Auxly Cannabis Group Inc. (OTCQX:CBWTF) Q2 2022 Earnings Conference Call August 15, 2022 10:00 AM ET
Company Participants
Julie Cannon – IR
Hugo Alves – CEO
Brian Schmitt – CFO
Michael Lickver – President
Conference Call Participants
Michael Freeman – Raymond James
Frederico Gomes – ATB Capital Markets
Operator
Good morning, ladies and gentlemen. My name is Michelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the Auxly Cannabis Group Q2 2022 Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session from the company’s financial analysts [Operator Instructions].
I would now like to turn the call to Julie Cannon, please go ahead.
Julie Cannon
Thank you, operator. Good morning, everyone. Thank you for joining us for Auxly Cannabis Group’s second quarter 2022 financial results conference call. A replay of this call will be archived on the Investor Relations section of Auxly’s Web site.
We will start the call with a presentation and corporate update by 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 our 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 Web site under the Investors section under presentation.
Before I turn the call over to 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 views 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 the original date of this call, and we undertake no obligation to update or revise any of these statements except as required by applicable law. Management refers to the cautionary statement and risk factors included 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.
Hugo Alves
Thanks, Julie and good morning, everyone [Technical Difficulty] our Q2 2022 earnings call. [Start] the presentation on slide five. As we have indicated throughout the year, our main goal for 2022 is to improve revenues and gross margins and achieve adjusted EBITDA profitability. Brian is going to present the financial results later in the presentation, but at a high level, we are very happy with the progress that we’ve made during the quarter towards achieving those goals. We materially grew revenue and increased gross profits. Yet, despite that growth, we were able to maintain our SG&A spending relatively flat, resulting in a 37% improvement in our adjusted EBITDA quarter over quarter. We have earned these results in an increasingly diverse and competitive market by remaining focused on product quality, innovating to meet the evolving needs of our consumers and continuing to improve our operating capabilities.
Turning to Slide 6, Q2 saw more new products launch into our market than any other time since the start of legalization, resulting in increased fragmentation and continued price compression. While this did impact our share of market across formats, we remained the number one LP in the 2.0 segment, including maintaining our number one position in vapes year to date. Our brands continue to be consumer favorites with Back Forty, in particular, continuing to garner leading shares in vapor and dried flower. And we remained among the leading licensed producers, being the sixth largest licensed producer by share of market. While we will certainly look to regain loss share over time, we’ll not chase share at the expense of profitability and what we are most encouraged by over the quarter is the increase in our revenues on a year-over-year and quarter-over-quarter basis; the significant increase in our blended gross margins to 36% as we are starting to see the margin impact of our Lemington Operations; our continued rate of innovation and the fact that we have been able to maintain our leadership in the 2.0 segment and vapor format despite maintaining our pricing over the first half of the year.
Slide 7 sets out our market share by product segment for the first half of 2022. As stated, our share has declined quarter-over-quarter, driven primarily by increased competition, continued price adjustments by many of our peers, as well as the residual impacts from last quarter’s operational supply chain challenges. In the vapor category, there has been a 65% increase in vape brands year over year and there are now 117 unique brand families and over 600 vape SKUs in market. The category is continuing to see aggressive price adjustments with the price per milligram of vapes declining 28.5% on average monthly basis since July of 2021. The vapor category is now dominated by the ultra value price tier. We saw 12 new brand families enter this ultra value price tier during Q2 alone, and ultra value sales now make up approximately 82% of total vape sales in July of 2022 as compared to just 32.5% of total sales in July of 2021. Despite those challenges and even with our competitors making significant price drops to try and win share, we still manage to capture almost 18% of the vape market during the first half of the year and remain the number one vape company in the country year to date. While we certainly acknowledge and respect all of our competitors, we are still a dominant force in the segment and are confident that we will be able to recapture loss share.
We deferred lowering price and during the quarter choosing instead to focus on implementing operational efficiencies that allow us to respond to pricing changes without material impact on our margin profiles. We are among the few companies that have a significant presence in the premium segment of vape, a segment where we have been able to maintain share through unique first to market products like our Kolab solventless vapes. And we are continuing to innovate. Our Back Forty vapor products fundamentally change the market and pave the way for many of our competitors in terms of format size, hardware and flavors. And during the back half of the year, consumers will see the next wave of innovations across all three of our brands and in particular Back Forty. In dried flower and pre-rolls, the other two key formats in our market, we also saw small share of market losses driven primarily by temporary production challenges during Q1 and early Q2 impacting product availability. This caused out of stocks on our most popular wedding pie strain in many markets during the front and middle of Q2. In the pre-roll segment, we remain capacity constrained in our pre-roll formats as we’ve waited for the arrival and commissioning of our automated equipment. And because of those constraints are slim roll pre-rolls are currently available in only four markets, Ontario, BC, Alberta and Prince Edward Island. However, like the vape format, we are encouraged by the continued traction of our brand despite these challenges, and we feel that flower and pre-rolls represent tremendous growth opportunities for Auxly.
