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

Good morning, everyone, and welcome to Vext Science's Second Quarter 2022 Financial Results Conference Call. As a reminder, this call is being recorded on August 25, 2022. [Operator Instructions] I would now like to turn the conference call over to Mr. Jonathan Ross. Please go ahead.

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

Thanks, Jon. Good morning, everybody, and thank you for joining our quarter 2, 2022 financial results conference call. I am joined on the call today by Stephen Bankosz, CFO of Vext. Our team continued to execute during the second quarter against the backdrop of a very challenging environment for most consumer-facing companies. Vext generated revenue of $8.8 million, which was down 6.5% compared to the same quarter last year and 18.8% compared to quarter 1 of 2022. The drop in sales on a sequential basis is related to both seasonal weakness as well as a shift in consumer behavior, as record high inflation continues to impact consumer spending across the country and across industries. Within this context, our team balanced promotional activity with mix back to maintain solid gross margins. We continue to drive efficiencies, and all these efforts translated into 27% growth in adjusted EBITDA compared to quarter 1 and margins of just over 55%. Vext cash flow from operations remained positive in the second quarter. I said it before and I will say it again, we are operators. Over the past 3 quarterly calls, I've highlighted the potential impact that an inflationary environment could have on consumer disposable income. The cannabis industry overall in our short-term results. In quarter 2, we began to see the first real evidence of this development. Gas prices hit record highs in the mid-June and credit card debt is starting to grow. These trends aren't just related to the cannabis industry and all the big retailers that reported and have been clear that they are seeing the same trends with further weakness expected. In Arizona, the state reported that the medical patient count dropped 30% from January through June. These patients have transitioned over to the recreational side of the market, where they will save the cost of a medical card renewal, but they will purchase less and must pay a higher tax on the product they buy. This impact on top of seasonally slower sales during the period caused Arizona cannabis sales to drop roughly 20% across the market from May to June. Sales in the market were down just over 11% from quarter 1 to quarter 2. Consumers are watching their pennies, and we saw evidence of this in the quarter with traffic and customer account relatively steady, but basket size was down. The wholesale side of our business was down as well, as other retailers adjust to lower consumer spending in the short term and it impacts order volume. As I mentioned last quarter, we expect these pressures to remain for the foreseeable future. We saw this environment coming and are meeting it head on. With operating expenses down 12.2% in quarter 2 compared to quarter 1 and customer count stable, we yet again demonstrated the strength of our business model. Vext's proven track record of execution and culture of operating excellence positioned the company well. Companies that can promote effectively and offer consistent selection, quality and value to the customer [ while faster ] enduring loyalty. This is exactly how Vext portfolio is positioned in the market and why we have one of the top brands in the state. From a sales perspective, we consistently bring traffic into our stores given their strategic locations and seasonal targeted promotional activity. We have recently made a key hire to head up sales in Arizona to continue growing what is already an effective sales organization. We also have a proven ability to innovate, bringing products to market that customers want at a solid pricing point. During Q2, we released new dessert style THC infused herbs, and they are currently available to consumers in Arizona. We also launched Vapen black our new line of distillate cartridges offering a premium flavor experience in addition to live risen disposables and additional cartridge flavors. And all new range of edibles will also be released before the end of October. Our recent manufacturing kitchen expansion will enable us to continue to grow the Vext's product portfolio and rapidly get new product on the shelves. From a cultivation perspective, we are also well positioned. The recent expansion at our Prescott Valley cultivation facility will be totally absorbed by our current vertical operations. With Phase 1 of Eloy coming on by quarter 3, we won't have to rely on the market for any material flower purchases for our current retail base. While any excess production can be allocated to our higher-value in-house lines of extracts, edibles and other products to sell in the wholesale market. We aren't dried flower wholesalers, and we never will be. Until the Eloy comes online, we are still relying on the market for a portion of our dried flower needs. During quarter 2, we purchased roughly 20% of the flower we used at wholesale. While it is an opportune time to do this given the decline in flower prices, it isn't a position we want to be in long-term. We can produce flower cheaper internally and what we believe, as higher quality law ensuring, we aren't subject to the swings of the market. The expansion plans for our retail and manufacturing footprints remain on track. We are in discussion with the city of Phoenix to expand our central Phoenix dispensary of 5,000 square feet and to add another 6,000 square feet of manufacturing to our current operations in the city. Both these build-outs will support the growth of our wholly-owned Vapen products as well as third-party partner brands. We are working on some targeted wholesale sales initiatives to grow the customer base as well. We have a competitive advantage with one of the top brand portfolios in the state, an efficient operating model and the ability to leverage existing capacity through our kitchen and manufacturing facilities without any additional CapEx. Turning to Ohio. We continue to have confidence in the upside here. Currently, we are operating primarily through joint venture in the state. As I noted on our past couple of calls, we've already made significant progress, stores becoming vertically integrated in Ohio and in September, we expect to file the transfer of dispenser license in Columbus to a JV that will set up immediately after approval. We anticipate receiving it by the end of the year. Ohio has exhibited better supply/demand dynamics than many other markets, including Arizona, given its structure. While still a developing market, so far in 2022, Ohio's station count has seen an increase of 21% according to state data. While this doesn't mean we won't experience a slowdown in consumer discretionary spending in Ohio, it does help mitigate some of the impact. In quarter 4 of last year, an affiliated entity of our JV partner in the state received a level 1 cultivator provisional license and arrangements are ongoing to build out an initial cultivation area up to 25,000 square feet with the extension of up to 50,000 square feet after 1 year of operation. We expect to receive the certificate of operation by September 2022 and achieve first harvest by the end of the year. As a reminder, also in quarter 4, we received approval from the state of Ohio and our granted ownership of an operating manufacturing facility in Jackson, Ohio through a JV. In quarter 2, Vapen brands were available on over 95% of its dispensary shelves in the state through our JV partner, and our partner sales continue to grow as the customer base expands. In the second quarter of 2022, sales were up more than 50% as compared to quarter 2 of last year. We have made strategic investments in our sales team, expanded product offerings, both in the Vapen line as well as introduced third-party manufactured and distributed brands like WINK and MAJOR to the Ohio market. We view Ohio as a growth opportunity and look forward to expanding these offerings to continue growing the company's market share in the state. In closing, I just reiterate that while the current market environment is difficult, Vext is well positioned. We have the balance sheet, cash flow, operations and team to continue gaining share and making strategic investments that we expect will pay significant dividends for shareholders as macro pressures moderate. I'd also like to welcome Stephen Bankosz, as the company's CFO. Stephen has been the CFO of our operating subsidiary in Arizona since January of last year and stepped into the Vext CFO and Corporate Secretary roles in June. I'll now pass the call to Stephen for a quick review of the financials. Stephen?

