Medipharm Labs Corp

TSX:LABS

Earnings Call Transcript

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the MediPharm Labs 2022 Second Quarter Financial Results Conference Call. Please be advised that today's conference is being recorded.

Before we begin, please note the following caution respecting forward-looking statements which is made on behalf of MediPharm Labs and all its representatives on this call. The statements made on this call will contain forward-looking information that involve risks and uncertainties. Actual results could differ materially from a conclusion, forecast or projections in the forward-looking information. Certain material factors or assumptions were applied in drawing a conclusion or making a forecast or projection as reflected in the forward-looking information.

Additional information about the material factors that could cause actual results to differ materially from the conclusions, forecasts or projections in the forward-looking information and the material factors or assumptions that were applied in drawing a conclusion or making a forecast or projection as reflected in the forward-looking information are contained in MediPharm Lab's filings with the Canadian and provincial security regulators, which are available on the SEDAR website at sedar.com.

I will now pass the call to David Pidduck, CEO of MediPharm. Please go ahead.

[David Pidduck, executive]

Thank you, operator, and good morning, everyone. We appreciate you joining us for MediPharm Labs 2022 Financial Results Conference Call. Joining me on the call today are Keith Strachan, MediPharm's President; and Greg Hunter, the company's Chief Financial Officer.

I will address some of our strategic achievements and growth opportunities and then hand the call over to Keith and Greg to provide more detail on the quarterly results.

I joined MediPharm in April from the pharma industry because I recognized the significant emerging opportunity for pharmaceuticals containing cannabinoids and identified MediPharm as the most pharma-like organization in the industry. As a team, we are relentlessly focused on driving revenue with our established platform both organically and through selective opportunistic M&A activity.

In tandem with this commitment to revenue growth, we are executing against several priorities to optimize the business and ensure that revenue is profitable. For the mid- to long term, we continue to invest in new pharma opportunities. Our priorities include rightsizing and better utilizing our manufacturing footprint, eliminating unnecessary head count and making continued progress on some key business fundamentals. We need to improve margins and pricing on certain products, renegotiate or exit certain contracts and continue making progress on working capital, inventory and cash management and maintain balance sheet strength. I'm happy to say that the team has made progress on all of these initiatives over the past few months.

Regarding our manufacturing footprint, we recently announced the sale of MediPharm Labs Australia. While the Australian facility was serving the local Australian market as well as the EU given the capacity available in Canada as well as the recent receipt of a GMP drug establishment license at our Canadian site, it made most sense to serve all jurisdictions from Canada at this stage. The sale is expected to close in the next 60 days with proceeds of at least AUD 6.9 million.

In addition to the cash injection, this change will provide annual savings of approximately $4 million annually. We also addressed the difficult challenge of rightsizing our head count. We had 2 key objectives with the restructuring. One was to treat our excellent employees with care and respect as they transition out of the organization. The second was to ensure that as we made changes, we retain the critical resources and talent required to fuel our growth plan. With this in mind, we have implemented head count reductions of more than 30% of salary employees. Changes were made across all departments and all levels, including VPs and managers, and should be fully implemented by Q4. We anticipate that these reductions will result in annualized savings of over $3 million starting in Q3 of this year.

There are also several incremental but important items that the team is starting to address within the organization, starting with a focus on gross margin. We are committed to ensuring that incremental sales are gross margin accretive, and we are not willing to generate volume for volume's sake. In Q2, there were cases where we sacrificed short-term top line results in order to maintain our margins. The finance team has already done a good job of bringing rigor to the cash management cycle, and we will continue to focus on inventory and receivables and carefully analyzing cash cycle time lines from production through collection.

We hope to see additional positive results from these efforts in early 2023. Given our balance sheet strength, we see the opportunity to execute accretive and opportunistic M&A in the current environment that builds on MediPharm's unique capabilities in the pharma, global and Canadian business segments. We will be very prudent both with our balance sheet and with our stock as we actively look for deals that would build on our strengths while driving returns for shareholders.

The recent acquisition of IP from Shelter Cannabis is an example of a creative deal that can be accretive for shareholders. We have manufacturing capacity, people, established channels and a sales pipeline that we can use to seamlessly leverage the right transaction and use it to drive us closer to profitability. Our balance sheet strength gives us an edge in the current market compared to many smaller players.

Turning to the larger strategic growth opportunity. In an industry that is still trying to find its seat, MediPharm knows exactly where its foundation is. As an earlier mover in the cannabis space with access to capital, MediPharm put resources into being a standout, high-quality producer with a portfolio of domestic and international licenses. And some of our peers were out buying facilities, they would later close or companies that are now being written off, we saw a path to success by investing in our core strength, securing licenses and building processes in preparation to be one of the very few players who can compete and win in the pharma cannabinoid space and the natural health products wellness space where GMP level quality is a must.