On the flower front, the operational issues we faced early in the year are behind us and we are making tremendous progress at our Leamington facility where we have been able to increase efficiency and reduce costs. We are seeing gains in flower, output and potency, while improvements to our post harvest process have also increased overall product quality, and we are continuing to innovate. We launched Mandarin Cookies, our first sativa under the Back Forty brand during the quarter, which quickly rose to a top 20 SKU in Ontario. And you will likewise see us launch unique high potency strains under both our Back Forty and Kolab brands in the back half of the year, like our Panda Puffs strain, which we’ll launch under Back Forty later this quarter and has been testing at industry leading potencies. And we’ve also ramped up our R&D program for flower so that we have new high potency strains ready to meet the evolving needs of our consumers.
Finally, we will use the competitive advantages provided by our Leamington facility to bring high quality cannabis to the ultra value segment. This segment now makes up 35% of the category. And given our low cost high quality cultivation capabilities in Leamington, we will look to participate in a broader part of the flower segment by increasing our breadth and depth of assortment in milled flower and large format bags under a new brand targeting this price tier. And with respect to pre-rolls, further automation equipment for our slim roll format has arrived and is being commissioned during the quarter, which will increase volumes and have a positive impact on margins in Q4. We have also received automation for our infused pre-rolls, a category that saw explosive 107% growth in the quarter. The receipt of automation will allow us to increase distribution and fill rates, as well as increase the breadth of our portfolio. We have exciting new high potency strains launching under both Back Forty and Kolab brands in the 10 times 0.35 grams slim roll format, as well as innovative infused pre-rolls launching under our Back Forty brand targeting a broader range of consumers in terms of price, potency and flavors.
Moving to Slide 8. As you can see, our brands have also grown in awareness in the first half of 2022. We are committed to building lasting brands and we will continue to make investments in insights, innovation and brand developments so that we can ensure we are helping our consumers with happier lives by consistently delivering quality products at a great value under brands that they can trust and love. Back Forty, in particular, has become one of the fastest growing brands in Canada, driven by its leadership in vapor and increasing portfolio of 1.0 products. Kolab has also continued to make awareness gains by remaining focused on higher potency, true to plant premium experiences for the discerning consumer. Foray has built a consumer following by remaining focused on the needs of our novice consumers, most recently announcing the launch of Edi’s by Foray, a low dose edible that allows consumers to enjoy a great tasting edible and control their cannabis experience. Edi’s first product, a 20 pack of chews, each with 0.5 mg of THC and bursting with familiar flavors like lemon, lime, cherry and orange, will be available in stores by end of this month. And finally, we believe that our Dosecann brand remains exceptionally positioned to address the wellness consumer. Even with a very limited product portfolio, Dosecann is a leader in the topical and capsules categories because of the quality, safety and efficacy of its products. We’ve recently launched the new topical Hot & Cold cream to market and has quickly become the top selling topical in Ontario.
Turning to Slide 9. As consumer preferences continue to evolve, innovation in new products continue to drive both consumer and customer purchasing behaviors. While product life cycles vary by category and price point as many as 15% of the top selling SKUs in each category are [new] products launched within the given quarter. In the first half of this year, we launched 27 new SKUs to market and we anticipate launching another 19 new SKUs during Q3. And while you will continue to see innovation across our portfolio, such as Edi’s by Foray and the Dosecann Hot & Cold cream that I just mentioned, you will also see an increasing innovation focus on our key growth categories of vapor, dried flower and pre-rolls throughout the balance of the year as we look to leverage our Leamington capabilities, new automation equipment and the development work that we’ve done in those formats during the front half of the year, all of which we believe will help recapture lost share and support our goal of achieving adjusted EBITDA profitability in 2022.
Turning to Slide 10. I will give a brief update on how we have worked to continuously improve our operations to make processes more efficient and unlock cost savings. First, as already mentioned, further pre-roll automation will be installed and commissioned during the course of Q3. This will more than double our capacity in conventional pre-rolls and triple capacity in infused pre-rolls, and we’ll start to feel the impact of increased throughput and enhanced product margin in Q4. Through continuous improvement efforts in vape and working with our key vendors, we are driving efficiencies through vape hardware and packaging modification, to reduce COGS without impacting product quality, thereby allowing us to stay competitive in the current price environment without materially impacting margin. And we are making fantastic progress at our Leamington facility, some of which I’ve already highlighted for you during the presentation. Process improvements and increase to automation saw us achieve a 46% increase in flower output quarter-over-quarter, resulting in approximately 18,000 kilograms of cannabis grown during the quarter, which is almost as much product produced in Leamington during the entirety of 2021. We also achieved improved product specifications across the key metrics of potency, moisture, terpene expression and bud structure, and a lower cost of production program.
