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Good afternoon. My name is Gabriel, and I will be your conference operator today. At this time, I'd like to welcome everyone to the Neptune Wellness Solutions 2019 Third Quarter Earnings Conference Call. [Operator Instructions] Thank you.Mr. Mario Paradis, you may begin your conference.
Thank you. Good afternoon, everyone, and thank you for joining us. As mentioned, the purpose of today's call is to review our financial results for the third quarter ended December 31, 2018, and to give an update on our business operations. Joining me today is Jim Hamilton, our President and CEO. As usual, Jim will review Neptune's operational quarter and highlights, and I will discuss our quarterly financial results.I'd like to remind you that our results are in Canadian dollars, and today's remarks may contain forward-looking statements. So before we begin, I'd like to remind you that all amounts 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 statements, 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 risks. Results may differ materially, and details on these risks and assumptions can be found in our filing with the Canadian Securities Commission and with the Securities and Exchange Commission. I'll now turn the call over to Jim.
Mario, thank you very much, and welcome, everybody. Thank you for joining us today. For those who care to follow, there is a presentation posted on our website, which I will refer to as we go along. And if you do have access to that and are looking at it, on Page 4, our agenda today, I'll look at some of the highlights. Mario will comment on the third quarter, but then we'll spend more time on the cannabis business today and tomorrow, touch on our nutrition business, and then we'll be open to some questions and answers.So just looking at Page 5, and if we could just begin with some highlights. We've actually clustered these with both those -- this is supposed to be a third quarter call, but both those that occurred in the third quarter, but subsequent events. And we are so happy to report, and we announced in January the receipt of our processing license from Health Canada. I think when we talked last, we said it was imminent and we were happy with the progress, and we were very happy that, that occurred on January 4.Also, for those who follow some of the social media channels, Twitter, you might have seen some photos of some inventories moving. Our cannabis inventories, we have in house. Initial production is underway, and it's really, really fun for our team and all of us here to see that.Relative to the site and capacity, we'll speak to in more detail, but we're on track for 200,000 kilos of capability towards the end of March and the ability to start that up through the first fiscal year. And we'll also talk a little bit about our already-installed 6,000-ton potential, and we're accelerating some work there.We are putting in some financial tools, weapons, if you will, for added flexibility for the future. As we mentioned last time, we have a great balance sheet and cash position to execute against the strategies that we have on the table right now. But we are preparing for new and interesting opportunities, and we're going to be putting the financial tools in place should they be needed, and we'll speak to that in a little bit more detail shortly.So those were some subsequent events. Touching back more on the third quarter, we're very pleased about our arrangement with Lonza. We have continued growth in our nutrition business. Remember, all our sales in the third quarter were nutrition. And we're very excited by some of the draft legislation that is pending for Canada, and as such and based on everything we're seeing in this market with our customers and conversations, we are boosting our estimated sales volumes as we speak, and we'll get into a little bit more detail in the presentation in a moment. But before that, we think we will have to reflect a little bit shortly on the third quarter financials, and then, Mario, if I could pass it back to you to touch on that, please. Thanks.
