Earnings Transcript for INLB - Q2 Fiscal Year 2022

Jason Assad: Hello, this is Jason Assad, Investor Relations with Item 9 Labs. Good afternoon, and welcome to Item 9 Labs Fiscal Q2 2022 Results Conference Call for the three months ended March 31, 2022. Joining me on today's call is our Chief Executive Officer, Andrew Bowden; and our Chief Financial Officer, Bobby Mikkelson. Shortly before this call, we filed our form 10-Q, a copy of which is available on the company's website at item9labscorp.com. That's item9labscorp.com. I'll start our call today by reading the Safe Harbor statement. The statement is made pursuant to the Safe Harbor for forward-looking statements described in the Private Securities Litigation Reform Act of 1995. All statements made in this call, with the exception of historic facts may be considered forward looking statements within the meaning of section 27A of the Securities Act of 1933 and Section 21E of the Securities Act of 1934. Although, we believe expectations and assumptions reflected in these forward-looking statements are reasonable, we can make no assurance that such expectation will prove to be correct. Actual results may differ materially from those expressed or implied in forward-looking statements due to various risks and uncertainties. For a discussion of such risks and uncertainties that could cause actual results to differ from those expressed or implied in the forward looking statements. Please see risk factors detailed in our Annual Report on form 10-K, those contained in subsequently filed quarterly reports on Form 10-Q, as well as other reports we file from time-to-time with the Securities and Exchange Commission. Any forward-looking statements included in this earnings call are made only as of the date of this call, and we do not undertake any obligation to update or supplement any forward-looking statements to reflect subsequent knowledge, events or circumstances. Lastly, please note that we will refer to certain non GAAP measures that when used in combination with GAAP results provides us with additional analytical tools to understand our operations. We provided reconciliations to the most directly comparable GAAP financial measures in our earnings press release. With that, I'd now like to introduce Item 9 Labs Corp's Chief Executive Officer, Andrew Bowden. Andrew?

Andrew Bowden: Thank you, Jason, and good afternoon, everyone. Thank you for joining us today for our fiscal Q2 2022 earnings conference call. On today's call, I will highlight recent operational momentum, as well as provide an update on our expansion progress on our Arizona and Nevada cultivation sites, and the latest national development of our cannabis dispensary franchise Unity Road. Following my remarks, our CFO Bobby Mikkelson will provide an overview of our financial results. Last year, our team invested heavily and focused on strengthening our position for future growth, both locally in Arizona and nationally across the United States. The momentum we've achieved over the past quarter demonstrates the power of this foundation and gives a glimpse into what's ahead for our national growth and product excellence. Focusing on execution sums up our plan for 2022 as we continue our mission to keep the door to cannabis entrepreneurship open for the everyday entrepreneur and bringing more high quality alternative medicine to consumers nationwide. As large equity holders, our goal remains aligned with our shareholders in creating long term value and brands that are built to last. At this point, I'd like to turn it over to our CFO, Bobby Mikkelson for a summary of our fiscal quarter two, 2022 financial results, following which I will provide additional details about our growth strategy going forward. Bobby?