Finally, we have had a very successful quarter of flower innovation in Leamington where we successfully trialed 26 new genetics with tremendous results, ensuring that we have a pipeline of exciting high potency genetics ready to release to market. We feel that there are very few competitors that can grow the same quality of flower with the efficiencies that we have in place at our Leamington facility, and we plan to leverage this competitive advantage to continue building leadership in 1.0 segment, grow our revenue and improve gross profit margin. I will stop here and now turn over the presentation to our CFO, Brian Schmitt, to walk you through the financial results. Brian?
Brian Schmitt
Thank you, Hugo and good morning [Technical Difficulty] Slide 11, a snapshot of our [revenues]. We are very pleased with our revenues for the quarter as seen on the left [side]. We not only improved revenues 21% over the previous quarter, but also exceeded revenues over both quarters of 2021, resulting in a year to date improvement of 66%. On the right side of that page, Auxly reported 27.3 million net revenue in the second quarter of 2022, an increase of 31% year over year where we continue to drive significant improvements in our cannabis 1.0 sales, which accounted for approximately 40% of total revenue as we continue to leverage our Lemington facility, while also maintaining our leading position in cannabis 2.0 sales, which accounted for approximately 60% of revenues. Lastly, our revenue distribution with our three primary customers remained consistent at approximately 85%.
Turning the Slide 12. Slide 12 captures our gross profit margin, adjusted EBITDA and net losses for the quarter, all with significant improvements. The gross profit margin of 36% for the quarter was in line with the same period of 2021, however, improved sharply over recent quarters, while [reflecting] an impairment associated with legacy third party products and increased depreciation expenses totaling $2.2 million. We saw improvements in the cost of finished cannabis inventory sold, as well as the impact of Auxly Leamington’s rapidly improving cultivation cost structure and yield through bio asset transformations. Cash costs of cultivated flower from the Auxly Leamington facility has decreased by more than 50% during the first six months of the year. Subsequently, flower costs have continued to decline and are currently well below $0.50 a gram. As we continue to dial in this facility, we anticipate further gross margin tailwinds in the short term. As stated earlier, one of Auxly’s goals is to become adjusted EBITDA positive. For our present and future investors, it is worth noting that Auxly’s measure of adjusted EBITDA includes all recurring SG&A expenses, whether that entails elevated cost related to supply chain challenges, innovation or other such expenditures. As such, we are pleased to report that the current period performance improved by more than $2 million or 37% quarter over quarter, primarily as a result of increased gross profits as I previously outlined, partially offset by a slight increase in SG&A. And finally, in the second quarter of last year, Auxly reported net income of $8.7 million, driven by one time events, which included the sale of KGK and recognition of gains related to the extension of the Imperial Brands convertible debentures.
Net losses for the first quarter of this year included non-cash charges of approximately $25.7 million related to the closure of our two Auxly Annapolis cultivation facilities. The net loss for the current quarter was $14.3 million, reflecting improvements in operations and increases in depreciation and amortization and non-cash interest expense, which totaled $9.9 million. We believe we are starting to see the results of our progress across all of our business sites, including ongoing production efficiencies at our Lemington facilities of focus on further opportunities for cost reductions, some of which we’ve outlined here for you today, and improved production volumes for the remainder of the year, as recent equipment purchases enable key product category sales.
With that, I’ll turn it back over to Hugo for concluding remarks.
Hugo Alves
Thank you, Brian. Before opening the floor to Q&A, I’ll conclude by saying that we’re starting to see the pieces come together. Our operational efficiency and throughput is getting better and better, allowing for additional cost savings as we maintain our path of improving margins and reaching adjusted EBITDA profitability by end of this year. We grew our revenues 31% year over year, maintained our leadership in the 2.0 product segment and are continuing to expand our 1.0 offering by consistently adding to our product portfolio with insights driven innovations and seeing those innovations succeed in market. So we think there is a lot of reason for optimism. We continue to see strong sales momentum in Q3 and are confident that we remain on track to meet our strategic goals for 2022. As always, I want to thank you for your time and your interest in Auxly. And I’ll now turn it over to the operator to open the floor for Q&A from our [analysts].
Question-and-Answer Session
Operator
Thank you, sir [Operator Instructions]. Your first question will come from Michael Freedman of Raymond James.
