Vext Science, Inc.
Q1 2021 Earnings Call Transcript

Published: 27 May 2021

[Operator:]

Good morning, everyone. Welcome to Vext Science First Quarter 2021 Financial Results Conference Call. As a reminder, this call is being recorded on Wednesday, May 26, 2021. At this time, all participants are in listen-only mode. Following the presentation, we'll conduct a question-and-answer session, instructions will be provided at that time for research analysts to queue up for questions. [Operator Instructions] I would now like to turn the conference over to Jonathan Ross, please go ahead.

[Jonathan Ross:]

Thanks Colin. Good morning, everyone, and thanks for joining us today. Vext's first quarter of 2021 financial results were released earlier this morning. The press release, financial statements, and MD&A are available on SEDAR as well as on the Vext's website at wextscience.com. We'd like to remind listeners that portions of today's discussion include forward-looking statements. There can be no difference to these forward looking statements appear to be accurate for the management's expectations or estimates of future developments, circumstances, or results contained there and will materialize. Risks and uncertainties that could affect future developments, circumstances, or results are detailed in the MD&A index and the other public filings that are made available on SEDAR and may 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 measures and such for non-IFRS financial measures are subject to disclosure and reconciliation included in our news release, disseminated earlier today. 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 am joining the call today by Eric Offenberger, Chief Executive Officer of Vext; and Vahan Ajamian, Chief Financial Officer. I will now pass the call over to Eric.

[Eric Offenberger:]

