Image source: The Motley Fool.
Neptune Wellness Solutions Inc (NEPT)
Q3 2020 Earnings Call
Feb 13, 2020, 8:30 a.m. ET
Contents:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Good morning. My name is Joanne, and I will be your conference operator today. At this time, I would like to welcome everyone to the Neptune Wellness Solutions 2020 Third 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 Strategy, you may begin your conference.
Martin Landry -- Chief of Corporate Development and Strategy
Thank you, operator. Good morning, everyone, and thank you for joining us. Earlier today we issued a press release announcing our results for the third quarter of fiscal year 2020. We also issued our management's discussion and analysis and consolidated financial statements. These documents have been filed with the Canadian Securities and Regulatory Authorities of the US 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 remark 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 may be required by Canadian and US Security Laws.
A number of assumptions were made by us in preparing these forward-looking statements, which are subject to risks. 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 Security Exchange Commission.
Joining me on the call today, we have Michael Cammarata, our President and Chief Executive Officer; and Claudie Lauzon, Interim Chief Financial Officer. Michael will start by giving you an operational update followed by a discussion on our B2C initiatives. Afterwards, Claudie will provide a detailed review of our third quarter financial results. Michael?
Michael Cammarata -- President and Chief Executive Officer
Thank you, Martin and good morning, everyone. Let me start by saying that our revenue growth of 41% quarter-over-quarter is a solid achievement in the light of the current cannabis and hemp landscape in Canada and the United States. However, our profitability is below our expectations and we have made significant positive changes across the organization to optimize our cost structure and accelerate our revenue growth to turn the corner towards generating positive EBITDA.
When I joined this Company six months ago, I set out a long-term business plan and vision. I reassess every facet of Neptune, especially, its B2B production capabilities and customer relationships. It quickly became apparent that there were several operational challenges that needed to be addressed immediately.
Across the Company, we've taken decisive action in an efficient manner to change and enhance management, our production plans and our customer relationships in order to accelerate Neptune's continued growth.
As a result of our actions, we are on track to achieve our vision to effectively grow and maximize our B2B extraction business, while also fully developing a direct-to-consumer model that I believe is the future of cannabis, nutrition and retail.
We are closer to that vision today with new high-valued partnerships in the consumer space, the launch of Neptune's first consumer brands and the significant changes to our B2B production lines and relationships. We rapidly become more than an extraction and a white label company. I believe our consumer business has the potential to become one of the most profitable segments of Neptune's future business.
We now have a nimbler team in place that has been able to adapt to the rapidly changing market and together we have adapted to external market forces and business challenges to enhance our operations at an unprecedented pace. From a production standpoint in Canada, our CO2 extraction equipment is fully operational 24/7 and we are fulfilling orders for our customers.
We are also upgrading our dicot and winterization capabilities that are used to further process raw oil produced on our Phase 1 extractor. This will provide additional capacity and reduce the cycle times to better serve our customers.
Regarding our ethanol extraction, our priority is to ensure that Phase 2 is done in the right way, no shortcuts to protect our long-term profit potential.
We've improved our storage capacity, modified the building to meet regulations and invested in training and staff to ensure the best quality products for our customers.
We've also taken action to upgrade our cooling agent to chill ethanol which is food-grade and will better protect our machinery. Our ethanol equipment will be up and running at room temperature in the coming weeks and the new cooling agent will be installed in the coming months. Running our extraction at room temperature requires an additional winterization step, slightly increasing the time, the process takes to produce distillates.
However, it does not impact quality in our nameplate capacity, which in Canada is a total of 200,000 kilograms of biomass annually and 160,000 of kilograms when cleaning and setup times are taken into account.
Our capacity utilization will be dependent on demand. Delays in the rollout of cannabis stores in Canada have had an impact on the demand for our cannabis extraction services in Canada. We have chosen to look at the long-term value of our client contracts and are working with our customers to find solutions suitable for both parties.
As a result, our extraction capacity in Canada is now fully committed for calendar 2020. There is currently a limited availability of cannabis concentrates on the market in Canada and we intend to fill that void by expanding our production capabilities to produce these cannabis derivatives and other specialty product forms.
