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Neptune Wellness Solutions Inc (NASDAQ:NEPT)
Q2 2020 Earnings Call
Nov 11, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, my name is Julie and I will be your conference operator today. At this time, I would like to welcome everyone to the Neptune Wellness Solutions 2020 Second Quarter Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions].

Thank you, Mr. Martin Landry, Chief of Corporate Development and Strategies at Neptune Wellness, you may begin your conference.

Martin Landry -- Chief of Corporate Development and Strategy

Thank you, Julie. Good morning everyone and thank you for joining us. Earlier today we issued a press release announcing our results for the second quarter of fiscal year 2020. We also issued our Management's Discussion and Analysis and Consolidated Financial Statements. These documents will be filed with the Canadian Securities and Regulatory Authorities, and with the U.S. Securities Commission and are available on the company's corporate website.

Before we begin, I'd like to remind you that all amounts discussed today are in Canadian dollars and today's remarks contain forward-looking information that represents our expectations as of today and accordingly are subject to change. We do not undertake any obligation to update any forward-looking statement, except as maybe required by Canadian and U.S. Securities laws. A number of assumptions were made by us, in preparing these forward-looking statements, which are subject to risk. Results may differ materially from what is projected, and details on these risks and assumptions can be found in our filings on SEDAR, and with the Securities and Exchange Commission.

Joining me on the call today we have Michael Cammarata, our President and Chief Executive Officer; and Mario Paradis, Neptune's Vice President and Chief Financial Officer. I will start by giving you an operational update and Michael will follow up with a strategic overview of recent corporate development. Mario will then finish with a detailed review of the financial information.

So let's start with Canada; we reached a significant milestone in mid of October, when we completed our Phase 2 capacity expansion at our Sherbrooke facility. This additional capacity will alleviate our constraint in the near term and help accelerate the company's revenue growth in the cannabis segment. However, the start-up of our ethanol process has been a longer than initially expected, which has delayed the full ramp-up by one month to the end of December. We're using a cold ethanol extraction process, which is faster, consumes less energy in our CO2 extraction process, and should enable Neptune to lower operating costs.

With regards to your CO2 operations, we have been running seven days a week since the end of July, and we're pleased by the yields and quality of extracts. With this new capacity, we've provided extraction services to two additional clients, expanding our customer base to five licensed producers in Canada. The construction of our packaging area is progressing well at our Sherbrooke facility. Recall that we're investing CAD7 million to expand our manufacturing and formulation capabilities in light of the arrival of the cannabis 2.0 products. Once the construction is complete and licensed by Health Canada, we will be able to formulate and package several product forms on a white-label basis, including tinctures, creams, balms, vape pens, capsules and powders among others. As part of this project, we will also amend or Health Canada license to include additional warehousing space, including refrigerated storage, which we think will be an important point of differentiation. Once licensed, we will be able to store in excess of 150 tons of biomass in room temperature and cold storage.

Lastly, the Phase 3A retrofit is also under way and expected to be completed before fiscal year-end. We will need Health Canada's approval of our Phase 3A expansion before starting commercial operation. This expansion is necessary to meet customer demand for extraction services, which continues to be sustained, due to the lack of extraction capacity in Canada.

Turning now to our U.S. operations; the expansion of our extraction capacity at our North Carolina facility is progressing well and on track to reach a processing capacity of 1.5 million kilos of biomass annually. In the U.S., we're using the same cold ethanol extraction technology we use in Canada, allowing for sharing of best practices between our two sites. Our sales pipeline in the U.S. is healthy. We recently announced a two year contract for extraction services, which could exceed $20 million. We also signed contracts with two well established U.S. based nutraceutical companies to provide finished products and bulk hemp extracts.

To further support our U.S. growth initiatives, we've appointed Brett DuBose as Vice President of Sales for the U.S. region. Brett will play a key role in helping Neptune accelerate its market penetration in the U.S. We will appoint additional staff and continue to invest in talent, to ensure we're a leader in both Canada and U.S. So overall, both our U.S. and Canadian operations are scaling up well, which should translate into revenue growth accelerating in coming quarters.

