Auxly Cannabis Group Inc. (OTCQX:CBWTF) Q3 2022 Results Conference Call November 14, 2022 10:00 AM ET
Company Participants
Hugo Alves – Co-Founder and Chief Executive Officer
Brian Schmitt – Chief Financial Officer
Michael Lickver – Co-Founder and President
Conference Call Participants
Frederico Gomes – ATB Capital Markets
Michael Freeman – Raymond James
Operator
Good morning. My name is Julie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Auxly Cannabis Group Q3 2022 Earnings Results 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]. Thank you.
Mr. Brian Schmitt, you may begin your conference.
Brian Schmitt
Thank you, operator and good morning, everyone. Thank you for joining us for Auxly Cannabis Group’s third quarter 2022 financial results conference call. A replay of this call will be archived on the Investor Relations section of Auxly’s website.
Joining us today will be Hugo Alves, CEO; Mike Lickver, President and myself Brian Schmitt, CFO. I encourage you to follow along with the presentation slides, which are posted on our website under the Investor Relations section under presentation. We are currently having some technical issue, so bear with us, but we are looking to get that post as quickly as possible.
Before I turn the call over to Hugo, I would like to remind everyone that our discussion today includes forward-looking statements that are based upon assumptions that are subject to risks and uncertainties that could cause actual assumption 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 to 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 you 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 will turn it over to our CEO, Hugo Alves.
Hugo Alves
Thanks, Brian and good morning everyone and welcome to our third quarter 2022 earnings call. Let’s start the presentation on Slide 5. And 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 experienced a temporary setback during the quarter. While we maintained our cash base margins during the quarter, we have lower than expected revenues. We were impacted by some external factors and the gradual decline of vape share of market over the past 12-months primarily due to pricing competition.
While we were able to lower SG&A by 10% during the quarter of 1.3 million, we are still busy working in that regard. We have made a number of changes that we believe will earn improved results in an increasingly diverse and competitive market by remaining focused on product quality, continuing to innovate to meet the evolving needs of our consumers, and continuing to improve our operating capabilities.
In line with a rapidly changing industry, we are constantly evaluating and balancing our portfolio with the demands and needs of our consumers and during the quarter, we took steps to optimize our portfolio by streamlining certain cannabis 2.0 products as part of a SKU rationalization process to focus the portfolio on consumer favorites while improving gross profit.
Moving to Slide 6, the top three categories of flower, vape and pre-rolls now account for 85.2% of total recreational sales. With vape slightly declining in gains in pre-rolls coming at the expense of flower, but combined flower and pre-rolls still represents 70% of all sales in Canada.
Vape has been flat as a category and has seen a 48% price compression on average price per milligram year-to-date. As we stated last quarter, we have continued to see significant growth within the ultra value segment in vape with over 40% of brands now participating at this lower price tier.
While this did impact our share of market in vape, we only took moderate pricing reductions in vape during the quarter. Pricing reductions across the industry began around this time last year and prior to our recent change, we were at a premium to most competitors by between 13% to 33% based on OCS retail pricing.
Our brands continue to be consumer favorites with Back Forty and Kolab project and Foray being top three vape brands year-to-date, and we defended our number one spot in 2.0 products.
While we will certainly look to regain lost vape share over time, we will not chase share at the expense of profitability.
And what we are most encouraged by over the quarter is the increasing strength of our flower portfolio. Despite some challenges with lower potency product that was sold through at the end of the second quarter. We took pricing action on vape products as one of the last LPs to do so. However, this was following further cost savings implemented to ensure margin stability which includes a reduction in our hardware pricing and optimization of our packaging.
The continued low cost performance of Auxly Leamington as we look to significantly increased flower and pre-roll sales in these two must win categories. And the fact that we have been able to maintain a leadership position in the 2.0 segment despite maintaining our pricing over the first eight-months of the year and still remain the number six LP in the market.
Turning to Slide 7. As consumer preferences continue to evolve innovation and new products continue to drive both consumer and customer purchasing behaviors. While products life cycles vary by category and price points as many as 15% of top selling SKUs in each category our new products launched within the given category.
For the year, we will have launched 60 exciting new SKUs to market with over half of them coming during the second half of this year. While many of our innovations in the first half of 2022, we are focused on a broad range of products across all categories, you will see the majority of our innovation focus across the second half of the year is in our key growth categories of dried flower infused and unfreeze pre-rolls and vapor products.
As we look to leverage our Leamington capabilities, new automation equipment, and all the development work that we have done in these formats during the front half of the year, including selecting several unique and higher THC potency genetics to expand our flower and pre-roll portfolio and the development of new infused pre-roll flavors.