Bobby Mikkelsen: Thank you, Andrew. With our 40% growth and year to date revenue to $12.8 million, we've continued to demonstrate the scalability of our business through the first half of '22. For the three months ended March 31, 2022, revenue was $6.6 million, an increase of $0.5 million or 9%, compared with $6.1 million for the three months ended March 31, 2021. This growth was primarily driven by our investment into increased production capacity to better meet the market demand for Item 9 Labs products. For the three months ended March 31, 2022, gross profit was $2.7 million, a decrease of $0.3 million or 10%, compared with $3 million for the three months ended March 31, 2021. The resulting gross margin was 40% compared with 49% for the three months ended March 31, 2021. The company experienced lower gross profit margins in the second quarter of 2022, due to price reductions as competition continues to rise in Arizona. Even with the increased competition, we sold 9% more units this quarter compared to last quarter. Additionally, to deepen market penetration of Item 9 Labs products, the company has sourced plant material and extract material from third parties. The effect of which is higher gross profit, but lower gross margin. Our Arizona expansion, which we anticipate completing by the end of this calendar year will reduce our reliance on third party materials, thus increasing profitability long term. For the three months ended March 31, 2022, total operating expenses were $5.5 million, an increase of $3 million or 120%, compared with $2.5 million for the three months ended March 31, 2021. We have invested heavily into fiscal 2021 and 2022 to meet growing demand in Arizona as well as funding the build out of our cultivation and lab site within the state. We strongly believe this expansion will improve earnings and future cash position. Operating expenses as a percentage of revenue increased to 78% from 47%, reflecting our focus on increasing revenue and scaling our platform more efficiently. We believe this ratio will decrease going forward as we scale the business. Of note, $1.8 million of our operating expenses for the three months ended March 31, 2022 were non-cash expenses, including depreciation, amortization and stock-based compensation. Also of note, $0.7 million of interest expense for the three months ended March 31, 2022 was non-cash amortization of debt discounts. For the three months ended March 31, 2022, operating loss was $2.8 million, an increase of $3.3 million or 636%, compared with an operating income of $0.5 million for the three months ended March 31, 2021. After adding back non-cash operating expenses, depreciation and amortization, interest income tax, acquisition related costs and stock based compensation, adjusted EBITDA for the three months ended March 31, 2022 was a loss of $0.9 million as compared with an adjusted EBITDA profit of $1 million for the three months ended March 31, 2021. It's important to note that approximately $1.9 million change from prior year is due to the addition of the franchise business as well as significant investments in human capital and infrastructure to prepare for anticipated growth. For the three months ended March 31, 2022, net loss attributable to the company was $3.9 million, or a net loss of $0.04 per share, compared with a net income of $0.5 million or $0.0 per share for the three months ended March 31, 2021. Cash and cash equivalents totaled $0.1 million as of March 31, 2022. I'd now like to turn the call back over to Andrew.