I will now turn it to Michael for his remarks. Michael?

Michael Cammarata -- President and Chief Executive Officer

Thank you, Martin and good morning everyone. We have made significant progress since we last spoke. Today, I'll talk about some of our new initiatives. On the extraction side, the dynamics of the legal cannabis and hemp extraction market remained favorable, with a limited availability of biomass extraction capability in both Canada and the U.S. So we will see continued sustained demand for our extraction and turnkey services.

In recent months, I spent a significant amount of time and effort developing our B2C and B2B strategy for the U.S. market. According to most estimates, the US hemp derived CBD market is expected to exceed CAD20 billion at retail in the next five years. This market is roughly three to four times larger than expected Canada cannabis market, and represents the largest opportunity in front of us. To that end, we will soon officially launched Forest Remedies, our first CBD brand. We will introduce a new look and feel of the brand, update the website increased the number of SKUs available on product innovations. We are currently in discussions with retailers to add point of sales distribution for Forest Remedies which will allow us to offer products, both online and in stores throughout the states.

Another promising initiative is our product development collaboration and partnership with IFF, International Fragrances and Flavors. Our collaboration gives us access to unrivaled product development capabilities, global reach, and together IFF and Neptune will develop and launch new CBD based products under the Forest Remedies brand in the coming months in the U.S. We will support our product development with creative and marketing services and media provided by American Media under our partnership agreement. This will ensure we have the marketing support necessary for Forest Remedies to gain significant traction at retail.

To conclude, my first four months of Neptune have been exciting and rewarding. While we saw some turbulence in our sector in recent months, Neptune has a unique business model, we have diversified our core customer base, and are well positioned to capitalize on growth opportunities. Our plan is to create a solid B2B and B2C platform globally.

I will now hand it off to Mario, who will go over the financial review. Mario?

Mario Paradis -- Vice President and Chief Financial Officer

Yes, thank you Michael and good morning everyone. Let me we start with some financial highlights for the second quarter ended September 30th. During the second quarter, we are announced the closing of a private placement for a gross amount of CAD54 million, and we also completed the SugarLeaf acquisition on July 24, 2019. Consequently, the results of operation of SugarLeaf were consolidated in our financial statements since then.

If we now look at the financial results for the quarter; during the second quarter in the cannabis business, the revenue were CAD1.2 million, with a negative gross profit of CAD1.7 million in comparison with a negative gross profit of CAD2.1 million in the first quarter of the current year. This improvement is directly related to the increase in revenues, slightly offset by the increase in expenses related to salary and overhead of the Sherbrooke plant in preparation for the business expansion. R&D expenses were in line with our expectation, with CAD466,000, an increase of CAD216,000 with the first quarter.

For the second quarter last year, salaries and fixed costs and overhead, including the depreciation at our manufacturing plant in Sherbrooke to prepare the site, were recorded in R&D and totaled CAD1.4 million.

As for the selling, general and administration, the expenses were CAD1.7 million, an increase of CAD1.2 million in comparison with the first quarter of CAD349,000, and this is mainly related to the SugarLeaf acquisition, including the amortization of the intangible assets for an amount of CAD800,000. The EBITDA of the cannabis segment was negative CAD1.7 million, relatively stable in comparison with the first quarter, with a negative EBITDA of CAD1.6 million. Despite the SugarLeaf acquisition impact and compared with CAD1.3 million last year. The increase in revenues was offset by an increase in hiring and preparation expenses for the upcoming business growth.

As for the Nutraceutical segment; total revenues for the second quarter including royalties revenue were CAD5 .1 million, an increase of CAD0.9 million or 20% sequentially versus the first quarter and down by CAD1.9 million over last year.

Total revenues declined versus last year, mainly due to loss of some customers and the timing of some orders. For the third quarter, we are expecting the same level of growth on a sequential basis over the second quarter, and will benefit from our first revenues in the hemp derived CBD turnkey solutions business in the U.S.