Thanks, Eric. As a reminder, the shift to a for-profit model as of quarter 1 2022 makes direct comparisons to prior year periods and were challenging until we lap that event in quarter 1 2023. Vext continued to demonstrate solid financial performance in the second quarter of 2022. Revenue during the quarter was $8.8 million, an 18.8% decrease compared to quarter 1 of 2022 and lower compared to $9.4 million in quarter 2 of 2021. Gross profit before the impact of biological assets was $5.7 million in quarter 2. Adjusted gross profit, which also accounts for the onetime fair value adjustment for inventory and is a more accurate representation of underlying gross profit was $6.5 million for the quarter. This compares to gross profit of $4.2 million in the prior year period and adjusted gross profit of $4.8 million in quarter 1. Adjusted gross margin was 75% in quarter 2 compared to 44% in quarter 1. I'd like to quickly flag there were a few immaterial changes in some of our quarter 1 numbers as a result of a review for the for-profit transition we executed last quarter. These changes to amortization, depreciation and cost of goods are primarily related to a true-up of acquisition date inventory following the completion of the dispensary's year-end audit. Adjusted EBITDA margin for the quarter were 55% in quarter 2 as compared to quarter 1, 2022 at 35% in quarter 2 of '21 at 37%. As Eric mentioned, we continue to generate positive cash flow, with cash flow from operations coming in at $0.9 million during quarter 2. Vext ended the quarter with $1.5 million in cash at June 30, '22, and the plans we have outlined for the rest of the year are fully funded between that cash balance as well as internal cash generation. On July 8, we announced that we had entered into a $22.2 million credit facility with the primary purpose of retiring certain higher rate secured debt. This credit facility lowers the company's cost of capital while giving us additional flexibility to execute our plans in Arizona and Ohio. The fact that we're able to secure the facility at a very reasonable rate of 7.5% at the time of signing, speaks to the company's track record of profitability and cash flow as well as the attractiveness of its assets. Thanks, everyone, for joining us for our quarter 2 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.