Moving to Slide 8. You can see an overview of our well rounded brand portfolio addressing various consumer segments, product formats and price points. To add to our award winning portfolio of brands, we are launching our newest brand Parcel that will participate in the ultra value price segment which makes up approximately 34% of the flower category today.
With a focus on dried flower, Parcel will launch with two dried flower and two mil flower SKUs with high THC potencies and unique flavors designed in line with evolving consumer preferences. Leveraging Auxly Leamington, we can bring high quality strain specific flower to consumers at a great value every day.
Back Forty continues to be our largest brand in the market with distribution in only over 90% of retail stores consistently ranking among the top brands in Canada where we are a leader in flower pre-rolls and vape products.
We will continue to grow the strength of the brand by delighting consumers with new and exciting additions to portfolio including our new high potency bold flavored vapes launching in Q4 and our newly launched infuse pre rolls which derive their flavor profiles from our top selling vapes, which consumers have shown us repeatedly that they love and trust such as our Cushman is the number one selling vape cart in Canada.
Kolab continues to round out our portfolio with a more premium offering and experience across the dried flower vape and pre-roll segments, a consistent consumer favorite Kolab has been one of Canada’s most innovative brands to-date, bringing many first to launch products, including the first one gram vape card, and live resin edibles.
Kolab will continue to participate in the premium segment with additions to flower and pre-roll SKUs in the second half of the year, and the first-to-market launch with Canada’s first ever blunt flavored vapes launching include Q4, with Honey Bourbon and Banana Blunt with elevated potencies and best-in-class hardware.
Turning to Slide 9. Auxly Leamington provides us with a strong competitive advantage by producing high quality, low cost cannabis at scale. There are few competitors that are growing the same quality of flower with the efficiencies that we have in place at our Leamington facility and we plan to leverage this advantage to continue building to leadership in dried flower and previously-roll segments and improve our overall gross profit margin.
Since taking over the Auxly Leamington facility last year, we have been focused on three core objectives. Improving product quality, reducing production costs and diversifying product portfolio and we are pleased that our efforts are showing impressive results as we have continued to see improvements in our product quality through potency, moisture and trim improvements.
Our year-to-date flower production costs are over 50% lower compared to 2021 by making significant changes such as improvements to our nutrient and fertigation programs, ramping up production capacity, and executing on multiple operational efficiency projects across the facility.
We have successfully trialed exciting new genetics over the course of the year and expanded our commercial production from three to seven strains and we are constantly testing and trialing new cultivars from our large genetic library with the goal of leading dried flower innovation in market.
We are excited for consumers to try the new cultivars, the majority of which will be shipped to market in Q4 and include Panda Puff, Banana OG, and Apple Fritter. All of which will add to our Back Forty flower and pre-roll lines and Mint Cream Pie, which we will launch under our Kolab brand.
Turning to Slide 7. We have previously spoken of our plans to further increase production capacity, as well as ramp up our premium roll automation and the several manufacture related delays that we have experienced to-date.
We have now installed and commissioned our second pre-roll maker and Auxly Leamington with one more larger scale units scheduled to arrive in Leamington in the back half of 2023. This second pre-roll maker will double our capacity in pre-rolls in short order and we will start to feel the impact of increased throughput and enhanced product margins in Q4.
We are pleased to announce that we are in the final phases of completing the commissioning of our pre-roll packaging automation. We have been working closely with our manufacturer since accepting delivery of the equipment earlier in the year.
And while we are disappointed in the length of time this process has taken. We are close to the finish line in reaching fully automated pre-roll packaging, a competitive advantage that we believe will be difficult to replicate from any of our peers.
We have also more than doubled our bagged flower capacity with the addition of a second flower packer, which has already been commissioned and is ready for commercial production to support our new flower offerings.
I’m going to stop there and now turn over the presentation to our CFO, Brian Schmitt to walk you through the financial results. Brian.
Brian Schmitt
Thank you, Hugo. I will start by providing a quick snapshot of revenues with further details related to the quarter. Revenues for the quarter were $19.8 million, which were lower than anticipated, in part due to the temporary impacts of reduced orders from two of our largest customers Ontario and British Columbia, as they work through their respective data security and labor issues. And by a one week closure of Auxly Charlottetown due to Hurricane Fiona.
In addition, revenues were impacted by lower vape orders falling price reduction notifications delivered during the quarter. And fewer dried flower reorders, while lower potency dried flower sold during the second quarter was being depleted.