Many companies are now seeing that the need for GMP facilities, but they are also realizing that transitioning an existing cannabis facility to a GMP facility is extremely expensive, difficult time-consuming and often not practical.

On the international medical cannabis front, our multiyear head start has given us access to markets like Europe, Australia and Brazil. In the world of research, we are becoming the go-to partner fully funded clinical trial. And in the pharma space, we are creating relationships to provide API and finished dose formats for future marketable drug products.

In Canada, many of you will the government-appointed Science Advisory Committee has just released a number of recommendations in relation to over-the-counter CBD health products. This committee recognizes the current Food and Drug Act has the framework to regulate nonprescription and natural health products containing CBD.

The MediPharm Dell and natural health products GMP licenses and award-winning CBD product portfolio make us the only purpose-built cannabis facility ready to participate in this market. Today, this report if implemented, could put CBD in the Canadian natural health products market. While the final recommendations and the time lines for implementation are unclear, we believe that MediPharm is already uniquely positioned to supply a full portfolio of NHP and GMP-compliant products.

In the U.S., where new marketable drugs are approved by the FDA in both new novel and generic formats. Manufacturers will need GMP API for mass production. The only FDA CBD approved drug today, Epidiolex is made with a naturally sourced API. MediPharm is 1 of only 2 commercial-scale natural extractors in North America. We had a natural CBD API drug master file. Epidiolex alone is a $900 million a year drug. Our R&D team has been working over several years to allow us to participate as a potential API supplier to this market.

In Germany, the current coalition government has made cannabis legalization a key priority. With a population of over 90 million, this will create a new wellness segment for nonsmokable formats. The long tail opportunity in Germany was further validated as we saw one of the largest cannabis companies in the world, purely make another acquisition in the EU last week. For MediPharm, we are already in Germany and have been selling medical cannabis products there since February 2021. Their health authority has accepted our GMP license for imports, and we had 12 extract products registered in their medical program with 4 new products launching by year-end.

According to Prohibition Partners, extracts accounted for 35% of German medical cannabis sales by April 2021. These are just some examples of opportunities on the horizon. The future for global opportunities requires stricter quality GMP expertise and processes, newer countries that start with only medical cannabis usually have very stringent approval processes. We are proud of our ability to get approvals in countries like Brazil, where we have been approved, and we'll be launching 2 products starting in Q3 of this year.

As the global cannabis market evolves, MediPharm's GMP and pharma approach provide unique advantages to accessing new global medical and wellness cannabis opportunities.

I will now pass the call over to Keith.

[Keith Strachan, executive]

Thanks, David. In Q2, while we saw overall sales results were challenging, we continue to see improvements in adjusted gross margins as we shift our mix in Canada towards B2C sales and away from B2B [ in total ]. MediPharm also continues to maintain its leadership in the Canadian wellness space.

In Q2, we were the #2 producer in the oil category nationally, with a 12% market share which actually jumped to 15% in the month of July. The category leader has a 40% market share, so there's still lots of room to grow. This is an area where we can win given our quality, expertise and differentiated product lines. Our award-winning oil portfolio and the rest of our product portfolio is driven by innovation which continues with our recent launch of a 30-pack of CBD, CBN soft chews, a rechargeable disposable vape and a 3 cartridge-based variety pack.

So far, in 2022, we have launched 14 new unique SKUs, which is a 75% increase over the same time period in 2021. Our entry into domestic flower offering under the acquired Shelter brand was delayed slightly with deliveries going out mid-May instead of April. Early indicators show solid demand in both the flower and pre-roll products. But with only 5 weeks of sales in Q2, we will provide a full breakdown of this product line performance following Q3.

In Q2, international revenue was down compared to Q1, but we continue to make strong progress. Revenue from international will remain lumpy quarter-to-quarter until the business is at scale. Our main customers continue to see consistent growth, and we anticipate delivering then large replenishment orders in the back half of 2022.

In Brazil, with the medical cannabis market is estimated to be worth $110 million by 2025, MediPharm is set up for success. In 2022, we have completed the very difficult product authorization process for 2 SKUs. We are currently the only Canadian producer to successfully complete this process.

In Q2, we received our first commercial purchase orders and import authorization for Brazil totaling over $500,000, which we expect to ship in the second half of 2022. Further orders will follow as we register additional products and complete replenishment.

