Neptune Wellness Solutions Inc. (NASDAQ:NEPT) Q3 2019 Earnings Conference Call February 13, 2019 5:00 PM ET
Mario Paradis - Chief Financial Officer
Jim Hamilton - President & Chief Executive Officer
Conference Call Participants
Doug Loe - Echelon Wealth & Partners
Good afternoon. My name is Gabriel, and I'll be your conference operator for today. At this time, I'd like to welcome everyone to the Neptune Wellness Solutions 2019 Third Quarter Earnings 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. 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 get 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 Exchange Commission.
And now, I'll turn the call over to you 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’ll 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 that we've actually clustered fees with both, those in response to our third quarter call, but both of those occurred in the third quarter, but subsequent events. And we are so happy to report that 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, that 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 and initial production is underway and it's really fun for our team and all of us here to see that.
Relative to the size and capacity, we'll speak to it 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 6000 ton of 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 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 a little bit more detail shortly.
So, those were some subsequent events. Just 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 the conversations, we are boosting our estimated sales volumes as we speak, and we'll get a little bit more detail in the presentation in a moment.
But before that we think we will have to reflect little shortly on the third quarter financials. And then Mario, if I could pass it back to you to touch on that please. Thanks.
Thank you, Jim. So, my comments today will focus on the quarterly performance unless otherwise indicated. Also want to remind you that we stopped to consolidate Acasti Pharma after the third year of last year. However, the comparative results of our quarterly results of operation in the consolidated financial statements still include Acasti numbers for the three months period ended December 31st, 2017.
In addition, considering our recent entry in the cannabis industry, we will discuss our two reportable operating segments being the nutraceutical and 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 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 under the Investor section on Neptune’s website.
And now at Page 8 of the deck, total revenues coming from the nutraceutical segment for the second quarter were CAD6.5 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 CAD2.2 million, a CAD0.2 million increase over same period last year, mainly related to better gross margins percentage. In term of EBITDA contribution from the nutraceutical segment, the adjusted EBITDA for the quarter is practically the same as the same period last year with CAD1.2 million compared CAD1.1 million last year.
R&D expenses related to the cannabis segment were CAD1.6 million compared with CAD1.4 million for the same quarter last year; slight increase of CAD0.2 million was mainly related to additional compensation and depreciation of the property, plant, and equipment.
Total investment in segment mainly consisted of salary and fixed costs and 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 cannabis segment totaled CAD0.5 million compared to CAD 0.3 last year and consisted mainly of our business development team, which included traveling and representation expenses.
The non-IFRS operating loss of the cannabis segment before taking into consideration non-cash stock based comp and the depreciation and amortization was CAD1.3 million in the third quarter in comparison with operating loss of CAD1.1 million in the same period last year and is pretty stable with the first quarter of the current year.
Corporate general and administrative expenses totaled CAD2.4 million during this quarter compared with CAD1.5 million in the same period last year. This increase of CAD0.9 million is mainly due to the increase in compensation including CAD0.4 million of non-cash stock-based comp and also legal fees and other corporate expenses.
The non-IFRS consolidated operating loss for the quarter was CAD1.9 million compared to a loss of CAD1.3 million in the same period last year excluding Acasti's results. This loss increase 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 CAD15.6 million with a total debt of CAD3.1 million. During the quarter, we disbursed CAD2.1 million for our Phase I and II CapEx investment. There is approximately still CAD3.6 million to be paid on the CAD10 million investment for Phase I and II. We estimated that approximately CAD2 million could be disbursed during the fourth quarter and the remaining during the first quarter next fiscal year. We continue to add 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, about all their brand new gear gets dirty now and we are – like I say, we have inventories in the house. We are executing on a commercial agreements. We have purchase orders in house and our Phase I CO2 technology is being commissioned to run operating as we speak.
Construction for installation of the solvent facility, the initial Phase II solvent facility is underway right now and we expect the construction to be complete on that end of March, and start-up through the April, June period.
Looking at page 13. In terms of a startup, I think that's a number a step. It always a curve and we think that by mid-year 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 pro with it. And we are looking at accelerating, the evaluation of bringing 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 jiggering some vessels in 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 mid-year 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 in years two and year three based on what we're seeing. And as Mario and I have talked in great detail of 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, sector, segment that we like a lot. And page 16, we shared before and this is some data from the middle of last year of California market, which is 60% in North based on extracts many people in the business. And then when I travel and visit and talk, predictive of the even 80% in those markets as we speak.
But looking at page 7 in Canada, that's not the case today. The majority, of course, is the consumed in flower but that will change soon. Please keep in mind in the Canadian context, the new regulations are pending, the draft is out there and the expectation is that this will be approved and in acted 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 followed some rapidly developing legislation with the de-scheduling of MCBD. The recent U.S. Farm Bill, there's some very interesting developments happening with the World Health Organization in terms of how the CBD should also be rescheduled internationally.
