Entourage Health Corp. (OTCQX:ETRGF) Q3 2022 Earnings Conference Call November 15, 2022 10:00 AM ET
Marianella delaBarrera - Senior Vice President of Communication and Corporate Affairs
George Scorsis - Executive Chairman and Chief Executive Officer
Vaani Maharaj - Chief Financial Officer
Conference Call Participants
Good morning, everyone, and welcome to the Entourage Health Corp. Third Quarter 2022 Conference Call. At this time, all participants are in a listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity for analysts and members of the media to ask questions. [Operator Instructions] A replay of this call will be available on the Entourage Health website later today and will remain posted for 90 days.
I would now like to turn the conference over to Marianella delaBarrera, Senior Vice President, Communication and Corporate Affairs with Entourage Health. Please go ahead, Ms. delaBarrera.
Thank you, Gaylene, and good morning, everyone. Welcome to Entourage's third quarter 2022 results conference call. Please note, as noted, this call is being recorded. For copies of our financial documents filed on November 14, 2022 or our press release issued this morning, or to retrieve a recording of this call, please visit our Investor Relations page of our website at www.entouragehealthcorp.com. The replay will be available later this afternoon.
With us today is George Scorsis, Chief Executive Officer and Executive Chairman of Entourage Health; as well as Vaani Maharaj, our Chief Financial Officer. Today, we will review the business highlights and financial results for the third quarter as well discuss recent developments. Following formal remarks, we will open the floor for questions.
I would also like to remind you that during today’s call, we will discuss our business outlook, which will contain certain forward-looking statements. Actual events or results could differ materially from those expressed or implied by such forward-looking statements due to several risks and uncertainties including those mentioned in our most recent filings with SEDAR. These comments are made based on predictions and expectations as of today. Other than as required by applicable securities laws, the Company does not assume any obligation to update or revise them to reflect new events or circumstances.
Now, at this time, it is my pleasure to introduce George. Go ahead, George.
Thanks, Marianella, and thank you to everyone for joining us this morning. Before we kick off the review of our results for the period, I wanted to address the news we issued alongside HEXO earlier this morning. We signed a long-term supply agreement to purchase bulk cannabis from HEXO to meet our supply demand and distribution commitments. More to come on this. But for now, we see this as a very positive development for our business. This will ensure we do not miss on any of our fulfilling or any of our large purchases ever again.
Moving on to our results. While I am optimistic of what's to come, I can tell you that our last two quarter results prompted us to accelerate many of our optimization choices and move quicker towards our strategic priorities. For starters, in Q3, we generated $10.1 million in net revenue, which is marginally up from the second quarter, but down year-over-year due to a few macroeconomic factors in the market. And frankly, the product shortages I just alluded to, which impacted our ability to fill some of our orders. Despite these challenges, we continue to be agile, and we are taking steps to accelerate our path to profitability. Engaging with strategic partners and optimizing our operations will serve to strengthen us and get us to EBITDA positive in Q2 2023.
Our strategy revolves around three priorities that contribute to my confidence in the statement. Firstly, optimization and simplification of our business strategy with a focus on our core competencies; secondly, cost synergies that reduced our operating expenses and lastly, investing in our commercial capability, distribution and innovation to accelerate growth.
I'll break each one down to further explain. Starting with our first objective, optimization and simplification of our business strategy. As part of our growth strategy for 2023, we developed a new narrative. We have always demonstrated our commitment to providing a consistent supply of high-quality cannabis products to the Canadian retail and medical markets.
While we have traditionally delivered on this promise, more recently, we encountered a setback in our production. As part of a temporary solution, we engaged third-party suppliers to supplement with quality grown flower products, and this is where the realization set in for us. As we solved our flower shortfall, it became clear that it's not economical for us to continue growing anymore. We can now procure quality supply, at a fraction of what it costs for us to produce it ourselves.
Following an in-depth strategic review and analysis and after careful consideration, we are announcing today that we've made the difficult decision to exit from cultivation. This decision was not taken lightly because we took the time to carefully review our operations in alignment with our business goals and impact on our employees. Although this is one of the most difficult decisions we've made in the history of this business, as it will impact 35% of our workforce over the long run, we know it's the right decision for the overall business and to the shareholders.
