KushCo Holdings, Inc.
Q2 2021 Earnings Call Transcript

Published: 8 Apr 2021

[Operator:]

Greetings and welcome to the KushCo Holdings Fiscal Second Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. I will now turn the conference over to your host, Mr.Najim Mostamand, KushCo's Director of Investor Relations. Mr. Mostamand, you may begin.

[Najim Mostamand:]

All right, thank you, operator. Good afternoon and welcome to the KushCo Holdings Fiscal Second Quarter 2021 Earnings Conference Call. A replay of this call as well as a copy of the supplemental earning slides will be archived on the Investor Relations section of the KushCo Holdings website ir.kushco.com.

[Nicholas Kovacevich:]

Thanks, Najim, and thank you all for attending our Fiscal Second Quarter 2021 Earnings Call. I know many of you tuned in last week to listen to the exciting news of our announced merger with Greenlane. We certainly have been receiving a lot of positive feedback and congratulatory messages since that announcement and we look forward to continuing to provide updates and more information as we move closer toward the expected closing date, which is targeted for late Q2 or early Q3 and calendar 2021. But of course, this is our earnings call. And I want to shift gears and focus on our financial results for fiscal Q2 before opening it up for Q&A. So with that let's turn to Slide 5 of the supplemental earnings slides where we go over our financial highlights for the quarter. Starting at the top of the slide, we generated $32.9 million in revenue for fiscal Q2, representing 23% growth over fiscal Q1, even if you exclude the roughly $3 million, we estimate slipped from fiscal Q1 to fiscal Q2, due primarily to the shipping delays at the ports we still experienced strong quarter-over-quarter growth as we continue to make progress on our strategy of aligning deeper with the top MSO's, LP's and leading brand customers. More importantly, fiscal Q2 saw a return to year-over-year revenue growth after several quarters demonstrating acceleration of our topline following nearly a year of disciplined execution and cost-cutting. While we're perhaps most excited by with this significant growth is the fact that an increasingly larger portion of it is coming from an elite customer group that we have been nurturing for the last two years now. In fact, more than three-fourth of our total revenue for Q2 came from our top 25 customers, up from 61%, the same period a year ago. We believe this validates our strategy to deepen our relationships with these customers as they continue to rapidly scale and consolidate the industry.

[Stephen Christoffersen:]

Thanks, Nick. I'll now turn to Slide 10 which displays a snapshot of our income statement for the quarter. Total net revenue increased 9% year-over-year and 23% quarter-over-quarter to $32.9 million. As Nick mentioned, we're seeing stronger growth from our MSO and LP customers as part of our strategy to align with the industry leading operators. On a GAAP basis, gross profit for the quarter was $6.4 million or 20% GAAP gross margins. As Nick mentioned, gross margins were down sequentially primarily due to an increase in shipping charges. But looking ahead, we believe that these shipping charges will normalize and we will continue to ship more product on boat which should help drive a rebound in gross margin in future periods. On a non-GAAP basis, excluding the impact of the China trade tariffs, gross profit was approximately $6.9 million or 23% of revenue. For a complete reconciliation of GAAP to non-GAAP financial information, please visit the reconciliation table at the end of this presentation or in our fiscal Q2 earnings release.

[Nicholas Kovacevich:]

All right. Thanks, Stephen. Now just to quickly wrap up, we're pleased with how the quarter finished especially given some of the shipping-related headwinds, we continue to face. Looking ahead, we remain encouraged by the rapid pace of new states legalizing cannabis as we've already seen this year with Virginia, New Jersey, New York, and New Mexico leaving actually only one state starting with the word new that is yet to legalize cannabis in the US. These catalysts along with the meaningful momentum at the federal level for cannabis reform, coincide nicely with our anticipated strategic merger with Greenlane. Once the transaction is closed, the combined company will be well-positioned to capitalize on these macro tailwinds through our enhanced scale, differentiated customer offering, and significant cross-selling opportunities. Due to the pending merger, which we expect to close in late second quarter or early third quarter of calendar 2021, we are retracting our net revenue and adjusted EBITDA guidance for fiscal 2021. That being said, we could not be more excited for the attractive opportunities that lie ahead as we joined forces with another industry pioneer to create the leading ancillary cannabis products and services company. And with that, I'd like to turn it over to the operator for Q&A session.

[Operator:]

Thank you. At this time we will be conducting a question-and-answer session. Our first question is from Owen Bennett with Jefferies. Please proceed with your question.

[Owen Bennett:]

Afternoon guys.

[Nicholas Kovacevich:]

Hey, Owen. How are you?

