SLANG Worldwide Inc. (SLNG) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to the SLANG Worldwide First Quarter 2020 Results Call. [Operator Instructions] I would now like to hand the conference over to your speaker today, John Vincic. Please go ahead.

Thank you, operator, and good morning, everyone. Our speakers on today's call will be Peter Miller, CEO and Chairman of SLANG Worldwide; Chris Driessen, President of SLANG U.S.A. and incoming CEO, Co-Founder and President; and Kelly Ehler, Chief Financial Officer. Joining them for the Q&A session will be Mike Rutherford, incoming CFO; John Moynan, General Counsel and incoming Chief Operating Officer; and Billy Levy, President and Co-Founder. Before we begin, I would like to remind listeners that certain statements made during this conference call presentation may constitute forward-looking information and forward-looking statements within the meaning of applicable securities laws. These statements involve known and unknown risks and uncertainties and other factors, which may cause the actual results, performance or achievements of SLANG Worldwide and its subsidiary entities or the industry in which it operates to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. When used in this conference call presentation, such statements use words such as may, will, expect, believe, plan and other similar terminologies. These statements reflect management's current expectations regarding future events and operating performance and speak only as of the date of this presentation. These risk factors are discussed in detail under the heading Risks and Uncertainties in SLANG's management discussion and analysis dated July 6, 2020, and filed on SEDAR. The company undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, other than as required under securities legislation. And now I would like to turn the call over to Peter Miller. Peter?

Thanks, John, and good morning, everyone. Thanks for taking the time to join our Q1 2020 earnings call. In addition to me, you will hear commentary from incoming CEO, Chris Driessen; and Kelly Ehler this morning and have the opportunity to speak directly to us during Q&A. As always, we'll do our best to be available after the call to shareholders or analysts who may have further follow-up questions or anything they want to discuss beyond the scheduled window of this call. Due to reporting delays associated with COVID-19, we are in an interesting position to discuss Q1 with the benefit of more context than normal. We've been able to observe and analyze macro events that straddled Q1 and Q2 and gained some additional insights into our businesses' ability to navigate and emerge stronger than we entered them. Chris and Kelly will walk us through a more detailed analysis, but I'm very proud to say that the team continued to organize our activities appropriately between core and emerging markets, along the strategy we announced almost a year ago. The reasons laid out for embarking on that strategy were validated by the way we weathered the initial storm created by the pandemic and the way we took full advantage of the return of demand at the end of Q2. Between the resilience of our core markets and the risk mitigation strategy of leveraging partnerships in emerging markets, we left Q2 with our first month of positive cash flow from operations and our highest revenue month of the year. That's not to say that this will be the case every month or that we will stop being extremely aggressive about profitability, but it is a strong indication that the things we are doing are working and that we've turned an important corner. There are many reasons for optimism and excitement in the second half of the year, and Chris will get into some of those along with further analysis of the quarter. Chris?