In the U.K., we have completed delivery for third-party customer branded sales, but we are also launching a MediPharm brand in this medical market. Expanding our brand beyond Canada into the U.K. will enable us to leverage attributes like ongoing research, stability and brand recognition. This will optimize our success in a market that is estimated to be worth almost $600 million for 2025. We have already set up our supply chain in the country complete with product registration and will begin first branded exports in the second half of this year.

Our unique positioning in the Canadian domestic wellness, international medical and pharmaceutical markets will enable MediPharm to scale rapidly without the need for additional capital, licenses or resources. We have made the investments, and we are focused on filling the sales pipeline.

I'll now pass the call to Greg to discuss MediPharm's financials. Greg?

[Greg Hunter, executive]

Thanks, Keith, and good morning, everyone. In our first quarter earnings call, we discussed the importance of growing our revenue base through organic and inorganic initiatives, reducing cash burn and driving towards profitability as top priorities. I'm pleased to report we made progress on these initiatives in Q2.

As David noted, in June, we implemented a restructuring plan that will see a reduction in the Canadian nonmanufacturing head count by 30%. This initiative will save over $3 million on an annualized basis starting in late Q3. In addition, we entered into an agreement to sell our Australian facility for a minimum of AUD 6.9 million or approximately CAD 6.2 million based on the latest exchange rate.

This transaction will have several key benefits: One, it will reduce our annual operating expense by $4 million; two, it will consolidate our global supply chain and production capabilities into our GMP facility in Barrie to drive further efficiencies; and three, it will strengthen our balance sheet with additional cash to continue to execute upon our strategy. The Canadian restructuring plant and the sale of our Australian facility will save at least $7 million on an annualized basis once complete.

Revenue for the second quarter was $4.4 million. Although overall revenue was down sequentially, our Canadian domestic sales initiatives are showing progress. Q2 revenue in the provincial sales channel grew 12% on a sequential basis and 50% on a year-to-date basis as sales increased to $2.8 million in Q2 and $5.3 million on a year-to-date basis. This growth is driven by our new and innovative products containing novel cannabinoids such as CBN and CBG and the launch of our Shelter brand in May 2022.

Turning to the P&L performance for the second quarter. Q2 revenues decreased sequentially from $4.9 million in Q1 to $4.4 million in Q2. Canadian domestic revenues of $3 million in Q2 were consistent with Q1. Within this segment, our provincial sales increased sequentially from $2.5 million in Q1 to $2.8 million in Q2, driven by new and innovative products and the launch of Shelter brands. However, as we continue to transform our business to end products, this growth was offset by a reduction in our tolling and B2B business.

Looking at international revenue components for the quarter. International revenues for Q2 were $1.3 million, which was lower than Q1 as we continue to see lumpiness in the international business as discussed in prior quarters. Australian revenue of $0.6 million in Q2 was consistent with Q1. German revenues were $0.6 million, which was lower than Q1, driven by variability in the flower business. Formulated oil shipments to Germany increased 40% in Q2 relative to Q1 but was more than offset by the flower decline.

International revenues represented 30% of total revenues in Q2 versus 39% of revenues in Q1. As discussed previously, international revenues will fluctuate as the market matures. We are confident international revenues will continue to grow with our sales and marketing investments in existing markets and with our expansion into new markets such as Brazil.

Gross profit for Q2 was negative $0.5 million compared to Q1 gross profit of negative $0.4 million. Gross profit in Q2 was impacted by severance or restructuring and a write-down of selected inventory. Adjusting for these items, gross profit improved sequentially from negative $0.4 million in Q1 to negative $0.1 million in Q2. While still negative, this is the fourth straight quarter of sequential improvement.

General and administrative expenses in the quarter decreased sequentially from $4.9 million in Q1 to $4.8 million in Q2. Q2 included severance for restructuring of $0.8 million, while Q1 included $0.4 million. Adjusting for severance, general and administrative expense declined $0.5 million.

Marketing and selling and R&D expense in Q2 of $1.6 million and $0.3 million, respectively, were consistent with Q1. These investments will vary as we selectively allocate resources to advance our capabilities and product portfolio with a vision to become one of the most sophisticated cannabinoid producers in the world and capture a sustainable portion of the global cannabinoid medical and pharmaceutical markets.

Other operating expense of $1.4 million was driven by noncash unrealized foreign exchange loss on intercompany loans to our Australian subsidiary. Adjusted EBITDA for Q2 was negative $6.3 million, which was impacted by $1.3 million from unrealized foreign exchange loss on intercompany loans to our Australian subsidiary, as previously noted. Excluding this item, adjusted EBITDA would have been negative $5 million, which is an improvement versus Q1.