[Owen Bennett:]

Hi -- and just a quick one from me. So you're getting a strong momentum on the stainless steel tanks. I just wanted to understand how incremental growth can be if you hit your target over 100 contracts, I think you said. And so can you remind us what the economics look like on this specifically and what's the average sales contribution per contract and what all the gross margins as I would call I think margins overall were around 40%. So would it be fair to assume that butane is somewhat higher than 40 and ethanol was below…

[Nicholas Kovacevich:]

Thanks, Owen. Great question, I'll let Stephen give some color first on the margins, but first at a high level, the way should be thinking about the stainless steel tanks in the butane business, it's not going to be so much of a driver of topline revenue growth, but I think a lot of people have said hey what is KushCo going to be doing when other companies come into the sector that are larger that are maybe from outside industries and so we're showing people what we're doing to protect against that. Right. Obviously, we feel that we have a unique product portfolio, we can get very sticky by selling across multiple categories. We feel we have intellectual property that will protect us. However, these are some additional things that we're doing, right. We've innovated with these stainless steel tanks nobody else is in the market to our knowledge with these tanks and then we're going out and signing contracts which are typically one-year with auto renew but if somebody loves the vessel that they're in they're not just going to change back to a carbon steel vessel, right. These are superior vessels; so once they become accustomed to it they are likely to stay in it for the long haul. So we like to think -- people to think of this business as just highly reoccurring, highly sticky, something that's under contract and does have very good margin profile, it's not going to be the revenue growth driver, but it's a very nice anchored billed and just continue to churn and then where we also can drive some revenue off of this is via cross-selling, we know that everybody is buying butane is either making oils or concentrates are likely going to need vape pens and concentrate containers and vape packaging to go along with it. So for those reasons, it's very strategic, but again I would caution people as to looking at this as something that's going to significantly move the needle from a topline perspective, I mean and then Steve why don't you go ahead and give some additional color on the margin profile there that Owen was asking.

[Stephen Christoffersen:]

Sure. Hey, Owen. Thanks for the question. So get on the material margin so butane is higher obviously than ethanol. So the direct material margin of that category is running right around 46%. Factoring in freight and because we basically keep the driver up there and COGS as well. You get sort of call it a landed margin 39%, 40% for that category. And then the sales person, there's a really small sales team out there that can kind of product team and can scale across the enterprise. I just wanted to give one call out. Obviously, it looks like the sequential decline. It looks like a sequential decline in energy. Previously we include energy and natural products in this bucket, so there was a fair amount of terpene business that was being captured in this bucket. So two things happened in the terpene category. Number one obviously was on the back of the vape crisis, the demand for botanical terpenes dropped significantly. Obviously, we're -- this is a non-cannabis derived terpenes botanical terpenes dropped. So we saw that impact in the bucket and then we also changed the accounting methodology, where we basically reworked our contracts -- with abstract with our vendor there and it's basically just capturing the margin as revenue whereas previously we were sort of transferring the product and recognizing revenue on the full amount. So I'm just a little bit of accounting noise in the way that we're accounting for that natural products bucket. But that's really what's driving the decline in the overall energy bucket.

[Owen Bennett:]

Okay, that was really helpful. Thanks, guys.

[Nicholas Kovacevich:]

Thanks, Owen.

[Operator:]

Thank you. Our next question is from Aaron Grey with Alliance Global Partners. Please proceed with your question.

[Aaron Grey:]

Hey guys, thanks for the question. First one for me is on the state of Illinois. Saw a nice jump quarter over quarter. So I just want to get some more color there whether or not there was anything timing going on there and other some big operators there that might have had an impact for the big step up or whether not that represents kind of a good run rate kind of going forward and also how much that might be tied to the additional 75 social equity licenses being opened up and kind of seeing more growth or continued growth I guess at the state level ? Thanks.

[Nicholas Kovacevich:]

Yes, you know, look, I think just at a high level, we're seeing the same data everyone else as Illinois seems to be really growing cannabis consumption and is up significantly seemingly like every single month, right, that they report the data. So, that's great. Obviously, more access is going to drive the growth we're seeing that in California and we have been talking about that forever as more retail stores open up. We're going to see higher cannabis consumption numbers. So, I think it's just a healthy market. We happened to be positioned with a few of the leading MSOs that are well set up in Illinois. So we're benefiting from the fact that we're with the right customers. I won't say specifically, I don't believe that the additional social equity licenses are contributing factor to this -- to this number. I'm at least at this point, but I do think it's great for the market just on a personal note. So look, I think this is going to be a market that continues to grow. And certainly with more access it will only grow faster. I mean this is a market where the economics are making sense for large MSO's to invest resources into. And so as a company that's trying to align with those MSO's we should continue to track very well this Illinois market.