Andrew Bowden: Now, I'd like to provide an update on our growth initiatives, which are focused on Unity Road openings and footprint expansion, as well as our cultivation, production and processing development in Arizona and Nevada. Here's a quick look at where our franchise partners are developing the Unity Road retail brand across the United States. They're all in various stages of development, some recently submitted licenses or will be soon. We believe our ramp and rollout will accelerate throughout 2022 as COVID-19 put a pause on most bureaucracies as well as licensing and permitting at the state levels. A handful of our franchisees are in the Northeastern United States waiting for their market to open or working with our team to go through the licensing process. We are currently guiding our four New Jersey groups in submitting their dispensary license application and we also recently obtained approval on our plans and permitting for the Unity Road shop in Maine. In the past quarter, our team assisted two groups in securing state and local approval to operate in South Dakota and New Mexico's cannabis program. Our South Dakota partners are opening one of the first dispensaries in Hartford, which is a suburb of Sioux Falls, South Dakota. They broke ground in February and are moving quickly along a projected opening this summer. The New Mexico adult use market opened in April. Our group there were awarded three licenses in March by the state and plan to open their first shop in Ruidoso with two additional cities to follow. In January, we signed our first Unity Road partner through our Local Alliance Program with an Oklahoma City Dispensary called Ring Side Medical, which is in the process of being rebranded to Unity Road. We launched the Local Alliance Program in 2021 to support existing dispensary owners and operators by providing them direct access to the buying power, resources and supportive network that's normally reserved for multi-unit operators. These partners retain 100% ownership of their dispensary license and business and benefit from the tools, expertise and ongoing support that our team provides. While we've had great momentum through traditional franchise development in our Local Alliance Program, last year we launched a National Dispensary Acquisition growth plan to accelerate Unity Road's expansion and made positive movement in the Denver market throughout the past quarter. This accretive acquisition program includes acquiring and converting cannabis retail stores into Unity Road shops, training the local team and selling the business to new and existing Unity Road franchisees to keep these businesses locally owned and operated. This growth strategy offers turnkey investment opportunities for prospective cannabis entrepreneurs. We closed an acquisition of an existing dispensary retail license and storefront in North Denver, Colorado in March, that will become our first corporate-owned shops under the Unity Road brand. We anticipate that rebranded store will be operational early this summer and plan to operate the dispensary for three to 12 months before selling it to a Unity Road franchisee. In March, we also signed an asset purchase agreement with a medicinal and recreational dispensary and cultivator operating in the desirable Washington Park neighborhood of Denver. The dispensary generated revenues of $5.4 million last year and will be Unity Roads first future flagship location. The space offers 5,000 square feet for retail operations, corporate offices and team training, as well as 3,000 square feet of medicinal and recreational cultivation. We anticipate the dispensary will be rebranded to Unity Road within six to 12 months of closing the acquisition, which is currently awaiting regulatory approval by Colorado's Marijuana Enforcement Division and the City of Denver. Onto our cultivation, production and processing developments in Arizona and Nevada. Last August, we secured a $19 million construction financing loan with Pelorus Equity Group for the completion of our site in Nevada and groundbreaking of our master site expansion in Coolidge, Arizona. $2 million of the proceeds from the Pelorus loan went toward the acquisition of the neighboring 45 acres of our Arizona site. Now at 50 acres, it is one of the largest properties in Arizona that is zoned to grow and cultivate flower. The remainder of the $13.5 million is going to our initial build-out in Arizona, which will bring us from our current 20,000 square feet of operations to more than 84,000 square feet. We broke ground on the initial development phase in November and anticipate completion in the next six months. This first round of development includes the construction of three steel buildings and two greenhouses, adding 9,600 square feet for indoor cultivation, 9,600 square feet of lab and packaging and 9,600 square feet of a head house to support the addition of two 18,000 square feet greenhouses we are adding. With the initial expansion phase, we expect to increase output of cannabis plant material by 250% to 300% with a per unit cost reduction of at least 30%. Further, the additional greenhouses will significantly reduce our reliance on third-party sourced materials for lab production. This is key to drive our profit margins upwards, also expansion of our existing lab allows for the addition of more state of the art equipment for all extraction processes, which will support product diversification. The remaining proceeds from the Pelorus loan are to complete our 20,000 square foot facility in Pahrump, Nevada that is currently, approximately 98% finished. Our team is working with Nye County and the City of Pahramp to finalize the certificate of occupancy and complete the construction process. The Nevada facility includes 4,450 square feet for flower, 990 square feet of vegetation space, 400 square feet for clones, 300 square feet for dry curing and 615 square feet of space for genetics. The facility also includes more than 2,500 square feet of post-processing and lab space along with the opportunity for a joint venture with an 1,100 square feet commercial kitchen. We anticipate the Nevada facility will be operational later this year. Beyond our retail and cultivation development, we've had great industry and media wins over the past quarter. Unity Road was named one of the best cannabis companies to work for by leading industry publication Cannabis Business Times. We ranked sixth in the dispensary category and score a full-page article in the March issue of the magazine. On 4/20, I was live with Cheddar News opening bell to discuss the anatomy of the budding cannabis industry, franchising in the cannabis industry and our efforts to keep cannabis local. Over the past few months we have also been featured in multiple articles with Benzinga and US News and World Report as well as in Rolling Stone, microcap.com, NewsBreaks, High Times Magazine, Global Franchise magazine, Phoenix Business Journal, Arizona Republic, Marijuana Venture and many more. The Chief Franchise Officer, Mike Weinberg was also the first to present on franchising in cannabis at a major franchise industry events this past February at the International Franchise Associations Annual Conference. Last year, we became the first cannabis dispensary franchise to join the IFA, which is the world's largest membership organization for franchises and franchise suppliers. The prominent organizations membership base includes more than a 1,000 franchise brands across 300 industries and Unity Road is currently the sole franchise model to represent the plant touching cannabis space. This concludes my prepared remarks. We will now address some of the previously submitted questions.