Moving to a few notable items on the balance sheet. Trade and other receivables declined slightly from $14.9 million at Q1 to $14.8 million at Q2. As discussed in previous quarters, there is one large customer owing a total of approximately $8.5 million at the end of Q2, which is subject to legal proceedings. As previously disclosed, during Q2, we received a favorable summary judgment with respect to this legal proceeding awarding MediPharm $9.8 million. This is a positive outcome for MediPharm, but there is still work to be done to collect this cash. Adjusting for this one customer, trade and other receivables is $6.3 million. Our cash balance on June 30 was $22 million, which decreased from $28.3 million at March 31.

Closing the sale of our Australian facility and collecting the summary judgment award could add an additional $16 million in cash to further support our strategy execution.

With that, I'll turn it over to the operator to open the line for questions.

[Operator]

[Operator Instructions] And the first question comes from the line of Aaron Grey with Alliance Global Partners.

[Unknown Analyst]

This is [ Remy Smith ] on for Aaron Grey. So kind of focusing back on Germany. I know you mentioned a little bit about the -- driven by variability in flower. But speaking to that decline, can you speak a little bit more to the dynamics with regards to product availability and started sales force? And also going off of that, while we understand you have a medical focus, how best do you think about Labs capitalizing on the potential adult-use opportunities in Germany upon legalization?

[Keith Strachan, executive]

Sure. It's Keith. Thanks for the question. Thanks for calling in. I think -- so a couple of things just on Germany. So we did see quarter-over-quarter decline, although we are seeing some good demand signals there. We actually have been working through some of the existing inventory that some of our partners have just to get them to have fresh inventory to get that out to patients. So some of that cleanup happened in the quarter which would have seen less deliveries go over. We'll see that kind of come back in the back half of this year as we give those customers' replenishment orders.

You mentioned [ that of themselves ], if you look at the insight data out of Germany, they are progressing month-over-month. So every month is better than the month before. So that's a really good sign as they're exclusive provider of cannabis products, as they grow, we grow, and we're really excited to participate in that.

So although, as Greg mentioned, until we get to scale in that country, there will be some lumpiness quarter-over-quarter. There is some great demand signals, and we're looking forward to showing that to the financial results.

Looking at recreational cannabis in Germany. We are really excited that the coalition government has taken on legalization as one of their priorities. Obviously, in the EU to run through the legislation process in that, we expect it to take some time. So we are cautious to make really concrete plans on how we're going to participate in that and how we see that legislation. But we are in the country now. I think that's important to note. So we've been there since 2021. We know the regulators well. We know our regional and state regulators well and supply chain well.

We do deliver to all pharmacies in the country. And if it is a pharmacy-driven program for the rec program, we will be able to participate pretty easily. Even though, as you mentioned, we are a medical company, what we see in Germany today and even in Canada is even though there's rec cannabis in Canada, 50% of users who walk into a rec store are going there for a wellness reason. So we expect the same as we see legalization in a place like Germany. So even though we are a medical wellness company, we expect to participate in that open access in a very meaningful way.

[Unknown Analyst]

Great. That's really helpful. And then my second question, in regards to your M&A, I know you spoke about this a little bit, but could you speak to what verticals might be appealing? And then would this be more on the medical side or you also evaluate adult-use opportunities as well?

[David Pidduck, executive]

Yes. This is Dave. Thanks for the question. There's lots of opportunities out there today, as you're probably aware. And I think we're being very cautious and careful and strategic about what we will pursue. So we have engaged advisers. And all of the segments that you mentioned are of interest, but we want to find one that both have synergy and is accretive and is sort of fiscally responsible given the current situation. And obviously, we're -- our balance sheet is very strong right now.

We're feeling very good in terms of our burn rate versus the cash on hand. But we have lots of -- there's lots of opportunities and people coming looking for that cash, and we really are thoughtful about where that would go. So certainly, the more medical, the better, the more pharma, the better pharma or wellness, all of those are of interest. And we're actively exploring those now.

And I think we see M&A as part of the solution to getting to profitability over time. So obviously, we're not in a position today to talk about sort of specific opportunities and where we're going. But we have repeatedly said that this will be part of our mix of strategic initiatives and an important part of what we do in the coming quarters.

[Operator]

[Operator Instructions] The next question is from the line of Tamy Chen with BMO Capital Markets.

[Tamy Chen, analyst]

First question is I want to go back to Germany. You called out or described it as variability in flower. And I was wondering if you could just elaborate what you mean by that? Are you saying that some of the flower didn't need import requirements or the potency variance threshold or something like that?