[Aaron Grey:]

All right, great. Thanks, that's helpful. And the second question from me. So I know you guys still had some issues during the quarter, impacted the gross margins, looking to get to mid-20's kind of overtime, any color that you could kind of offer in terms of I think prior we're talking about fiscal 4Q. Is that potentially going to get pushed out a little bit now still uncertain just because you're still having some impact at the freight level or any kind of color in terms of the timing of when you get to that kind of mid-20 target? Thanks.

[Nicholas Kovacevich:]

Yes, look good. Yes, sorry. I'll give the high level. So, and then I'll let Stephen jump in. But at the high level ultimately, we feel that we have the direct material margin or direct product margin to hit the mid-20's even today although freight and other issues have dragged that down. Tariffs alone. Right. We estimate cost between two and three points of margin. So again, if the tariffs were to go away we would jump up considerably. So there is those factors, but still with that I mean I think we feel confident. We don't know how the freight is going to clear up and, but in the bigger point that I wanted to drive home before I give Stephen, the floor is that that's one of -- that also is one of the driving factors with the Greenlane merger is a path to significantly higher margins because of the fact that they have company-owned brands and demand a margin premium. I mean they're going through direct to consumer channels, which are typically higher margin than the enterprise channels that we service. So the KushCo business certainly can execute on the mid 20's but combined Greenlane KushCo business has a higher ceiling for margins, especially as Greenlane continues to gain traction on their company owned brands. Go ahead, Steve.

[Stephen Christoffersen:]

Yes. I was just going to make a point, while we are starting to see some of the freight headwinds, get a little bit better and that might sort of materialized certainly before the end of our fiscal year. Keep in mind, Aaron the inventory that we purchased, we capitalize a lot of those freight and tariff costs on the balance sheet right we've already spent a lot of that money, right. So as we sort of sell through that inventory. We're going to be thinking about it that the freight headwinds are going to have a little bit of a lag. So, I just wanted to be, if you're thinking about your model sort of taken those into consideration but we certainly do start to see it normalize and get back to that mid-20's GAAP gross margin, but obviously as Nick alluded to a big driver, big selling point for us. The management team for the Greenlane merger was a path to significantly higher gross margins for the combined pro forma company.

[Aaron Grey:]

All right. Great, thanks. And I'll jump back in queue.

[Nicholas Kovacevich:]

Thanks, Aaron.

[Operator:]

Thank you. Our final question is from Scott Fortune with ROTH Capital Partners. Please proceed with your question.

[Scott Fortune:]

Good afternoon and thank you for taking question. Just a little bit of clarity here since 77% of revenues come from the top 25 MSO's. Are you seeing longer term supply orders out there larger purchasing orders ahead of these MSO's are ramping up into the states in the second half 2021 here just kind of the incremental outlook on the second half as your order purchasing coming through ahead of that.

[Nicholas Kovacevich:]

Yes, we're Scott, great question. We're seeing the MSO's planning for growth, getting some orders either forecasted or actually put in that are larger as they're growing. We're also seeing some of the MSO's managing acquisitions and obviously that's hard not knowing exactly when those are going to close, but we've even had scenarios were again factored into the freight and where we've helped out some of the MSO's that we're in a jam because of the fact that acquisitions closed and volumes kind of spike ahead of them being ready from an inventory supply standpoint also some other vendors that have dropped the ball. So again, we'll go ahead and airfreight in some vape pens for them, but kind of setting the expectation that going forward in a more normal cadence will be receiving forecast will be planning against those and we'll be able to both freight in goods and preserve margins. So, some of the margin stuff was one time, just in terms of the customer dynamics as well. So that's an important call up. But yes, I mean, we're seeing the ramp there we're some COVID lockdowns that I think the suppressed Canada and they're coming out of those. So, every market is a little bit different, but yes, for the most part, we're tracking that growth with our -- with our key MSO clients and that's why we're not concerned about growing our business. We know grow zones will take care of our, top clients and then ultimately like I tell my sales team almost every day. If we can add another client it's of the same profile of these top 25, we can really move the needle. So in addition to maintaining and cross-selling our current client base but we want to be able to add a meaningful client or two every single quarter going forward.

