Akerna Corp. (KERN) Q3 2022 Earnings Call Transcript

Akerna Corp. (NASDAQ:KERN) Q3 2022 Earnings Conference Call November 14, 2022 11:00 AM ET

Company Participants

Peter Seltzberg - Investor Relations

Jessica Billingsley - Chief Executive Officer & Chairman

Dean Ditto - Chief Financial Officer

Conference Call Participants

Ryan Kintslinger - Alliance Global

Operator

Good morning and welcome to Akerna’s Third Quarter 2022 Financial Results Conference Call. As a reminder, today’s call is being recorded. All participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]

At this time, I would like to turn the call over to Peter Seltzberg, Investor Relations for Akerna. Please go ahead, Peter.

Peter Seltzberg

Thank you, and welcome to today’s third quarter ended September 30, 2022 conference call. On the call today are Jessica Billingsley, CEO and Chairman of Akerna, and Dean Ditto, CFO of Akerna.

Before management begins with formal remarks, I’d like to remind everyone that during this conference call, certain statements will be made that are forward-looking within the meaning of the Safe Harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Words such as estimates, projected, expects, anticipates, forecasts, plans, intends, believes, seeks, may, will, should, future, propose, and variations of these words or similar expressions or versions of such words or expressions are intended to identify forward-looking statements. These statements include, but are not limited to statements regarding the future growth and prospects for Akerna and statements regarding expected future revenue recognition.

These forward-looking statements are not guarantees of future performance, conditions, or results and involve several known and unknown risks, uncertainties, assumptions and other important factors, which could cause actual results or outcomes to differ materially from those discussed, including risks related to changes in the cannabis market and risks related to the impact of the COVID-19 pandemic. These risk factors are more fully described in Akerna's filings with the SEC. Forward-looking statements speak only as of the day they are made. Akerna undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Lastly, as a reminder, these results are discussed in further detail on our Form 10-Q. Financial results reported today are preliminary. Final financial results and other disclosures will be reported in our quarterly report on Form 10-Q and may differ materially from the results and disclosures of today, due to among other things, the completion of final review procedures, the occurrence of subsequent events for the discovery of additional information. We encourage you to review the filings in detail.

And now, without further ado, I would like to turn the call over to Akerna's CEO, Jessica Billingsley. Jessica, go ahead.

Jessica Billingsley

Good morning, everyone. Thank you for joining us. Today, as we did last quarter, we will be covering three key areas of the business. First, the key company performance highlights for the quarter; second, the progress on our balance sheet and capital structure initiatives; and third, development in the cannabis sector. Then I'll turn the call over to Dean for a detailed financial review, followed by a Q&A session.

Earlier this morning, we reported our Q3 2022 results. After two fairly heavy investment years in which we completed a number of strategic acquisitions, this year, we have remained focused on integrating and positioning the business to take advantage of future market development and expansion opportunities, as well as synergies and cost structure improvements.

Beginning in Q1 of this year, while other firms as see themselves to speculating on future state macroeconomic scenarios and resisting the reality of the data, we see the opportunity to make tough decisions early, reducing our cost structure and reviewing our client pricing to accelerate our path to profitability. This progressive of action is proven fruitful, as we've steadily improved our cost structure and continue to track a path to profitability.

Highlighting the quarter, we saw software revenue growth of 17% year-over-year and nearly 40% for the year-to-date. Our current annual run rate, closing out the first half of the year is running slightly ahead of the full year last year, and we're anticipating seeing some strong catalyst in 2023, which we'll discuss in just a moment.

Gross margin for the quarter was 62%, consistent with last year's period, and year-to-date was 67% compared to 62% for last year's year-to-date. While this is a clear demonstration of year-over-year growth, we do acknowledge that this growth has trended down potentially, both domestically and internationally, the pace of new entrants into this space is slowing. And with existing operators, we're seeing some purchase decisions being delayed. I'll elaborate on this more in a moment when we discuss industry impacts of the recent US election cycle.