I think just for reference, it's interesting, especially those who have been with us a number of years and know that you make three days and four days, the CBD in the United States and think about this from 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 US 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, but differentiation in page 20, we thought it might be helpful to explain a little bit more how we're trying to build the metrics that supports differentiation which is so important to consumers and customers. So extraction, purification, isolation, clearly 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 conditions specific formulas, we think will be very important -- condition specific formulas that deliver on a specific consumer needs, it's not enough to be a single entity, but rather formulated products. And also to deliver those conditions specific needs and unique delivery forms that are delivering value.
And you will see from us over time more examples of how we are executing against these three 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, licensing and IP agreement and the purchase agreement with Lonza. A picture there for those who can see it on 21 is an example of how that the look of the equipment.
And this is for the production of really world leading two-piece hard shell technology, really in our experience and belief as a corporation, the better delivery from ultra 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 and the formula are important.
And we like this a lot and 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. And 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 non-dilutive 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 last time in October; 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 this 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 product space as we speak relative to that concept.
So, some comments on nutrition, a little bit about cannabis today, and rolling forward, we'd like the extraction business, we're happy to be there. And we're happy to be operating in the cannabis space as a license 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 -- your first questions, sorry, will be from the Doug Loe, Echelon Wealth & Partners. Your line is open.
Yes, thanks very much, gentlemen and good afternoon. Congratulations on all recent progress here. Just wanted to focus on your Lonza relationship, if I may, Jim, I mean 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 you know, I think some of their IP around Capsugel and so forth.
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 IPs that you might be filing in that realm?
And maybe just a little more detail on sort of timelines 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 that alliance might throw up over the next say six-day course?
Hey Doug, thank you. Okay. There's multiple kind of solutions in this regard, one would be soft gelatin capsules. You typically see that often in omega-3 space or high volume nutrition products. It's a good delivery form. We personally believe in a high value items products such as the cannabis space, a two-piece hard shell as far more an appropriate product. We not only see that say that for just the manufacturing through efficiencies, if you will, in terms of product disappearance and production and a few things like that. We'd especially like it in terms of some of the stability profiles and the formulation properties that the two pieces can bring.
We like Lonza too, we 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. And we've been collaborating with them on as well -- remember too that they're publicly-traded Basel based -- Basel Switzerland-based Corporation with operations around the world and we like to -- the collaborative opportunities that exist from a commercialization standpoint.
Remember it's focused in Canada today, but the collaboration that consists not only technically, but also commercially between the two organizations. So, we like that a lot. Their IP is mostly around the delivery system, Doug, and I would say not so much around formulation, but we are very interested in it and our working as we speak on additional formulation, I would say, a consumer conditions specific formulations, that could be helpful and the capsule would be a perfect vehicle to deliver this. And remember, especially, in conditions specific formulas, they're often taken chronically. And so for example, for inflammation pain Anxiety is frequently taken every day rather than once in a while. I don't know whether that answers the question.
No. That's good feedback, Jim. Thanks. And then a quick question for Mario, while I'm on the line here. Just wondering what proportion of the nutritional revenue -- growth of revenue would you say is targeting cannabinoid formulation initiatives there and specifically looking at slide 20 here and all of the novel patents and research initiatives you have ongoing, just wondering how much of that is actually going to Biodroga and what proportion of revenue is allocated for this development?
Doug, because if I may. Mario right now it's says zero, because it's federally legal for them to commercialize that in Canada and it has been federally legal 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 have 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, 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 multi-nationals this afternoon. I think 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 four to six 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 have not been legally able to commercialize anything in CBD Hemp, U.S. or Canada.
Got it. Great feedback. Thanks, Jim.
[Operator Instructions] Your next question comes from the line of Daniel Simons from Nomis Investors [ph]. Your line is open.
Hey, Jim, congratulations on everything. Just, in January, you stated that when you would see the processing license that the company will expect sales from the existing supply contracts for the contracts are about to be signed. Is there any further clarification on that? Or will sales be driven mainly from the canopy contract.
A – Jim Hamilton
Well, Daniel, it's a great question and it's something, I'll tell you, that we as a management team debate a lot. In fact, we 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 they are very, I would say, investor friendly.
But we also have come to the conclusion that it'd be commercially in our interests not to get too transparent in terms of the number and the nature of 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 cost 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 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 thing would be important is that, will those revenues include raw materials, yes or no. And I think at times you'll see the 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, this is always 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. Our 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 with that.
Very good. Thank you.
I have no further questions at this time. I will now turn the call back over to Mr. Jim Hamilton for closing remarks.
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 might add 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 are very excited by the engagement we're getting with customers and other players in this space. We are very happy to be licensed and we're very happy to be moving forward and thank you for this 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.