Vext Science, Inc. (VEXT) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to Vext Science Fourth Quarter 2021 Financial Results Conference Call. As a reminder, this call is being recorded on April 20, 2022. [Operator Instructions] I now would like to turn the call over to Jonathan Ross. Please go ahead.

Thanks, Dennis. Good morning, everyone, and thanks for joining us today. Vext's fourth quarter 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 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 assurances 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 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 financial statements are presented in U.S. dollars and the results discussed during this call are in U.S. dollars. I'm joined on 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.

Thanks, Jon. Good morning, everybody, and thank you for joining our full year and quarter 4, 2021 financial results conference call. I am very pleased with our team's performance during 2021. Vext generated revenue of $37.2 million, which was up 48% compared to 2020. Even more importantly, Vext translated that revenue growth into adjusted EBITDA of $13.4 million, indicating a growth of 100% compared to 2020. For the 12 months ended December 31, cash flow from operations was $11.7 million, demonstrating that EBITDA was translated to cash. Arizona introduced recreational sales and generated over $1.9 billion in combined medical and recreational sales for the full year, according to a report from Headset. This was higher than several market accidents, and we remain optimistic that Arizona will continue to offer solid long-term returns for our shareholders. I'm equally pleased by the results our team generated in quarter 4 in the face of the emerging and new well-published inflationary pressure as well as the roll-off of government-related COVID support. Our team has once again proven the effectiveness of the operating model and the strength of the Vapen brand making targeted investments and effective promotions aligned with the demographics of our dispensaries and building customer loyalty. These efforts translated into $9.3 million in revenue and gross margins of 42.5% in the quarter, both roughly flat with quarter 3. Our steadfast commitment to operating efficiency with a keen eye to cost at all levels of our organization drove adjusted EBITDA of $3.4 million, also approximately even with quarter 3. Our cash flow from operations and fully diluted earnings per share were $4.8 million and $0.01, respectively, in quarter 4. Inflationary pressures have continued into Q1 and will remain with us for the foreseeable future. In an environment like this, the skilled operators will rise to the top. We are confident that Vext's proven track record of execution and culture of operational excellence positions the company to continue generating results in the face of these external factors. Moving into quarter 2. We expect price sensitivity to remain a key factor for most of the market just as it was in Q4 and Q1. This is likely a transitionary phenomenon as macro supply chain pressures resolve over time, and as excess supply of dry flower in the market gets absorbed. In our view, Arizona is going to be a very attractive long-term market, layering a strong start direct sales in 2021 on top of a growing population of 7.5 million currently, the return of a tourism sector that brings roughly 45 million nonresidents to the state annually and the massive development of multiple industries, most notably the semiconductor manufacturing space, where $55 billion is going into the state over the next several years, and it all points to a solid long-term demand. I'll now turn to some of our ongoing growth initiatives in Arizona starting with cultivation. In Q4 and Q1, we completed small expansions at our Phoenix and Prescott Valley cultivation facilities. Bringing total indoor cultivation to 24,000 square feet. We are currently absorbing all the flower we produce and the production coming out of these 2 expansions will be completely absorbed by our current vertical operations. As we discussed on our Q3 call, we have split our Eloy cultivation expansion into 2 phases to better match our current flower absorption rate with footage expansion. We have no intention of becoming a bulk flower supplier to the Arizona market. This 2-phased approach will also enable us to effectively control construction costs, which have been subject to inflationary pressure. Phase 1 is on track. It will bring us to approximately 17,000 square feet under canopy in that facility, and we continue to target completion by the third quarter of 2022. We are currently assessing the timing to build out the remaining area based upon market conditions in Arizona for flower consumption. Through Q1, we have been able to fully leverage our supply at retail. During Q2, we will have to go to the market for some flower, which we expect will have a slight impact on margin as we transition the first harvest at Eloy Phase 1. While flower is currently in an oversupply situation, market flower is still more expensive than what we can produce internally. We expect to initiate additional expansion to our current retail and manufacturing footprint later this year. At our Central Phoenix location, we are currently in zoning discussions to combine the main dispensary with our 3,000 square foot customer waiting area in Cafe on the same pad. I can't provide timing right now, but CapEx would be minimal. We estimate roughly [ $1 million ] and bringing the total dispensary footprint to 5,000 square feet at the location. We are also in discussion with the city of Phoenix to add another 6,000 square feet of manufacturing to our current operations in the city. This would also be relatively low CapEx build-out. This will support both growth of our Vapen brands as well as the growth we are continuing to see in third-party brands like WINK and MAJOR, which we have brought into the state. and are scaling nicely. Let's turn to Ohio for a moment. As discussed on previous quarterly calls, Ohio is a large, limited license state that is currently medical only, but has the potential for significant adult use upside. Ohio reminds us of Arizona in many ways and has the return on capital characteristics we look for. During 2021, we made significant progress towards becoming vertically integrated in Ohio. Currently, we are operating through JVs in the state. In July, we will be in a position to transfer our Columbus retail license to our JV. In the fourth quarter, an affiliate of our JV partner in the state received a Level 1 cultivator provisional license. This license enables our partner 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 following further application and approval. During the quarter, we also announced the JV, we had received approval from the state of Ohio and have been granted ownership of an operating manufacturing facility in Jackson, Ohio. We've learned from our Arizona playbook that building cultivation capacity in limited license states with large populations and adult-use upside is a clear path to generating solid returns on capital for shareholders. And we continue to look at opportunities in Ohio and expect to take the next steps required to make this second course day for Vext next to Arizona over the next 12 months. Through 2022, we will remain focused on generating organic growth through both our operated dispensaries and continued penetration in share of shelf space with the Vapen brand through the wholesale channel. We'll also remain focused on building out our upstream and midstream operations, which will support our organic growth objectives, build an additional high-margin revenue stream give us the option to accretive addition to our retail footprint when it makes sense to do so. This morning, we also announced that Daniel Engel will be joining the company as CFO effective May 2, 2022. I want to express our thanks to Vahan for the work he has done over the past year on the team. Daniel brings a long track record of success as both the CFO and COO, with deep experience managing growth and efficiency programs in the retail and manufacturing sectors as well as in executing M&A and successful integrations. Daniel is a licensed CPA and will be based on the ground in Arizona. At this stage in the company's development, it is critical for us to have a CFO with a daily connection to the operations as we look to continued growth in 2022 and 2023. Prior to passing the call over to Vahan, I'd like to close by saying Vext is entering 2022 with financial flexibility, a solid balance sheet, fully funded expansion plans and ongoing cash flow generation. Q1 will be the first period where we'll be able to report on a for-profit basis, which we will expect to make it clear for the broader market to understand our story and make Vext more comparable to other players in the space. Thank you for your time today. I look forward to continuing to update you when we report Q1 next month. I'll pass the call to Vahan for a review of our financial results. Vahan?