Thanks, Peter. Q1 was a quarter of evolution in many ways for SLANG Worldwide. The company's #1 objective is profitability across all entities on a consolidated basis. Due to a host of factors, including potential at profitability, specific market conditions and capital requirements, the company has made the intentional pivot to form a strategic partnership with proven operators to bring our portfolio of products to market. This emerging market strategy preserves capital, time and resources while also optimizing revenue for the greatest opportunity at profitability. We are constantly analyzing data, both internal and external, to identify how to best drive value for our shareholders. We believe that delivering consistent profit and being cash flow positive represents the best way to drive that value in the long term. The quarter saw us continue to execute on our business transformation strategy by continuing its progress to transition from core to emerging markets, specifically in California, Michigan and Massachusetts. The company previously intended to pursue a license and wholesale products in each of these markets to develop it into a core market. This core market strategy requires intensive time, capital and resource commitments to bring to reality. The emerging market strategy has been executed on by SLANG many times in the past, including most recently with Standard Wellness in Ohio, Wellness Connection of Maine, Elite Cultivation in Oklahoma and Gage Cannabis in Michigan. We expect to announce more progress on our emerging market strategy very soon. Core markets are defined as markets where the company and its associate companies manufacture and distribute products at the wholesale level. This model naturally has a higher top line revenue potential due to wholesale. The company also received licensing revenue in addition to wholesale revenue. The key factor in determining whether a market is core or emerging is our ability to generate profit. This decision is based on a host of both internal and external factors, including tax regime, regulations, access and intensity of capital deployment, bandwidth, infrastructure, local leadership, cost of entry, pricing dynamics and size of the market. The company's revenue composition is directly related to it being a core or emerging market. Emerging markets always have a lower top line revenue than that of a core market. Ideally, SLANG will work to convert emerging markets into core markets when and where possible to realize healthy top and bottom line while being conservative with our capital. That said, we do not expect to convert any more core markets into emerging markets. And conversely, we do not expect to convert any emerging markets to core markets in 2020. In the first quarter, we showed positive revenue growth year-over-year but declined quarter-over-quarter as we transitioned California, Massachusetts and Michigan to the emerging markets models. And while these markets are more profitable to SLANG once fully transitioned, it did adversely affect our revenue in the short term. In addition to lowered revenue due to the previously mentioned market transitions, we also faced headwinds due to the impact from the global pandemic, COVID-19. The effects of COVID-19 were felt into the second quarter as many states enacted stay-at-home orders for extended periods of time. And while most states deemed cannabis businesses essential, many of our markets experienced steep declines in customer visits as dispensaries switched to a delivery or curbside pickup model. And while we did see a short but sharp increase in late March, it was not sustained as almost 40 million Americans subsequently lost their jobs. Our revenues were affected in both the dispensary channel and the ancillary market via our distribution partners. SLANG sells non-cannabis products like our Firefly 2+ dry herb vaporizer, O.penVAPE 2.0 batteries and various other items through both distribution and direct-to-consumer from our various e-commerce initiatives. Non-cannabis product distributors sell primarily to smoke shops, tobacco shops and other alternative stores. These locations were not deemed essential during the pandemic and were not open for long periods of time in many states. All of these factors contributed to the decline in revenue quarter-over-quarter. But enough about our challenges. It's management's job to overcome whatever obstacles might come our way, and we will do just that. We have many great things happening around the company, which will continue to be additive to our success in the future. I'm pleased to report that we have already begun to address these obstacles by entering into a strategic partnership in Michigan with Gage Cannabis, and we expect to make announcements regarding Massachusetts and California in the coming weeks. We are also excited about the eventual closings of our previously announced acquisitions of network partners in both Colorado and Oregon. This bolstering of our core market strategy will not only increase revenue but support our long-term profitability goals. We did see remarkable gains in our core markets in Colorado and Oregon in the first quarter, both quarter-over-quarter and year-over-year. Revenue in these core markets increased by 181% quarter-over-quarter and 757% year-over-year. We have also diversified our product offering to include flower through our partnership with Cookies. Our SLANG Network partner, Allied Concessions Group in Colorado, recently opened a new hydrocarbon and rosin production facility, which will allow SLANG to enter into popular and growing concentrate categories in the coming months. We expanded our District Edibles line to Oregon, where we have already seen early success with both gummies and sours. Our brands continue to have leadership positions across multiple categories in multiple markets. We continue to possess a strong balance sheet even today. We had cash and cash equivalents on June 30, which were higher than they were on June 1. This demonstrates our ability to execute on our strategic plan with prudent use of capital, pivot our strategy quickly and efficiently when necessary and still demonstrate brand leadership in those markets. In all, I'm very pleased with the company's ability to overcome obstacles that come our way, even in the midst of a global pandemic, civil unrest and a reeling economy. We're a scrappy company that's designed to generate profit and brand leadership over the long term. I feel more conviction than ever that we are on the right path to profitability. Our strategy is definitely starting to take root, and we expect positive gains in both core and emerging markets in the second half of 2020. Finally, I'm extremely excited to transition into the role of President and CEO for SLANG Worldwide. With all the work we have done to improve our margins, optimize our core and emerging market strategy and diversify our product offering, there has never been a better time to be paying attention to SLANG. Expect us to keep swinging punches and bunches, keeping our head down and continuing to execute. Work hard, never quit. That's what this great company is all about. And now over to Kelly for a financial review. Kelly?

