress against our key financial objectives on both a sequential and year-over-year basis.

During the quarter, we continued to deliver strong top line growth, gross margin expansion and improvements in advertising efficiency. We also continued to tightly control growth in operating expenses.

For the 3 months ending June 30, 2019, ChromaDex reported net sales of $11.1 million, up 10% compared to $10 million in the first quarter of 2019.

Year-over-year net sales were up 42% compared to the second quarter of 2018.

TRU NIAGEN business net sales were up 17% sequentially despite lower selling and marketing spend as a percentage of net sales.

Year-over-year net sales of TRU NIAGEN grew by 134%. This strong growth was partially offset by expected declines in our ingredients and other legacy businesses.

Turning to the rest of the P&L. Our gross margins were up 360 basis points from 52.8% in the first quarter of 2019 to 56.3% in the second quarter of 2019. Excluding certain charges in the second quarter of 2018, year-over-year gross margins increased by 580 basis points compared to 49.3% in the second quarter of 2018 or by 700 basis points as reported.

We've completed the wind down of our Purple Corn ingredient, and as expected, the impact was immaterial in the second quarter. Increased TRU NIAGEN consumer product sales drove the improvement in gross margins, a trend which we believe will continue.

Our total operating expenses for the second quarter of 2019 was $13.4 million, down $0.3 million compared to the first quarter of 2019. Our selling and marketing spend was up $0.1 million to $4.3 million in the second quarter compared to $4.2 million in the first quarter of 2019. As a percentage of net sales, this expenditure was down 270 basis points from the first quarter of 2019, as we made continued progress on improving marketing efficiency in our TRU NIAGEN business.

In the second quarter of 2019, G&A expenses were down slightly to $7.9 million versus $8.3 million in the first quarter of 2019. Excluding legal fees of $2.9 million and equity compensation expense, G&A expense was higher by $0.2 million versus the first quarter of 2019. The higher G&A expenses included higher royalties resulting from the sequential growth in our TRU NIAGEN business.

Through the second quarter of 2019, our operating loss was $7.2 million versus $8.4 million in the first quarter of 2019. The net loss attributable to common stockholders for the second quarter of 2019 was $7.8 million or a loss of $0.14 per share as compared to a net loss of $8.3 million or a loss of $0.15 per share for the first quarter of 2019. The net loss in the second quarter of 2019 includes $0.6 million of debt issuance costs related to the $10 million convertible notes offering. These are classified as interest expense under U.S. GAAP and amortized over the original term of 45 days.

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, we are introducing 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, noncash stock compensation costs and total legal expenses. Litigation expense represents the majority of our legal spend today. We're excluding total legal spending from adjusted EBITDA since we expect it to decline significantly after the trials are completed.

Looking at the underlying performance of our business in the second quarter of 2019, adjusted EBITDA, excluding total legal expense was a loss of $2.1 million. This improved by $600,000 versus the first quarter of 2019, which was a loss of $2.7 million. The $600,000 improvement in adjusted EBITDA, excluding total legal expense was primarily driven by higher gross margins and higher sales. We were pleased to see 3 consecutive quarters of improvement in this key metric.

Moving to the balance sheet and cash flow. We ended the second quarter of 2019 with a solid balance sheet, with cash of $19.8 million, which includes the $10 million convertible notes issued in May. In the second quarter of 2019, our net cash used in operating activities were $9 million versus $3 million in the first quarter of 2019; or $7 million, excluding the onetime $4 million upfront payment to Nestlé that was recognized as deferred revenue and is included in cash used in operations.

The higher cash outflows from operations this quarter were driven by investments in working capital, which was $3.9 million use of cash in the second quarter of 2019 compared to a $1.1 million use of cash in the first quarter of 2019 or investment of $5 million year-to-date.

We invested $2 million in inventory in the second quarter of 2019 and $2.5 million year-to-date. This inventory is to support growth in 2019 and 2020. Accounts receivable were up by $0.4 million in the second quarter of 2019 and $1.4 million year-to-date, which we expect to collect in the third quarter.