On the right side of the page Auxly reported $69.8 million in net revenue year-to-date, an increase of 28% year-over-year and we continue to benefit from improvements in cannabis 1.0 sales and continued leadership [2.0](Ph) products.
During the third quarter headwinds previously noted. Sale of flower for products accounted for approximately 36% of net revenue down by 4% from second quarter. Lastly, our revenue distribution with the three primary customers remained consistent at approximately 85%.
The next page captures several key financial metrics of the company. Gross profit margin, which includes non-cash impairments and fair value adjustments was lower in the quarter, primarily due to the net – the change in net fair value gains and losses on unrealized and realized biological assets and inventories.
During the second quarter net fair value gains were $4.8 million, whereas this quarter they were negative $0.7 million. We recorded $2 million in impairments during the current period primarily a result of SKU rationalization and products not meeting quality specifications.
Table below, cost of finished cannabis inventory sold margin tells a different picture. This includes depreciation but excludes non-cash items. From this chart, you can see a steady increase in margin to 25% over the last two quarters, this quarter being impacted by lower firearm sales, meaning less of the Auxly Leamington low cost benefit was captured this period. It should be noted without depreciation, the adjusted margin would have increased to approximately 28%.
The middle section of the slide shows progress in the reduction of SG&A to $11.6 million in the third quarter, from $12.9 million last quarter, with reductions in several categories including selling expenses, professional fees, wages and office expenses.
These reductions partially offset lower sales for the period resulting in adjusted EBITDA of negative $5.8 million, which was lower than the second quarter however an improvement over the remaining quarters.
Turning to net losses for the period, the company determined the existence of impairment indicators which resulted in the assessment that the carrying value is exceeded the recoverable amounts by $45 million. As a result, the company wrote off goodwill balance of $24.8 million, with the remaining $20.2 million allocated to other assets of the company based on their carrying amounts.
Despite recent higher non-cash net losses associated with the sale of Auxly Annapolis facilities in Q1 and the current period impairment, cash use in operating activities has shown significant improvement, with positive results in the second quarter and net cash usage of $2.9 million in the current quarter contributing to a year-to-date usage of $8.2 million.
Lastly, we believe the factors impacting revenues in the third quarter behind us and that our new product offerings and enhancements coupled with increased capacity being implemented in this quarter will help us improve revenues while maintaining margins. We are leveraging Auxly Leamington and look to make further substantial progress in sales of flower and pre-roll products to account for approximately 70% of new sales.
With that, I will turn it back over to Hugo for concluding remarks.
Hugo Alves
Thank you Brian. To summarize, Q3 was a challenging quarter for the company. Amongst difficult competition, we remain the sixth largest licensed producer in market share and continue to defend our number one spot and 2.0 products.
We continue to demonstrate success with insights driven innovation and are focused on winning in our three key categories of dried flower pre-rolls and vapes by engaging our consumers and expanding distribution and market share.
With Auxly Leamington’s cultivation capacity, automation and improved product quality, we will continue to leverage the economies of scale and expect to see continual improvement in our bottom line.
I will now turn it back over to the operator for questions from our analysts. Thank you.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Your first question comes from Frederico Gomes from ATB Capital Markets. Please go ahead.
Frederico Gomes
My first question is just when you are pricing adjustments, so maybe could you provide more color on that what sort of impact you expect that you have in Q4, both in terms of volume and margins? What are you seeing so far this quarter is that having a positive resonate with consumers so far? So any color there will be helpful. Thank you.
Michael Lickver
Hi Frederico this is Mike, thank you for your question. We worked pretty diligently over the first nine-months of the year to find ways to improve our margins in the vape category by finding reductions in hardware, optimizing our packaging, so really preparing ourselves for the continued price compression.
To answer your question, we did end up taking price, it would have impacted near the end of September. So we do expect to see some momentum and an uptick throughout Q4 as retailers would have been able to pull the revised pricing and near the end of the third quarter.
Frederico Gomes
And then, in terms of your flower, on the flower segment, you mentioned that the potency see for some of your products sold in the previous quarters kind of impacted sales in Q3. So could you talk about the cultivation in Leamington right now the potency that you are getting there currently and how are you seeing the ramp up there? Thank you.
Michael Lickver
So we did have a few challenges throughout the quarter where the market has shifted and potencies are going higher and higher, we see it with amongst all the competition. So we took measures to improve our potency. We have been able to do that with an average of around 15% across that category, so call it 2% to 4% in potency across all of our streams.
The range on a go forward basis with respect to cultivation of the Leamington, we are seeing anywhere from a 20% all the way to some strains coming in at over 30% now. So we are very encouraged by the improved quality and our ability to get potency up throughout the quarter. You will start seeing those improved potency strains hit the market in early fourth quarter.