Our quarterly gross margin as a percentage of sales was stable at 26% compared with the first quarter this year. In term of dollars, we generated CAD1.6 million, an increase of CAD300,000 over the first quarter and a decrease of CAD0.8 million over the same period last year, mainly related to lower sales.

SG&A were stable in comparison with the first quarter this year, and also when compared with last year. The adjusted EBITDA for the quarter in the Nutraceutical segment was CAD0.9 million compared to an adjusted EBITDA of CAD0.5 million in the first quarter and CAD1.5 million last year. The variation is again directly related to revenues.

The Corporate, General and Administrative expenses for the quarter was CAD13.9 million in comparison with CAD4 million in the first quarter and CAD1.9 million last year. The increase of CAD9.9 million versus the first quarter and CAD12 million over last year, is mainly coming from the increase in compensation related to equity instruments, such as restricted stock units, RSU, and stock option for an amount of CAD7 million.

There is also an increase in salary and benefits and hiring fees related to the base of employees we are hiring, and to marketing expenses. There was also some expenses that should not be present in the following quarters, such as litigation legal fees for an amount of CAD560,000. CAD1.8 million related to the SugarLeaf acquisition and CAD850,000 for severance and change in management-related expenses.

The consolidated quarterly EBITDA loss for the quarter is CAD4.6 million, compared with an EBITDA loss of CAD3.6 million in the first quarter and CAD1.2 million for the same quarter last year. And, it is mainly related to increase in the Corporate, General and Administrative expenses for the quarter, as indicated earlier.

The quarterly net loss increased by CAD43 million to reach CAD20.8 million in comparison with the net loss of CAD6.5 million for the first quarter and CAD3.1 million last year. The increase in net loss is mainly related to the additional non-cash stock-based compensation, to the acquisitions cost and intangible amortization related to the SugarLeaf acquisition to severances and change in management-related expenses, and finally to a non-cash financial expenses related to the accretion of the contingent considerations and the passage of time for an amount of CAD4.1 million.

Turning to our liquidity; at the end of September 2019, our cash position was CAD24.4 million. Subsequent to the quarter, on November 6th, we closed a revolver line of credit with a large financial institution, to support our Nutraceutical business for an amount of CAD5 million. This cash level, combined with the access to the line of credit will support our near term growth strategy.

I now turn the call to the operator for the question period.

Questions and Answers:

Operator

[Operator Instructions]. Your first question comes from the line of Doug Loe with Echelon. Your line is open.

Doug Loe -- Echelon Wealth Partners -- Analyst

Yeah. Thank you and good morning, gentlemen. Thanks for the update on the quarter. Mario just a quick housekeeping question, in your commentary you talked about revenue growth rates into Q3 being comparable to what they were in Q2. Could you just clarify whether you meant consolidated or whether that was specific to the nutritional or Canada segments?

Mario Paradis -- Vice President and Chief Financial Officer

No, it was more specific to the Nutraceutical segment. So 20% growth versus the first quarter, and we anticipate at least the same kind of growth for the third quarter in comparison with this quarter.

Doug Loe -- Echelon Wealth Partners -- Analyst

Perfect. Okay, thanks for that clarification. And then second of all, just -- I didn't hear you mentioned the Lonza alliance in your commentary, I was just wondering if you might be able to provide some specific insights into how the production line for gel cap cannabis formulations is evolving there?

Michael Cammarata -- President and Chief Executive Officer

Hi, Doug. In terms of our Lonza capsules the equipment is fully licensed with Health Canada and we're still operating on track with expectations on that line. There was nothing specific to mention.

Doug Loe -- Echelon Wealth Partners -- Analyst

Okay. That's perfect. And then maybe one last question while I have got the floor. So congratulations on nailing down a formal alliance with with IFF, as you announced was going to be an eventuality last month, and thanks for specifically saying that aromatherapy was going to be a product category to which most of the SKUs were going to apply. As you may know, there is a lot of evidence that topical cannabinoids can work well in specific medical markets, including like osteoarthritis pain, joint pain in general. Just wondering if maybe this is a question for IFF, but maybe if you can address, that would be great. If they have any interest in establishing any specific medical claims for pain or other markets, and if that might be relevant to the specific alliance? And I'll leave it there, thanks.