We are looking to diversify our extraction capabilities to include solventless and hydrocarbon extraction methods, which are well-suited to produce high quality cannabis concentrate.
As a result of the realignment of Neptune's Canadian extraction capabilities and the evolving needs of the market, the retrofit of the Company's large legacy extraction equipment destined for the Phase 3A expansion has been put on hold. We are still proceeding with the licensing of these rooms with Health Canada, but the large extraction equipment won't be commissioned in the near-term.
We will look at other uses for the space including the opportunity to produce higher-end and higher-margin products. Ahead [Phonetic] our Sherbrooke facility, we are in a process to request an amendment to our licenses received by Health Canada to include additional packaging and warehousing areas. Licensing these additional areas will increase Neptune's capacity to provide turnkey solutions to our customers in formulation, purification, blending and manufacturing and packaging services. We will also have more flexibility to manufacture white label products including tinctures, vape pens, capsules, powders, teas and emulsions.
As a part of this initiative, we will also request additional warehousing space including refrigerated storage, which we think will be a competitive advantage for our production.
To accelerate our go-to-market strategy, we are applying to receive permission to sell cannabis products in Canada directly to licensed cannabis distributors and retailers. On receipt of these licensing amendments, we expect to launch cannabis products in Canada under the Forest Remedies and Ocean Remedies and Neptune brands.
In the US, the market for hemp abstract has seen a significant level of volatility in the last 12 months where pricing for CBD refined oil has declined more than 60%. This decrease in bulk hemp abstracts prices is having a negative impact on the Company's B2B bulk extract sales.
Prices for hemp biomass have followed a similar pattern, which has also put pressure on our tolling fees in the United States. We will use some of our available extraction capacity in North Carolina to produce high-quality extracts, which we will use in our Forest Remedy products.
Turning now to our B2C strategy. Today, we announced the official launch of Forest Remedies. Starting immediately, as detailed in a separate press release filed this morning, consumers in the United States will be able to purchase Forest Remedy products directly from our new website at www.forestremedies.com. We are supporting these launches with a full scale marketing and public relations campaign with our strategic partner American Media and its media properties including but not limited to In Touch and US Weekly.
The Forest Remedy line consists of wellness products including hemp-derived soft gels, topical balms, massage oils and a pet soother to start. Forest Remedies products will be priced at a 50% discount on average to the leading CBD brands, providing the consumers with high-quality product at accessible prices.
Today, we are also releasing our essential oil and aromatherapy lines commercialized under our Forest Remedies brand. The initial essential oil line comprised of six single oils and in the coming weeks, we will be releasing additional aromatherapy products including a variety of blends that we have developed in collaboration with our partner International Flavors & Fragrances or IFF.
To celebrate this line's idea, we will hold a media event this spring at IFF's headquarters in New York. We have also built a brand for our omega-3 products, which will now be sold under the Ocean Remedies brand. Ocean Remedies clinically studied omega-3 products deliver omega-3s that are better and easier absorbed than those in regular fish oil and continue to be leaders in the market.
Further, product launches under the Ocean Remedies brands are planned for later this year. Other opportunities in the B2C market include a recent exclusive partnership to create 3D-printed dissolvable CBD-infused teas for drinks. We can now formulate dissolvable functional food that can be printed in any shape including logos and infuse them with CBD oil to make them functional CBD beverages. Our focus to expand our B2C offering has been supported by our recent management hires.
We hired Eric Dodge as Senior Branding Manager with responsibilities to oversee the growth of Forest Remedies and Neptune's other brands. Eric was recently brand manager of the Oral Care Innovation at Tom's of Maine, a subsidiary of Colgate-Palmolive.
We've also recently hired Tyler Segel as Creative Manager to handle creative work for all of Neptune's brands. He previously was the Creative Director for Factory North where he helped develop the Schmidt's Naturals brand. We will use our existing assets to support our B2C vision, which I personally believe will become the fundamental value of our company.
At Neptune, we're recruiting a world-class talent to bring us towards our vision of a fully realized B2B extraction business and the development of our consumer brands that can change the way cannabis is used and consumed. These recent hires demonstrate this commitment and are example of our ability to attract top-tier talent who believe in our future and we are just getting started.