[Keith Strachan, executive]

Tamy, it's Keith. No. So the flower that like we look at the 2 categories that we sell in Germany, we have our extract products, which is formulated oil and then we have the flower.

Our formulated oil sales were actually slightly up quarter-over-quarter. So that's why we mentioned our variability in the flower. So oil category for us remains to be very strong. It's -- naturally it should as an extract company. And the flower, as I mentioned in the last question, it was more of rightsizing some inventory in the region is that we work through some of it. And then that way, we can do replenishments on the back half of the year. We haven't been running into many problems with meeting criteria. That's something that we would flag in Canada before it's exported even before. Since we don't grow it, MediPharm actually wouldn't commit to purchasing something that doesn't meet our requirements either. So we have derisked the flower process there in some centers.

[Tamy Chen, analyst]

Okay, I understand. Okay. So then a follow-up to that, just rightsizing some inventory, stepping back a little higher level in Germany. In terms of the demand in that market, how has that sort of played out relative to yours and status expectations, do you feel the rightsizing of the inventory was more so, you just shipped a decent amount initially and it just naturally takes some time? Or is the demand there or maybe the competitive intensity there, a bit more than you had thought and so you have to adjust how much you're selling into your partners over there?

[Keith Strachan, executive]

Yes. I think more of the working through the inventory was more of just what we do deliver, especially initial deliveries, they're large loaded. The protest from one of our Canadian partners in the flower to Germany through packaging and release that takes some time.

So sometimes, we'll move that up a little bit higher than demand in order to get some economies of scale through the process. So that's probably more of it. I think the demand, the increase in patients, increase in what they call the patient pay segment, where the patients are going in and paying with the coverage has been increasing and status specifically has been increasing with that market.

So as we see kind of month-over-month increase in the active participation of patients in the market. Stat is right on pace with that or if not beating. I think as far as expectations go, you mentioned expectations of ourselves and so, I think that we expect it. The competition we saw it in Canada, we saw in Australia. So we expect it to be more entrants into the market. And what we're doing is we're using our experience having been there for 1.5 years and we are using our quality story message and products to make sure that we're staying on the forefront of patients, especially in that extract category.

[Tamy Chen, analyst]

Okay. Great. And one last question for me is I wanted to ask about the focus on margin-accretive revenue that makes sense to me. You mentioned in Q2, there was some sacrificing of revenue for margin. I was curious if you could elaborate whereabouts that was in and how you think about this trade-off between growth and margins when, generally speaking, in the industry now in the various regions, competition is quite high and price intensity is also quite high.

[Keith Strachan, executive]

Yes, it's a great question, and as kind of we looked at our overall business and Dave spoke about the business fundamentals. We rightsized our business. So we did 30% decrease in our nondirect labor in Canada, we looked at redundant assets in the sale of our Australian facility. And then along with those business fundamentals is we can't be saving dollar bills to boxes on their way out. We need to be selling products that are profitable. Some of those sacrifices that we saw in Q2 are more probably around the B2B and spot market.

So we still remain very competitive in Canadian out used sales. So not really discontinuing anything there as far as where we're seeing margins, but more on-the-spot sales that would include some international flower where there's a fall sale or it's just an end product seller that's looking for the best field that day, we kind of take our name or that ring in some circumstances where we see some of our peers who are happy to sell at a loss just to move out some of their inventory. So we're not participating in that where we would also be selling too much of a loss. So we need to make sure that we're selling products that are gross margin accretive.

[David Pidduck, executive]

And maybe just building a little on that, looking through the portfolio and all of the contracts in all of the segments that will play. We, over the last several months have been very focused on, are there particularly egregious nonprofitable contracts or business spot or otherwise that don't make sense, and we've been cleaning them up. And cleaning up little ones of those actually are very helpful in terms of cash flow and in terms of profitability.

So I think some of it is probably good housekeeping. And we're just more focused on it now rather than -- and it's like many companies rather than just pure revenue, revenue, revenue at any cost. And I think we're seeing that in the industry generally. And we are particularly focused on it ourselves.

[Operator]

At this time, there are no further questions. I will turn the call back to David for any closing remarks.

[David Pidduck, executive]

Great. Thank you, operator. Everyone, thanks for taking the time this morning, and have a great week. We look forward to next quarter and further updates. Have a great week.

[Operator]

Ladies and gentlemen, this does conclude the MediPharm Labs 2022 Second Quarter Financial Results Conference Call. Thank you all for joining. You may now disconnect.