Michael Cammarata -- President and Chief Executive Officer

It's Michael Cammarata. So that is definitely an area that we're going into. We have 10 studies going on of our own right now, including some that are looking at occasional anxiety. But we are expanding that with the partnership with IFF, to help us get additional claims.

Doug Loe -- Echelon Wealth Partners -- Analyst

Perfect. Thanks a lot.

Operator

Your next question comes from the line of Justin Keywood with GMP Securities. Your line is open.

Justin Keywood -- GMP Securities -- Analyst

Good morning and thanks for taking my call. I'm wondering, with the report from the CDC last week, isolating the potential cause of the vaping illness, do you anticipate that this will have a impact on existing customer orders or potential new customers that have maybe been a bit cautious around this uncertainty?

Michael Cammarata -- President and Chief Executive Officer

I think that's something that's very -- I think it definitely helps the overall market. But I think when we are looking at the, waiting crisis, we are well aware of like synthetics and different carriers. So we're very cautious on what we put into our formulation. So I think now it will allow us to even allow for additional customers that are probably sitting on the sidelines.

Justin Keywood -- GMP Securities -- Analyst

Right. And do you think this will have an immediate impact or still be gradual going into next year as derivative products become available?

Michael Cammarata -- President and Chief Executive Officer

I think there is additional customer -- we have a definitely a waiting list of customers, as we continue our expansion plans. But I think in the vaping side, we are always making sure that we kept minimal risk to vaping, while that was undergoing the investigations. We have no great exposure to vaping. So this will be an addition that what we are -- on top of our plan. So this will be a positive for us because we were on the sidelines as a company in the vaping side, with very minimal exposure to it. So now we'll probably open up the door to a lot of customers in the vaping area.

Justin Keywood -- GMP Securities -- Analyst

Okay. Makes sense. And then for the large U.S. hemp farming contract, are there any a minimum volumes for this agreement, or any additional color that you could provide would be helpful?

Martin Landry -- Chief of Corporate Development and Strategy

Yeah, hi. Hi, Justin, its Martin, are you referring to the CAD20 million U.S. contract over the two year period?

Justin Keywood -- GMP Securities -- Analyst

Correct.

Martin Landry -- Chief of Corporate Development and Strategy

Yeah. There is -- I'm not sure if we want to get into the specifics detailed, but it's not similar, the structure of our U.S. agreements are not similar to our Canadian agreements. So for that specific win, there's no minimum volumes.

Justin Keywood -- GMP Securities -- Analyst

Okay. And then, just one more, on the America media advertising services, does that CAD12 million -- are you able to access that on a discretionary basis over the five year period, or is it more equally contribued?

Michael Cammarata -- President and Chief Executive Officer

It's actually going to be probably more loaded in the beginning, because it were about the launch of Forest Remedies. We are obviously going to try and launch that very successfully to be able to accommodate retailers. So that's something that will be -- there is a certain amount between now and March, and then it will be expanded to the rest, as we roll-out that brand.

Justin Keywood -- GMP Securities -- Analyst

Okay, great, thank you for taking my questions.

Michael Cammarata -- President and Chief Executive Officer

Thank you.

Operator

Your next question comes from the line of John Chu with Desjardins Capital Markets. Your line is open.

John Chu -- Desjardins Capital Markets -- Analyst

Hi, good morning. First, maybe on the IFF, maybe just a little bit more detailed in terms of -- it sounds like the initial roll-out of products will be more on the non-edible side. Obviously there is some uncertainty with where the FDA is on that. Maybe just some commentary on -- is that the strategy and any input in terms of the timing of when the FDA might come back with expanding the health-based CBD product portfolio?

