Auxly Cannabis Group Inc

TSX:XLY

Earnings Call Transcript

[Operator]

Good morning, everyone. My name is Kelsey, and I will be your conference operator today. At this time, I would like to welcome everyone to the Auxly Cannabis Group Q1 2022 Earnings Results Call. [Operator Instructions] Thank you.

Ms. Cannon, you may now begin your conference.

[Julie Cannon, executive]

Thank you, operator, and good morning, everyone. Thank you for joining us for Auxly Cannabis Group's First Quarter 2022 Financial Results Conference Call.

A replay of this call will be archived on the Investor Relations section of Auxly's website. 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 with the presentation slides, which are posted on our website 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 provide 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. And note that all references on this call are to Canadian dollars, unless otherwise stated.

And with that, I'll turn the call over to our CEO, Hugo Alves.

[Hugo Alves, executive]

Thanks, Julie. Hello, and good morning, everyone, and welcome to our Q1 2022 earnings call.

I'm going to start the presentation on Slide 5 of our deck. And as I mentioned on our last earnings call back in March, our main goal this year 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 macro level, we continue to advance towards that goal. We grew revenues 147% relative to Q1 last year, thanks to strong consumer demand for our products. We also improved adjusted EBITDA by 14% year-over-year, and we continue to get tighter on costs.

This was the first quarter that we picked up a full quarter of Auxly Leamington expenses on our statements and we still managed to decrease SG&A slightly quarter-over-quarter, and we ramped up production at our Leamington facility to now 75% full utilization, and we'll start to see the impact of that extra yield on our revenues here in Q2. And of course, it's winning with our consumers by providing them quality products under brands they can trust and love that is going to drive Auxly to profitability. While aggressive price investments by some of our peers and a few operational and supply chain hiccups did impact our share in some product formats, we remain the #1 company in the 2.0 market segment and we maintained our top 5 position total market.

We also increased our distribution footprint to 93.6% in the quarter. That's up from 92% last year. And our brands continue to resonate with consumers, with Back Forty, in particular, now the #1 brand in vape and the #4 brand in flower nationally. And our leading innovation platform was hard at work, launching 10 new products during the quarter, including another first-to-market with our Kolab Live Rosin Chew and our entry into minor cannabinoid-rich vapes with our Foray Blueberry Gelato cartridge.

On Slide 6, we have a few Q1 highlights. And I've already covered most of these highlights, and I don't want to cover too much of Brian's presentation, but I will just call out two points here: first, while we grew revenue 147% year-over-year, we did see a 23% decline in revenue quarter-over-quarter, and that decrease was attributable to recurring Q1 seasonality, where we have seen Q1 sales generally lag Q4 sales in our industry. Now that said, we were able to manage this dynamic better this year than last, with revenues down 23% quarter-over-quarter, compared to last year, where they were down 47% over the same period. And we did experience some operational and supply chain challenges, which I'll discuss throughout the presentation. Secondly, I'll call out the 16% blended gross margin noted on the page. Brian will elaborate, but I note that absent impairments primarily related to the shutdown of our Auxly Annapolis facilities, our gross margin would be about 3% higher than our Q4 margin.

Turning to Slide 7. As already stated, Auxly remained the #1 LP in the 2.0 market segment and the #5 LP total market. And like last quarter, where you would have seen this slide before, there remains a sizable gap between Auxly and the #2 producer in the 2.0 segment, and it is an increasingly tight race for the #1 spot overall total market. Now while our position relative to our peers and gaps in market shares between us remained relatively consistent, we did lose market share relative to Q4 of last year, which was primarily driven by aggressive price investments by some of our peers, especially in vapes, which we chose not to follow in the quarter and some operational supply chain hiccups which are largely behind us, but which did result in significant availability constraints during the quarter in vapor, concentrate and dried flower formats.

