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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. [Operator Instructions] Thank you.Mr. Martin Landry, Chief of Corporate Development and Strategy at Neptune Wellness, you may begin your conference.
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 Discussion & Analysis and consolidated financial statements. These documents will be filed with the Canadian securities and regulatory authorities and with the U.S. security commission and are availability 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 expectation 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 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 on 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-October when we completed our Phase II 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 longer than initially expected, which has delayed the full ramp-up by 1 month to the end of December. We're using a cold ethanol extraction process, which is faster, consumes less energy than our CO2 extraction process and should enable Neptune to lower operating costs.With regards to our CO2 operations, we have been running 7 days a week since the end of July, and we're pleased by the yields and quality of extracts. With this new capacity, we provided extraction services to 2 additional clients, expanding our customer base to 5 licensed producers in Canada.The construction of our packaging area is progressing well at our Sherbrooke facility. Recall that we're investing $7 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 platforms on a white-label basis, including tinctures, creams, balms, vape pens, capsules and powders, amongst others.As part of this project, we will also amend our 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 IIIa retrofit is also underway and expected to be completed before fiscal year-end. We will need Health Canada's approval of our Phase IIIa 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 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 2 sites. Our sales pipeline in the U.S. is healthy. We recently announced a 2-year contract extraction -- for extraction services, which could exceed USD 20 million. We also signed contracts with 2 well-established U.S.-based nutraceutical companies that provide finished products and bulk hemp extracts.To further support our U.S. growth initiative, 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 the coming quarters.I will now turn it to Michael for his remarks. Michael?
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 attraction 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 U.S. hemp-derived CBD market is expected to exceed $20 billion at retail in the next 5 years. This market is roughly 3 to 4x larger than expected Canada cannabis market and represents the largest opportunity in front of us.To that end, we will soon officially launch Forest Remedies, our first CBD brand. We will introduce a new look and feel of the brand, update the website, increase the number of SKUs available and product innovations. We are currently in discussions with retailers to add point-of-sale 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 & Flavors (sic) [ International Flavors & Fragrances ]. 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 4 months at Neptune had been exciting and rewarding. While we saw some turbulence in our sector in recent months, Neptune has a unique business model, we've 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?
Yes. Thank you, Michael, and good morning, everyone. Let me start with some financial highlights for the second quarter ended September 30. During the second quarter, we announced the closing of a private placement for a gross amount of CAD 54 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 $1.2 million with a negative gross profit of $1.7 million in comparison with a negative gross profit of $2.1 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 $466,000, an increase of $216,000 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 $1.4 million.As for the selling, general and administration, the expenses were $1.7 million, an increase of $1.2 million in comparison with the first quarter of $349,000. And this is mainly related to the SugarLeaf acquisition, including the amortization of the intangible assets for an amount of $800,000.The EBITDA of the cannabis segment was negative $1.7 million, relatively stable in comparison with the first quarter with a negative EBITDA of $1.6 million despite the SugarLeaf acquisition impact and compared with $1.3 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 $5.1 million, an increase of $0.9 million or 20% sequentially versus the first quarter and down by $1.9 million over last year. Total revenues declined versus last year mainly due to the 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 terms of dollars, we generated $1.6 million, an increase of $300,000 over the first quarter and a decrease of $0.8 million over the same period last year, mainly related to lower sales. SG&A was 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 $0.9 million compared to an adjusted EBITDA of $0.5 million in the first quarter and $1.5 million last year. The variation is again directly related to revenues. The corporate, general and administrative expenses for the quarter was $13.9 million in comparison with $4 million in the first quarter and $1.9 million last year. The increase of $9.9 million versus the first quarter and $12 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 $7 million. There is also an increase in salary and benefits and hiring fees related to the pace 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 $560,000, $1.8 million related to the SugarLeaf acquisition and $850,000 for severance and change in management-related expenses.The consolidated quarterly EBITDA loss for the quarter is $4.6 million with -- compared with an EBITDA loss of $3.6 million in the first quarter and $1.2 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 $14.3 million to reach $20.8 million in comparison with the net loss of $6.5 million for the first quarter and $3.1 million last year. The increase in net loss is mainly related to the additional noncash 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 noncash financial expenses related to the attrition of the contingent considerations and the passage of time for an amount of $4.1 million.Turning to our liquidity. At the end of September 2019, our cash position was $24.4 million. Subsequent to the quarter, our -- on November 6, we closed a revolver line of credit with a large financial institution to support our nutraceutical business for an amount of $5 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.
[Operator Instructions] Your first question comes from the line of Doug Loe with Echelon.