[Scott Fortune:]

Okay, I appreciate that. And then on the international side, Canada is up pretty significantly quarter-over-quarter, you called out a little bit, 2.0 products and more stores are coming on board kind of step us through even it's tough COVID environment. Right. But can you step us through the international side and the opportunity as you bring on Greenlane going into Europe, potentially as a strategy going forward, but kind of mix as you see upside there.

[Nicholas Kovacevich:]

Yes, I think Canada is a good market. It's going to get better, there is consolidation taking place as we expected. There is 2.0 I think it was obviously it was brand new when it hit and I think there were decisions made in terms of supply chain based on historical relationships, may be based on price, whereas I think the US has already gone through a lot of that maturation in terms of understanding which vape hardware can lead to the best performance and ultimately win market share with the end consumer, I mean I think people operators in Canada are now switching to C-CEEL for that reason. So that -- that's a good sign. And again, I think will help the 2.0 market there with just better quality vape devices in the field. So that's good. And then that's a launching point for global cannabis. We know the Canadian LP's have the ability to shift their product and also expand globally in the Europe and Australia. And so aligned with them will allow for our global expansion on the KushCo side. But we've always looked at global expansion for KushCo alone as maybe something later down the road and simply because the enterprise clients aren't as -- aren't as large and the markets aren't as concentrated you just don't have the ability to drive the volume that you do here in North America. However, with the Greenlane business model its different variable to go directly after consumers and we know cannabis consumption globally still remains very high and is growing only higher, right. So having that ability to now go after consumers with CPG products and the ship company own brand into traditional and specialty retail that's a compelling argument to strengthen and actually invest more in Global Operations Europe being probably the main one given the population. Given the trajectory, and also given the existing footprint and presence that Greenlane has also Canada where Greenlane has a significant presence and we're going to actually be able to see in these federally legal markets like Canada, how much adoption of the CPG products are going to be in mainstream retail. We know that in the US, there is more adoption in specialty retail and smoke shops. Today, we're expecting a significant adoption into cannabis retail stores over the next few years, but at some point when are these CPG products is going to be sold in mainstream retail, well I think in a federally legal environment that's likely to happen sooner. Canada being one of them. We're going to be closely monitoring how that market plays out as sort of proxy to how future legal country markets are going to play out as well.

[Scott Fortune:]

I appreciate it. Thanks for the color.

[Nicholas Kovacevich:]

Thanks, Scott.

[Operator:]

Thank you, ladies and gentlemen. We have reached the end of the question and answer session. And I will now turn the call over to Nick Kovacevich for closing remarks.

[Nicholas Kovacevich:]

Okay, thank you all. I appreciate you attending. We appreciate the thoughtful questions, as always, and for you continue to be up to speed on the latest with the company. I know we just did the merger call last week, a lot of fun things going on, a lot of exciting things, both from an industry perspective, but perhaps more importantly from a company perspective as we are preparing to get all the necessary approvals to consummate this merger with Greenlane, it's truly a game changer. As I mentioned on the call last week, we believe it just makes sense, makes a ton of sense. First and foremost, it's coming together upto successful pioneers in the industry, right. 25 plus years of combined operating experience and bringing together two complementary product portfolios and customer bases, it also is effectively diversifying our business. I mean, giving us substantial cross-selling opportunities to execute on. Together, we will achieve a level of size and scale and we can build a strong platform that will ensure profitable growth over the long haul. And it would take arguably take much longer for us or for them to do that on a standalone basis. We know these businesses need scale and this merger will accelerate that. On top of that KushCo shareholders will benefit from the NASDAQ listing, which many of you know, has been a goal of ours for quite some time and we're now almost they're doing it in this creative way that we believe is going to add incremental value for our shareholders. Together with Greenlane we're creating ancillary powerhouse that is anchored by the leading MSO's, LP's and brands with a strong portfolio of company owned brands and retail and consumer channels. Upon closing we expect to finally get the recognition the market -- in the market that we believe KushCo deserves as more institutional investors will be able to invest in our stock and participate in our go-forward success. This is especially true given the likelihood that federal legalization will not occur for the next several months, if not quarters. Given these scenario, investors that want to invest into top MSO's US operators but don't want to own non-exchange-listed or non-NASDAQ listed stocks can now directly invest in our combined company upon closing and by proxy received that meaningful exposure to the top US cannabis operators. Overall, incredibly excited by the opportunities in front of us with both this merger and the industry in general and we look forward to providing more updates here in the coming months. So again, thank you all for listening. We hope you all take care, stay safe, and we'll see you on the next earnings call. Cheers.

[Operator:]

Thank you, ladies and gentlemen. This concludes today's conference call. You may now disconnect.