We also want to let you know that our CFO search is ongoing. As previously discussed, we're looking to build a state-of-the-art management team and the CFO was a key member. As the market has changed, we've had to change the requirements of the job to manageable B2B and B2C channels. We are having discussions with several candidates and we look forward to making a hire announcement soon.
In the meantime, our Interim CFO Claudie is doing an amazing job. We strongly believe that our existing infrastructure gives us the competitive advantage to benefit from the changing consumer habits for cannabis products and the potential uses for cannabis-derived ingredients across personal care, home care and beauty.
Our management's experience launching, commercializing and marketing wellness products puts us in an ideal position to succeed with the launch of Forest Remedies and Ocean Remedies brands.
Despite a slightly slower-than-anticipated start on the production side, we are building the foundations for this company for many years to come. I'm excited about the prospects for the year ahead, especially the launch and the significant potential of the Forest Remedy and Ocean Remedy brands.
I will now turn it to Claudie for a detailed review of our financial results.
Claudie Lauzon -- Corporate Controller and Interim Chief Financial Officer
Thank you, Michael, and good morning everyone. Total revenues for the three-month period ended December 31, 2019 amounted to CAD9.2 million, representing a sequential increase of CAD2.7 million or 41% over the second quarter ended September 30, 2019 and an increase of CAD2.6 million or 40% compared to $6.5 million for the three-month period ended December 31, 2018.
Revenues from the Cannabis segment reached CAD2.8 million, an increase of CAD1.6 million sequentially from the three-month period ended September 30, 2019. Neptune started the commercial operations of its Cannabis segment in March 2019 and hence had no revenues in the prior-year period ended December 31, 2018.
Revenues from the nutraceutical segment for the three-month period ended December 31, 2019 amounted to CAD6.3 million, representing an increase of 23% sequentially over the second quarter ended September 30, 2019 and mostly stable compared to the three-month period ended December 31, 2018.
Net income for the three-month period ended December 31, 2019 amounted to $5.6 million compared to a net loss of CAD3.7 million for the three-month period ended December 31, 2018.
The variations from net loss to net income is due to a change in fair value gain of CAD64.5 million related to the revaluation of the contingent considerations related to the acquisition of SugarLeaf Labs Inc. This change in fair value gain was partly offset by an impairment loss on goodwill of CAD44.1 million related to SugarLeaf.
During the third quarter, management performed an impairment tax on goodwill related to the acquisition of SugarLeaf and determined that a write-down was needed due to a decline in the pricing of hemp-derived CBD refined oil, as well as a decrease in forecasted sales volumes. Adjusted EBITDA decreased by CAD5.1 million for the three-month period ended December 31, 2019 to negative CAD7.1 million compared to the three-month period ended December 31, 2018.
The decrease in adjusted EBITDA is mainly attributable to investments made in the Cannabis segment to grow the workforce in anticipation of increased sales volume as well as an increase in salaries and benefits at the corporate level.
Cash and cash equivalents were CAD20.8 million as of December 31, 2019. On November 6, 2019, Neptune closed a revolving line of credit with a large Canadian financial institution for an amount of CAD5 million to support the nutraceutical segment.
That concludes my opening remarks. I will turn it to the operator to open the line up for questions. Operator?
Questions and Answers:
Operator
[Operator Instructions] Your first question comes from the line of Gerald Pascarelli. Your line is now open.
Gerald Pascarelli -- Cowen and Company -- Analyst
Hi, thanks. Good morning.
Michael Cammarata -- President and Chief Executive Officer
Good morning.
Gerald Pascarelli -- Cowen and Company -- Analyst
My first question just housekeeping item on the impairment. I guess what underpinned the assessment for the $45 million writedown? I know it was $122 million carrying value last quarter. It's still at $78 million as of this quarter and I'm just trying to assess kind of given what we are seeing from a price -- from a deflationary perspective in the US CBD market, the potential for further writedowns on goodwill? Thank you.
Martin Landry -- Chief of Corporate Development and Strategy
Hi Gerald, it's Martin. I think we need to just remind everybody that the purchase price we paid for SugarLeaf is $18 million or CAD24 million. But the total purchase price if all the earnouts would be achieved was estimated at CAD150 million.