On Slide 8, we can double-click into our market share performance on a product category basis. And I'll focus here on the categories that saw a decline. So starting with vape, while vape continued to get more competitive quarter-over-quarter with 51 new SKUs and 10 new brands entering the category, the loss of vape share was primarily driven by aggressive price investments by some of our peers. We also suffered a material shipping delay of hardware during the quarter due to lockdowns in China. This resulted in us being out of production on some of our most popular Back Forty vape carts for close to a month during the quarter. But I would note that even with our competitors taking unsustainable price drops to try and win share and with Auxly hampered by a lack of hardware, we still managed to capture 20% of the vape market during the quarter and remain the #1 vape company in the country.

In concentrates, we saw a marked increase in competition primarily as a result of the explosion of infused pre-rolls, which fall into this category. We also encountered supply chain issues with third-party manufacturers and packaging suppliers, which resulted in a severe undersupply of our most popular SKUs during the quarter. We did take steps to fix this during the quarter, and I'm happy to say that our supply constraints have eased, and we've already seen the concentrate share rebound in April.

In dried flower formats, as you can see, we managed to increase share slightly in dried flower, but lost a little share in pre-rolls. Overall, I think these results are encouraging as we did experience some temporary operational issues at Auxly Leamington, which impacted our yields quarter-over-quarter. We experienced an approximate 25% drop in our yields during the quarter. And given the lower yields, we prioritized the dried flower format to pre-rolls, but we still experience constrained availability in both formats. Overall, I think we managed the situation well, and we were able to protect our flower and pre-roll shares, but we do feel that we left share on the table in both of these categories.

Brian will talk about Auxly Leamington later in the presentation, but I'm happy to say that the yield issue is behind us, thanks to a mix of ramping facility utilization and process improvements we are now seeing record yields and all-time highs from a quality perspective, which consumers of our latest drops of wedding pie and Mandarin cookies have noted and applauded.

On that note, I want to move us to Slide 9. While seasonality, aggressive pricing in vape and temporary operational supply chain challenges impacted our quarter, we remain confident in our ability to win with consumers, continue growing and achieve our strategic goals. So how are we going to do that? First, as already mentioned, our supply chain and operational challenges are largely behind us and our production constraints have eased. That's the most important step, getting our products into distribution because when our products are in market, they are undeniable. We will continue to receive additional automation equipment throughout the course of the year and continuously improve processes to drive further efficiencies, but flower yield and vape hardware issues are behind us.

Secondly, we will continue to give our consumers the new and exciting products that they crave. Newness continues to be a key purchase driver in our industry. So while our competitors fight to capture share through price investments, we'll continue to delight our consumers by redefining categories with fresh new products. We released 10 new SKUs in Q1 and plan to introduce 20 more in Q2 as we target 60 new SKUs during the course of 2022. And notably, we are focusing our innovation on product categories, which best advance our strategic goals. For example, in vape, we will expand our Back Forty vape family by launching new unique strains like the recently released Strawberry Cough. We continue to premiumize our Kolab vapes with the highest quality inputs, such as the recently launched Kolab Live Rosin cartridge. And with the launch of Foray's Blueberry Gelato cart, we have expanded Foray's vapor offering to include formulations, rich and minor cannabinoids.

In dried flower and pre-rolls. Our Back Forty consumers have been asking us for a [ sativa ] strain, and we have delivered with our Mandarin cookies strain in both dried flower and pre-rolls, which we launched this month to great success.

And on Slide 10, we're going to continue building our brands to win consumer awareness, trust and loyalty. We're very encouraged by the progress that Back Forty continues to make with a relatively small portfolio of products. It is the #1 vape brand, has grown to the #4 flower brand and we continue to see Back Forty innovation get incredible traction in market. We believe that Back Forty can be a top 3 brand total market by end of this year.

We also continue to see great traction for our Kolab and Foray brands. With Kolab, we will continue to focus on higher potencies and true-to-plant experiences that our Kolab consumers demand. Most recently, we launched a series of solventless extract products in edible, vapor and concentrate formats. And with Foray, we're focusing on product attributes and differentiation with our novice consumer in mind by introducing fast-acting formulations and products, rich and minor cannabinoids.

Finally, while the wellness segment of the market has been slower to develop, we are continuing to see growth in our Dosecann products, and we'll introduce a new topical and new high-potency oil products throughout the year.

I'm going to stop here and now turn over the presentation to our CFO, Brian Schmitt, to walk you through the financial results. Brian?

[Brian Schmitt, executive]

Thank you, Hugo, and good morning, everyone.

If I could get everyone to turn to Slide 11 for a quick snapshot of our historical revenue in total market share and further details for the quarter. On the left side of the slide, you will see that the seasonal impact of retail sales was evident in the first quarter, similar to the pattern during the same period of 2021. Our share of market for the quarter was 6.9%, a slight decrease from the fourth quarter, where we ended the year with 7.4% market share. However, we continue to hold our position as the top 5 LP in the country by total sales.

On the right side of the page, Auxly reported $22.6 million in net revenue in the first quarter of 2022, an increase of 147% year-over-year where we continue to drive significant improvement in our Cannabis 1.0 sales, which accounted for approximately 39% of total revenues as a result of our expansion into the competitive dried flower and pre-roll categories while maintaining our #1 position in cannabis 2.0 sales, which accounted for approximately 61% of revenues. While revenue decreased from the fourth quarter of 2021, we were encouraged by the lower rate of change as compared to the first quarter of 2021, despite a few notable impacts as Hugo touched upon earlier. These were decreased flower availability during the winter months in the [ Auxly ] Leamington and the impacts of COVID-19 related lockdowns in China on our supply chain and inventories. These impacts are now behind us. However, I will provide additional comments regarding Auxly Leamington in a few moments.

The next slide, Slide 12, captures our gross profit margin, adjusted EBITDA and net losses for the quarter. Our gross profit margin for the first quarter was 16%, a decline year-over-year, however, a slight improvement over the fourth quarter of 2021. This quarter, gross profit margin was impacted by the impairment associated with the closure of the 2 Auxly Annapolis facilities as announced on February 7 of this year. The charges related to these closures were approximately $5 million, which had a net impact of approximately 4% as indicated by the gray in the bar chart, which would have otherwise resulted in a gross profit margin of 20%.

Similarly, while not on this slide, the cost of finished cannabis inventory sold margin, which excludes fair market value adjustments and impairments, was 23%, a slight decline from the prior same period in 2021, however, an increase of 3% over the previous quarter. An adjusted EBITDA loss of $5.6 million for the quarter was an improvement of approximately 14% year-over-year, primarily as a result of increased gross profits, partially offset by higher SG&A to support cannabis 1.0 product sales and selling expenditures. Adjusted EBITDA for the quarter was also better than the fourth quarter of 2021 despite the seasonal decline in revenues, supported by slightly lower SG&A of $12.8 million, which included the first full quarter consolidation of Auxly Leamington. And finally, the net loss for the quarter was $39.3 million, of which $25.7 million was related to the closure of the 2 Auxly Annapolis facilities, as indicated by the gray bar graph. The details of those charges are found in Note 27 of the financial statements.

Turning to Slide 13. I'd like to spend a few moments discussing our Leamington facility and some of our recent developments. As we've noted previously, we acquired this cornerstone asset in November of last year. This is a purpose-built facility and one of the top greenhouses in the country, which presently grows one of the most popular [indiscernible] strains in the market. During the quarter, we began to further utilize the available post-harvest space to assemble the automated pre-roll packaging equipment, which was received during the quarter.

As we continue to commission the machine, we are also looking to bring on further capabilities to both increase production and reduce costs to fulfill pre-roll sales opportunities. As outlined on the right portion of the slide, during the second half of 2021, Auxly Leamington was producing approximately 48,000 kilograms of cannabis annually. Since that time, we have increased production to meet consumer demand to where we are presently harvesting approximately 75,000 kilograms. As noted earlier, we did experience lower flower availability during the winter as indicated by the line chart below. This impact was most significant during January and February but has improved strongly in March and [ year-to-date ].

Please keep in mind that gross profit margins from Auxly Leamington is only realized upon product sales to our wholesale provincial customers, and that harvest of flower products may only be available at a retail location 1 to 2 months later. Despite these challenges, we are very encouraged by the current flower availability and how that will support stronger future sales and gross profit margins in the second and third quarter.

With that, I'll turn it back over to Hugo.

[Hugo Alves, executive]

Thanks, Brian.

Before I open the floor to Q&A, I'll conclude by saying that Q1 was a challenging quarter. Some of those challenges like seasonality were expected. Others like the vape hardware shortage were harder to foresee, but we believe that the operational and supply chain headwinds are behind us and our operational efficiency and throughput is getting better and better. We remain the #1 player in vapor, the #1 player in 2.0 overall, and we continue to build the leadership in dried flower and pre-rolls. We grew our revenues, 147% year-over-year, and we are aggressively adding to our product portfolio with insights-driven innovations and seeing those innovations succeed in market. And finally, we are continuing to see increases in brand awareness, trust and loyalty among our targeted consumer segments. So we think there is a lot of reason for optimism. We are seeing strong sales momentum in Q2, and we are confident that we remain on track to meet our strategic goals.

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. Thank you.

[Operator]

[Operator Instructions] And your first question comes from Frederico Gomes from ATB Capital.

[Frederico Yokota Gomes, analyst]

Maybe to start off, just regarding your adjusted EBITDA target for this year. Could you remind us some of the assumptions that stand behind that goal of reaching adjusted EBITDA positive now in terms of sales and gross margins? And also, could you tell us how confident are you in reaching that target by the end of this year?

[Brian Schmitt, executive]

Thanks, Frederico. I'll take that question. Certainly, we've indicated on the last call that we are looking to be adjusted EBITDA positive in H2 2022. The key assumptions behind that are the inclusion of Auxly Leamington gross profit and adjusted EBITDA from that facility, which, again previously, we acquiring all our products effectively wholesale. So like many other LPs, we will now benefit from the positive results from Auxly Leamington. And then in addition to maintaining our SG&A at present levels, [indiscernible] charges that naturally increase with increased revenue. We do intend to hold SG&A relatively flat. And the major driver in respect of adjusted [ EBIT ] in addition to the margin pickup from Auxly Leamington revenues as we are targeting by the end of the year to be revenues in the mid-$30 million to low $40 million per quarter.

[Frederico Yokota Gomes, analyst]

Okay. That's helpful. And then maybe more of a big picture question, I guess. When we look at other LPs, not only Auxly, we see that you have a lot of market share volatility. Many of them are losing share. Many of them reported very challenging Q1 results. And even so, you're saying that you have some difficulties in terms of share because other LPs are competing too aggressively on price. So I'm just curious, where do you see this going? When will this environment normalize, just considering that the broader macro-environment is just difficult right now in terms of raising capital and still you have these LPs unprofitable and being too aggressive in terms of pricing?

[Hugo Alves, executive]

Frederico, so let me try to unpack that one a little bit. Look, in terms -- we are seeing some significant price investments by some peers. We, obviously, monitor the vape segment very closely. And we'll look like from a revenue management perspective, what makes the most sense for Auxly. But as I said, in terms of our strategy and what we're looking to do, we think that when our products are in market, we've done all of the right things to have broad distribution, brand build and really focus on the quality, safety and efficacy of our products to drive consumer trial and then repeat purchase. So we're confident that with the supply chain and operational headwinds behind us, especially, the -- very encouraged by the increased yields at Auxly Leamington with the growing distribution, the increases in brand awareness and loyalty that we're seeing with our brand family. And of course, with our sort of industry-leading innovation, our ability to really turn insights into differentiated products that resonate with our specific consumers, we feel confident in our ability to meet our strategic goals this year.

[Frederico Yokota Gomes, analyst]

Okay. I appreciate that. Maybe just a last one for me. You mentioned distribution. Do you have any update on Quebec?

[Hugo Alves, executive]

Yes, sure. So Quebec, we -- look, we're not in Quebec yet. We're continuing to work with the SQDC to see how we can bring value to their assortment, as it's been well documented. It is a tougher market to get entry into, but we're continuing to explore. But nothing -- no new significant -- nothing new of significance to report this quarter.

[Operator]

Your next question comes from Michael Freeman from Raymond James.

[Michael Freeman, analyst]

Congratulations on moving up in the overall LP market share standings, we have yet #4, but #5 is still pretty darn good. I wanted to ask you about the seasonal effects. Like we've been seeing them across the [ LP ] industry, recognize that there is generally a seasonally soft sales. But I wonder if you could tease apart for us, again, sort of market-driven sales dynamics that happened going from fourth quarter to first quarter? And then Auxly specific dynamics and also touching on how you are able to better manage that seasonal impact this sequentially this year? And how you might be able to further smooth that in future years?

[Hugo Alves, executive]

Yes, sure. Why don't I take a stab at that one and then Brian or Mike, if you have any additional color, please feel free to jump in. So Michael, I think in terms of how we were able to better manage it, I think, first, we knew it was coming. So we were able to work with our provincial customers to sort of plan ahead a little bit better. And we have a larger portfolio, right? So a seasonal impact in one format or a brand family or a set of SKUs is less impactful than it was last year. So I think we were able to manage it better through foresight and scale. In terms of how those dynamics work, I think like other industries, there is some seasonality after the year-end period where people generally tend to spend a little bit more. And then our provincial customers, while they also work to improve on this, there is a slight change in their purchasing patterns as they approach their March 31, Q1 year-end. So you see a little bit, I think, on the consumer side, but then also a little bit on the customer side during Q1 drive some of that seasonality.

And in terms of how we'll manage it better in future years, again, is continuing to work with our provincial control board customers to smooth out the supply a little bit. They'll obviously get better, will get better over time. This is only the second Q1 that we've had. And again, our portfolio will increase over the year. So that will kind of mitigate any little spikes that we might have in a category or a certain brand.

Brian, Mike, open to you, if you want to add further color.

[Brian Schmitt, executive]

No, I think that was a complete answer.

[Michael Freeman, analyst]

Okay. All right. That's really helpful. I wonder if we can talk about the path to positive EBITDA in the back half of the year. I -- we've spoken about margin pickup related to Auxly Leamington facility, the installation of automation equipment and how those will be realized in a sort of stepwise and delayed session. I wonder how -- where we should expect to see margin pick up from these and other factors as you proceed towards your goal of positive EBITDA?

[Brian Schmitt, executive]

Thank you, Michael. Really from several fronts that you've actually highlighted, and we've communicated previously, is somewhat fundamental on the pre-roll side that, presently, we do not have the full automation. We do have a lot of labor associated with packaging and completing those products. So as we get the automated packaging, we will certainly pick up margin, but -- more -- equally important is we have increased sales into the category of pre-rolls, is a growing category, and we believe we can capture further market share and we are limited to our ability to sell those products into the market to the extent we wish to. So it's on the pre-roll side, in particular, it's partially automation and increased volume, which will be both beneficial to margin.

In terms of Auxly Leamington, as we've previously outlined, now we are on an equal footing with all the other LPs in the sense that we are no longer buying B2B [ from ] the wholesale market for our input materials, substantially all of our input materials now come from Auxly Leamington. And as such, Auxly Leamington is highly automated and the cost structure for that facility is improving quarterly such that we will pick up both gross profit EBITDA from the facility as those products are ultimately sold through our brands and are sold to our wholesale partners. So there is a slight delay from harvest from Auxly Leamington until it's ultimately sold.

[Michael Freeman, analyst]

Okay. Okay. That's really helpful. Now if you would indulge just one more. A question for Michael. Recognizing that there was a dip in absolute terms in market share this quarter. I wonder how Auxly seeks to win this back through innovation. And wondering what consumer trends you're seeing and how you might invest in innovation to meet those needs.

[Michael Lickver, executive]

Yes. Thanks, Michael. I think the strength of our innovation portfolio has built up a lot of credibility in the market over the past 2 years. I think some of the trends we're noticing that we've been on the forefront of -- similar to what Hugo had mentioned in the script, we're seeing minor cannabinoids and we're seeing variations and premiumization of inputs around the vape formats. In addition to that, I think we've seen over the past 4 months, a category of infused pre-rolls going from not existing at all to being incredibly fast-growing and very popular amongst consumers.

And then on the flower side, similarly, high [indiscernible] genetics are still winning the day and the investments we've made and commit to continue making at Auxly Leamington to select those unique genetics will continue to win in the market. So we've got a combination of all of those trends. Our innovation portfolio seeks to address all of them. We always route everything we do deeply in consumer insights and start from there and go into product development. So you'll continue to see that from us throughout the year as we continue to fight and grow share back.

[Operator]

[Operator Instructions] And your next question comes from Venkata Velagapudi from Research Capital.

[Venkata Velagapudi, analyst]

Most of my questions on my list are already asked by previous analysts, but I still have two more questions. First thing is you mentioned in your presentation that 85% of sales are coming from Ontario, BC and Alberta. So I just want to know, like, do you have any guidance over geographic diversification. Yes, maybe your entry into Quebec may diversify geographically to some extent. But do you have any guidance over this?

[Brian Schmitt, executive]

In respect to the largest provincial customers is Alberta, B.C. and Ontario, the 85% of sales is fairly consistent with our quarterly results in previous quarters. We are not in Quebec. So that distribution will change once we get to Quebec, but in all material respects, most of our sales come from those three provinces. And then obviously, the remaining circa 15% come from all the Atlantic provinces and [ Manatee ] Saskatchewan.

[Hugo Alves, executive]

Yes. I'll just jump in, I would say, we absolutely are trying to get into Quebec. I think Auxly Leamington, and the scale there also gives us the ability to consider other opportunities, which we are monitoring in select international jurisdictions that we find of interest. So we'll continue to look there and try and get into Quebec as a way to expand our geographic footprint.

[Venkata Velagapudi, analyst]

That's great. And my one more question is do you see any regulatory support, or do you have any visibility over regulatory outlook that may improve the prospects of Canadian cannabis LPs? I understand that the legal LPs have a lot of competition. But is there any -- do you see anything -- any support from regulatory point of view that may help you to gain market share from illicit market?

[Hugo Alves, executive]

Yes, look, that's a great question, and I'll take a first stab and then, Mike, if you or Brian want to add some additional thoughts, go ahead. So we are, obviously, very keenly focused and follow the regulatory developments. And I think there are some useful proposals out right now in terms of excise tax, potential excise tax reform and things like that, that could help with cash flow issues. We are monitoring the sort of vape regulatory framework very closely to make sure that we're able to respond to any changes in the regulatory framework quickly and not lose share and in fact, use it as an opportunity perhaps to advance -- attain share relative to some of our competitors that might not be able to move as quickly. So we are encouraged also by the increasing progress that's been made internationally on the -- from a regulatory perspective, where it could present opportunities for Canadian producers.

Brian, Mike, feel free to jump in with any additional points.

[Brian Schmitt, executive]

No, I think that was a complete answer, Hugo.

[Venkata Velagapudi, analyst]

Yes. That's great, Hugo. And lastly, you mentioned that 10 new SKUs were launched in Q1. Just want to know how many of them were launched in Ontario.

[Hugo Alves, executive]

Mike, why don't you -- Mike -- I believe all of them were launched in Ontario, but Mike can confirm?

[Michael Lickver, executive]

Yes, that's correct. All of them.

[Operator]

Thank you. And there are no further questions at this time. So ladies and gentlemen, this concludes your conference call for today. We thank you very much for participating and ask that you please disconnect your lines. Have a great day.