A - Jason Assad: Thank you, Andrew. Thank you to those of you who have submitted questions. Here's the first one. Can you please explain to someone not already in the cannabis space, how your franchise model could help an entrepreneurs like myself start my own cannabis business?

Andrew Bowden: Absolutely. Thank you for your question. Our Unity Road dispensary franchise model is like any other traditional franchise concept, except our commodity of cannabis. So much like you can become a franchisee of McDonald's, UPS Store or Great Clips and have the national brand name recognition, proven business model, standard operating procedures, resources, training and ongoing guidance, you have that same support when you become a Unity Road franchisee. The complexities of operating a cannabis business make it difficult for small independent dispensaries to understand and stay on top of all the varying regulations and everyday challenges of managing and operating a compliant and successful dispensary. Our Unity Road franchise opportunity provides a solution for industry newcomers and small locally owned and operated businesses to compliantly thrive. Thanks to the robust backing and support of a national franchise. Our time tested SOPs and experienced team that has a combined 200 plus years in cannabis and franchising guide franchisees through every operational functions of the business in -- whether it'd be securing a license or assisting with cash flow, product selection or changing regulations. Unity road offers one of the safest routes for cannabis entrepreneurs interested in staking their claim in this massive $25 billion cannabis industry.

Jason Assad: Thank you. Can you talk a little bit about the Arizona market, what you're seeing? And also, what other markets are you pursuing that you believe opportunistic?

Andrew Bowden: Yeah, absolutely. The Arizona cannabis market generated approximately $1.4 billion in sales in 2021 with adult use sales around $650 million and medicinal markets recording about $758 million in sales. This demand is greater than most states have seen during their first year of legalization and the market is continuing to grow with the adult use market beginning to surpass medical sales and combined market continuing to outpace monthly sales records. As seen in other states, cannabis can be emerging as a significant source of tax revenue for Arizona. Arizona Joint Legislative Budget Committee recently released data is showing that cannabis taxes collected in the state are exceeding that of alcohol and tobacco combined. In March, the state collected $11.9 million in dedicated marijuana excise tax and $94.3 million fiscal year-to-date. Our Item 9 Labs products are in more than half of the Arizona dispensaries and continue to track among the top brands sold. A majority of these cannabis stores are in Phoenix, but we also have a large following in Tucson and have been distributing our limited release runs for the market as well. With our strategy to grow our Item 9 Labs product nationally alongside Unity Road, Colorado is the next market we're eyeing up for product expansion. As I mentioned earlier, we currently have a shop open in Boulder, another opening in North Denver and an APA for dispensary in the Wash Park area of Denver. We anticipate our Item 9 Labs product brand entering the market in our Q1 or Q2 2023 fiscal year.

Jason Assad: Thank you. Is the lack of access to capital for many private company is creating opportunity for you as a public company? And are you seeing a lot of opportunities to possibly acquire new assets at attractive valuations?

Bobby Mikkelsen: Hey Jason, it's Bobby. I'll hop in there. Access to capital is challenging all around, but we are certainly seeing the latter with attractive acquisition opportunities. Currently our acquisition focus is on increasing our Unity Road retail footprint.

Jason Assad: Thank you, Bobby. In terms of M&A, you're growing scale, would you consider a sale of the company if a larger player expressed interest?

Andrew Bowden: I'll jump back in, this is Andrew. We will always strive to do what's in the best interest of our shareholders. This is and always has been an equity play for me and the management team. Our goals are very aligned with our shareholders and if an opportunity presented itself, we would definitely evaluate it.

Jason Assad: Thank you, Andrew. That wraps up all our questions. Andrew, I'll pass back to you for closing remarks.

Andrew Bowden: Thank you for joining us on our call today. We are clearly very optimistic about the future of our company. As always, our main focus is value creation for our shareholders. As large equity shareholders ourselves, our goals remain very aligned with yours and we will continue to strive to operate our company, best serving our collective best interest. If you haven't yet, we invite you to visit keepcannabislocal.com to see our latest campaign and keep tabs on our company news via item9labscorp.com. Thank you.

Q -: