Auxly Cannabis Group Inc. (XLY) Earnings Call Transcript & Summary

Good morning. My name is Anas, and I will be your conference operator today. At this time, I would like to welcome everyone to Auxly Cannabis Group Year-end Q4 2021 Earnings Results Call. [Operator Instructions] Ms. Nawrocki, you may begin your conference.

Thank you, operator, and good morning, everyone. Thank you for joining us for Auxly Cannabis Group's Fourth Quarter and Full Year 2021 Financial Results Conference Call. A replay of this call will be archived on the Investor Relations section of Auxly's website. I will start the call with a presentation and corporate update from our CEO, Hugo Alves, followed by a recap of our year-end financial results by our CFO, Brian Schmitt, before opening the floor to questions from my financial analysts. Joining us for the question portion of the call will be our President, Michael Lickver. I encourage you to follow along the presentation slides, which are posted on our website under the Investors section under Presentation. Before I turn the call over to you Hugo, I'd like to remind everyone that our discussion today includes forward-looking statements that are based on assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from the these expressed today. Management can give no assurance that any forward-looking statement will prove to be correct. Forward-looking statements during this call speak only as of the original date of this call, and we undertake no obligation to update or revise any of the statements, except as required by applicable law, including in Auxly's disclosures. I note that all references on this call are to Canadian dollars unless otherwise stated. With that, I'll turn it over to our CEO, Hugo Alves.