Yes, thank you, Jim. So my comments today will focus on the quarterly performance unless otherwise indicated. I also want to remind you that we stopped to consolidate Acasti Pharma after the third quarter last year. However, the comparative results of our quarterly results of operation in the consolidated financial statements still include Acasti's numbers for the 3 months period ended December 31, 2017.In addition, considering our recent entry in the cannabis industry, we will discuss our 2 reportable operating segments being in the nutraceutical and the cannabis segments. Corporate, general and administrative expenses, net finance costs and income taxes are not allocated to the segments, and they are presented as unallocated costs. Consolidated results for the third quarter fiscal 2019 results can be found in our press release and in Neptune's consolidated financial statements and related MD&A available on SEDAR, EDGAR and on the Investors Section on Neptune's website. And now at Page 8 of the deck, total revenue coming from the nutraceutical segment for the second quarter were $6.5 million, an increase of 2% when compared with the same period last year after excluding the impact of our krill oil manufacturing business, sold last year. Our quarterly gross margin as a percentage of sales was 30%, compared to 22% for the same period last year, and in line with our expectations.In terms of dollars on total revenues, we generated $2.2 million, a $0.2 million increase over same period last year, mainly related to better gross margin percentage.In terms of EBITDA contribution from the nutraceutical segment, the adjusted EBITDA for the quarter is practically the same as the same period last year, with $1.2 million compared to $1.1 million last year.R&D expenses related to the cannabis segment were $1.6 million, compared with $1.4 million for the same quarter last year. The slight increase of $0.2 million is mainly related to additional compensation and depreciation of the property plant and equipment. Total investment in this segment mainly consisted of salary and fixed costs at our manufacturing plant in Sherbrooke, including the depreciation, in order to prepare the site and start the cannabis oil extraction business in compliance with Health Canada's requirements. During this quarter, SG&A related to the cannabis segment totaled $0.5 million, compared to $0.3 million last year, and consisted mainly of our business development team, which incurred traveling and representation expenses.The non-IFRS operating loss of the cannabis segment before taking into consideration noncash stock-based comp and the depreciation and amortization was $1.3 million in the third quarter in comparison with an operating loss of $1.1 million in the same period last year and is pretty stable with the first 2 quarters of the current year.Corporate, general, and administrative expenses totaled $2.4 million during this quarter, compared with $1.5 million in the same period last year. This increase of $0.9 million is mainly due to the increase in compensation, including $0.4 million of noncash, stock-based comp, and also legal fees and other corporate expenses.The non-IFRS consolidated operating loss for the quarter was $1.9 million, compared to a loss of $1.3 million in the same period last year, excluding Acasti's results. The loss increase is mainly related to our investment in the cannabis business development and the increase in corporate G&A expenses.Turning to our liquidity. At the end of December 2018, our cash position was $15.6 million with a total debt of $3.1 million. During the quarter, we disbursed $2.1 million for our Phase 1 and 2 CapEx investment. There is approximately still $3.6 million to be paid on the $10 million investment for Phase 1 and 2. We estimate that approximately $2 million could be disbursed during the fourth quarter and the remaining during the first quarter next fiscal year. We continue to have the necessary cash to execute our business plan.I will now turn the call over to Jim.
Mario, thank you for all the financial detail. Let's go to Page 11 and talk about our cannabis business, and Page 12. As I mentioned earlier, license granted, production underway, which is really, really fun. I was joking with our production guys not so long ago, but all their brand new gear gets dirty now, and we are -- like I say, we have inventories in the house. We are executing on commercial agreements. We have purchase orders in house and our Phase 1 CO2 technology is being commissioned, run, operating as we speak. Construction for installation of the solvent facility, the initial Phase 2 solvent facility, is underway right now, and we expect construction to be complete on that end of March and startup through the April-June period.Looking at Page 13, in terms of startup, I think that's never a step, it's always a curve, and we think that by midyear, we'll have that 200 metric tons available. I will say, and we'll touch on this a little bit more on demand, we're seeing tremendous demand for extraction. And remember, this facility has built and installed the capability for 6,000 tons of production capacity that's built and installed. It's run before. We ran krill with it, and we are looking at accelerating the evaluation and bring it on -- that online sooner. And what do we mean by that when it's already built and installed? We are looking at some possibilities of optimizing the process in terms of jacketing some vessels and some temperature controls that are more sympathetic to the quality of cannabis manufacturing that we think could be highly value added based on our research and lab trials, so that is underway as we speak. So 200 tons ready to go, as we said, midyear, and the 6,000-ton capability exists and is on deck, and we're evaluating that as we speak.Page 14, cannabis processing sales volumes. Based on contracts, conversations and what we see right now, we are boosting, for those who have access to the presentation, we're boosting what we're anticipating in the first 12 months of operations to be in the 30 to 50 metric ton production zone. And we've also looked at increasing years 2 and year through 3 based on what we're seeing. And as Mario and I have talked in great detail, this business