So, what we did from an accounting standpoint is account for those earnouts as a liability on our books and that's what we're writing -- part of what we're writing down today is those potential earnouts.
To answer your questions, what's been the trigger to reflect an impairment today? Well, you may have seen I'm sure the price of the hemp extracts have been extremely volatile this year and the last 12 months and they're down by more than 60%. So, that's obviously having an impact on our future sales and our profitability and that's what we've reflected.
And to your point, there are -- there is still CAD34 million of earnouts on our book. So, we still think that SugarLeaf will hit some of their earnouts and we still think that they have a bright future ahead of them, but we needed to reflect the current environmental -- environment conditions.
Gerald Pascarelli -- Cowen and Company -- Analyst
Thanks, Martin. Super helpful. Let's just turn to SugarLeaf. So I'm just trying to get an idea of where the capacity build out is relative to the legacy 30,000 kilos that you had in your Phase 1 operations. I understand that running at room temperature is going to result in the extra winterization step. But relative to the 30,000 legacy kilos, can you provide kind of where you are in terms of capacity at Sherbrooke right now? And then, when you ultimately expect to build to the 200,000 kilos of capacity albeit even if it's at room temp and not utilizing the coolant? Thanks.
Martin Landry -- Chief of Corporate Development and Strategy
Yes. So our phase -- so that's our Canadian facility in Sherbrooke. Our Phase 1 of CO2 extraction is running at full capacity at 30,000 kilos annually when -- you need to maybe take into account setup times and cleanup times and maybe reduce that by 20%. Our Phase 2, we've undergone a successful extraction tests and we still need to commission some of the other aspects of the system. And we, as Michael said in his opening remarks, we're going to run that at room temperature in the coming weeks, and the capacity utilization will be dependent on demand, but to bring it to full capacity would require us to run it round the clock seven days a week. So we would need to train some of our team and add some labor resources and we'll do that as demand increases and as we see the demand for that. So it doesn't -- it's not extremely long for us to hit full capacity if we need to, but right now as Michael alluded in his remarks, our capacity is not fully committed.
Gerald Pascarelli -- Cowen and Company -- Analyst
Understood. You mentioned that you see an opportunity to fill -- to fill some underserved segments within the Cannabis 2.0 products concentrates in particular. By expanding your production capabilities to produce these products, are you talking about white labeling or actually producing Neptune-branded products to sell into the Canadian marketplace, or maybe is there an opportunity for both? Thanks.
Michael Cammarata -- President and Chief Executive Officer
Gerald, it's Michael. It would be the opportunity for both. So we're proceeding with both.
Gerald Pascarelli -- Cowen and Company -- Analyst
Okay. And then just last one for me. I'm sorry. Did -- were you going to say something?
Martin Landry -- Chief of Corporate Development and Strategy
Yes. Well, Gerald, just to add on Michael, we have had several discussions with provincial cannabis distributors. And they -- it is something they've told us that there was a need there and it's part of our expansion, and it's part of our strategy to maybe have a broader offering and get into higher-end niche products. So it's something we're exploring right now.
Michael Cammarata -- President and Chief Executive Officer
Definitely something that we really want to do to focus on the consumer, because what we've seen from early sales data in Canada on Cannabis 2.0 and then look -- also looking at other more developed markets like in California, we see that the consumers are really willing to pay for premium products that are unique and innovative. So we want to make sure that we could stand out by offering the most variety of product offerings to our white label customers, our B2B customers and also for our brands.
Gerald Pascarelli -- Cowen and Company -- Analyst
Got it. Thanks, Michael. Super helpful. Just last one for me, and I'll hop back into the queue. The move to potentially include additional extraction capabilities like hydrocarbon and solventless, would that be incremental? I know, it's still early days, but would that be incremental to your Phase 2 cold ethanol build out, or would it be kind of split between cold ethanol and these other solvent -- these other extraction capabilities as part of the incremental 170,000 kilogram build out?
Michael Cammarata -- President and Chief Executive Officer
It'd be incremental.
Gerald Pascarelli -- Cowen and Company -- Analyst
Okay. Thanks very much, guys.