Great. Thank you, Chris. March 31, 2020 marks our first full quarter as a public company with comparable results for March 31, 2019. I would note that the comparable quarter includes the results of NCG and Firefly from January 22, 2019, so results are not fully comparable. Where relevant, I will make the appropriate comparisons to the fourth quarter of 2019 since this information is most relative in terms of the financial direction and operational focus of the company. With respect to revenue, first quarter 2020 revenue increased 17% to $4.7 million compared to the first quarter 2019 revenue of $4 million. When compared to the fourth quarter of 2019, revenue declined by approximately $4 million, driven primarily by several factors: rental payments, which are recognized annually; the decision to exit the wholesale business in California; and the beginning of the impact of COVID-19 in our markets. Despite the overall revenue decrease, there were several bright spots, which point to the opportunity for future growth and support our decision to focus on the core markets of Colorado and Oregon. Revenue in these markets increased by 181% over the fourth quarter 2019 and by 750% over the first quarter of 2019. We also saw significant growth in licensing revenue, with 64% growth compared to the first quarter of 2019 and a 5% increase compared to the fourth quarter of 2019 in spite of the significant market headwinds between these periods. One area where COVID-19 impacted most heavily was in hardware sales, which were down 81% when compared to the fourth quarter of 2019. Normally, our customers submit their refill orders over the end of the quarter, but as many customers were shut down in March, we did not see the same level of restocking as the prior year periods. As markets reopen, we expect that there will be a catch-up activity in future quarters. In terms of gross margin, the first quarter of 2020 gross profit of $2.9 million represented a 61% gross margin, increased by 32% when compared to adjusted gross profit of $2.2 million in the first quarter 2019, with a gross margin of 56%. That said, gross margins on our product and licensing business improved to 53% in the first quarter of 2020 from 47% in the fourth quarter of 2019, again, as a result of our refocus on the core markets of Colorado and Oregon as well as the ongoing cost reduction initiative. EBITDA, and I'll turn now to the expense side. We've been keenly focused on adjusting our overall cost structure in order to align with the rapidly changing business environment since the latter part of 2019 and as we've integrated our acquisitions. The most significant decreases have been salary and consultant cost reductions among other cost-saving measures, the impact of which began during the fourth quarter 2019 but will not be fully realized until later in 2020. EBITDA loss was $2.7 million in first quarter 2020 compared with the first quarter 2019, adjusted EBITDA loss of $8.8 million and fourth quarter 2019 adjusted EBITDA loss of $1.5 million. Nearly every expense line item declined from fourth quarter 2019 to the first quarter 2020, with the exception of noncash expected credit losses, depreciation and share-based payments. However, during the first quarter of 2020, our revenue, and thus, gross profit declined due to the issues discussed above, including COVID-19, while our SG&A cost rationalization measures continued to reduce costs into the second quarter of the year. As noted above, measures taken during the fourth quarter 2019 and first quarter 2020 are expected to result in additional savings in future periods and the recently announced changes in executive management, which will further reduce overhead costs. The overall reductions in salaries and consultant costs will result in savings of approximately $6.8 million on an annualized basis once salary and benefits continuation and other costs related to the change has been fully realized. While we face continuing challenges in the second quarter 2020 due primarily to the impact of COVID-19, these cost reductions are expected to position the business well as things pick up. As we move to talk about our cash and financial position, we think it's important to note that we were cash flow positive during the month of June. This is a great testament to the resilience of our model as well as the positive impact of the cost savings implemented over the last several months. We had total cash and cash equivalents of $10.4 million at the end of the first quarter 2020, and this reflected a deployment of approximately $8 million in cash during the first quarter. Included in this cash deployment were a number of significant one-off cash expenses in the first quarter, with $1.6 million used for D&O insurance and $2.8 million of cash advanced to network partners in order to fund the operating expenses. The balance its operating costs. While we continue to expect fluctuations in monthly cash burn, we're moving in the right direction, and we will continue to closely manage our cash. We are confident that we have sufficient financial resources to continue to fund our business plan. We continue to operate with minimal debts, which contribute significantly to our financial flexibility. We continue to be focused on identifying additional opportunities for cost-savings, efficiently generating incremental revenues and maintaining a nimble operating model. Turning now to our bottom line results. We reported net income of $23.5 million in the first quarter. Net income arose primarily as a result of changes in option valuation. The primary driver of option valuations is the SLANG share price. Options will continue to be valued quarterly until expired or acquisitions complete. We've announced our intention to exercise the option to acquire ACG, but we have informed the owners of NSH that we do not currently have any intention to exercise the option to acquire this business. Depreciation has significantly declined in the first quarter of 2020 when compared with the prior year. We completed an impairment evaluation of our intangible assets as part of the 2019 year-end audit, and as a result, significantly wrote down the intangible assets. As a result, depreciation will continue to be lower going forward. Outlook. We are excited about the outlook for the business. We faced significant headwinds from COVID-19 during April and May, in particular. However, we believe that we are starting to see the light at the end of the tunnel. June results have shown encouraging improvements over the previous 2 months, including positive cash flow, and give us confidence that our actions over the last several quarters have been the right ones in order to position the business for the future. At this time, I will turn the call back to Peter for more discussion of our outlook and some concluding remarks.

Thanks, Kelly, and thanks, Chris. As you've heard, we remain very focused on our operating strategy, especially after seeing its durability during difficult times and its leverage in a robust market environment. We're looking forward to the growth catalysts and potential tailwinds of Q3 and are happy to take any questions or comments from folks on this call.

[Operator Instructions] Your first question comes from the line of Noel Atkinson from Clarus Securities.

I have a few questions here. Okay, first off, so congratulations on the Q1 strength in Colorado and Oregon. Can you -- does that relate to restocking after a slowdown related to the vape crisis in Q4?

Good question. I'm going to let Chris speak to the specific dynamics of Colorado and Oregon. I would say, as a headline, I wouldn't attribute that as the primary driver, but Chris can give some great color on the local Colorado and Oregon markets.