First, congrats on the EBITDA performance and the margins. With respect to OpEx and G&A, in particular, it looks like that came down by about $0.5 million quarter-over-quarter, I guess. Can you elaborate, I guess, on where the savings were and how sustainable the Q2 level is looking out into the second half?

Well, Russ, thanks. Yes, I believe it's sustainable. I actually think we can accelerate it a little bit. We're seeing some of the results of the capital investments, as we talked about in the first quarter, where we're picking up operating efficiency and gaining traction that way. So I think that's really driving it. Plus candidly, just an awareness of what's going on in the market and trying to turn the orders over faster in the stores and really better focus on what add value, what doesn't add value, and we've done some further reductions in headcount, as we go and we look at it constantly that way. If we have an opening, do we fill the opening type of thing. So we really have that mindset here and always have that we want to operate at lean and it's just now -- the necessity is more prevalent now that you have to save as much as you can and figure out how to do it for less. I mean it's just -- really weren't like a stagflation area within the cannabis space right now in Arizona. In Ohio, it's a little bit different. There, we are gaining sales and stuff along those lines and keeping those expenses tight as we have from startup mode.

And dovetails on my next question, I guess, just from the consumer base. You talked about in Arizona having seen lot of medical patients transition to becoming adult-use patients, Ohio is still medical only. Would you characterize that customer base as perhaps being a bit more resilient perhaps in terms of their spending on cannabis given that they've only got that medical option to them.

Well, Russ, I'm no expert in all of the psychology of consumers and people like that. What I am noticing and it continues to trend this way is, it really depends on the demographics of the store and where it's located. So if you look at our main store, and you've had been out here to see it, it's in that urban setting, as I've talked about previously. And what we see there is that patient count, they will continue to buy and they don't view it as a discretionary spend as much as a staple. So it's a consistent consumer base in that. But what they do is they have the pressures of fuel costs and other necessities that they're doing, so they will allocate their dollars. So they will be in at the same frequency rate, spending less. And that's what happens on that. Recreational is that the limits are set a lot on the state, and that's why you see the basket size drop, but the average count is the same. So that's part of the way we can gain the efficiency too, is because they're buying less items. So it's easier to get in and out. On the Deer Valley store, what you see is the demographics, is a little bit higher on disposable income. So instead of coming in 3 times a month, they'll come in 2 times a month, but the basket size while going down because it's more recreational than medical, it's not as dramatic of a decrease. So that's what we're seeing. So you've got less frequency there, but on higher spend. In Ohio, what we're seeing is, as the medical patients continue to grow, so it's really tough to determine and we don't have as good of retail records there at this point. It's tough to determine whether the spend on the basket size is going down or what exactly is happening. But we do know that some of the wholesale numbers are falling and it's a little bit more competitive. So my suspicion is that there is more price sensitivity on the retail side there. That said, if you look at June, when you look at Arizona numbers, June is where the big drop was. And coincidentally, it's targeted at June 14, was the highest on record for gas prices in the United States history. And Phoenix has had one of the higher inflationary rates in the country. So you saw that kind of coming together. And I'm just a firm believer that everything tracks off of fuel. So if fuel coming down, you're going to start to see some consumer spending come back. People have more disposable income. I don't think it goes back for quite a while, but to a better level, but we did see some increase in some sales numbers in July.

Next question comes from Neal Gilmer with Haywood.