is projected to be EBITDA and cash flow positive within the 12 months of operations and in the fiscal year, which I remind everybody begins April 1. We will see Mario -- shipments in cannabis, we anticipate, between now and the end of the fourth quarter.Looking forward, on Page 15, I think it's really important to understand when you look at our business and you look at the extraction and value-added business to know the zone that we are participating in. And this is a zone, a sector, a segment that we like a lot. And Page 16 we shared before, and this is some data from the middle of last year of a California market which is 60% and north based on extracts. Many people in the business, and then when I travel and visit and talk, they predict it will be even 80% in those markets as we speak. But looking at Page 7 (sic) [ 17 ], in Canada, that's not the case today. The majority of course is consumed in flower, but that will change soon. Please keep in mind, in the Canadian context, new regulations are pending, the draft is out there, and the expectation is that this will be approved and enacted October of this year. And what that means is it will be opening up whole new fields for products that will be built on extracts, which is really important.And when we look at Page 18, not only in the Canadian context and not only for THC and CBD, in the U.S. context, we're seeing, as many have followed, some rapidly developing legislation with the de-scheduling of hemp CBD with the recent U.S. Farm Bill. There are some very interesting developments happening with the World Health Organization in terms of how CBD should also be de-scheduled internationally. And I think just for reference, it's interesting, especially those who have been with us a number of years and know the omega-3 days and krill days. CBD in the United States, and think about this for a moment where it was federally illegal in the DEA perspective as well as not permitted from an FDA perspective, it is today largest -- larger than the vitamin E sector, and it is on track to surpass the omega-3 supplement category very soon. This is really, for me, a long-term nutrition products person, quite a staggering dimension, and we are seeing a tremendous amount of interest as we engage in the U.S. context and the Canadian context for extracts. We like the extraction business, and that's why, Page 19, our objective is and continues to be focused on extraction, purification and formulation of value-added differentiated products and to do so on a global scale. And to extract is never enough, and we've talked about that before about differentiation. On Page 20, we thought it might be helpful to explain a little bit more how we're trying to build the matrix that supports differentiation, which is so important to consumers and customers. So extraction, purification, isolation, clearly, and we think we're pretty good at that. We've been doing that quite a number of years. In fact, some may recall some patent filings in that regard last year, in the latter half of last year. But condition-specific formulas we think will be very important, condition-specific formulas that deliver on specific consumer needs. It's not enough to be single entity, but rather, formulated products. And also, to deliver those condition-specific needs in unique delivery forms that are delivering value. You will see from us, over time, more examples of how we are executing against these 3 elements of differentiation, a little bit more detail on the unique delivery forms with our Lonza arrangement, which is on Page 21. This is an agreement, a licensing and IP agreement and a purchase agreement with Lonza. The picture there, for those who can see it on 21, is an example of how that room will look and the equipment. And this is for the production of, really, world-leading, 2-piece hard-shell technology, really, in our experience and belief as a corporation, the better delivery form for high-value API products. We like it very much in terms of the potential higher stability, especially in complex formulas where terpenes and the maintenance of those terpenes in the formula are important. And we like this a lot, and we're getting a lot of very, very interesting engagement with customers in this regard and terrific technical support in R&D development with Lonza for same, so an example of execution on differentiation.Page 22, just for those who have been following, we have filed today a base shelf prospectus. This would be an example, as we mentioned earlier, about putting the financial weapons in place to give us the flexibility for future strategic moves. Again, our cash position is sufficient for us to execute against the existing plan, but for strategic moves beyond and above that, we want to make sure that we have the financial infrastructure in place so we can move quickly. And it's not just the shelf, but similar tools in terms of developing nondilutive instruments with scale financial institutions, which Mario has in development as we speak. So putting the infrastructure in place for future strategic moves.And just moving to our nutrition business, I wanted to speak on this a little bit more. We touched on this on Page 24 and last time, in October. Our nutrition people have been working on some very interesting formulas which would be a nutrition solution for consumer marketers that cannot participate in the cannabis space because of licensing and other legal constraints. So an ability for them to play in the space and appeal to consumer needs in this regard, and we have some interesting developments there in Canada. But given the CBD developments in the United States, we think this is a fantastic differentiating platform that we can engage with, combined with CBD in future, and we're actively engaging in the U.S. context in the nutrition products space as we speak, relative to that concept. So some comments on nutrition, a little bit about cannabis today and rolling forward. We like the extraction business. We're happy to be there, and we're happy to be operating in the cannabis space as a licensed producer. And with all that, I think we can conclude the formal remarks, and we'd be happy to invite questions at this point in time if our operator is with us still.