; Yes, I'd agree with that. Good morning, Noel. Yes, the vape crisis was kind of largely in the rearview mirror as we started Q1. And I think the strength you saw there, really, was just a tightening of our strategy as we continued to introduce new products and increase our market penetration. So you're just seeing that momentum build in those core markets. But no, I wouldn't attribute that to a restocking after the vape crisis.

Are you able to give us any more detail on that? So it sounds like then you're making good headway in these core markets. And I'd be interested in Colorado, in particular, because it's been such a big piece of your total serving and your total units for the last year. So can you give us a sense of product mix on a high level that you're seeing good momentum in, things like that?

Yes, absolutely. So as you mentioned, Colorado is certainly one of our strongholds. We're really widely distributed in Colorado with, really, large collectives, and what we've really seen was kind of a shift. One of the real strengths of our company is the diversification, not only in the categories that we serve but the segments within those categories. So an example of that would be we sell premium products. We sell ultra-premium products. We sell value-based products. So there's different demographics walking into different stores. The demographic of somebody walking into a store in Aspen, for example, is not buying the same products that somebody might be buying in a place like Pueblo. So for us, one of those strengths that we've got, the ability to go back and forth and service both sets of customers. So when people are primarily focused in one of those categories and more specifically one segment within those categories, we've got the ability to diversify what we do and service a lot of demographics in a lot of different places, which really has been one of the core strengths that we have in Colorado and in other places.

So we've seen, in Canada, a significant shift towards the value part of cannabis flower, in particular over the -- since COVID started. So are you saying that your value lines have outperformed basically during the COVID epidemic in your core markets?

Yes, absolutely. That's dead-on. So we saw a massive shift just in consumer preference as a lot of people lost their jobs, became more sensitive about their financial position. It wasn't that people stopped using cannabis, they may just be purchasing something a little differently than they had in the past. So we saw larger format items, for example, like a 1 gram cartridge instead of a half gram cartridge really shoot up. Our value line is a product called the O.penVAPE RESERVE line. And so we saw those percentages massively increase, which was a testament that, hey, people are still consuming, they just may be buying something a little differently. We benefited from that because we offer products in a lot of different categories and particularly at vaping in many different segments within that category. So as people -- consumer sentiment and buying preferences started to shift, we were able to capture that as they changed.

And Noel, I think that's a good comment about Canada in that we've seen in Colorado, in these core markets where we've operated for many years, some of the dynamics of a new market like Canada, which we're very excited about, having just received a sales license at our partner company to sell directly to retailers and provinces. But that Canadian market dynamic is kind of where Colorado was 5, 6 years ago. So the -- those -- that experience is built in. I'd also say, though, to Chris' point about diversification, it was still uncertain and difficult times financially for folks when we dropped our first Cookies flower SKUs. And that was definitely at the very high end of the spectrum. We still saw those products sell out immediately. And also, very importantly, created pull for our value brands at the wholesale level, meaning stores really wanted an allocation of those premium products because they had a strong sense they would sell through, which they did. And to compete for those allocations, they carried more of our other products as well on the value side. So it was a great synergy and a great example of how premium can still sell in even a mature market. Canada hasn't proven that yet, but I think it's both bullish for our ability to weather the choppiness, macro choppiness in mature markets like Colorado, and I think it's promising for everybody in a market like Canada.

Okay. Just one more quick thing before we move on to one other question. So on -- so you bring up Cookies, which I think is probably one of the most significant partnerships for SLANG going forward. So are you able to ramp up your production of some of these high-demand products, whether it's your value lines or your vapes or your larger format vapes or the Cookies flower? Are you guys able to ramp up now to serve that demand?

Yes. We are going to scale all of those things based on market demand, but I'll give Chris the floor to give you some detail around how.

Yes, absolutely. The direct answer is yes. So whether it's in raw material allocation and procurement to service our existing lines of in-house brands, Cookies, we've got great cultivation partners, both in Oregon and Colorado, that are well prepared to grow as the market demand warrants. So yes, the answer is yes. One of the things I would point out there that these markets ebb and flow. People's financial situation, their consumer preference of what they're wanting to purchase changes over time. We've seen this play out again, again and again, as we enter new markets. And so largely, everybody kind of moves down the same time line, but they're all at different places on it, depending on the maturity of their market. But the short answer is yes, we do have capacity. We are able to scale up as demand warrants, and more importantly, do that in a cost-effective way.

Okay. Great. Two more quick things. Based on your comments at the start of the call, plus the comments on the financials, should we be inferring that revenue will be declining sequentially in Q2 from Q1?

We're not offering any guidance on that directly. We want to work closely with the market to help guide them to a good understanding. But we're not offering a full forward guidance at this point on Q2.