Thanks John. Good morning everybody, and thank you for joining our quarter one 2021 financial results conference call. As this is our first quarterly conference call, I'd like to start with a quick overview of the Company, our assets and our strategy for anyone new to the Vext's opportunity. Vext primary focuses on the Arizona market, where we have operated successfully within the medical market since 2013 and received approval to enter the recreational market in January of this year. Vext operates two dispensaries in Phoenix. One of which, we believe is a top performing dispensary the state. We also currently have two indoor cultivation facilities, one in Phoenix and one in Prescott Valley, with a total of 20,000 square feet under canopy, expanding to 24,000 square by the end of quarter one 2022. The Prescott Valley site also includes an outdoor cultivation space. To this point in time, we have these facilities, but normally what we announced that we had security agreements to purchase them outright. The purchase of our Phoenix facility has already closed, while we expect the purchase of the Prescott Valley indoor and outdoor operations to close in June. In addition to the expansions to our existing footprint, we've recently announced our decision to purchase an industrial facility at Eloy, to build out as large-scale indoor cultivation center. The City of Eloy approved our plans to build out our cultivation facility on May 11th. We expect to close that transaction in June to take roughly nine months, bring it up to 34,000 feet under canopy. So, with the Eloy coming online our expansion at existing facilities, we expect almost triple our total production capabilities to roughly 58,000 square feet under canopy over the next 10 months. Vext operates on a fully integrated basis on May 20th. We also announced that the State of Arizona had approved, Vext again operating an expanded manufacturing facility in Phoenix. Previously, we're conducting extraction and concentrate production and manufacturing out of a portion of one of our cultivation facilities, which we can now allocate to producing additional biomass while we wait for our Eloy facility to come online. The expanded manufacturing facility gives us roughly four times more space, enables us to meet increased demand for our brand Vapen and improves throughput as we grow. All of these expenses are fully funded by the cash on our balance sheet, and our expectation for continued and internal cash generation as demonstrated with first quarter results. Our wholly Vapen brand is one of the leading brands in Arizona and is stocked by the vast majority of dispensaries in the state. Awareness of the Vapen brand extends well beyond Arizona, thanks to effective in-state marketing and a quality promise that has built the brand's reputation and resulted in a significant social media following. We currently produce a full line of branded products, including flower concentrates, extracts, edibles, vapes, topicals and tinctures. Our new manufacturing was designed with a dedicated product development area, which is not something that was available in the space we were using before and will enable our team to continue innovating our portfolio of branded products to meet consumer demand. While Arizona remains our primary focus, Vext has a unique approach to building out in other markets. We have accumulated strategic beachheads in six markets outside of Arizona in a capital light fashion with a consistent focus on returns. We have leveraged the awareness of the Vapen brand outside of Arizona as well as our proven operating capabilities in SOT to strike JVs with partners, primarily in limited license states. Currently, Vapen product is available through these JVs in Ohio, Kentucky, Nevada, Oklahoma, California, and ultimately Massachusetts. I will touch on Ohio a little later in the call, but we view Ohio as our next leg of growth, and we recently struck a deal to access a retail license in the state, along with the processing in wholesale arrangement we already have there. We expect again seeing the results of our JV operations in other states in our P&L later in 2021. I will now turn my attention to our Q1 financial results. Our team in Arizona continued to execute our strategy of delivering strong financial results in the first quarter. With revenue growing 43% sequentially to $9.2 million and 124% from $4.1 million in the same quarter last year, even more importantly, that's continued to translate its solid top line results into growth and adjusted EBITDA, which was up 27% sequentially to 3.1 million and up from a loss in the same quarter of last. Vext'scashflow from operations continued to be positive to the tune of $2.3 million in the first quarter. We continue to generate positive diluted EPS during the first quarter. When the Arizona market transitioned to an adult-use framework early in January, the speed of the move caught operators and consumers a bit by surprise, but the market has gained momentum and is demonstrating growth, both of our operated dispensaries in Phoenix generated record results in March and April with May so far continuing that trend. In our view, Arizona will continue to be one of the most attractive cannabis markets in the U.S. over the next few years, both from an absolute growth perspective as well as based on return on capital. With our two operated dispensaries in the Phoenix metro area and recently announced expansion in both our upstream and midstream footprints. That's disposition to continue to solidify a leadership position in the state. Vext has been profitable since 2016 and a focus on shareholder returns will continue to guide our strategy. While I will touch on Ohio shortly, Arizona is going to remain our principal focus from a capital allocation perspective over the next 12 to 24 months. Once our Eloy cultivation facility is up and running in early 2022, we will have more capacity than we were required to support our current operated dispensaries, leaving more run way to further ramp up wholesale sales of our faith and branded line of products and support future expansion to our retail network. As we have seen another limited licensed states that have gone adult-use upstream capacity is a key competitive advantage to ensure supply as the market grows, provide additional margin, and support to your creative expansion of owned or controlled retail operations. I'd like to turn to our multi-state footprint for a moment focusing on Ohio as an example of how we gain a foothold and begin to generate results in a new state. Ohio is a limited licensed state with a population of roughly 11.7 million in a growing medical market. The state has 51 operating dispensaries out of a total of only 60 that has been currently approved. Ohio reminds us Verizon in many ways and has the return on capital characteristics we look for. In 2020, we struck an LOI with a partner in the state to get Vapen brand in the market. Currently, Vapen is selling well and we continue to expand the product offerings. Vapen has been stocked on the majority of dispensary shelves in Ohio. On March 15th, we announced that we signed an LOI that will enable back to establish a retail presence in the states through a joint venture within Ohio LLC. Well, we'll take some time to solidify and wait for regular to approval of the license transfer. We see Ohio as another leg of growth for Vext following Arizona. For the remainder of 2021, we will remain focused on generating organic growth through both our operating dispensaries and continued penetration and share of shelf space with the Vapen brand through the wholesale channel. We will also remain focused on building out our upstream and midstream operations as I already outlined, which will support our organic growth objectives, build an additional high margin revenue stream and give us the operation to a provably add to our retail footprint when it makes sense to do so. Thanks for your time today, I look forward to continuing to update you throughout we expect will be a very exciting year for Vext shareholders. I'd now like to pass the call to Vahan for a review of our financial results. Vahan?

[Vahan Ajamian:]

Thanks, Eric, and good morning everyone. As Eric noted, Vext continues to generate solid financial performance in the first quarter of 2021. Revenue during the quarter was 9.2 million, compared to 4.1 million in Q1 of 2020 and 6.4 million in Q4 of 2020. As a reminder, Vext provides and charges for services provided to two Phoenix dispensaries that in accordance with current regulations are structured as not-for-profits. As a result, our revenue is segmented between management fees, professional services, product sales, equipment leasing, and property leasing. Given these distinct leavers, we have as to when and for what we can charge dispensaries, the revenue mix reports on our financials may not perfectly match the underlying operations of our two primary customers, the not-for-profit license holders. That said, from a big picture perspective, Q1 was a record quarter for both our results as well as for the actual dispensaries and wholesale businesses we manage. The good news is that this reporting structure looks to be a short-term phenomenon. The state has indicated that operators in the Arizona market will be provided with guidelines to transition to a more typical for profit structure during 2021. Should we be in a position to acquire the licenses for the dispensaries we manage? We would certainly like to do so, as we expect it would make it easier to understand our financial results, reduce quarter to quarter fluctuations, and make our results easier to compare with those of operators in other states. While we are still waiting on the roadmap, outlining how we may be able to acquire dispensaries directly, our goal would be to try and time any such change to take effect at the end of a quarter so as to not have a situation where we would report in mixed quarter, partly managing not-for-profits and partly owning dispensary. Gross profit in Q1 was $4.2 million compared to $1.2 million in the prior year period, and $3 million in Q4 of 2020. Gross margin in the quarter was 45.4% compared to 29.4% in the same period last year and 47.1% in Q4 of 2020. Vext has always operated very lean with a keen eye to return on capital. As a result of this approach and the factors I mentioned that drove higher gross margins, we generated $3.1 million in adjusted EBITDA under quarter compared to an EBITDA loss of $74,717 in the same quarter last year, and positive EBITDA of $2.4 million in Q4 of 2020. Once we are able to transition to a four profit model, we see quarter to quarter fluctuations beginning to even out and become more predictable. Adjusted EBITDA margins remain strong at 33.4% this quarter. We generated positive fully diluted EPS of $0.01 in the quarter, and operating cash flow of $2.3 million. Vext ended the quarter with a solid balance sheet. We had $16.4 million in cash at March 31st. And as Eric mentioned, the expansion plans we have outlined for the next 12 months are fully funded between Vext cash balance as well as internal cash generation. Thank you very much for joining us on our inaugural quarterly financial results conference call. I'll now turn it over to the operator for your questions.

[Operator:]

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Russell Stanley from Beacon. Russell, please go ahead.

[Russell Stanley:]

Good morning and congrats on your first call. First question, just around retail, almost four months now into the adult use market. Just wondering, what lessons you've learned to this date around the adult-use consumer in Arizona and how that compares to the medical patient in Arizona?

[Eric Offenberger:]

Ross, it's Eric. Good morning and thanks for the question. So far, when we're working at the adult, the common theme was March was a lot of people coming in to see what it was, February the same type of a thing. The average ticket price has been less than our stores. One of them is in a more of an urban setting, and it was a really great medical market. It's not as much of a recreational market, while you still do get those customers. A lot of free roll sales. Again, as I said, lower transactional values. On the new store we opened in July, it's in a higher demographic as far as disposable income, and we're seeing bigger ticket prices in that store, and we think that trend will continue as we go forward. We're entering summer. So, it's going to be a little bit hotter and we won't have any tours and obviously coming out of COVID. So, we anticipate that will also grow, just it won't be as great as until the fall, when the weather gets better. And hopefully all the Canadians can come down, big tours.

[Russell Stanley:]

Excellent. Maybe a similar follow-up question around the wholesale business. Just wondering how that's evolved since the opening of the adult use? And I'm wondering has your product mix on that front changed in any way? Or that business has become any more or less competitive since adult use market opened?