Thank you, Carla. Good morning, everyone, and welcome. Brian and I are delighted to be with you again to present our Q4 2021 and full year results. We see Auxly's 2021 strategic objectives. These objectives did not change throughout the course of the year and were to recap maintaining leadership in the 2.0 product segment, building 5 license producer by national share of market, improving margins and revenues while being disciplined in our spending and achieving adjusted EBITDA profitability. And I'm proud to say that Auxly was able to achieve most of these goals in an environment of unprecedented challenge. And that is a testament to the quality and commitment of our people and their tireless efforts. In terms of maintaining leadership in 2.0, we were able to successfully defend our #1 ranking in the 2.0 product segment and finished the year as the largest license producer in the segment, capturing a 15% share of the 2.0 in 2021. We continue to dominate the vape segment, again, defending our #1 LP position and increasing our share of market by 4% year-over-year 2021. With more than 100 vape brands in the market nationally, all 3 of our vape brands Back Forty, Kolab Project and Foray secure the top spot -- top 5 spot brand nationally and Back Forty was the #1 vape brand in the country. And we exited the year having secured top 5 sales positions across all 2.0 product categories that we participate in. The most ambitios goal that we set for ourselves in 2021 was to extend our brands into 1.0 formats in a meaningful way. Not only did this entail developing and commercializing a product portfolio in a new market segment, but it also entailed acquiring the capabilities that we believe would be needed to become a serious player in the 1.0 segment. We view this objective as critical to maintaining Auxly's growth trajectory given the size of the addressable market for 1.0 products currently representing over 70% of total market. And during 2021, we significantly strengthened our cultivation platform with the acquisition of Sunens Farms, now called Auxly Leamington, whereby giving us the scale and quality of cultivation that we believe enable us to remain competitive over the long term. And while we are still building our base portfolio and distribution of 1.0 products our efforts to-date have enjoyed enormous consumer success, and we exited the year as a top 10 LP in both dried flower and pre-roll formats. Over the course of the year, Auxly went from the 30th ranked license producer in flower at the end of 2020 to the #7 for license producer nationally with 5.1% share of market. And we went from the 19th largest producer in pre-rolls at the end of 2020 to the #8 right, LP at the end of 2021, with 3.5% market share. And notably, our Back Forty brand in particular has been a consumer favorite [indiscernible] establishing itself as one of the top-selling flower SKUs on Ontario and securing the #4 brand position in the province. And our unique Back Forty pre-rolls, quickly gained consumer claim, and we recognized as the Best Indica Pre-roll at the 2021 Kind Awards. We successfully achieved our goal of becoming a top 5 LP. Auxly almost doubled its market share position year-over-year, ending 2021 with a 7.4% share of market nationally and being the fifth largest license producer by share of market. And we were able to do that by being hyper focused n our consumers and commercializing what I believe as an industry-leading innovation pipeline, which I'll touch on a little later in the presentation. We also continue to focus on depth and breadth of distribution to ensure that consumers can always access our products. and we ended the year with excellent coverage by having presence in over 92% of stores across Canada. And we continue to see great sales momentum with our portfolio and continued opportunities to build deeper connections with consumers through focused brand development and insights innovation. Over the first 2 months of 2022, the company has moved into the #4 LPs spot by share of market. Our CFO, Brian Schmitt will discuss Auxly's financial performance later in the presentation, but I'll note some quick highlights. We successfully grew our net revenue 79% year-over-year to $83.3 million, including ending Q4 with net revenues of $29.3 million, a 20% increase over Q3. And we managed to increase our top line while maintaining spending relatively flat with SG&A for 2021 almost $1 million lower than SG&A in 2020. And as discussed on our last call, we did continue to encounter operational and supply chain challenges during the year, which negatively impacted our gross margin, but we were able to achieve a blended gross margin of 23% for the year, which was an improvement to the 21% gross margin achieved in 2020. And while those operational challenges and general industry headwinds negatively impacted our ability to achieve adjusted EBITDA profitability in 2021, we were able to make significant strides towards that goal. We improved year-over-year adjusted EBITDA by 24% to negative $21.7 million. While disappointed that we were not able to achieve this target in 2021, achieving adjusted EBITDA profitability is our primary strategic target in 2022. And we believe that we'll be able to achieve that goal through continuing to drive the top line with focus on differentiated brands and products, increasing the depth and breadth of our distribution, leveraging the increased output from our Leamington facility, investments in automation to increase production capabilities and output and continuous improvement initiatives throughout the organization. Turning to Slide 6. The chart on the left shows Auxly's continued leadership in the 2.0 market relative to its competitors, where we have a sizable advantage relative to our closest competitor. When you look at total market, it is a tighter rate for top spot. And the chart on the right-hand side of the page shows our relative standing on a total market basis where we ended the year as the fifth largest producer. Notably here, in 2021, no other cannabis company in Canada gained more market share than Auxly, and we significantly outperformed the Canadian rec market, growing at-the-till sales by approximately 157% year-over-year, while total industry sales only grew by approximately 49%. Moving to Slide 7. You can see a picture of our national share of market performance on a quarter-by-quarter basis for every product category that we participate in. These are national market shares in order to give you a clear view of how we performed across the country and throughout the year. And a few high-level points to draw to your attention here are: In vapor, we lost about 0.5 point of share over the course of Q4. This was driven by some of our competitors dropping prices aggressively. We question the sustainability of core price investments, and we chose not to follow that trend at this time and instead focus on supporting our products in store, and we are happy with the results and trade-off. In Concentrates, we also lost a bit of share over the quarter, but this is not a concern as it was driven by supply chain interruptions, which constrained product availability. Those issues are resolved, so we expect to see our concentrate share tick back up, and we gained share in every other format. As I mentioned on our Q3 call, we expected to recapture share in edibles with the launch of new SKUs, and we're delighted with the consumer reception that our new edible formats have received. As already discussed, we saw continued growth quarter-over-quarter growth in dried flower and pre-rolls. And we've also made significant share gains in oil and topical products where our Dosecann branded products continue to win over consumers with superior quality and value. And also a shout out to our innovation team for Dosecann daily's relief cream which is not only the product that I get the most complements on but also recognize that this year's Kind Awards winning the best topical category. And I should note that we were able to achieve the #5 ranking in topicals with 1 single SKU, and we're excited to extend our topical lineup in 2022 to address other functional needs of our Dosecann consumers. And on that note, I'd like to turn to Slide 8. Insights-driven innovation is one of our core capabilities. I am biased for sure, but I believe that no other cannabis company on the planet can match Auxly's innovation capabilities and outputs. Our ability to translate consumer insights into differentiated products and manufacture and distribute them at scale is unrivaled in cannabis. Over the course of 2021, we successfully launched 51 new SKUs to market including 10 first-to-market SKUs like our industry-leading live terpene sticks. And we've already launched new SKUs in 2022, and in the aggregate, have 60 innovation SKUs in development for release over the course of the year so that we can continue to service the evolving needs of our consumers and build deeper brand connections. Let's move to Slide 9. One of Auxly's winning aspirations is to create a leading portfolio of brands as measured by awareness and share of market. We obsess about creating brands that our consumers trust and love, so I am thrilled to see the impressive awareness gains that our brands have made over the course of the year. Using Brightfield Research Group data, you can see that all of our brands continued to gain awareness among consumers over 2021. And Back Forty in particular, which we only launched at the end of 2020 has become the fastest-growing brand in Canada and almost doubled awareness over the course of a single year. This was in part driven by its dominant vape position, where it is the #1 vape brand nationally and its rapid growth in dried flower, where it's the fourth largest flower brand in Ontario and Alberta and the third largest flower brand in British Columbia. We are committed to building lasting brands, and we'll continue to make investments in insights, innovation and brand development so that we can get closer to our consumers and earn their trust and loyalty. Turning to Slide 10. Before passing the presentation over to Brian, I'd like to spend a few minutes discussing our acquisition of sole ownership of Auxly Leamington, our 1.1 million square foot greenhouse facility, formerly called Sunens Farms. The acquisition positions Auxly as one of the largest cultivators of cannabis nationally and gives us the capabilities that we believe are needed to make a concerted and sustainable push for 1.0 market leadership in Canada. Auxly Leamington gives us the competitive advantages of scale, lower cost and surety of supply and the scale of the facility also gives us the ability to execute on attractive export opportunities to foreign jurisdictions of the industry. It has also simplified our cultivation supply chain and allows Auxly to improve its cost by materially reducing our reliance on third-party for dried flower and extract inputs and consolidating the margin previously left behind at Sunens onto the Auxly balance sheet. Finally, it allows Auxly to remain hyper-focused on its consumers. As the sole owners of the Leamington facility, we have exclusive access to a genetic bank of over 150 cultivars, which enables us to tailor our dried flower product offerings to the evolving preferences of our consumers. On Slide 11, you can see that Auxly Leamington is driving our concerted push into 1.0 market leadership. Our Back Forty and Kolab brand -- our Back Forty and Kolab Project brands, sorry, are among the fastest growing branded portfolios in the 1.0 market segment and the output from Leamington is being used exclusively to service those portfolios. And as Brian will touch on we're currently increasing production at Sunens to be able to service the increasing demand for our flower products. And we expect to make further output and efficiency gains with improved availability of automation, which is being commissioned over the course of the year. I'm going to stop there. Thank you very much for your time and attention. I'm now going to turn the presentation over to our CFO, Brian Schmitt.

