Vext Science, Inc.
Q1 2022 Earnings Call Transcript

Published: 31 May 2022

[Operator:]

Good morning, everyone. Welcome to Vext Science's First Quarter 2022 Financial Results Conference Call. As a reminder, this call is being recorded today, May 31, 2022. [Operator Instructions] I would now like to turn the call over to Jonathan Ross. Please go ahead, sir.

[Jonathan Ross:]

Thanks Michelle. Good morning, everyone, and thanks for joining us today. Vext's first quarter 2022 financial results were released yesterday. The press release, financial statements and MD&A are available on SEDAR, as well as on the Vext's website at vextscience.com. We would like to remind listeners that portions of today's discussion include forward looking statements and the forward-looking statements are included in today's press release. There can be no assurance that these forward-looking statements will prove to be accurate or that management's expectations or estimates of future developments, circumstances or results contained therein will materialize. Risks and uncertainties that could affect future developments, circumstances or results are detailed in the MD&A and Vext's other public filings that are made available on SEDAR, and we encourage listeners to read those risk factors in conjunction with today's call. As a result of these risks and uncertainties, the developments, circumstances or results predicted in forward-looking statements may differ materially from actual developments, circumstances or results. This presentation also includes non-IFRS financial information and such non-IFRS financial measures are subject to the disclosure and reconciliation included in our press release disseminated yesterday. Forward looking statements made during this conference call are made as of the date of this call. Vext disclaims any intention or obligation to update or revise such information, except as required by applicable law. Vext's financial statements are presented in U.S. dollars and the results discussed during this call are in U.S. dollars. I will now pass the call over to Eric Offenberger, Chief Executive Officer of Vext.

[Eric Offenberger:]