Our many talented employees are working with us as we transition out of cultivation activities over a five-month period, commencing immediately. I want to start by thanking our valued employees for their hard work and dedication to Entourage's success in the past. We are doing everything we can to ensure our employees are treated fairly, which includes sourcing new roles with the new organization and outside with our peers over the next five months.
This leads me to expand further on our supply agreement with HEXO. With the supply arrangement enhanced, Entourage is positioned well to meet the growing demand for our branded products. Have always been of the mindset that our industry is poised for a collaboration. And by leveraging HEXO's cultivation capabilities, it will allow us to distribute more consistent premium products to the market at a fraction of the price.
Our partnership with a like-minded company that has a proven ability to deliver the highest quality cannabis products will ensure that Canadians continue to have access to our full portfolio of strains, including our proprietary strains. While this marks a significant shift in our business model, we are capitalizing on it, and the result will be a much more streamlined business and cost structure.
The reality is that every cannabis company in Canada is making cost savings a priority today. And if they are not doing that, they simply won't survive. We expect to realize an annualized cost savings of over $10 million from winding down our cultivation operations and that's just a conservative estimate. As a result, we will be able to increase supply of in-demand products, grow accretive margins, drive revenue, increase cash flow and achieve our positive EBITDA goals by Q2 of 2023.
Vaani will provide more color in her view as I know she's also eyeing the significance of cash savings, and she will provide more insight into this. In fact, while our industry peers are contending with cash and funding issues, plus insolvency risk, that's one area I can confidently confirm is not a concern of Entourage. With the $30 million in financing from LPF and deferral of our debt payments, our year-to-date cash position is one of the best in the industry, and we are well positioned to drive for profitable growth in 2023. How can we comfortably get to profitability by this time? By carving out our growth acceleration plan that is rooted in our brand development.
For now, I want to address how we're continuing to produce quality products for our adult-use and medical channels. First up, the adult-use market. While we have a diverse portfolio of products, we noted early in the year that premium and pre-rolled market segments are the two fastest-growing segments with the highest margins. And these two segments are turning out to be the sweet spot for Entourage and in the brand color, cannabis and Saturday.
Having established brand loyalty in the market, now we need to capitalize on this opportunity to build our house brands and play to our distribution strengths with color pre-rolls capturing over 4% of the market share and our placements secured in close to 2,200 stores, representing an 80% retail footprint. We will continue to leverage our commitment to innovation and brand building. We will be able to bring higher yields to the market with our new cultivation partner, which will enter result in higher expanded margins and higher returns.
Taking a look at our medical business, we have grown 7% in medical sales and over 17% in the last nine months, which has compensated for the slips in our adult-use sales. We are noting a consistent sequential increase in patient registration and retention, and in fact, up 20% per quarter. The company now has 10 union groups, 5 insurance partners and 24 clinics signed to our Starseed medical platform. With the launch of Syndicate, our new e-commerce platform, targeted patients without insurance coverage, we are giving new patients access to comprehensive catalog of cannabis products, formats and brands at a competitive price.
All those coming soon. Products from Irwin Naturals, a large U.S.-based wellness conglomerate that we partnered with in Q3. They have over-the-counter access and pharmacies across Canada and the U.S., a potential entry way for when CBD products become legal in the coming year or so. Through our medical platform, we plan to gain a significant share of the Canadian medical cannabis market.
As a recap, our goal is to achieve a positive EBITDA run rate Q2 of 2023. As a result, our medical cannabis business continues to grow and generate high margins. We expect the recreational market in Canada to correct itself, and we'll be ready to increase our market share when it does. Meanwhile, we are focused on improving sales, marketing and distribution of all our brands, doing so at a lot lower cost with a consistent quality supply source.
I'm going to hand it over now to Vaani, who will run us through the financials for the period. Thank you again, everyone. Vaani, over to you.
Thank you, George, and thank you to everyone joining us on our call this morning. Please note that for the course of my financial discussion today, all financial information is prepared in accordance with international financial reporting standards and is in Canadian dollars unless otherwise stipulated.
Without a doubt, consistent with our second quarter review, the third quarter was impacted significantly by our grow rooms being closed from February 12 to the end of June 2022. Not being able to fulfill orders, losing 13 harvests and substantial freight costs to procure third-party product combined to drive unfavorable financial results.