Martin Landry -- Chief of Corporate Development and Strategy
Thank you.
Operator
Your next question comes from the line of John Chu. Your line is now open.
John Chu -- Desjardins Capital Markets -- Analyst
Hi. Good morning. So maybe my first question would be on the capacity that's not fully committed yet. And maybe just talk about the pipeline that you have currently, the discussions you're having. Is it more LPs, or is it more CPG-related companies that seems to be filling that in terms of the discussions you're having? And maybe get a sense of how that mix might come through going forward, especially given some of the LPs might be having some financial difficulties?
Michael Cammarata -- President and Chief Executive Officer
Yes, we definitely have seen an uptick in inbound requests and we've been very selective on who we work with and also really putting an emphasis on CPG and nutraceutical companies that are entering the space.
We definitely have quite the opportunity especially because of the product offerings that we've been focusing on as we've transitioned into offering a variety of different Cannabis 2.0 products and increasing our capabilities. So we're focusing obviously heavily in prioritizing CPG companies and nutraceutical companies and really highly focusing on certain LPs.
John Chu -- Desjardins Capital Markets -- Analyst
Okay. And then maybe just a follow-up in terms of the solventless and hydrocarbon alternatives for extraction. Maybe just talk about what type of expertise you might have? Obviously, there's some additional capex requirements, licensing and even just permitting from some of the local cities and whatnot. I think hydrocarbon you do have a bombproof room. So maybe just give us a walk-through about all of those considerations that come into play?
Michael Cammarata -- President and Chief Executive Officer
And that was something that was really unique to us because of our facility already being bombproof and really being recently built and spending tens of millions of dollars on that facility that is state-of-the-art. We were able to move into this area quite efficiently without increasing a lot of capex, which actually allowed us to enter quicker and faster and we also have the legacy of a lot of PhDs and chemists and formulators and with our Biodroga business, great operations and research that we would be able to tap into to actually speed up that process. So that's something that we hope to come on quickly.
Martin Landry -- Chief of Corporate Development and Strategy
And John, it's Martin. To add on that, you may remember last summer, we've beefed up also our expertise in cannabis space with a couple of high-profile hires. So those extraction methods are a little bit more niche, a little bit more unique to the cannabis space, and we do have internally the expertise to perform them quite well.
John Chu -- Desjardins Capital Markets -- Analyst
Okay, perfect. And maybe just talking about the US hemp-derived CBD oil price environment there. Just presuming then you've had to downgrade your sales outlook for that. So does that push everything back considering that you're moving from a tolling model to more of a -- of one where you're going to be producing products and maybe producing your own brands? How much of that push things back a bit from what you may have already forecasted previously on the sales front?
Martin Landry -- Chief of Corporate Development and Strategy
Well, tolling in the US is something extremely competitive and it's never been our key focus. We've never thought this was going to be a strategy for us. In the long run, we always thought that the mix of tolling versus white label and bulk sales would go down over time. So I think the pricing dynamic has accelerated that shift for us, focusing on bulk sale extracts to our legacy nutraceutical and health and wellness clients is something that we're doing well at this point and something that we're going to pursue going forward. And the launch of our Forest Remedies brands will also use some of that capacity, right? Because all the extracts that will go into those products are going to be extracted into the SugarLeaf facility. So, in terms of the outlook, we don't provide any forward-looking statements, but obviously with the current economic pricing, it's having an impact.
Michael Cammarata -- President and Chief Executive Officer
But keep in mind, as we're closer to the consumer, we're also again closer to the top of the revenue waterfall. So as we launch our own brands, we also are capturing retail revenues and then eventually subscription revenues in addition to our white labeling and extraction.
So I think the shift that we're making right now is part in time to get closer to the consumer, it's going to have an overall positive effect and create a lot of shareholder value, because when you look at the market and you look at how the LPs are valued and you look at how the extractors are valued and you look at how the brands are valued, you can quickly see that getting closer to revenue that, you can instantly receive from credible retail partners and directly from the consumer, gives you an edge not only with the revenue upside potential, but also on the innovation side and to be able to capture a lot more revenues and the biggest stake of the pie.
John Chu -- Desjardins Capital Markets -- Analyst
Okay. And then just my last question then, I'll hop back into queue, would be, you talked about some high-profile potential customers that you've had discussions with over the last few months. So, maybe just remind us what the traditional sales cycle that you've seen with some of the other customers that you signed up on the nutraceutical side? How long does that cycle take place in terms of when we actually might see some of these customers sign on? And then therefore you can announce something?
Michael Cammarata -- President and Chief Executive Officer
Yes. So, it's a little bit different on the CPG and the nutraceutical side than it is on the cannabis LP side. I think, a lot of the cannabis LPs, rush the market with announcement. With the nutraceutical and the CPG customers, it takes a little bit longer of a cycle because you have to focus not only on the quality of the product and the state-of-the-art manufacturing, but you also have to focus on the company values and I think we've done a really good job of being -- incorporating diverse hiring practices, being energy-efficient ESG and I think that that's something that stands out. So we're on a fast track with a lot of the big CPG companies.
On the nutraceutical companies, they're now starting to enter the space. And as you can see, they're starting to purchase and we've been working with a lot of these customers in our legacy businesses. So we had an easier approach as well as a quicker-launch period with them. So, I think that, that business does take a little bit longer on the sales cycle but those customers are much more sticky when they come in. And I think that that's something that puts us in a unique position.
John Chu -- Desjardins Capital Markets -- Analyst
Thank you.
Martin Landry -- Chief of Corporate Development and Strategy
Thank you, John.
Operator
[Operator Instructions] Our next question comes from Doug Loe. Your line is now open. Our next question comes from Doug Loe. Your line is now open.
Doug Loe -- Echelon Wealth Partners -- Analyst
Sorry gentlemen, I was on mute. So most of the questions are sort of related to capacity utilization and brand differentiation and so forth. And so, maybe I'll just ask the question in a slightly different way. Your Biodroga segment actually performed reasonably well in comparison to the historic expectations. And so, just kind of wondering on whether you might be thinking more forwardly about finding ways to integrate the nutritional formulation and consulting services within that division to explore ways to differentiate novel cannabis or hemp formulations in -- specifically in the direct-to-consumer market?
Michael Cammarata -- President and Chief Executive Officer
Yes. Our Biodroga business has actually been uniquely positioned and we're focusing on it right now to expand it -- not only to some of the IP that it holds, we've also filed for patents and provisionary patents and we've expanded our IP portfolio, which actually will apply to a lot of the hemp and cannabis-derived ingredients.
So, as we shifted -- took a moment to shift our Biodroga business into creating unique IP that we can actually take part not only on the formulation and the process with its historical customers, but we also bring that IP to make it more sticky. So we actually took a look at Biodroga in initial six months and said okay, what can we do to increase the IP it held and also make the customers more sticky and bring additional customers both into the cannabis and hemp space, but also make our offerings unique, because I think the biggest thing that we're trying to do is have a variety of options because, now that we're starting to get feedback from the customers and what's working and what's not at retail, we want to be able to have a unique offering that we can have higher margins on and also promote our IP pool.
So, as we're increasing our IP pool and we've actually had a great relationship with IFF that has also helped us with our R&D and research and even making non-product offerings more unique and also that -- an IP that we can bring to the market pretty quickly now that we're so much closer to the consumer.
John Chu -- Desjardins Capital Markets -- Analyst
That's great feedback. Thanks, Michael.
Martin Landry -- Chief of Corporate Development and Strategy
Thank you, Doug.
Operator
There are no further questions at this time. I will turn the call back over to the presenters.
Martin Landry -- Chief of Corporate Development and Strategy
All right. Well, thank you very much everybody for joining us today and have a great day. Thank you.
Operator
[Operator Closing Remarks]
Duration: 35 minutes
Call participants:
Martin Landry -- Chief of Corporate Development and Strategy
Michael Cammarata -- President and Chief Executive Officer
Claudie Lauzon -- Corporate Controller and Interim Chief Financial Officer
Gerald Pascarelli -- Cowen and Company -- Analyst
John Chu -- Desjardins Capital Markets -- Analyst
Doug Loe -- Echelon Wealth Partners -- Analyst