Thanks, Eric, and good morning, everyone. As Eric mentioned, I'll be stepping down and transitioning to Daniel. I will be assisting with the transition until May 31. As Vext grows in Arizona and Ohio, Daniel's presence on the ground in Arizona will be very important. He brings senior-level experience that will also be key to ensuring the company leverages its growing platform and continues driving value for shareholders. It has been a pleasure to serve as the company's CFO over the past year, and I look forward to watching Vext's progress in the coming months. I will focus my comments this morning on our fourth quarter financial performance. Vext continued to demonstrate solid financial performance in the fourth quarter of 2021. Revenue during the quarter was $9.3 million, flat with Q3 of 2021 and up compared to $6.4 million in Q4 of 2020. From a big picture perspective, Q4 was a solid quarter for both our results as well as for the actual dispensaries and wholesale businesses we manage despite the macro pressures that Eric mentioned. Similar to Vext's consolidated revenue, the revenue from operations of the 2 licenses we manage were roughly flat during the quarter. Management fees in Q4 were up from the prior year period and higher than Q3 of 2021. The increase was substantially related to ongoing construction at Eloy as well as work done to prepare to the move for a for-profit operation beginning in Q1 2022. Professional services revenue was up from Q3 as Eloy went into full construction mode. Product sales revenue was lower than Q3. Gross profit in Q4 was $4 million, flat with Q3 and up compared to $3 million in the prior year period. Gross margin in the quarter was 42.5% down a touch from 43.6% in Q3. Gross margins in Q4 of 2020 were 47.1%. Gross profit in dollars grew year-over-year as a result of the new manufacturing facility coming into operation and growth in both our cultivation and retail operations. Adjusted EBITDA margins for the quarter were strong at 36.2% compared to 37.5% in Q3 and 35.8% in Q4 of last year. Vext generated $13.4 million of adjusted EBITDA through 2021, which compares to $6.7 million during all of 2020. We generated positive fully diluted EPS of $0.01 in the quarter and cash flow from operations of $4.8 million. Vext ended the quarter with a solid balance sheet. We had $6.5 million in cash at December 31 and the expansion plans we have outlined for the next 12 months are fully funded between that cash balance as well as our internal cash generation. To reiterate, this will be the last quarter we report under the current structure in Arizona. As a result, we expect Q1 2022 to be cleaner as we report under a more typical for-profit structure. We believe that this will make it easier to understand our financial results, reduced quarter-to-quarter fluctuations and make our results easier to compare with those of operators in other states. As you know, up until and including Q4, we were managing the operations of the license holders and billing accordingly. Starting in Q1, the revenue we report will be the actual sales in the dispensaries in Arizona as well as wholesale sales. We have historically been building behind the dispensaries in terms of their actual revenue run rate. Accordingly, there should be a modest revenue pickup to the revenue reported in our financials starting in Q1, solely as a result of the new structure. As you will now also be consolidating all of the costs related to the operations, we don't expect to necessarily report a similar bump in EBITDA from the for-profit conversion that may be a wash in dollar terms. Thanks, everyone, for joining us for our Q4 financial results conference call. I'll now turn it over to the operator for your questions.