Michael Cammarata -- President and Chief Executive Officer

Well, two parts to that. The first part is, definitely, we're focusing on aromatherapy, for their launch initially, and then also utilizing some of our proprietary formulations with like the Omega-3s formulation and MaxSimil. But when going to the edible side, obviously that's a rolling target with the FDA in the States. We obviously are paying attention to it, and the unique thing that I think we've set up over the last couple of months is ability to be very agile and to be able to launch products fast and I think that with IFF as a partner and tapping into the 105 dedicated R&D facilities around the world, plus our facilities, we're able to adapt to market changes and opportunities fast than anybody else in my opinion.

John Chu -- Desjardins Capital Markets -- Analyst

And maybe just talk about -- you said potentially over 50 SKUs over time, what kind of a roll-out can we expect in year one calendar 2020 and then year two, can we get to 50 by the end of the second year?

Michael Cammarata -- President and Chief Executive Officer

I think we'll probably exceed that by the end of the second year, or double it. I think we're in a very good position. We've identified the claims, who we want to go after. We've identified the markets that we want to go after. We've identified a strategy, both online and offline. And I think that is something that's going to be very unique to us, and I think partnering with our customers like IFF to actually develop brands is going to be something that you can see more and more of in coming months.

John Chu -- Desjardins Capital Markets -- Analyst

And presumably that agreement, obviously with the rebranding of Forest Remedies, it sounds like you're already in discussions on the retailer side, from a retailer distribution perspective. Can you give us any color on that? Because you're talking 2020 to enter the mass market retailers?

Michael Cammarata -- President and Chief Executive Officer

We are in discussions with the retailers. There is actually part of a collaboration that we are looking to enter the B2C space pretty quickly and I think that IFF obviously allows us to enter it even faster. I think the retail plan that we we're looking at is, well really to be able to get closer to the consumer. So I think that our consumers will be able to go on to our site and be more active, as far as get subscription model, where they will be able to participate in products that aren't out yet, and then once we get feedback from them, we'll deploy it at a handful of retailers in the States. Once we see our packaging and our price points are right in the States, then we'll do a full deployment across all channels.

Justin Keywood -- GMP Securities -- Analyst

And then maybe just a little bit more on just some of these research and clinical study that you're working on. You listed a few in terms of just increasing the absorption of cannabinoids, the anxiety and a workout recovery focus on there. Any sense on timing in terms of when you can get some of the feedback from those clinical studies, and how would you prioritize some of these over the others?

Yeah, I think that obviously we're working very rapidly. We have amazing Chief Science Officer, Graham, who is leading that charge with partners like IFF. And I think there are some studies that we had already ongoing prior to this, and so now we are able to enhance the amount of studies that we can do at the same time, and be able to do it in a cost efficient way with IFF. So obviously, we're looking -- obviously heavily at occasional anxiety and looking at using our proprietary formulations with MaxSimil and Omega-3s and how they play into the cannabinoids. And so we should have some hopefully promising results sooner than later. And hopefully, you can tie in with their product launches at retail.

Okay. And then just the last question, so presumably the Phase 3A expansion, when do you expect to have the construction completed and how much money is left to be spent on that?

Martin Landry -- Chief of Corporate Development and Strategy

So John. It's Martin. It's not a construction, because we're using equipment that's already installed. So what we're doing is, we're putting some security measures in place to -- that are required by Health Canada, like access controls and security cameras. So that's what is going on right now. That is CAD4 million of CapEx and we think that retrofit, as we call it, should be done before fiscal year-end.

Justin Keywood -- GMP Securities -- Analyst

Okay, thank you very much.

Michael Cammarata -- President and Chief Executive Officer

Thank you.

Operator

There are no further question at this time, I will turn the call back over to the presenters for closing remarks.

Martin Landry -- Chief of Corporate Development and Strategy

Thank you everyone and wish you all a very good day.

Operator

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

Duration: 27 minutes

Call participants:

Martin Landry -- Chief of Corporate Development and Strategy

Michael Cammarata -- President and Chief Executive Officer

Mario Paradis -- Vice President and Chief Financial Officer

Doug Loe -- Echelon Wealth Partners -- Analyst

Justin Keywood -- GMP Securities -- Analyst

John Chu -- Desjardins Capital Markets -- Analyst

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