Yes, first line will be from your first question -- sorry, will be from Doug Loe from Echelon Wealth and Partners.
Congratulations on all the recent progress here. Just wanted to focus on your Lonza relationship, if I may, Jim. And you talked -- so first of all, congratulations on putting that in place toward quarter end, and assume much of the alliance sort of relates to in licensing some of their IP around Capsugel and so forth. I was just wondering if you had any IP strategy around filing on composition of matter for incorporating cannabis oil into Capsugel, in combination with other small molecules that Lonza would have additional expertise in formulating and whether there might be some IP that you might be filing in that realm.And maybe, just a little bit more detail on sort of time lines over which you expect to be generating some Capsugel revenue, and if you're at liberty to share, maybe some expectations on what revenue that alliance might throw off over the next, say, 6 to 8 quarters.
Doug, thank you. Look, there's multiple kind of solutions in this regard. One would be soft gel and then capsules. You typically see that often in the omega-3 space or our high-volume nutrition products. It's a good delivery form. We personally believe in high-value items, products such as the cannabis space, a 2-piece hard shell is far more an appropriate product. We not only see that -- say that for just the manufacturing sort of efficiencies, if you will, in terms of product disappearance in production and a few things like that, but we especially like it in terms of some of the stability profiles and the formulation properties that the 2-piece can bring.Now we like Lonza, too. We've worked and known them for many, many years. They're the largest in the space globally. They have between probably 40% and 50% of the global market share for the capsule business. They have tremendous laboratory and R&D capabilities as well that we've been collaborating with them on as well. Remember too that they're a publicly traded Basel-based, Basel, Switzerland-based corporation with operations around the world. And we like too the collaborative opportunities that exist from a commercialization standpoint. Remember, it's focused in Canada today, but the collaboration that comes is not only technically, but also commercially between the 2 organizations. So we like that a lot. Their IP is mostly around the delivery system, Doug, and I would say not so much around the formulation. But we are very interested and are working as we speak on additional formulation, I would say consumer condition-specific formulations that could be helpful, and the capsule would be a perfect vehicle to deliver this in. Remember, especially in condition-specific formulas, they're often taken chronically. And so for example, for inflammation, pain, anxiety, it's frequently taken every day rather than once in a while. I don't know, Doug, if that answers the question.
No, that's good feedback, Jim. And then a quick question for Mario while I'm on the line here. Just wondering what proportion of the nutritional revenue, Biodroga revenue, would you say is targeting cannabinoid formulation initiatives. I mean specifically looking at Slide 20 here and all of the novel patents and research initiatives you have ongoing, I just wonder how much of that is actually going through Biodroga and what proportion of revenue is allocated to [indiscernible].