Frederico Gomes
Okay, and then my final question this on your SKU portfolio. So you mentioned that you are doing some rationalization there and outsourcing some of it. Could you give us some more color on specific categories where, you believe outsourcing makes more sense and how does that impact your capacity utilization in those again? Thank you.
Michael Lickver
We look at all categories on the manufacturing side in terms of what could make sense to outsource. I would say there is a specific focus on 2.0 products. And when we are looking at utilization rates for outsourcing, we are going to ensure that if we select a product to outsource that we would avoid any impact to the overall utilization rate. So it’s something we are continuing to monitor and look at to-date. We have successfully outsourced three SKUs as a trial and we have not seen an impact to the Charlottetown utilization rates.
Frederico Gomes
Thank you. I will hop back in the queue.
Operator
[Operator Instructions] Your next question comes from Michael Freeman from Raymond James. Please go ahead.
Michael Freeman
Good morning, Hugo, Brian and Mike, thanks very much for taking your questions today. My first question is on the pre-roll production infrastructure that you folks have been expanding recently. You mentioned that the new high throughput equipment was installed and commissioned and should impact fourth quarter sales. You were also talking about pre-roll packaging machines. I’m wondering if the combination of the quality improvements and cultivation, the install of the pre-roll manufacturing machine and its packaging machine are all lined up such that fourth quarter could see a large increase in pre-roll sales. Thanks.
Michael Lickver
Thanks, Michael. Mike, here again. Thanks for that question and the answer is yes, we should start to see that coming through in the fourth quarter here. We certainly will have additional production capacity, as we are sitting here today.
Michael Freeman
Okay. And will this – do you think this will span the entirety of the fourth quarter, will it be a partial quarter of this capacity increase?
Michael Lickver
I would say partial.
Michael Freeman
Okay. Now, with expanding pre-roll sales and hopefully flower sales in the fourth quarter, I’m wondering if we can reflect on the EBITDA positivity any targets aimed at fourth quarters still. I’m wondering what needs to happen during the fourth quarter in order for Auxly to hit positive EBITDA reflecting on revenue levels that that you might target for this?
Brian Schmitt
Hi Michael, it is Brian. It certainly remains our primary goal to be adjusted EBITDA positive. However, the focus is on improving sales velocity is our top priority. And historically, the fourth quarter has been most favorable quarter and we are optimistic about those trends for a lot of the reasons that we talked about on the call with respect to, we have the new innovations, pre-roll in flower, SKUs coming online here in the fourth quarter.
And we have some of the external factors from the third quarter being two of our three largest customers, issues behind us as well as Hurricane Fiona. So, we are optimistic that the revenue will increase materially.
And then we continue to work on reducing our production expenses and SG&A. So we have seen a downtick in SG&A, we continue to manage that. And as Mike spoke to, we have reduced operating costs going forward. So we look to improve our gross margins as well. So it is really those three things in concert with that we are targeting.
Michael Freeman
Okay, thanks Brian. And is there a revenue range that would give you a good chance of landing EBITDA positive in the next quarter?
Brian Schmitt
Yes, I think and we have indicated before, we are making significant strides in gross margin, particularly as we sell more flower. So again, our innovations for this back half of the year are predominantly focused on flower, pre-roll and some vape enhancements in our SKUs.
So we are very confident that we can increase the revenue and consequently then increase our margins, in terms of revenue we are targeting high-20s, low-30s to be the sweet spot here in the short-term.
Michael Freeman
Okay thank you very much. If you indulge just one more question. Wondering about Auxly Leamington winning at home being Canada right now. Looking at the where you distribute products, seeing that Quebec remain sort of unaccepted. Wonder, if you are further evolved views or plans to access the Quebec market? Thanks.
Michael Lickver
Hey Michael, Mike again here. Continue to find avenues into that province. One of the ways we have been able to affect some progress early in the fourth quarter here is by effecting our first B2B transaction into the province.
Effectively marking the first revenue and first gram sold into the province through B2B transaction. Outside of that, we continue to submit for every SQDC product call and build a relationship with them and continue to try and get in from all different avenues.
Michael Freeman
Okay. Extremely helpful. I will pass it on. Thanks.
Operator
Presenters there are no further questions at this time. Please proceed.
Brian Schmitt
Thank you for your attendance at our call today. We apologize for the delay in getting the deck up it is up now. So we again apologize for that. Thank you for all and we look forward to speaking to you again at our year-end results sometime in March of 2023. Thank you very much.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for joining and ask that you please disconnect your line. Thank you.
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