Thank you, Hugo, and good morning, everyone. Please turn to Slide 12, where we've outlined the balance sheet impact of the acquisition as well as core operational capabilities. Starting with some of the core capabilities. The facility is fully licensed for cultivation, processing and sales under the Cannabis Act. The 1.1 million square foot facility includes 877,000 square feet of fully completed space with the remaining areas available for additional warehousing and processing capacity that can be built out as required. In terms of the annual production capacity, Auxly Leamington commenced harvest activities at the beginning of 2021. And following a change in genetics, has helped drive our growth in dried cannabis products within -- with sales commencing in June. Consumer demand continues to be strong for our branded Back Forty and Kolab products. And as of today's date, production capacity has again been increased to approximately 65,000 kilograms annually with further room to expand. Turning to the assets acquired. For most of the year, Auxly Leamington was reflected in our financial statements has an investment in joint venture on the balance sheet and as a one line in our earnings statement as share in loss on investment in joint venture. Upon acquisition, the balance sheet changed significantly with the addition of $155 million in property, plant and equipment and the assumption of loans, payables and obligations under capital leases of approximately $78 million, of which $15 million was immediately paid down on closing of the transaction. The fair value of the consideration paid largely represents the previous investments made by the company. We are, of course, delighted to have completed this transaction of a top-tier facility with sufficient capacity and favorable cost structure, which will continue to drive our future revenues and strongly contribute to margins. Now turning to Slide 13. I'd like to move into our year-end financial results, which show the progress we've made over the past 2 years since we commenced cannabis sales. We have demonstrated a strong positive trend in share of market, which is a key indicator of the company's performance. Auxly's revenues closely follow our success as represented by share of market. However, they are influenced from time to time by our wholesale partners' buying patterns. Our share of market for 2020 was 3.1%, which increased to 5.5% in 2021. Continuous improvements throughout the year and into the fourth quarter have propelled us to the #5 LP position with 7.4% market share. As a result, Auxly's reported another record quarter, having achieved $29.3 million in net revenue in the fourth quarter of 2021, an increase of 20% quarter-over-quarter and ended the year with $83.8 million in net revenue, an increase of 79% over 2020. Year-over-year, we drove a significant improvement in cannabis 1.0 sales, which accounted for approximately 31% of total revenue as a result of our expansion to the competitive dried flower and pre-roll categories. While maintaining our #1 position in cannabis 2.0 sales, which accounted for approximately 69% of revenues. Next slide, Slide 14, captures our gross margin, adjusted EBITDA and net losses for the year, all of which improved. Our margins on cannabis inventory sold for the fourth quarter were consistent with the previous quarter at 20%, even as the sales of cannabis 1.0 cost increased. Gross profit margin for the year was 23%, with a mix between product categories and again, with 2.0 products being the main driver. While margins on cannabis 1.0 products remain lower than cannabis 2.0 products, we anticipate improvements in gross profit from dried flower and pre-roll products as automation is implemented and volumes increase over the next few quarters. SG&A decreased in 2020 by approximately -- 2021 by approximately $900,000, which includes the impact of Auxly Leamington and higher selling expenses in support of store openings, marketing initiatives and fees associated with revenues. And adjusted EBITDA loss of $21.9 million for the year was an improvement of approximately 24% over 2020, primarily the result of increased gross profit, partially offset by higher selling expenditures. And finally, the net loss for the year improved by approximately $51 million as compared to the same period in 2020. The improvement was primarily the result of net income related to the sale of KGK, recognition of a gain from the Imperial Brands debenture amendments and improvements in continuing operations. With that, I'll turn it back over to Hugo to stick to Slide 15.

Thank you, Brian. Turning to Slide 16 (sic) [ Slide 15 ] 2021 was an incredible year of growth for Auxly, and we are excited to carry that momentum that we've earned in 2021 into this new year. We continue to improve our business and achieve adjusted EBITDA profitability, make progress towards being the #1 licensed producer in Canada and, of course, to help our commercial with happier lives. This year, we're going to continue to improve revenues and gross profit margin to achieve adjusted EBITDA profitability. That is our key target this year, and we're going to achieve it by leveraging the increasing flower output of our Leamington facility, continuing to build focus and differentiated brands and product offerings, continue to increase the depth and breadth of our distribution, cost optimization through investments in automation to increase production capabilities and output and continue its improvement initiatives throughout the organization. We are also going to continue winning with consumers and building brand traction through a deep commitment to understanding our consumers and developing products that help them with happier lives, building brands that consumers love and trust and being the choice of consumers in store. And we want to service the evolving needs of our consumers with insights-based innovation and ensure that our consumers can access our products broadly and reliably. To conclude, 2021 as the year that Auxly emerged as a Canadian market leader and we believe set the foundation for our continued growth in 2022 and beyond. Before I open up the floor for Q&A, I'd like to thank all of our incredible employees, our customers, retail partners and consumers for all of your support throughout the year. On behalf of myself and everyone at Auxly, thank you. And I'm now going to turn it over to the operator to open the floor for Q&A.

[Operator Instructions] Your first question comes from Rahul Sarugaser with Raymond James.

This is Michael Freeman on for Rahul today. First, congratulations on a really significant 2021. We're very, very impressed with the market share capture. So well done there. My first question is on the 100% takeover of Auxly Leamington. Wondering if we could -- if you could expand on the impact of that JV full acquisition on margins going forward and when we should expect to see this impact setting in future quarters?

Thanks, Rahul (sic) [ Michael ]. I would say with respect to signings as we tried to indicate in the MD&A, we had very little impact in Q4. And to remind our listeners, the acquisition was November 22, effectively 6 weeks in the quarter. And ultimately, we only recognize annual EBITDA or gross margin pickup upon sale of the flower our wholesale consumer. So we had very little impact as you can appreciate shipments from November, we're ultimately sold a little bit in December but will be primarily sold in Q1. To answer your question with respect to margin, the business Auxly Leamington began cultivation at a lower output at the beginning of the year, losing money at the time. But as we have this acquisition, the business is EBITDA positive. So we expect that to flow through upon sale of our products ultimately through the Kolab, Back Forty and our other 2 brands. The impact, we think, will be fairly significant with respect to our adjusted EBITDA gap at this point. We expect it to be fairly material pickup.

All right. That's helpful. Are you able to give sort of a range for -- you indicated a EBITDA or margin pickup will be significant maturity? Are you able to give sort of a range of where you expect margins to be, say, in second, third, fourth quarter this year?

Yes. So sorry, I apologize, I apologize I called you Rahul, apologies for that. With respect to margins, we ended up at 23% for the year. as we've indicated, we expect well into the 30% range just with the Auxly Leamington pickup. Of course, there's some timing issues, as I've indicated respect to when those products moved internally or ultimately sold. We expect the benefit from that in Q1. And quite frankly, the other important thing is this puts us on a level playing field with all other LPs. So our margins at 23% are fairly strong. But effectively, you could say we were handicapped because many of our third-party cannabis purchases were effectively at wholesale prices.

Great. Okay. Brian, that's very helpful. If you'll indulge one more. Hugo, you mentioned that you had -- you saw a small decrease in your -- in Auxly's vape market share on account of competitors aggressively pricing based. I mean by our calculations, are at the sale of these dates is happening at negative margins on their part. Wondering if you could expand on how you -- how you see this playing out? Like how -- you mentioned -- you said very diplomatically that you questioned the sustainability of this. I wonder if you could just speak a little bit more about the conditions in the vape market today.

Michael, so as I said during the presentation, the irrationality of the price drop, we don't think it's sustainable. We're focused, as you know, this year, as I mentioned, on achieving adjusted EBITDA profitability. So we're not willing to chase the competitor down there, choosing instead to support our products in store and to stay in our kind of brand parameters. But I'm going to turn it over to our President, Mike Lickver, to give you more color.

Michael. So just to build on Hugo's point, we have strategies to continue to be competitive in the vape market and defend our position. And I think I can outline a few of them quickly. We're going to continue to differentiate, and that's how we have always done it in the vape market. We have innovative inputs. We're going to continue that into 2022. Example to be more true to plant such as Resin and Rosin and into minor cannabinoids, that's how we see the market trending in 2022. We also have the best hardware in the market, lowest failure rates, and we continue to improve that constantly. As Hugo mentioned, we invest with our retail partners in building long-term relationships to support our brands and drive awareness, provide access to the consumer. And last, certainly not least, we are constantly seeking to understand the needs of our consumers, understanding why, how, where they use our vapor products and tailoring our products to those needs, the street convenient form factors. So I guess a different way of answering your question, but we do believe in the long-term value of the vape market. We do believe it will continue to grow throughout 2022, and we're not looking to do any sort of drastic pricing changes we're looking to maintain and defend our share.

Your next question comes from Frederico Gomes with ATB Capital Markets.

Thanks for my questions. maybe just on your adjusted EBITDA target expected to be profitable in 2022. But is that by any specific quarter or for the whole year? And maybe can you just provide more color on the key drivers for you to get there? Are we talking more about revenue growth or cost study or margin expansion? Just any color there would be helpful.

Frederico, I'll take that. So we had provided guidance last for effectively the second quarter of 2022. We recently received our automated packaging machine. It has actually arrived. That is a critical element for getting profitability up in the drug flower crude oil category. As indicated, that machine recently arrived at is presently being commissioned. So we -- I think we indicated last time that we would expect to receive it in January, it did not come in January. So we are slightly delayed there. So we do think that will impact cost a little further into Q2. We've also seen an experience in this quarter coming up, Q1, which effectively ends today. There have been some supply chain issues with the war. We've had some disruptions with respect to some of our supplies from China and competition for ocean and air freight. So we have moved out that date to the second half of 2022, so H2. And we will continue to push for the second quarter of 2022. But realistically, we feel that much more comfortable with Q3 to Q4 time frame.

Okay. And then it looks like the overall industry, it seems some significant slowdown in sales in the first quarter of this year. We know that there's seasonality there, but could you comment on what you're seeing internally? And what are your expectations for growth in Q1 this quarter?

Sure. I'll start, and then I'll pass it over to Hugo. We have seen and many analysts have published the sales information from [ Pi fire ] . And it appears that industry sales are seasonally lower, similar to last year, 8% to 9% from what we've seen. With respect to Auxly, in particular, as we indicated in our last conference call, we have paid a fair bit of attention to our inventory on hand with our wholesale partners and manage those levels in addition to our very efficient SKU portfolio. As such, we will presumably like other LPs see some lower sales but not anywhere to the extent of prior year.

Yes. I would only add to that. We do continue to -- we see seasonality in Q1. I think we can kind of see that as a trend 3 years of commercial operations. Certainly, the inventory management practices as the customers get to year-end also have an impact. But as Brian said, we've -- we're a year smarter, so we've been able to manage better we don't expect the impact to be as -- at the same level as last year. So there is seasonality. There is certainly inventory management, but overall, you'll see smoother revenue.

Your next question comes from Jack Keating with Research Capital.

Well done last year. My first question relates to how many new SKU applications have you already submitted in 2022?

We have, in the aggregate 60 innovation SKUs in development. We've already released some of them, and some of them are in market. What were shipped to our customer last month. There is, I think, another 14 this month shipped and 3 next month. So this is already in process to commercialize a new SKU is kind of -- it's 6 months or more. It's not kind of a fast thing. So we have 60 SKUs planned for this year.

Okay. Great. Thank you. Last question. Will the inventory impairments continue in 2022?

We've had historical inventory impairments, and I would say they're relatively small to what I've seen with other LPs. Our impairments for the last 2 years have been primarily associated with retirement of the SKUs and obsolescence. So as we continue to roll over our portfolio I can't say that there will not be any inventory impairment, but I would say I expect them to be very nominal going forward because we do, again, have a limited number of SKUs relative to some of our peers, so that does help with product obsolescence and packaging obsolescence, et cetera.

Thank you. 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. Have a great day.