[Operator Instructions] Your first question comes from Russell Stanley with Beacon Securities.

I guess first on Arizona, you mentioned that the beverage products are scaling up nicely. Just wondering if you can elaborate on what you're seeing with the pickup there, especially given the macro headwinds you've talked to and whether you're seeing any cannibalization and whether you're seeing these products drive any new cannabis users to the market?

Well, Russ, it's -- this is Eric. It's tough to say whether you're drawing new cannabis users to the market. I'm inclined to believe that because you see the recreational customer base growing in Arizona. So that would lend to believe that. But actually quantifying it, that's hard. We see that the major brand with the 100-milligram performs better at this point in time than the WINK brand, which is a lower dosage micro dosage, and that seems to be consistent with the pattern. But from our standpoint, it just broadened the offering that we have and makes it more of a complete sale to a customer that's looking to reduce their costs. So they have less transactional costs by buying from us and getting a full line.

Got it. And maybe moving over to Ohio and understanding the priority is getting vertically integrated here, but you've got the existing manufacturing operation there already. And with the state working through its process to issue the additional 73 retail licenses. Just wondering how much share scope for potential expansion there is for that business just as a wholesale entity?

Well, I think there's a lot of growth for that. That's a -- that facility is a large facility. It's 13,000 square feet in its existing footprint. So it's got a tremendous amount of opportunity for growth. The nice thing about that one, too, is the facility is where the cultivation is that's going to be the Tier 1 cultivation and it has ample space too. So it's just a large complex, which will give us a lot of efficiency there and make it easy to manage. So we won't have multiple buildings we're trying to take care of our staff or the various overhead expenses. So yes, I'm pretty excited about Ohio.

Maybe just one last question on Ohio before I get back in the queue. Given those additional retail licenses are coming, the state is a cap of 5 stores per owner. Just wondering what the market is like for additional retail licenses and whether your focus might be on acquiring additional operating stores or whether undeveloped licenses might be more attractive?

I really think it's like everything that we look at. It depends what's attracted to us, what's going to be fit in nicely to the company and candidly, which one has a better ROI on it. We've always been focused on what we can return and operate and what it's going to cost us to do such. So yes, we'd obviously look at any opportunities in that state. Ohio and Arizona both.

Your next question comes from Neal Gilmer with Haywood Securities.

Happy for '20. Maybe Eric, I'd start, you touched on a little bit in your prepared remarks just with respect to a little bit of pricing pressures and obviously, inflation. Everybody in every sector is talking about inflation. Your EBITDA margin is north of 36% are excellent. What sort of levers do you have sort of in place? Is that sustainable? Or should we expect a little bit of a dip that's mostly sort of outside of your control?