[Eric Offenberger:]

Well, remember, the Vapen brand has done very well and established the absolute growth on the edible side, more demand for the edibles, the milligrams on that was limited to a hundred. So, we've had to scramble a little bit as was mentioned in our opening comments, that the market came on a lot faster than we'd anticipated, that's all ramping up. We've got our increased production capacity. We're expanding the flavors offered on the coming lines and those types of things. Cartridge sales are still really good. They're solid. The other products shatter the waxes. The concentrate brands they're doing well. So, yes, we're seeing increased demand there and we think that'll continue. We may see a little bit of a wall after 4/20 rush where people will stock up and then it will balance back out in May, and we think that that'll continue to be the trend.

[Russell Stanley:]

Maybe just one last question, I'll get back in the queue. Just, once you got LOI, as you noted, you'll have excess capacity for beyond your own retail and perhaps wholesale needs. You've mentioned organic growth as a priority this year. But just wondering, what you're seeing on the M&A front with respect to adding additional retail acquisitions, given how active Arizona has been on the M&A front over the last several months in particular? Are you still seeing opportunities that are attractive from a valuation perspective? And what might we see to do there? That's it for me. Thank you.

[Eric Offenberger:]

Yes. I think just the M&A activity and what's attractive is, it's going to continue to be there. And some of the operators that could be a potential to join Vext or seeing what the adult-use means to their business or their valuations or and stuff. So I think that's going to continue. I don't see that changing and I think there'll be opportunities that present themselves and we'll look at what makes the most sense for the valuation for the shareholders.

[Operator:]

Your next question comes from Matt Bottomley from Canaccord. Matt, please go ahead.

[Matt Bottomley:]

Good morning, guys. Congrats on the first quarter. Relatively new to the story here. So we saw a large transaction in the space in Arizona a couple of weeks ago. So just wondering, if you could give a little more background on what the actual regulatory framework is looking right now with respect to adult-use, given that Arizona seems to be in terms of new licenses, the highest barrier state at least that I'm aware of? But there are going to be new social equity considerations. So just wondering if you can give the landscape right now and what those new licenses may look like and when they may come online? And if there's a plan to maybe have partnerships with that or any sort of consideration in that regard?

[Eric Offenberger:]

Well, thank you for the question. It's Eric again. On the social equity, the state has gotten out their proposed regulations for comment. I saw the last draft of that late last week, and I think that'll continue to change. They're trying to decide exactly what the basis will be, this is income component or in the operating requirements. That said, absolutely. With the Vext model and our familiarity with the joint ventures, we think there's a real opportunity for us to partner with social equity license holders to have an equity stake in it to help them grow. And also, we see that as a potential channel as we talked about the Eloy and the retail product from the Vapen brand that we see that as a real opportunity. We've had unofficial meetings with people that are interested in that area, but they're tire kickers right now since we don't have regulations and we don't know exactly when the application process will be. That said, if the applications or anything like what happened on the last 13 that came out, we think there'll be a significant interest in it.

[Matt Bottomley:]

Great. That's helpful. And then another question on Arizona. Just looking at -- there's about 130, 140 stores in the state, which is a relatively modest amount relative to the population. What we saw in Colorado, at least what I gleaned was, there was a lot of saturation with under-capitalized players and some companies have been able to kind of roll up a number of retail arrangements there. Looking at the Curaleaf and Harvest and some other companies in this space that are getting critical mass there, is there still a good population of these type of mom and pop players considering for M&A? Just because it seems that the prices are fairly lofty in the transactions that we have seen on an individual store basis. But I imagine that it's still fairly disaggregated with respect to adding up to that entire 130, 140 license framework there.

[Eric Offenberger:]

Absolutely, I think you're spot on. That's our analysis of it too. And the nice part is since we've been in the market since 2013 and we are in Arizona, we know a lot of those operators on a personal level, Matt, from customer -- also hanging out with them, having lunch, beers, whatever. So a lot of them are trying to figure out where they fit in, what they want to do. Some of them are younger in nature. So they're also looking at, are they going to sell and have enough money to retire? Are they going to still be in the workforce? Where are they going? And I think those are some of the things that are settling out. And as people have more time to digest what's happening in the marketplace, that that's when the opportunities are going to start presenting themselves that they're identify what it is they want. And they've been looking at the transactions that have been occurring, to try to determine where they're at. That said, a lot of them are smaller operators and have had the licenses for a long time and don't have a lot of business document or other exposure to businesses. And they're not hiring professionals to help them. They're talking to people they know. And that's kind of how this has been transpired for the remainders.