Thanks, John. Good morning, everybody, and thank you for joining our quarter 1 2022 financial results conference call. I'm joined on the call today by Vahan Ajamian. I will keep my remarks shorter this morning to leave more time for your questions given we are -- we just recently held our quarter 4 and 2021 Annual Call. On January 1, we transitioned to a for-profit model. As quarter 1 is the first quarter we're reporting under this model, I will offer some highlights regarding the transition at the end of my prepared remarks. I am pleased with our team's performance during the first quarter of the year. Vext generated revenue of $10.8 million up 18% compared to the same quarter last year and 16% compared to quarter 4 of 2021. I would just highlight that sales are a little higher in quarter 1 than if we had reported under the not for-profit model given the full consolidation of the operating dispensaries for the full quarter. Even more importantly, we continue to translate revenue into a robust adjusted EBITDA margin of 36% in the quarter. Vext cash flow from operations continue to be positive to the tune of $3.1 million for the quarter. The first quarter marked a 5% sequential drop in Arizona's medical and recreational cannabis sales revenue given inflationary pressure that are hitting into consumer high -- into consumer budgets. As I mentioned on our quarter 4 call last month, we expect inflationary pressures will continue to impact consumer discretionary spending for the foreseeable future. In an environment like this, we are confident that Vext's proven track record of execution and culture of operational excellence positions the company to continue generating results. Our dispensaries continue to see solid traffic in quarter 1 owning to the proximity to their core customer bases. The strength and price competitiveness of the brand portfolio and seasonal targeted promotional campaigns, we see an opportunity continued growing share while generating profit for shareholders. Companies that can promote effectively in offer consistent selection, quality and value to the consumer will foster enduring loyalty. In quarter 1, we completed the expansion of our Prescott Valley cultivation facility bringing total indoor cultivation to 24,000 square feet. Over 2021 and through the first quarter of 2022, we have been absorbing all of the flower we produced in the production coming out of this build will also be completely absorbed by our current vertical operations. As discussed last month, we have split our Eloy cultivation expansion into two phases to better match our current flower absorption rate with footage expansion. Phase 1 is on track and we expect completion by the third quarter of 2022 which will bring us to approximately 17,000 square feet under canopy in that facility. We will not Greenlight Phase 2 until we see construction costs moderate and bulk flower costs stop falling. Through most of the quarter 1, we were able to fully leverage our own supply at retail. We anticipate that during quarter 2 we will have to go to the market for product of about 30% to 35% of our flower consumption. It is an opportune time for sourcing flower in the market. However this will have a slight impact on margins. Once Eloy Phase 1 comes in on quarter 3, we would expect this to be less of a factor at quarter 2 next year. The expansion plans for our retail and manufacturing footprint remain on track. We are in discussion with the City of Phoenix to expand our Central Phoenix dispensary to 5,000 square feet and to add another 6,000 square feet of manufacturing to our current operations in the city. Both of these builds will support the growth of our wholly owned vaping products, as well as our third party partner brands. One trend that began to take shape during quarter 1 is a shift from the medical market to the recreational market. In the Arizona medical sales decreased during that quarter and have dropped for five consecutive months largely in favor of recreational sales. Margins are lower overall in the rec market but we are well ahead of this move. Our manufacturing and kitchen expansion will enable us to continue to grow the Vext product portfolio and rapidly get new products onto the shelves to the majority of the dispensaries in Arizona. Edibles are a rapidly growing segment and the rec market generate relatively high average margins. During quarter 1 we introduced six new gummy flavors and we will continue to innovate during the remainder of 2022. Edibles also come with solid margins which will contribute to margin in the price sensitive market, while retaining our consumer base through an increased focus on store performance and customer loyalty. Turning to Ohio. We continue to have confidence in the upside of that state. As mentioned on our last quarter conference call, we have already made significant progress towards becoming vertically integrated there. Currently, we are operating primarily through our joint-venture in the state. As announced earlier last year, we have an LOI in place to establish another JV which relates to a dispensary license in Columbus. Through the LOI, we are on track to apply to transfer that retail license to a JV to be established immediately after approval. As affiliated entity of our JV partner and the state received a Level 1 cultivation provisional license in the fourth quarter of 2021. And arrangements are ongoing to build out an initial cultivation area of up to 25,000 square feet with the potential to expand up to 50,000 square feet after one year of operation. Last quarter, we also announced that through our JV partner we received approval from the state and have been granted ownership of the existing manufacturing license in Jackson, Ohio. Vapen brands are available on the majority of dispensary shelves in the statement -- in the state through our JV partner, and our partner sales continue to grow. In fact, March and April were the best two months in their operating history. We have expanded product offerings both in the Vapen line, as well as introducing third party manufactured and distributed brands like WINK and MAJOR to the Ohio market. We will continue to expand those offerings to continue to grow the company's market share in the state. Now I'll walk through some of the changes related to our transition to a for-profit model of operations. I'll address major balance sheet and P&L items and leave you to project those items on to the cash flow statement, which obviously had some significant one-time movements given the moving parts in the other two statements. As I mentioned earlier, sales are a little higher in quarter 1 than if we had reported under the not for-profit model, which also boosted our gross margins for the quarter because the operating entities are now fully consolidated, we would expect both of these line items to remain higher than in the past on a normalized basis. One of the most notable one-time impacts resulting from the transition is the inventory line. Because of the way inventory flowed under the not for-profit model, it would be billed immediately to the dispensary customer under the product sales line item in our P&L. When we consolidated and transitioned under the for-profit model, we could only book a certain value as inventory, which depress not only inventory in the quarter, but artificially reduced cost of goods sold and therefore inflated gross profit. We have provided an adjusted gross profit number for quarter 1, which takes us one-time impact into account, as well as the impact to the P&L from their fair value of biological assets, which is a standard practice in the industry, and better reflects the underlying gross profit and gross margin trends. Accounts receivable came down significantly as expected, given the fact that at the Vext level, this AR was really related to the billing to the dispensaries and was captured by the additions to intangibles under the for-profit model, which primarily reflects the value of the licenses under the new model based on a consideration given for Vext during the shareholder acquisition of the dispensaries. Going forward, we expect the shift to reporting as for-profit will make it simpler for the broader market to understand our story and make Vext more comparable to other players in the space. In closing, I'd just reiterate that while the current market environment is difficult, Vext is well positioned. We have the balance sheet cash flow operations and team to continue gaining share and making strategic investments that we expect will pay significant dividends for shareholders as macro pressures moderate. Before I pass the call over to Vahan, I wanted to personally thank him for his friendship and all that he's done to help the company, and he's transitioning to Daniel Engel taking over. Daniel is listening to the call, but not participating this time. But he will be in the future. Vahan, I turn it over to you for the last time. Thank you for all you've done.

[Vahan Ajamian:]

Thank you so much, Eric. And the shift to a for-profit model makes direct comparisons to prior periods more challenging for Q1. Vext continue to demonstrate solid financial performance in the first quarter of 2022. Revenue during the quarter was $10.8 million, a 16% increase over Q4 of 2021. And up compared to $9.2 million in Q1 of 2021. Gross profit before the impact of biological assets was $8.1 million in Q1, adjusted gross profit which also accounts for the one-time fair value adjustment for inventory and is a more accurate representation of underlying gross profit was $6.2 million in the quarter. This compares the gross profit of $4.1 million in the prior year period, and $4 million in Q4. Adjusted gross margin was 57%. Adjusted EBITDA margins for the quarter was even with Q4 at 36% and up from 33.4% in the prior year period. As Eric mentioned, we continue to generate steady cash flow with cash flow from operations coming in at $3.1 million during Q1. Vext ended the quarter with a solid balance sheet. We had $3.8 million in cash at March 31, 2022. And the expansion plans we have outlined for the rest of the year are fully funded between Vext cash balance as well as internal cash generation. Thanks, everyone for joining us for our Q1 financial results conference call. I'll now turn it over to the operator for your questions.

[Operator:]

[Operator Instructions] Your first question comes from Russell Stanley of Beacon. Please go ahead.

[Russell Stanley:]

Good morning and congrats on the quarter and the for-profit transition. Just a question Eric, around the comments made in the press release and during your prepared remarks around a number of Arizona brands, I guess focusing on the premium segment and drawing a comparison with beyond, maybe could you elaborate I guess on how you're positioning the brands in an inflationary environment? And I guess the second question around that is, are you seeing consumers start to forgive the term come down market to -- to the benefit of brands that are more competitively priced?

[Eric Offenberger:]

Well, we've always kind of price the brand. I always use the analogy of target not to give up my plug. But that's kind of how we've always seen the brand. We didn't think that, you know, being a Nordstrom brand, or a top level brand really gave you enough consumer base. And particularly that happened as we originally started in 2013. Our stores located in a very urban setting and many of you that's been there, you know, you can see it. It's a great market. It's loyal, but that consumer base has less discretionary income. So we always had to price the brand in that realm. So yes, I think you're seeing that. What I really think the trend is on the consumer, Russ is that as fuels gone up, you know, you're about 5.50 a gallon here in Arizona, and our stores are located in the Phoenix Metro that what you see is consumers are less likely to drive that there's that spread between what they can get down the street versus what they can get at our store. And if that spreads not that much, that customer is really sticky and loyal because they come in and get the good service and they get that rapid speed, that that's been beneficial to us. Now that said, your average ticket prices are definitely declining. And that's partly a function of the medical switch from medical to recreational because there's more limits that are placed on the recreational customer of what they can buy and how much they can buy at a transaction. So we are seeing some of that impact on the retail. As we talked about in the comments earlier, the traffic has been good and sales remain solid. It's just you're doing more transactions to get to that sales volume.

[Russell Stanley:]

Got it. That's great color. And maybe just a follow-up in your remarks around edibles. You talked about gummies, but in Arizona, I guess, can you update us on how WYNK and MAJOR performing relative to your expectations and what you're seeing there?

[Eric Offenberger:]

MAJOR is exceeding my expectations. WYNK is more of a product that's going to take a little bit of time. It's in the seltzer class and there's been a couple of other people introduce seltzers into the marketplace. In Arizona, it's a lower dose product. And I think that bit more difficult, especially with the inflationary pressure. Because with Wink, you're marketing something that's an alternative that's going to go to, you know, let's take it to a party and instead of having a six pack, you have, you know, four or five WYNK's and you end up with your 10 milligram dosage that you would get out of the normal edible. So, but it's price points a little bit more dramatic. Per milligram than some of the other product lines. So I think it's going to take a little bit more time to get that type of a product, have a broad consumer base. But the MAJOR sells very well. In fact, we stock out of it. So we're increasing our production levels on MAJOR right now. Same thing in Ohio with MAJOR. It's a great product. We're really happy with that product.

[Russell Stanley:]

Maybe just one more before I get back in the queue. Just a question around, I guess, the state just issued 26 social equity licenses and that represents, I guess, an expansion of the addressable wholesale market. I guess, when do you envision stores starting to come online there and how much of a lift are you hoping for there?

[Vahan Ajamian:]

I think it's 18 months before the stores come online and it depends how well they do with zoning to get to stores. I think that's going to be a challenge getting through the zoning and everything with all the activity going on in the Valley as far as semiconductor builds and stuff like that. So, I think that'll be interesting to see how that goes. That said, you know, I think a lot of people that get these licenses, you know, think that, you know, they'll build cultivation at the same time. So I think it's still 12 to 18 month proposition before you see all that cultivation expansion that's gone on absorbed into the market. I also think -- I don't think we're unique as far as being vertical and trying to watch our margins. And control what our, you know, our margin is because that's really what, you know, you don't see it in the stock price, but that's how you're rewarded in the marketplace is how you're doing your margins and translate it down to the bottom line. So I think that everybody else will be doing the same thing. That said, if you're one of the people that have been operating the lease licenses or just doing a cultivation that don't have the retail front, I think it's going to be tough sledding for the next 12 to 18 months.

[Russell Stanley:]

That's great color. I'll get back in the queue and congrats again.

[Vahan Ajamian:]

Thank you.

[Operator:]

Your next question comes from Neal Gilmer of Haywood Securities. Please go ahead.

[Neal Gilmer:]

Hi, good morning. Congrats on the quarter and I'm sure you have lots of fun with that whole transition to more profit. But that's behind you. I joined a little bit late, so apologies if I got two questions here, one was covered earlier. But I wanted to follow-up with your comments on the Ohio market where you commented where March and April were the best two months that they've had in their history. So maybe what you sort of just answered with Russ with respect to the Arizona market, what are -- are you seeing a similar sort of trends in Ohio to smaller basket sizes and increased volumes that sort of led to that a little bit surprising that it was the best ever. Obviously, it's coming off January, February slow. But in this sort of inflationary environment to what you're seeing in Ohio?

[Vahan Ajamian:]

Well, Neal, good morning. Yes, the transition to for-profit and biological assets that was a lot of fun. So, we went right up to the deadline to get that thing taken care of. So anyway, we're through it now and the team did really well. The accounting team did a great job and we had some nice help from Grant Thornton, so that was good for us. That said in Ohio, I think there's a couple things going on with Ohio. One is I think that market based upon how the state's done their limited license and it's coming into year three of the program, they're seeing more growth and talk around recreational and more acceptance and everything. I think that's helping it. But I really think the biggest thing that we've done in Ohio is we're getting our team established out there and that team's starting to click and you know, I'm a firm believer everything starts with sales. And we have a good sales team out there and good leadership and the managing partner that's out there has, you know, had a good background and that's really kicking in. Then on the vacant side with what we bring, the SOPs are designed for production level volume, not for two of these, three of these and that's why the Vapen brand has been target. So it's been set up for efficiency and operations and stuff like that and those things are starting to click into place there and you get sales people in your price competitively, now you've got sales. So I think that's been it, and you're seeing a little bit more biomass available so that you can do a distillation product instead of doing a more of a live risen type of product or some of those types of product lines can go there. And we've expanded the gummy lines, we've expanded the chocolate bar offerings, we've added the major beverages, we're doing other product lines that we think will continue to help with Ohio.

[Neal Gilmer:]

Okay, great. That's good to hear. My second question is just sort of a follow-up on -- maybe just Vahan's comments because I may have missed when you said at the beginning of the call with respect to your CapEx plans or what your CapEx budget is for 2022? And obviously, that's been the cultivation in Ohio and expansion in Arizona. But like you had a little over $4 million on CapEx in Q1 and just what the expectations are for the balance of the year?

[Eric Offenberger:]

Well, I think it really all gets down to -- right now, I think the CapEx left is somewhere around $2.5 million is what we have right now that's left for it. And as Vahan made in the comments from anything that we've disclosed, we've got funding as we throw off the cash from operations and the existing cash on the balance sheet and stuff like that. And candidly, it's a matter of how fast you go or how slow you go. We're really more in the mode mindset right now with the inflation, the way the market is going is we're cautious of what we're doing in Arizona like we normally were more so than in the past. It was built it and get it done, and we've gotten those efficiencies, and we're seeing those in sales growth and operating expenses come down. In Ohio, how do you get the cultivation up and going as quick as you can because that market's got more price for that market, and you've got the opportunity pretty soon to apply to get the store so you can control the vertical chain there and bring up the margins. So that's how we're looking at it. We've kind of gone -- I don't want to say we've gone back to the bootstrap mindset, but we've kind of gone back to the bootstrap mindset internally a thought of let's not build stuff just to build it. So we've really seen the efficiency and the gain. And I'm going to put a period to that, and then I'm going to transition and say, I don't think we'll be able to do anything with the retail until 2023. It's just really tough getting through the zoning, use permit stuff within the city right now. They're just backed up and they still haven't completely came out of COVID. It takes a long time to get stuff through. So by the time you get that all permitted and through and make sure the use permits, you're looking at probably a 2023 build, and that's where we'll address expanding the retail stores and cleaning that up.

[Neal Gilmer:]

Okay, great. Thanks very much for that additional color.

[Eric Offenberger:]

Thanks.

[Operator:]

[Operator Instructions] Your next question comes from Andrew Semple of Echelon Capital Markets. Please go ahead.

[Andrew Semple:]

Hi there, good morning. Congrats on the Q1 results.

[Eric Offenberger:]

Good morning, Andrew.

[Andrew Semple:]

Good morning. My first question here is on the EBITDA margins. I believe if we go back to our discussion at the end of last quarter, there's maybe some expectation that we might see some EBITDA margin pressure with the initial conversion or it seems that margins held up maybe better than anticipated here. And I just maybe want to dig at that a little bit. Maybe how much of that was an improvement of the underlying business or maybe some conservatism around the initial conversion of the stores to full ownership in the accounting surrounding that?

[Vahan Ajamian:]

Well, I definitely think a lot of it had to do with the accounting that -- we had a fair market value adjustment. So as we mentioned in the comments, that you had to do a -- we ended up picking up inventory that when you reduce it to the valuation based upon the assets or the consideration we gave up versus what we got in value on the fairness opinion, we ended up having to push that down. So let's say you had just -- these are example numbers, not actuals. So let's say you have $5 million of inventory you picked up, but you had to push it down to a $3 million values for the fairness opinion because you couldn't go above -- you couldn't go above. So we gave up less than we got in value for the stock of the dispensaries. So that's what happened. And you pushed it down, and you didn't really -- we couldn't really see that until we got really into the detail of where that valuation was going to come out on that valuation opinion. And that's where you see the intangibles got created, and you dropped the receivables and all that minutia moving it up and down on the balance sheet. So I think that really had an impact favorably more than we foresaw happening. On a go-forward basis, I think some of that will come through in the second quarter a little bit. I'm not really -- I don't have enough visibility on what its impact is at this time, but that will continue to happen. So does that address it? Or do you want to try to go add it a little bit more?

[Andrew Semple:]

No. That's helpful. And maybe we can take some of that off-line. But maybe moving on to the next question here. I just want to ask on Prescott being completed in the first quarter. Did you see any benefits within the first quarter from that expansion coming online? Or would you expect to have seen first product from that expanded facility kind of hitting the market in Q2, so there might be some more lane room from sales and margin improvement there? And on commenting on that, could you maybe speak to the benefits you're seeing from that facility being online and how those first kind of productional runs from that expanded facility have gone?

[Eric Offenberger:]

Yes. That facility -- it's like everything else. It's really about the team that's up there and what they're doing, and they continue to expand the strains that we offer. We've really done a good job in the last year of increasing the amount of strains and the variety that we're offering and growing. We've got -- between Phoenix and Prescott we have a lot more options than we've had in the past. So what you're seeing is not only for the expansion, better, bigger mother rooms, but more controlled mother rooms so that we can cycle the plants out and keep the life better on those genetics. We've brought in some new strains. So yes, we're seeing some impact of that. As far as like the overall production, while it's up, it's not up dramatically at this point yet because that's still -- you're still bringing that through the manufacturing process. So I think there's a potential for margin improvement. But my bigger thing is that I think there's a potential for luring more customers in that buy flower by having more changes in strains and more frequency of it.

[Andrew Semple:]

Great. That's helpful. Thank you for taking my questions. I'll get back into the queue.

[Operator:]

Ladies and gentlemen, as there are no further questions, this will conclude your conference call for this morning. We would like to thank you for participating and ask that you please disconnect your lines.