But for now, what I'm making clear is this. We are taking competitive measures to ensure we are solidifying our leadership position in the available market. The cost-saving measures we enacted earlier this year are tracking through to our P&L.

We're proud to announce that each reported expense line is down from a year ago levels. This is a clear demonstration our cost reduction efforts, staff reduction, reduced facility costs and other considerations, successfully saving us approximately $600,000 per quarter, which are currently being realized.

On today's call, as on our call last quarter, I'd like to reemphasize our three key performance metrics: committed annual recurring revenue, or CARR, growth in bookings and growth in client transactions. I'll clarify each of these metrics, explain why they're important and how we're performing. Then we'll provide an update on our strategic alternatives evaluation.

Starting with metrics. Most of our revenue today is comprised of subscription revenue. As a result, the most important metrics we track and measure our present success is our total CARR with the total amount of contracted recurring revenue for which clients design contract.

Our CARR was approximately $17 million as of September 30, which represents a slight increase year-over-year, was also slightly below what we reported last quarter. As we shared in our last earnings report, this decrease did not represent a spike in client loss of churn. We continue to see a reduction in CARR with clients who have produced and we negotiated their contracts.

This represents the reality of a foster consumer economy that's reaching across a number of sectors a reality where, in light of macroeconomic factors, some clients have made select service cuts. However, broadly speaking, we have retained our clients for their most mission-critical needs.

It's important to make clear that we're partnering with our clients to help them adjust this climate. With over 13 years of experience backing us, we are acting as a trusted adviser in meeting the needs they have today, providing mutual value both now and in the long term, and it ultimately positions us to expand with them as new markets eventually open.

To underscore this important point, while it is routine in times of economic challenge for businesses to reduce costs, given our demonstrated ability to maintain and evolve our client relationships, we anticipate this represents a potential growth opportunity for the future.

With regard to bookings, this equates to the dollar amount of new signed software contracts, the value of which will be recognized over the life of the contract. We consider growth in bookings to be a near-term leading indicator of our performance.

Our Q3 software bookings were approximately $0.5 million, which was also softer than what we had hoped to see and below what we saw in the early part of the year. We will continue to closely track our cost structure in light of these software bookings numbers, and of course, will also start to recognize some of the revenue from the prior quarters with longer lead times.

Turning now to our third metric, client transaction growth, which we believe is the single most important long-term indicator of our true market share. Our transaction volume increased by 10% sequentially, and our transaction dollar amount reflected a 10% decrease. And what this illustrates is that as a result of supply and demand as well as consumer spending habits, growth in legal cannabis transactions will closely track the legal market opportunities.

This is a trend we publicized after identifying the consumer spending on Labor Day. Historically, a top spending holiday was relatively flat year-over-year. What this means to our clients is that competitive market pressure is high and differentiation is key. Akerna's product portfolio and ecosystem was strategically designed to guide our clients through this climate.

The transaction volume growth continues to provide a future revenue catalyst, as regulatory changes bring opportunities to monetize transaction volumes, including through retail and wholesale payment opportunities. Macroeconomic climate and domestic political challenges certainly create headwinds for the industry that ultimately, we're still charting on course for collective industry growth.

I'd like to now turn to what we're doing to strengthen our balance sheet and position ourselves for the future growth that we anticipate. On top of the $10 million round of funding we closed in the beginning of the third quarter, we have also been taking the necessary steps to maintain compliance with NASDAQ listing standards. And to that end, we also issued a preferred convertible issue that was structured in a way so as not to dilute our shares and accordingly, we completed our reverse split last week.

The details are in our filings, and Dean will touch on the specifics of that during this call. But the takeaway is that we are continuing to make solid steady movement in strengthening our balance sheet, and we remain ready to capitalize on operating growth opportunities as they present themselves, whether that is through new US state markets opening, US federal banking actions such as the SAFE Banking Act and/or international utilization.