[Operator:]

[Operator Instructions] And your next question comes from Andrew Semple from Echelon. Andrew, please go ahead.

[Andrew Semple:]

My first question here, I just wanted to ask on the supply situation in Arizona, as consumer demand builds with the transition to the adult-use markets. Do you [Audio Gap] understand the point of your branded products as well as what was available in the wholesale market?

[Eric Offenberger:]

I think you cut out there. Could you just repeat the question? Sorry about that.

[Andrew Semple:]

Sure. Sorry about that. I was just asking from the supply standpoint of the Arizona market. Do you feel comfortable that your dispensaries are adequately supplied when with the transition to the adult use sales from the standpoint of your own branded products as well as from the wholesale market?

[Eric Offenberger:]

Andrew, good question. It's similar to what I think you'd see in other markets. On the flower side, that's the tightest artists for us to meet the demand of. We're buying more on the wholesale market there than we historically have. On the concentrates side, we have not really seen an issue with that. As part of our strategy, anticipating the dollar is, we've put the outdoor facility and to be able to get biomass, better control that we don't have to buy as much in the open market. And we've had that available to us. So that's really what we're seeing. We think the flower will stabilize in the next 12 months period of time, but that'll continue to be the biggest push. That said, as we talked about the opening comments, we're expanding our cultivation capabilities, and have been doing such since November. And with Eloy coming on, that's a 9 to 10 months proposition before that'll start to show any results to help us, but it'll still be flour. And that's good because that's good for the market because it'll keep the pricing more stable. And who doesn't like stable prices on a retail storefront. Also, the problem to have as far as we're concerned and we just keep plugging away to make sure we're aligned with the proper people.

[Andrew Semple:]

And very solid quarter-over-quarter growth; however, I didn't notice the gross margin and EBITDA margin pulled in a couple points. I'm just wondering, if that was just reflecting a shift in the product mix or whether Vext had to utilize the wholesale markets a little bit more, maybe put some pressure on the margins? You can speak to the dynamics on what may have impacted the margins quarter-over-quarter. That'd be helpful.

[Eric Offenberger:]

Yes, the really biggest impact to our margins is what Vahan behind talked about earlier is the fact that these are not-for-profits right now and the levers that we have in order to invoice or build the not-for-profit operation. So in the first quarter, the margins going to have a little bit more pressure on it, because we're billing primarily for packaging materials and build up of inventory, that point in time. Those margins are still very solid, but they're more of a product billing in the first quarter versus a softer cost of labor or something along those lines. It really depends which lever we're going to pull in which quarter, says, it's going to fluctuate the margin. And that's what Vahan had mentioned in his comments that with the four profit will be able to have that as a more traditional and smooth instead of it'd be in a function of the product. Vahan, is there anything you'd like to add on that?

[Vahan Ajamian:]

No, I think you've covered fairly well. It's all a matter of which levers we pull in and to what extent any given quarter. And yes, this quarter, it's the packaging where you have the direct costs that you have to pass through, which tend to have slightly lower margins, but especially given the revenue jump from Q4 to Q1, pretty happy with other gross and EBITDA margins lined up this quarter.

[Andrew Semple:]

And just the final question here on Ohio, I believe they issued another round of dispensary license applications or one that's coming in this summer. Obviously, that should help support a stronger wholesale market in that states. Just wondering, if that announcement would change your plans at all in Ohio, relative to what you're currently planning in that market?

[Eric Offenberger:]

Andrew, I think that really if you look at it from our standpoint, Ohio is going to go from 60 they're going to add another 70. So it's going to go to 130. We identify Ohio is almost identical to us, as Arizona. And that's why we liked that market so much. So we think it's going to behave similar to Arizona has maybe potentially more upside because of the population difference between the two states. In the long run, we think they'll eventually go to a recreational model like most states do. They're met the medical program continues to grow. We'll obviously try to secure additional licensing on the retail front there in Ohio. And we see it as a positive exactly like you're saying it that the market will continue to grow.

[Operator:]

Your next question comes from David Lavigne with Trickle Research. David, please go ahead.

[David Lavigne:]

So I had a lot of questions answered. I've been following this story for a long time and trying to model it and I haven't been very good at it. It's been difficult because of all the levers as you refer to them. But, just a general comment, I really feel like actually, your numbers were pretty close to what we had. And I feel like in spite of the levers and I know that that's still going to be the subject of some variability going forward. But I feel like, the visibility in general is improving here. I mean maybe it's just one quarter and that doesn't constitute a trend, but I feel like the visibility around your numbers is improving. Is that -- do you feel that way or did I just get lucky maybe this quarter?

[Eric Offenberger:]

So, I think, yes, the visibility is definitely getting it approved. Candidly, we've put together a good team that's actually all behind in the -- I don't know it's [indiscernible] and everything that we're putting together and it's helping us to tell the message better than we were in the past. It's been profitable since 2016. We continue to generate positive cash flows and we run the business, and I've always told anybody that listened, we're operators, the team's a bunch of operators and we needed help on the capital market side. We've gotten the right people into place now on this, helping tell the story. Vahan, you know this industry very well. What color would you add to it?

[Vahan Ajamian:]

Yes, I agree. I think as the Arizona market now transitioned to adult use, we are seeing very nice gradual ramp-up, every single month. We now have two dispensaries as opposed to one. So, I think we're getting to that critical mass, or hopefully we'll get there fairly soon where any one quarter or any one month or any one sort of timing of shipments will impact the consolidated results less and less as we go forward, as we just increased in scale and you have that critical mass. So, I'm pretty pleased with how things are going. And so, good work on the nailing the numbers for the quarter.

[David Lavigne:]

I think the critical mass issue is probably the issue I was looking for. So, let me just ask you something conceptually as we move forward then, because, obviously, you have this focus on the upstream and the midstream. I think that makes sense to me, as you sort of adult use rolls out. It sort of seems like that's going to drive a new level of demand. I know that, you're still wrestling with numbers. But can you give us any sense of where you sort of look out there and see where you start to transition from being a buyer of upstream product to that sort of surplus you noted? I mean is there some place up there where you kind of look and go, okay, that's the place where that'll probably happen?

[Eric Offenberger:]

I think that's tough to answer right now, David, because, we're still trying to see how the adult use goes, and we've got plans to increase our footprint, that's one of the big challenges in Arizona has always been the size of the store, could only be 2.000 square feet in the Phoenix Metro. And they're going to allow us to go to 5,000, but you still have your setbacks and zoning issues and everything to deal with. We feel confident that, we'll be able to get both stores to that 5,000 foot magic number soon, which will give us the ability to absorb more of the product ourselves. We have ample parking in the locations, but it does get challenging with COVID and increased demand of getting customers through in a time that we find acceptable and not having them in the queue way too long. So, it's hard to say, what that point is going to be. We have, the nice thing is that, we have the demand. We are tight on the supply, on the flowers side. We have the asset now identified and we have the capital structure to build it out. So, we see it as a relatively short-term of two to three quarters before we really start to see it come on the line and get a better feel for it.

[David Lavigne:]

Yes, I suppose ultimately that question sort of dovetails into the question fryer, which is sort of about margins and I guess that was what I was really trying to get at. So, well, we just got to wait and see how that rolls out. But listen, I thought this was a really, really positive quarter, and I'm very encouraged by what's happened. I think like I said, visibility seems be tidy, getting to that critical mass issue and I just it was a really great quarter. Congratulations.

[Eric Offenberger:]

Hey, thank you. And thanks for following us, staying with us.

[Operator:]

There are no further questions at this time. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.