I think -- Neal, I think we're like everybody else is still trying to feel our way through it. From the perspective of us as a company, it's an expense control is really the biggest lever you have. You're not going to really be able to do a whole lot on the other side, but we think the expense control. The nice thing, too, is with the vertical operation and the fact that we don't have an overcapacity or an oversupply on the flower side. We don't have to enter into the wholesale market where you see more of the pressure on downward for sales price. So we're not experiencing that as much. We've fortunately, through the first part of the year are able to absorb everything we want. I think we've made a comment in the management discussion, MD&A that we've been able to supply the stores and that's really impacted the cash flow positively. And as long as we can continue to get the majority of the flower that we use or consume from ourselves, I think that will continue to help us with that margin. But yes, you're getting in pressure on -- it's a weird pressure because you're getting a downward pressure on your sales pricing, your transactional price as you see the market have excess supply and then the labor pool is still tight. So you still have that pressure on upward costs of attracting talent and maintaining that talent. So it's kind of an interesting one right now.

Yes. No, fair enough. So then maybe my other question maybe sort of a crystal ball and you're going to say you don't have that. But you also talked about how you feel that the pricing pressure right now is sort of a transitory perspective and that you think over time that flower will be absorbed and so forth, and you'll have a rebound in pricing. Do you have any sense of when that is? Are we looking like into '23 before that sort of normalizes? Or what's your sort of sense on the ground there in Arizona?

I think it's until '23 easily. I just think that's the way this -- that the things actually happen. From my perspective and just based upon an experience, you got to run it now. You got to think about it as a commodity because you've got that excess. So it's all about cost control and price discipline and that pretty basic stuff. And that's from our standpoint, that's why we've made the investments and the manufacturing facilities and looking at flow to make sure we could maintain our cost structures as much as possible, because we realize that you're going to have a pressure on the sale price. With $5 gas, it's very challenging in the markets that we serve demographic wise. But at the same token, I think people are less likely to shop outside of their territory either. They're not going to drive for that when there's excess capacity.

[Operator Instructions] With that, your next question comes from Andrew Semple with Echelon Capital.

Congrats on the results and the conversion of the stores. First question here. I just want to go back to Ohio. Could you maybe provide a little bit more of a detailed overview on how that cultivation facility build-out is going, whether that's on track with previously communicated time lines and budgets kind of given the supply constraints and the inflationary pressures we've seen and your expectations when that might be first product available in market in that state?

Yes. Thanks, Andrew. The project is still on track. It's maybe 2 or 3 weeks behind would be my guess right now. The benefit of Ohio and here's a plug for our partner in Ohio is because they are a construction company and contractors, it's pretty darn easy to manage that project, which was one of the attractions to us of partnering with the people we partnered with was to make it easier for the management aspect. So that's been really helpful. It's still on budget. We also because the partners contractor we have a little bit less of an overhead burden that they charge through on it, and we have ample chance to save where we can. Most of the stuff has been built at this point in time. It's just a matter of getting it all in and installed. So we're knocking wood. You probably look in late fourth quarter to actually have some flower produced and get the whole plant up to capacity by the end of the year so that you're into 2023 on a normal cycle on the 9-week production cycle.

That's helpful. Switching gears to Arizona. I just want to go back to the comments, Vahan mentioned in his prepared remarks about EBITDA perhaps being neutral in dollar terms upon the store conversion. However, the business is now going to be subject to 280E taxation. So just wondering if you're expecting any impact to the after-tax cash flow generation what the conversion to full ownership and the for-profit model with those stores?

I'll start that one, Andrew, and then we'll let Vahan kind of clean it up. But I think that you're really not -- from a tax standpoint, the taxes don't really change because the dispensaries will still file their own federal return. So you will still have the strategy of making sure the cost of goods as legitimate as you can make it on to the income statement of that dispensary. So the -- from a tax standpoint, nothing really changes. But from a cash flow, yes, I think that you're going to see that we are going to have to make additional tax payments maybe on the dispensary side because you will have the state of Arizona tax that you're going to have to -- you won't be really change that. So we'll see. The tax people are working on it right now, and I'm not a tax expert, but yes, there's definitely -- there's more potential to that.

Okay. And maybe one more, if I may. I just wanted to also go back to prepared remarks, Eric. I believe you mentioned you expect the oversupply of flower in Arizona to maybe be taken up by the market. Just want to maybe dig into that comment a little bit more. Are you expecting demand to take up some of that supply? Or are you expecting maybe some of the supply of wholesale flower into the market, some of that growth might slow? How are you thinking about that market, the flower market in Arizona coming into a bit more of a balance through the course of '22?