And touching on the legal and regulatory environment update. Last month, President Biden had a historic moment when he was the first sitting US President to suggest that the scheduling of cannabis should be reevaluated and that simple cannabis offenses at the federal level should be partnered. These actions, when coupled with the potential for SAFE Banking and the soon to be proposed PREPARE Act, signify unprecedented momentum for cannabis utilization at the federal level.

As for this midterm election cycle, in total, we saw five states with recreational cannabis on their ballot. Arkansas, Maryland, Missouri, North Dakota and South Dakota. Both Maryland and Missouri passed their initiative becoming the 20th and 21st state to legalize recreational cannabis. With the passage of these initiatives nearly half of Americans live in states for cannabis uses legal for anyone 21 years or older. Future wins be celebrated. The two states with passing measures demonstrate a continued bipartisan interest of voters when it comes to cannabis. Importantly, these initiatives represent the opening of two new recreational markets. Although time lines and license structures are largely yet to be determined, we remain positioned and ready to enter these markets to stay open.

At the time of these remarks, there are many Senate and House races yet to be finalized. I want to be clear when I say that this statement applies regardless of which party has the majority in the change. The federal legalization of cannabis must be seen as a bipartisan vote because of the statistically responsible thing to do. We saw this during COVID when cannabis was declared an essential industry in Colorado and other states, and we continue to see this in the state economy.

In the face of this macroeconomic climate, putting federal cannabis actions such as incremental action, including safe banking, should be at the forefront of the minds of Congress, regardless of which party has majority, the economic benefits, increased revenue and job creation or bipartisan.

We believe that our long-term meeting indicators all suggest good progress heading into the fourth quarter and beyond the three series. First, our core business of compliance is a must-have and not a nice to have service for our clients. We will continue offering a best-in-class suite of services that addresses the needs of small to medium-sized businesses, midsized enterprises, and larger cannabis enterprises.

Second, the cannabis market is projected to grow and we are positioned as a central player with more of the industry running on a -- each year. Third, we are making the prudent and necessary decisions to ensure that we are the go-to solution in the cannabis space for many years to come by narrowing our focus to our core must-have product clients and ensuring we are firmly entrenched to rise with the industry and category, to enjoy the growth that is projected for the years ahead.

We remain optimistic about our future and we believe the cost-cutting we've done in conjunction with the opportunities we have in front of us will subment our leadership position and enable us to realize their long-term financial objectives.

Now, I'll hand the call over to Dean Ditto, our CFO, who will provide a financial overview of the quarter. Dean?

Dean Ditto

Thanks, Jessica. This morning, I'll provide an overview of our financial results and key business metrics for the third quarter ended September 30th, 2022. For the three months ended September 30th, we recorded $5.4 million in revenue in the third quarter, $5.3 million or 98% of which was software sales. This improvement was driven largely by the addition of acquired businesses with accelerating software growth.

The primary driver of the year-over-year growth was from the acquisition of the enterprise platforms. We presently have approximately $400,000 of CARR in backlog.

For the three months ended September 30th, gross profit was $3.4 million and that was slightly ahead of $3.2 million in last year's quarter and resulted in a 62% growth margin, which was in line with Q3 in 2021.

For the year-to-date, the gross margin was 67%, reflecting higher performance in the first half of the year than in the current quarter. The gross margin improvement in the year was due to synergies realized from our acquired enterprise assets, which have higher margins, mitigated by slower sales growth. We also continued to implement ongoing initiatives to drive operating efficiencies in an effort to hold margins stable at these levels.

Moving to operating expenses. Product development expense was $1.4 million for the three months ended September 30th compared to $1.6 million for the same period last year. This represents a decrease of $0.2 million, or 12% from the same three-month period. Product development expense decreased, primarily due to the effects of headcount reduction in the restructuring, which lowered overall salary and benefit costs as well as stock-based compensation costs.

Following the restructuring, we have implemented controls over hiring and managing open headcount. Sales and marketing expense was $1.9 million for the three months ended September 30, compared to $2.0 million for the same period last year. This represents a decrease of $0.1 million, or 6% for the same three-month period. The decrease is due primarily to the effects of headcount reductions from the restructuring, which lowered the overall salary and benefit cost run rate and also reduced stock-based compensation costs. In addition, we incurred lower trade show and promotional expenses in the 2022 period. These decreases were partially offset by an increase in contractor consulting costs.