Right now, 0, Doug, because if I may, Mario, right now, it's 0 because it's federally illegal for them to commercialize that in Canada, and it has been federally illegal for them to do so in the United States as well. I can say one of the things that we've been doing the last weeks is engaging with both the TSX and the NASDAQ as well as our insurance companies and the bankers to make sure that everything we do, whether that be in the United States or Canada, is done in a way that is very compliant with their views on the business. We believe that we've got understandings with at least some of them thus far, and we'll continue to do that and conclude that very soon.And we'll be focused in the United States with Biodroga. And when I say Biodroga in the United States, what we mean more by that is it is more of a nutrition products approach in the United States with hemp CBD than we see in the regulated markets of Canada and rest of world in this space. So in fact, I was just speaking with one of the large multinationals this afternoon. I think the -- what we're seeing is the big consumer product companies in the United States that were really hands off, I would say, as recent as October, November, have a very, very different perspective in the last, I would say, 4 to 6 weeks, and we're seeing quite a number of projects starting to accelerate with them as we speak. So I think the U.S. platform is rapidly changing right now, Doug, so we'll see how that evolves. But to date, we've not been legally able to commercialize anything in CBD hemp, U.S. or Canada.
[Operator Instructions] Our next question comes from the line of [ Daniel Feming ] from [ Numis Investors ].
Jim, congratulations on everything. Just in January, you stated that when you received the processing license, that the company will expect sales from existing supply contracts [ or ] the contracts that are about to be signed. Is there any further clarification on that? Or will sales be driven mainly from the Canopy contract?
Well, Daniel, it's a great question, and we -- it's something I'll tell you that we as a management team debate a lot. In fact, we've had this discussion with our Board the last couple of days about how transparent we want to be in this regard. And we have a number of major investors on our Board and are very, I would say, investor friendly. But we also have come to the conclusion that it'd be commercially in our interest not to get too transparent in terms of the number and the nature and the characteristic of our commercial agreements, Daniel, as much as we can because it's not helpful for us in terms of some of our negotiations and some of our engagements as we go forward. And that includes, by the way, not just on the commercial deals, but also in terms of some of our costs and margins, at this stage, although, Mario reminds me that that will become more transparent in our books as we go quarter to quarter going forward.Having said that, we feel, and I think it's important for investors now to understand, as we've said before, when we look at our site infrastructure and operating costs, that is transparent in our books today. And we'd like to emphasize that we don't see a major variable component in our site operating costs as we add volumes onto that site. Now that would exclude getting into some maybe more heavy labor application forms in future. But today, for the processing, and as we fill that facility, we don't see a big major variable cost expense.Number two is I think, Daniel, when you look at our books and our numbers as we go forward, as with everyone else in the extraction space, I think another will be important is that is -- will those revenues include raw materials, yes or no? And I think at times, you'll see raw materials in, and other times, raw materials out. And so it's going to be, and for Doug Loe and some of the analysts that follow, it's going to be a challenge because I think a lot of us are top line centric. And I think, ultimately, for people in our space, it's going to be very much bottom line focus will be where the big differentiators are.So Daniel, we're going to ask you to try and work with us a little bit as we get the commercialization going. But let's just say, as we put in that one slide, and we've got agreement with our board on this as we speak today, that based on current contracts and based on the engagement we're having with customers, we feel very, very good about the line of sight we have on the numbers that we just shared in terms of our site engagement, if you will, on the volumes. And that site is licensed, and that site is now operating. We're really excited about that.
I have no further questions at this time. I will now turn the call back over to Mr. Jim Hamilton for closing remarks.
Well, thank you very much, and Mario, thank you for you and the team, and everyone for all the work and the preparations for this. And just to summarize for all our supporters and investors that this sector and segment that we are in, I really, really like it. It is a great place to be, and we're very excited by the industry dynamics. We're very excited by the engagement we're getting with customers and other players in the space. We are very happy to be licensed, and we're very happy to be moving forward. And thank you for the support. Watch this space. It's going to be really fun as we roll forward.So thank you very much, thanks for listening, and we'll be in touch soon. All the best.
This concludes today's conference call. You may now disconnect.