I think it will be like every economic situation, it will be a combination of supply and demand. I think that the demand, as Jon mentioned, with the semiconductors [ and the ballot ] and Phoenix continues to grow, as far as population. And I think it was yesterday that there's another $1.5 billion that LG is building a battery plant here for electric cars, that's on the table now that you will continue to see valid growth, so that will create our demand. That also, I think, because the state's vertical and some of the licenses of people doing cultivation or at least where they don't have the vertical, they leased to license from somebody that those players won't have that outlet and it eventually will either shrink what they produce, or they'll have to rationalize that asset like anybody else does. And I don't see anybody that's vertical going while let me buy on the wholesale market versus operating the existing grow I have in using that asset, you got a better margin chance if you're taking and producing it yourself. And that's why the vertical stay works so well. And that's why we're so excited about Ohio, to be in vertical because you can control your future. The nice thing about Ohio is you can also be in the wholesale flower business in Ohio because of that structure. So it's a double whammy, it's Arizona 5 years ago.

Your next question comes from Shaan Mir with Canaccord Genuity.

Congrats on the quarter. In your prepared remarks, you commented on the persistence of inflationary pressures into the first quarter, and I think many of the other analysts have touched on that. My question relates more to your stores in Arizona, in particular, have you noticed any differences in the purchasing patterns between your 2 locations, given the demographic variances for the customers at those stores? And if you could -- maybe you could help outline kind of what the baskets look like today versus what they're looking like mid last year?

Well, the baskets are actually looking pretty good. I've been surprised that the North store continues to have a higher transactional value, but not as many customers as the existing store in the central area. So I haven't been -- that hasn't surprised me. The nice thing that from our business standpoint, and I commented on this last year a lot was we were surprised how recreational grew but it didn't grow as much as other people might have experienced. And I think it was the demographic where the store was. And that actually helps you in an inflationary period, too, because they didn't -- they came frequently. So they wouldn't come and buy, hey, let me come in and buy $200 or $300 at a time, they would come in and buy $75 to $80 and then they'd be back in 3 or 4 days and buy another $75 or $80. So that's continued, and that's really nice. There's been some really -- you have to be more creative on your specials now, and we've ran some promotional things, whether it's been sweepstakes in the stores or give away gas cards and that kind of stuff, and it seems to be working. We're going to continue to do what we've been doing and just go to work every day.

And then just another one from me. And thank you for the update on the timing of that Eloy facility. My question is a bit more about the regulatory approvals to bring that online. We've seen a number of MSOs comments on regulatory delays pushing back kind of the onboarding dates for their facility builds. And those have impacted the numbers quite significantly. I believe a few have even called out delays in Arizona. So I was just wondering where you are in the regulatory process of bringing that asset online? Or have you started conversations with the regulators in the state? And if I could add, how tight is that time line that you're building into your expectations to get that regulatory approval for that site?

From our standpoint, the regulatory approval has been really good. I think most people's regulatory issue is with permitting and use permits not necessarily getting the state cannabis Board to come in and say, "Yes, you can operate". Fire has been a b**** at existing places in Phoenix. And -- but that's always a challenge because you're doing stuff with volatile chemicals and things like that. So that's always been a challenge. Fortunately, for us, as we brought on the new manufacturing, we had the permitting on the existing manufacturing so you can kind of transition through it. But that's been a challenge. We commented on it about the store over on Indian school that were still messing around with permitting on that one-off trying to get them to join the lots and then let you have the use permit to be able to build the 5,000 square foot retail space and the bigger footprint. So that's been a challenge. As far as the city of Eloy, they've been fantastic. We did that project last year. We have all our permitting from the city. All of the things are green lighted there. It will just be -- once it's ready to go, we'll have the certificate of occupancy and then just bring the state in, and they'll check the cameras and the security, and we'll be up and operating. So that should go relatively fast. The other nice thing is we talk about the expansion of the existing cultivation. We're right now and work on them. We've got an additional mother room here in Phoenix that we're growing the mothers out right now for Eloy. So that would be a little bit of an indication of where we're at on timing.

Looking forward to Q1, I'll pass it on.

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.