We also paid a bonus totaling $1.5 million to our employees in the second quarter of 2019, which is reflected in the change in accrued liabilities. Total accrued reliabilities were a $0.9 million use of cash in the second quarter and a $0.8 million use of cash year-to-date. We expect working capital to be a smaller use of cash in the second half versus the first half as we invested early in inventory and paid performance bonuses to our employees in the second quarter.

Now let's look at our expectations for full year 2019 versus full year 2018. Consistent with our outlook last quarter, we continue to expect strong growth in our top line, primarily driven by TRU NIAGEN in our U.S. e-commerce and Watsons international business as well as with other distributors and cross-border opportunities in certain new international markets, partially offset by continued decline in the legacy ingredient business as we focus on fewer other ingredients.

Gross margin expansion, driven by increased sales of TRU NIAGEN in our e-commerce business and cost savings across our supply chain, which are supported by better economies of scale in other efficiency initiatives.

Selling and marketing expenses, they're down significantly as a percentage of net sales as we leverage 2018 investments in new customer acquisitions and diversify our marketing strategies beyond digital and direct response marketing. However, we now expect selling and marketing expenses to be up $1 million to $2 million in absolute dollars as we focus on additional initiatives to attract new customers through investments, including earned media.

Lastly, general and administrative expense is expected to be up a few million for the full year, in absolute dollars, but down significantly as a percentage of sales.

In summary, the key drivers in 2019 are the continued strong growth in sales of TRU NIAGEN, improved gross margins as a percentage of net sales, continued increases in the efficiency of our TRU NIAGEN sales and marketing expenses, leveraging fixed overhead spending and managing our legal efforts as efficiently as possible. Based on our current financial outlook, we no longer expect to achieve cash flow breakeven in the fourth quarter of 2019 or early 2020.

There are 2 primary factors impacting our expectations on the timing of achieving cash flow breakeven.

First, the California trial date has been pushed out to mid-October, which means legal expenses will be higher in the fourth quarter than originally anticipated, and we expect to pivot to vigorously prosecute the Delaware patent litigation in 2020.

Second, as we have said, we expect quarter-to-quarter fluctuations of marketing efficiency as a result of the timing of brand campaigns to attract new customers. While we've been encouraged by recent trends in customer retention, we're working on marketing initiatives as they accelerate new customer growth, which will require additional investment.

Going forward, rather than providing a time line for achieving cash flow breakeven, we'll provide a financial framework for investors to evaluate the key metrics required to achieve this objective. More on this in a moment.

We will continue to prioritize achieving cash flow breakeven while still making investments to drive growth that we believe will increase shareholder value. This manifests itself across the business, but I'll highlight 3 areas. First, litigation expense and timing is unpredictable, but it's important that we make the necessary investments to defend our IP in order to maximize the value of our NIAGEN franchise.

Second, it's important that we maintain flexibility to invest for the long term in selling and marketing expenses, especially if we see increased demand for our product and improved customer lifetime value.

Finally, working capital is currently an area of investment, driven primarily by inventory and customer receivables resulting from the growth in our business.

We have strengthened our balance sheet with an incremental $10 million capital raise in the second quarter. This enables us to continue to build a global brand, own the science, which includes making the necessary investment to protect our IP against infringement, and focus on fundamentals for the long term.

Rather than provide a specific time line, I want to share our financial framework for cash flow breakeven. As you can see in our second quarter results, our current quarterly operating expense is approximately $13 million or $11 million excluding noncash equity compensation and D&A. These figures include elevated legal spending. Assuming we maintain the current level of spend to scale the business and deliver gross margins of around 60%, quarterly breakeven net sales should be approximately $17 million to $19 million.

In addition to mix, a key driver of gross margin improvement is supply chain cost savings initiatives. We currently expect some of these savings to occur in the fourth quarter of 2019, with the majority of savings to be realized in 2020. Importantly, we continue to make progress in improving the underlying business, with sequential improvement in adjusted EBITDA excluding total legal expense. We remain focused on this key metric that tracks the progress in our business to achieve profitability.