General and administrative expense was $1.8 million for the three months ended September 30 compared to $2.1 million for the same period last year. This represents a decrease of $0.3 million, or 12% from the same three-month period. The decrease was primarily due to lower financing and acquisition-related costs as well as lower stock-based compensation and franchise tax costs in the 2022 period. These decreases were partially offset by higher bad debt expense, Board of Director compensation costs and proxy-related expenses associated, with the shareholder meeting.

There are a few adjustments in the year-to-date numbers that, I'd like to call out as well as part of the financial performance conversation. The first two items are non-cash expenses. And the last item is a non-recurring charge. Contingent consideration adjustment. In connection with our acquisition of 365 Cannabis in October 2021, there is a contingent consideration, or in common terms in earn-out to be paid in cash or common stock or any combination thereof. Upon the completion of the assessment period associated with the revenue targets, the fair value of the contingent consideration was reduced to $3.3 million as of September 30, 2022.

Impairment charges. Earlier in the year, the company performed a paramount analysis on the tangible assets and goodwill and found it necessary to book impairment charges in order to report these long-lived assets at fair value and in accordance with GAAP.

Restructuring adjustment. To remind also in May 2022, we implemented a corporate restructuring initiative to restructuring, as approved by our Board of Directors, which resulted in a reduction of the company's workforce by 59 employees, or approximately 33% of the company. As a reminder, we measure EBITDA and adjusted EBITDA because we believe it is helpful to investors in understanding our performance, and allows for comparisons of our performance and credit strength to our peers.

Adjusted EBITDA excludes the effects of non-cash expenses, like impairment charges, adjustments to fair value and stock-based compensation and non-recurring items, such as restructuring, business combination and financing charges.

Looking at adjusted EBITDA for the three months ended September 30, 2022, we reported a loss of approximately $1.4 million, narrowing our loss slightly from a year ago and down more significantly from $2.3 million in the June quarter.

We continue to experience customer churn due to a number of reasons, including customers going out of business or otherwise exiting the cannabis segment. Churn has increased by 15%, compared to the same quarter of the prior year. Our average B2B deal size has decreased by 16% year-over-year, indicating customers are closely monitoring their purchases.

As Jessica noted during her earlier remarks, this trend is something we anticipated and addressed in a proactive way. We remain confident that as tailwinds return to the cannabis sector, we remain best positioned to capitalize on opportunities as our core software is a must-have and not a nice to have.

Turning to key figures from our balance sheet and cash flow statement. Our cash and restricted cash was approximately $9.5 million as of September 30, 2022. Net cash used in operating activities was $3.2 million for the quarter. Net cash used in investing activities was $1.6 million, which primarily consists of investing in capitalized software development. We raised $9.2 million from a unit offering that closed in July.

As of September 30, 2022, our convertible debt was valued at $14.5 million. Due to the amendment to the debt agreement, which effectively moved the amortization of the debt out in time of January 2023, we did not reduce the principal balance of the debt during the quarter.

I'd like to take a moment as required to address the going concern disclosure incorporated into our 10-K filed in March of this year. While we are pleased with the operating results this past quarter, we recognize the continued downward pressure on working capital. The ability of the company to continue as a going concern is dependent on our ability to secure other sources of financing to reduce debt and to attain profitable operations.

Our corporate liquidity requirements primarily include payroll costs, technology and infrastructure costs, corporate overhead expense, and debt service costs. Our current sources of liquidity include cash on hand as well as proceeds we anticipate from the access to our ATM program. We recently completed a reversed stock split that was approved by our shareholders, and we continue to explore strategic options available for the business.

Management is working in a focused manner to produce a consistent and sustainable working business model that is designed to generate returns for our shareholders and reward them for their commitment to and investment in Akerna.