Michael Freeman
My first question relates to Auxley Leamington, and this is such an important factor. It seems increasing or improving your top and bottom lines. You indicated near the end of your comments there that you had grown around 18,000 kilograms during the quarter, which placed you around 72,000 kilogram per year run rate. How would you describe, I guess, your progress in reaching full capacity? How would you describe what full capacity is for this facility, are you happy with this level of output? And then where would you say the focus is of improving operations at Leamington lie right now?
Hugo Alves
So I think in terms of the utilization rate, we are at around 77% at the facility. But as indicated, we’re seeing kind of record yields at the facility right now. So that’s really kind of negated the need for us to turn on more capacity there. But as our sales increase, we think that we will use that capacity. We are also in the process of attaining a couple of — certification, which would allow us then to also explore export opportunities to higher margin medical markets. So I don’t know if that answers your question, but we are at around 77% utilization. We think that we have more than enough capacity there to service our portfolio and the growth of our portfolio, and allow for us to explore some other higher margin opportunities.
Michael Freeman
My next question is on your top line. It was — compared to our estimates, this was a great big reach and we are not always perfect on our estimates, but this wasn’t surprised to the positive. Was there — do you engage in any wholesale sales of your products and was that a factor in this year’s — this quarter’s rev beat?
Hugo Alves
We are only B2C, so we don’t engage in B2B sales at this time.
Michael Freeman
And if I could squeeze one more in. We’ve seen some — we’ve seen you guys do some consolidation in your — among your facilities and finding efficiencies there. I guess moving operations to Leamington and having [fast] plus to your Charlottetown facility be your [course]. Should we expect any further reshuffling or the further efficiencies that could be gained through consolidation?
Michael Lickver
As we continue to prioritize reaching adjusted EBITDA profitability, you’ve heard time and time again today and in previous quarters that that is the goal. We’ll absolutely continue to look for efficiencies throughout the entire Auxly value chain, and part of that ongoing analysis will include an evaluation of all of our current assets.
Operator
[Operator Instructions] Your next question will come from Frederico Gomes of ATB Capital Markets.
Frederico Gomes
I guess my first one is on your market share. So seems like, as you mentioned, you have been losing ground there over the past six months or so. You know, maybe could you help us, I understand that your pricing strategy you’re trying not to compete heavily on price and some LPs are. But could you help us identify, you know, what sort of tangible steps you’re working on right now to reverse course and you know start regaining some of that share? Is it about improving your cost of production to potentially reduce some of your prices, or are you seeing any sort of alleviation of competition in the market for some categories? So any color there would be helpful.
Hugo Alves
I’ll start there. So I think we’re heavily focused on our product quality, always have been. We think we have among the highest quality products in the market, including in the vapor category. And as we’ve outlined consistently through an insights driven innovation philosophy of being able to meet the evolving needs of consumers in a dynamic market where to a large extent consumers are still trialing all of the new products that come into market every single quarter. So we will always look to offer our consumers superior value at any price point, driven by a combination of product quality, brand consistency, ease of access and price. So we have focused really, really hard on the front half of the year on implementing operational efficiencies that will allow us to be competitive in any price environment including in vapor. So I think we’ll start to see the impact of those changes in our vape pricing in Q3.
We have also seen a fundamental shift in the market in terms of overall pricing, as I mentioned, the ultra value tier continues to grow, which is — shouldn’t be entirely surprising in the inflationary environment that we’re operating in. So we will also look to address that that tier of the market by leveraging the competitive advantage that we feel we have in Leamington in terms of our scale, quality and cost structure. Whereas in — and then in the back half of the year, we’ve been busy in the lab in the front half coming up with the next wave of innovations in our key growth categories. And I think you’ll start to see those roll out in the back half of the year. And we feel very confident in the performance of those innovations based on the traction that our innovations get in market with every release. So I hope that addresses your question. Mike, Brian, I don’t know if you have further to add, but…
Frederico Gomes
So any update on Quebec and starting sales in Quebec?
Mike Lickver
No. No material update. We continue to consider all options and try and work with the SQDC. Unfortunately, it’s still a restrictive environment and outside of servicing Quebec consumers through medical channels, which we continue to do. Our objective is to continue to meet with SQDC to understand how we can bring value to their assortment, but no material update.
Frederico Gomes
And maybe just a last one for me, on your capital position. Good job managing your cash use this quarter, especially through working capital. So could you maybe talk about your CapEx needs for the reminder of the year, both in terms of growth, CapEx, as well as maintenance?
Brian Schmitt
We updated the MD&A slightly in terms of total CapEx for the year, the range is $7.5 million to $10 million. We have spent just under $5 million through June and then the CapEx is obviously highly focused on the cannabis 1.0 space, both in equipment and outfitting Lemington as applicable.
Operator
Ladies and gentlemen, as there are no further questions, this will conclude your conference call for this morning. We would like to thank everyone for their participation, and ask you to please disconnect your lines.
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