Lastly, let me briefly touch on the financial outlook for the Nestlé deal. We don't anticipate meaningful revenues related to this agreement in 2019 and are also taking a conservative view to 2020, which is the likely launch year. There's a wide range of possibilities with respect to the partnership with Nestlé in 2021 and beyond, and we are committed to maximizing the potential for our shareholders as well as consumers. We value Nestlé as a partner and look forward to a long, mutually beneficial relationship.

Operator, we are now ready to take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question comes from Jeff Van Sinderen of B. Riley FBR.

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Jeffrey Wallin Van Sinderen, B. Riley FBR, Inc., Research Division - Senior Analyst [2]

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Let me say congratulations on the improving quarterly metrics. Can you speak a little bit more about the EFSA positive opinion, and how that moves you forward in the EU regulatory approval process? I think you mentioned drafting legislation that has to be associated with that.

And then a tougher question, any sense of time frame around that?

And then also, can you speak more about the soft launches in China and Japan, and what the next steps are there?

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Robert N. Fried, ChromaDex Corporation - CEO & Director [3]

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Well, we're not surprised that, Jeff, this is your first question. Yes, we're extremely excited about this EFSA opinion. It's perhaps the most respected -- certainly, one of the most respected regulatory bodies in the world, and that they were able to render a positive opinion in little more than a year is a testament to our excellent staff, the quality of our dossiers, the research and the relationship we have with them.

We hope and expect that this influences regulatory bodies worldwide. But as we pointed out, this is only step 1 in a multiple step process towards getting full approval to selling in this very, very significant market of the EU. However, it is the most difficult of all of those steps.

It is a recommendation from EFSA we now need to get the EU Commission to actually draft an approved legislation. Generally, that happens. It takes time, though. And as you know, Jeff, from previous conversations, we've stopped giving estimates of time. It could be a long time, it could be less, we don't know. But we are happy with how quickly we receive this decision, and we hope that it bodes well for the subsequent decisions.

In addition to getting that EU Commission to draft the legislation, we also have to get the individual member states to approve the product, TRU NIAGEN, and then we also have to get health claims, although there are vitamin B3 health claims already approved in the EU as we speak.

So there is work to be done. But as you know, it's a tremendous market. It's a tremendous opportunity. We have some great partners who are extremely interested in this decision, Watsons being one, Nestlé being another. So we believe we are poised to take -- to well take advantage of this exciting opportunity, and we think we will as quickly as one can do. That's the best I can give you in terms of outlook.

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Jeffrey Wallin Van Sinderen, B. Riley FBR, Inc., Research Division - Senior Analyst [4]

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Okay. That's helpful. And then just a follow-up on the China and Japan soft launches you mentioned. Just wondering what the next steps are there?

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Robert N. Fried, ChromaDex Corporation - CEO & Director [5]

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Okay. On the cross border?

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Jeffrey Wallin Van Sinderen, B. Riley FBR, Inc., Research Division - Senior Analyst [6]

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Yes.

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Robert N. Fried, ChromaDex Corporation - CEO & Director [7]

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Okay. Right. So we have done a launch cross border using third-party platforms into both Japan and China. It is a soft launch. We are not aggressively marketing in those territories as of yet. However, we are very encouraged by what we have seen thus far. Both of those markets are very sophisticated and sizable, especially in terms of dietary supplements, but also the antiaging space. Both of those markets are important for antiaging. We acknowledge and recognize that they are both great opportunities. We have put the infrastructure in place. We have applied the experience and knowledge that we've learned here in the U.S. and in other cross-border platforms to those and got off to a much quicker start in both of those territories than we did in other previous territories.

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Jeffrey Wallin Van Sinderen, B. Riley FBR, Inc., Research Division - Senior Analyst [8]

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Okay. Great. And then turning -- a question for Kevin. I know you guys provide a little bit different framework this time, but -- and I think you did guide to gross margin improvement. Just wondering in terms of kind of the next couple of quarters, how we should think about the magnitude of improvement? Or how we should -- or what we should expect for the magnitude of gross margin improvement? Should we expect it to be similar to the level that was experienced in Q2? Or how should we think about that for gross margin?

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Kevin M. Farr, ChromaDex Corporation - CFO [9]

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Well, I think sequentially we should see more improvement in the third and fourth quarters, as TRU NIAGEN basically becomes a bigger part of our business. And I think the other thing that could provide an incremental benefit to us is some cost savings programs that we've been working on. And as we look at those cost saving programs, they relate to really looking at our supply chain and optimizing our supply chain and getting scale from our supply chain.

We also did some product design changes that you'll be seeing later on this year. And we think that incremental value will be coming late in the fourth quarter with most of the sales benefits or cost benefits showing up in 2020.

So I think you'll see some steady progress, but I don't think you'll see the kind of incremental growth that we had in the second quarter until these cost savings come online in late fourth quarter and the first quarter of next year.

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Jeffrey Wallin Van Sinderen, B. Riley FBR, Inc., Research Division - Senior Analyst [10]

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Okay. That's helpful. Then one more, if I can squeeze it in. I know you spoke a little bit about Nestlé, obviously, a terrific and important partner for you. Anything else you can say about the progress in getting to technical feasibility? What form you think the product will hit the market in 2020? Just anything around that would be helpful.

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Robert N. Fried, ChromaDex Corporation - CEO & Director [11]

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So our expectation is in 2020 the product, but that Nestlé offers in the marketplace will be in powder form, not in beverage form. The work that we're doing on creating stability in liquid is ongoing. We have excellent scientists working on it. We know we're doing the proper procedures. We are highly confident that we are doing it the right way, and we are confident that we will solve the problem. We don't know if it will be solved by the end of 2019, but we are confident that it will be solved. Remember, nicotinamide riboside is already found in trace amounts in milk. It's already found in liquid. So the process is a multivariate process, partly binding to the protein found in milk. Also, there's a beating process. It's going to ultimately be a combination of various chemical -- chemistry processes to create stability that lasts long enough on the shelves, but we have confidence that we will get there.

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Frank Louis Jaksch, ChromaDex Corporation - Co-Founder & Executive Chairman [12]

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Yes. Just the follow-up on our expectations. I think I said in my prepared remarks is that, look, we're not expecting much in 2019. And in 2020, they're doing a limited launch. So I think the real benefits that you'll be seeing will be in 2021, as they do a larger scale launch in 2021 of loose powder, and hopefully, ready-to-drink, but still a lot of work to do there.

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Operator [13]

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Your next question comes from Jeffrey Cohen of Ladenburg Thalmann.

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Destiny Alexandra Buch, Ladenburg Thalmann & Co. Inc., Research Division - Research Analyst [14]

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This is actually Destiny on for Jeff. Congratulations, again, on a great quarter. I just had a couple of quick questions around the marketing. I'm curious to know -- firstly, if you would be able to give maybe a rough estimate of the breakdown of repeat customers to newly acquired customers? Would you say maybe it's 2/3 repeat, 1/3 newly acquired? And then would you also be able to speak a little bit more about acquisition costs and conversion rates for your e-commerce platform?

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Robert N. Fried, ChromaDex Corporation - CEO & Director [15]

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We appreciate those questions. And in the future, we expect to get more detailed with some of that information. But right now, we're really not providing customer acquisition cost information, but to say that it has declined. The customer acquisition cost has gone down over time. And the percentage of revenue attributed to repeat buyers has gone up over time. But we're not yet providing detailed information on customer acquisition costs and the breakdown of repeat versus new.

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Destiny Alexandra Buch, Ladenburg Thalmann & Co. Inc., Research Division - Research Analyst [16]

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Okay. Fair enough. And then I'm also curious, one other marketing question. As you have these publications, do you ever see or get feedback from, like channels, such as your health care practitioners requesting some kind of flyer or something in that format to help give them to their customers, if that makes sense? Do you ever get any requests like that?

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Robert N. Fried, ChromaDex Corporation - CEO & Director [17]

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We do get requests like that, but you bring up an interesting point, which is health care practitioners, in general. It is not a large segment of our business but it is a fast-growing segment of our business. And we have been increasing dramatically weekly the number of health care practitioners that are purchasing and reselling TRU NIAGEN to their patients. We view that as a very important part of the business as well as the sports segment of our business because not only does it build the ground swell of awareness of our product but also is a business unto itself. So we have been investing in creating marketing materials, many of those marketing materials are requested by the health care practitioners themselves. But in educating them, informing them, meeting with them, and we are excited about that as a future prospect and the way it's performed thus far.

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Destiny Alexandra Buch, Ladenburg Thalmann & Co. Inc., Research Division - Research Analyst [18]

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Right. Okay. Got it. And then for your -- in Canada, in general, do you have any other distributors kind of in your pipeline that you're working with to expand that network?

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Robert N. Fried, ChromaDex Corporation - CEO & Director [19]

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Can you ask that one more time. One of the words you said digitized out.

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Destiny Alexandra Buch, Ladenburg Thalmann & Co. Inc., Research Division - Research Analyst [20]

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Okay. In Canada, do you have any...

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Robert N. Fried, ChromaDex Corporation - CEO & Director [21]

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Oh, in Canada?

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Destiny Alexandra Buch, Ladenburg Thalmann & Co. Inc., Research Division - Research Analyst [22]

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Yes. Do you currently have any other distributors that you're in conversation with to expand your network?

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Robert N. Fried, ChromaDex Corporation - CEO & Director [23]

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We have no distributors or retailers that we've announced. We do get inquiries frequently, but at this point in time, it is -- the ones that we've announced, which is Whole Foods, Showcase and WELL Health.

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Operator [24]

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Your next question comes from Ram Selvaraju of H.C. Wainwright.

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Raghuram Selvaraju, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Healthcare Analyst [25]

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Firstly, on the clinical front, I was wondering if you could give us perhaps a little bit more color on how long you expect it to take for the new studies that you mentioned, specifically in CKD and A-T, to potentially mature and perhaps yield data? Is it likely that we would see some results from these studies over the course of next year. So do you have any further visibility on timing?

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Frank Louis Jaksch, ChromaDex Corporation - Co-Founder & Executive Chairman [26]

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No, I wouldn't say we have any real visibility on timing. Most of those studies on these collaborative studies have taken longer than we thought and it's largely a function of enrollment. How long do they take to enroll the population and then how long is it going to take them after enrollment to analyze the data and then report it and publish it.

So I wouldn't expect based on where we sit right now and those -- where those studies are, that they would be something you would see in 2020, but you never know. I mean, some of them are smaller and they may report them, but it's hard for us to give any real visibility -- get any or give any real visibility on that. So...

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Raghuram Selvaraju, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Healthcare Analyst [27]

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Okay. Fair enough. With respect to the way the e-commerce business is evolving, do you have a sense of what could approach steady state in terms of the overall percentage contribution by e-commerce to the overall revenue base? And if so, do you have a sense of at what sort of point in the future that steady state might be reached?

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Robert N. Fried, ChromaDex Corporation - CEO & Director [28]

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I think it's difficult. I mean, it's already a significant percentage of the business, I expect it to continue to grow because we have these legacy businesses that are not growing, as you know. However, what's difficult to project at this point in time is how the retail business and these other wholesale businesses; the HCP -- this health care practitioner business; and the sports business will grow. We expect them to grow as well. So it's difficult to project a steady state because we don't know which of those segments, the B2B segment or the direct-to-consumer segment will grow more rapidly.

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Raghuram Selvaraju, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Healthcare Analyst [29]

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Okay. As a follow-on to that, I think this was kind of the underlying crux of my query. If you think about what is preferable, those segments, you just mentioned that are not e-commerce-related that are indeed growing versus further growth in e-commerce, with respect to improvement in sales efficiency, what would be preferable in terms of the growth trends that you expect to see as the revenue mix evolves? In other words, what's the most efficient way to grow sales, such that you're not necessarily expending more effort than is absolutely necessary in an optimized manner on the sales front?

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Robert N. Fried, ChromaDex Corporation - CEO & Director [30]

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Well, there are 3 types of costs in terms of efficiency: there's the cost of the good, there's the overhead, and then there's the marketing costs. And these different segments have different costs associated with them. Obviously, the margins are best in the direct-to-consumer business, but the marketing expense is highest in the direct-to-consumer business.

The lowest hanging fruit, as you -- as I think pretty much as what you're asking, I would think is in the retail business because as we get regulatory approvals in these various countries, we seek out partners, like Watsons. And indeed, we already have this wonderful relationship with Watsons, who's already expressed interest in expanding that relationship into other territories.

So in those cases, assuming the deal we make with Watsons is somewhat comparable to the one we have in place, the path to incremental revenue is really a deal away.

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Raghuram Selvaraju, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Healthcare Analyst [31]

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Right. Got it. Okay. That's helpful. On the litigation front, I was wondering if you could point to any recent indications that there might be a speedier resolution to the overall situation vis-a-vis Elysium, if there has been any indication on their side that they might not necessarily be willing to pursue, shall we say, a kamikaze course, and possibly agree to some kind of settlements? Or if there has been no change in their overall demeanor so far?

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Robert N. Fried, ChromaDex Corporation - CEO & Director [32]

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Well, let me say that if there were communications like that, it would be something we wouldn't disclose. So I'm not saying one way or another, if there were conversations. But I will say that the trial is scheduled for 2 months from now. So one way or another, at least one aspect of the conflict is going to come to a resolution within the next couple of months. We're excited about it. We're very excited for the facts to come out and for the general public and the investors to see what they -- to learn what they will learn once these facts become disclosed.

We are very proud of the way we conduct ourselves as a company and the way we have in the past. And we're confident that once these facts are disclosed, that will confirm that we have conducted ourselves well throughout. If there's an opportunity to create shareholder value. We are certainly interested in doing just that, but right now, we are eager to get this thing to trial and tell our story.

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Raghuram Selvaraju, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Healthcare Analyst [33]

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And given your understanding of the scope and nature of the trial proceedings, do you have a handle at this juncture on how far into 2020 the trial itself could stretch if you expect it to conclude within the course of 2020? And if so, in what sort of time frame, the first half of 2020 or early 2020? Or could indeed the trial proceedings themselves be largely wrapped up before we get to the end of 2019? Just wanted to get a handle on the time line.

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Robert N. Fried, ChromaDex Corporation - CEO & Director [34]

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So remember, there are 3 separate disputes here. There's the California commercial dispute, there is the patent dispute and then there is the New York dispute, and the trial is for the California dispute, which is scheduled for mid-October.

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Raghuram Selvaraju, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Healthcare Analyst [35]

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Right. That's what I'm asking about specifically, the California trial.

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Robert N. Fried, ChromaDex Corporation - CEO & Director [36]

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Fair enough. The California trial is -- we're estimating it will be a 2-week trial.

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Raghuram Selvaraju, H.C. Wainwright & Co, LLC, Research Division - MD of Equity Research & Senior Healthcare Analyst [37]

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Right. And then last question. On the R&D front, I was just wondering, relative to what you were saying earlier about the feasibility and products, engineering assessments that you're doing relative to the Nestlé collaboration on the liquid formulation side of things. Can you give us a sense of what kind of contribution that is making to your R&D spend? How much of the R&D spend is associated with that?

And then if there's any other kind of additional breakdown you can give on what specific activities are going on contributing to the R&D line item, that would be helpful?

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Kevin M. Farr, ChromaDex Corporation - CFO [38]

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Yes, I think with regard to the R&D line item, we haven't really given guidance on it for perspective of all 2019, but we have said we're more focused. And as we look at 2019, it's probably going to be similar to what it was in the prior year, and we are within that budget. We are funding the technical feasibility as well as other important efforts with regard to our IP.

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Operator [39]

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This has concluded the allotted time for questions. I will now turn the call over to Brianna Gerber for closing remarks.

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Brianna Gerber, ChromaDex Corporation - Senior Director of FP&A and IR [40]

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Thank you, Cheryl. 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 3774159. Thank you, everyone, for joining us today and for your continued support of ChromaDex.

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Operator [41]

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This concludes today's conference call. You may now disconnect.