This concludes our prepared remarks. We are happy to take any questions you may have. Please keep in mind that the forward-looking statement disclaimer discussed at the beginning of this call applies equally to the Q&A session.

Now let's turn the call over to the operator for questions. Operator?

Question-and-Answer Session

Operator

And at this time, we'll be conducting our question-and-answer session. [Operator Instructions] Our first question comes from the line of Ryan Kintslinger with Alliance Global. Please proceed with your question.

Ryan Kintslinger

Hi, great. Thanks guys for taking my questions. With the economy leading your customers to scale back on some services, I'm curious at a high level, what's the strategy to drive bookings and growth. For example, are there pockets of strength, or areas of focus? And if we look at your $0.5 million of bookings in the quarter, what types of contracts were these and any other details to help us understand where you're winning business?

Jessica Billingsley

Hi, Ryan, its Jessica Billingsley. So answering that question is where are we seeing some good growth opportunity in some additions? We're certainly seeing some very strong markets continue to grow and for us to continue to expand in some of our strongest markets. So the cue to know would be Pennsylvania and Puerto Rico. We're also starting to see just a little bit of emerging market activity. As, you know, New York continues to be very slow and moving ahead. But we do -- we have seen a little bit of movement in New Jersey. And also, we're starting to see some expansion in the Southern US and Mississippi is going to start to issue some of their licenses. Alabama is in its licensing application phase now, and how the time line to release and announce those applications next year. We're very bullish on both the Southern United States and Latin America as markets in general. And then, of course, we think there are some existing markets that are just strong and will continue to be strong.

Ryan Kintslinger

Great. That's helpful. And then if I think about a lot of those states like New Jersey, Mississippi, Alabama, where you're seeing movement, you're starting to see the licensing application start. Talk about how you're positioned? Are the customers that are applying already contracted to use you if they get licensed, are these existing customers that you've had with other states? Just talk about how you're positioning in the state?

Jessica Billingsley

Sure. So a mix of both. We certainly in some of these states that are in the application phase, we have existing clients that have already put us on the application with the most applications in most states have some take-up section for what is the electronic tracking system that you plan to use. And we certainly have a number of existing clients who have noted us there. We have some existing consulting clients with whom we're working and we’re in pace with more competitive licensing, Alabama being notable there. And then, of course, there are other states where we have existing large clients that maybe haven't specifically noted us, but we expect we'll be using this.

Ryan Kintslinger

Great. One more question. I'm curious if the service level declines you discussed in the near-term, you think we'll continue to more than offset bookings by some amount? And if so, is there anything you can do from a pricing standpoint to retain the customers that are remaining in cannabis? I know you talked about some customers are leaving, because they're leaving the exit -- they're exiting the market. But what about those that are staying in the market just pointing back on service level agreements?

Jessica Billingsley

So I don't have a crystal ball. It's a great question. I would like to think that we are nearing the tail end of that. However, I don't think that anyone can call that for sure. I do think that we're starting to see -- we've seen a lot of shakeout this year, maybe it's a great way to put it. And I wouldn't expect to continue to see that at the same way over time.

I think a lot of our clients were feeling the pinch, and looking and saying, "Hey, where can we contract and then there's a little bit of a, hey, we're just going to hump down through this economic time. And of course, as I noted in my prepared remarks, what's great about that is our four products are a must have, and a nice to have.

And in working with these clients and being a really good partner through this period of time, we're in a really great position for a land and expand and to grow with them as they continue to grow because, of course, there's still a tremendous amount of growth opportunity over the next few years in cannabis.

Ryan Kintslinger

Great. Thank you.

Operator

[Operator Instructions] And it shows that we have reached the end of our question-and-answer session. I'll now turn the call back over to Jessica Billingsley for closing remarks.

Jessica Billingsley

Thank you, operator. We are the technology ecosystem for cannabis. And we appreciate you spending time with us this morning and following our progress, and thank you for your interest in Akerna, and we look forward to sharing our progress with you as we move forward.

Operator

And this concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.