Mario, just a quick housekeeping question. In your commentary, you talked about revenue growth rates in the 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 cannabis segments?
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.
Perfect. Okay. And then second of all, just -- I didn't hear you mention 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 formulation is evolving there.
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.
Okay. That's perfect. And then maybe just one last question while I've got the floor. So -- and congratulations on nailing down a formal alliance with IFF, as you announced, was going to be an eventuality last month. And thanks for specifically saying that aromatherapy is going to be a product category to which most of the SKUs were going to apply. As you may know, there's a lot of evidence that topical cannabinoids can work well in specific medical markets, including like osteoarthritis pain, joint pain in general. Just wondered if -- maybe this is a question for IFF, but maybe if you can address it, 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 this specific alliance? And I'll leave it there.
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 a partnership with IFF to help us get additional claims.
Your next question comes from the line of Justin Keywood with GMP Securities.
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 an impact on existing customer orders or potential new customers that have maybe been a bit cautious around this uncertainty.
I think that's something that's very -- and I think, it definitely helps the overall market. But I think when we're looking at the vaping crisis, we are well aware of like synthetics and different carriers, so we're very cautious on what we put into our formulations. So I think now it will allow us to even allow for additional customers that are probably sitting on the sidelines.
Right. And do you think this will have an immediate impact or will still be gradual going into next year as derivative products become available?
I think there's additional customer -- we have definitely a waiting list of customers as we continue our expansion plans. But I think in the vaping side, we're always making sure that we kept minimal risk to vaping while that was undergoing, the investigations. We have no rate exposure to vaping, so this will be an additional to what we -- 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.
Okay. Makes sense. And then for the large U.S. hemp farming contract, are there any minimum volumes for this agreement? Or any additional color that you could provide would be helpful.
Justin, it's Martin. Are you referring to the USD 20 million contract over the 2-year period?
Correct.
Yes. This -- there is -- I'm not sure if we want to get into the specific details, but it's not similar. The structure of our U.S. agreements are not similar to our Canadian agreements. So for that specific one, there's no minimum volumes, no.
Okay. And then just one more. On the American Media advertising services, does that $12 million -- are you able access that on a discretionary basis over the 5-year period? Or is it more equally contributed?
It's actually going to be probably more loaded in the beginning because as we're about to launch Forest Remedies, we obviously are going to try and launch that very successfully to be able to accommodate retailers. So that's something that will be -- there's a certain amount between now and March, and then it will be expanded to the rest as we roll out that brand.
Your next question comes from the line of John Chu with Desjardins Capital Markets.
First maybe on the IFF, maybe just a little bit more detail in terms -- it sounds like the initial rollout of products would be more on the nonedible side, and obviously, there's 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 hemp-based CBD product portfolio?
Well, 2 parts to that. The first part is definitely we're focusing on aromatherapy to -- for the launch initially, and then also utilizing some of our proprietary formulations like the omega-3 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 the 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 their 105 dedicated R&D facilities around the world plus our facilities, we're able to adapt to market changes and opportunities faster than anybody else, in my opinion.
And maybe just talk about your -- you said potentially over 50 SKUs over time. Like what kind of a rollout can we expect in year 1 calendar 2020? And then year 2, can we get to 50 by the end of the second year?
I think we'll probably exceed that by the end of the second year and -- or double it. I think we're in a very good position. We've identified the claims we want to go after. We've identified the markets that we want to go after. We've identified the strategy, both online and off-line. And I think that it's 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 the coming months.
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 retail distribution perspective? Can you give us any color on that? Because you're talking 2020 to enter the mass-market retailers?
We are in discussions with retailers. It's actually part of the collaboration that we're looking into 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're looking at is 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 the -- subscription model, we'll be able to participate in products that aren't out yet. And then once we get feedback from them, we'll deploy that 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.
And maybe just a little bit more on just some of these research and clinical studies that you're working on. You listed a few in terms of just increasing the absorption of cannabinoids, the anxiety and the workout recovery focus on there. Just 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?
Yes. I think that, obviously, we're working very rapidly. We have an amazing Chief Science Officer, Graham, who's leading that charge with partners like IFF. And I think there's some studies that we had already ongoing prior to this. And so now we're 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 [ users on 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, we can tie in with the product launches at retail.
Okay. And then just the last question. So presumably the Phase IIIa expansion, when do you expect to have the construction completed? And how much money will have to be spent on that?
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 $4 million of CapEx, and we think that retrofit, as well call it, should be done before fiscal year-end.
There are no further questions at this time. I will turn the call back over to the presenters for closing remarks.
Thank you, everyone, and wish you all a very good day.
This concludes today's conference call. You may now disconnect.