More importantly, despite these headwinds, the major story here really is our revenue. Despite not having our price cultivars, we maintained market share in a turbulent market. Overall, adjusted EBITDA improved for the three and nine months ended September 30 on a year-over-year basis by 29% and 39%, respectively. On a consecutive basis, adjusted EBITDA declined by approximately $500,000 or 21%. The major drivers to this are revenue and cost of goods sold and to a much smaller extent, SG&A.
Let's take a closer look at revenue. The major headline here is that while our net revenue, which is revenue less excise duty, was lower by $700,000 or 7% for the three months ended September 30, 2022, compared to the same period for the prior year, the fact is that on a consecutive basis, our Q3 revenue is higher than the prior quarter by $400,000 or 4%.
For the nine months ended September 30, 2022, our net revenue grew by $500,000 or 2%. We experienced another quarter of growth in our medical channel, which is up 5%, driven by higher patient enrollment as well as larger basket sizes. The adult-use channel was impacted by the shortage of our proprietary cultivars and decreased by 7% year-over-year, though it was up 21% sequentially from Q2. Our proprietary cultivars typically comprise 40% to 45% of our revenue, and our preservation of market share represents higher sales of other SKUs largely pre-rolls. There were no bulk sales during the quarter.
Our channel mix year-to-date is comprised of 42.4% medical, 57% adult-use and 1% bulk, whereas the mix for the same period in 2021 was 37%, 60.7% and 3%, respectively. From a pricing point of view, market turbulence continued through the quarter, consistent with our experience throughout fiscal year so far.
For the nine months ended September 30, 2022, our average selling price per gram after excise duty was relatively flat at $2.53 per gram, partly due to the mix as well as lingering market factors related to pricing. We continue to expect our average selling price on an aggregate basis to remain stable or improve over time as we introduce more premium innovation and formats.
Our gross loss before changes in fair value was $4.9 million for the three months ended September 30, 2022, compared to a gross loss of $4.2 million for the same period in 2021, which is an increase of 18%. Whereas the same metric for the nine months ended September 30, 2022, reflected a higher gross loss of $900,000 or 112%.
Lower gross margin and gross profit were heavily influenced by certain transactions in the quarter compared to the same period for the prior year. Specifically, a $4.3 million increase or 92% in inventory provisions due to older products and higher freight cost of $2.7 million or 167% related to freight associated with sourcing products through 3P providers.
Without the provision, gross loss before changes in fair value would have been $4.1 million, representing growth of $8 million or 190%. This cleanup of inventory reflects management's commitment to ensuring only high-quality product is available for sale.
A quick correction. Without the provision, we would have had a gross profit of $4.1 million. As discussed earlier in the call, the grow room closures during the second quarter continued to impact the results of our operations. Since plans were propagated close to the beginning of Q3 and we have a 12-week vegetative cycle, our yield is lower compared to the prior year.
From an SG&A perspective, Q3 2022 SG&A was higher than Q3 2021 by $2.4 million or 52% and relatively flat to prior year for the nine months ended September 30, 2022. The change for the quarter was due primarily to the timing of certain spend and pervasive investment in our marketing promotion expense to preserve shelf space and listing as well as higher salary expenses due to severance costs, which are typical of transactional activities.
Turning to our balance sheet. We ended the third quarter with cash and cash equivalents of $8.1 million, reflecting a decrease of $6 million compared to Q2 2022. A big factor is that our year-to-date cash position is one of the best in the industry and with the backing of our strategic partners, we are well positioned to drive for profitable growth in 2023.
As George mentioned, on October 31, 2022, the company amended its credit facility agreement with LPF and received the first tranche of this funding under the amended credit facility amounting to $15 million. The second tranche of funding of $15 million will be received on January 31, 2023. The credit facility continues to bear an interest rate of 15.25% with the option at the company's discretion to capitalize interest in lieu of cash payments and the debt is set to mature on December 31, 2024.
With the $30 million in financing from LPF, the deferral of those debt payments, we can remain focused and disciplined on improving our cost structure instead of looking for funding sources like many of our peers are currently doing. Additionally, with the company repositioning its portfolio around selected market segments in alignment with our distribution partners, we fully expect to realize larger savings, accretive margins and increased revenue.
The last piece I'd like to mention is the phase-out of our cultivation operation. I echo George's sentiment. This was not an easy decision, and regretfully, it will largely impact our valued cultivation colleagues. While we work through the transition plan, I'd like to sincerely thank our colleagues for their contributions, their commitment to our cause and their determination in making Entourage a great place to work.
As you can see, we have a plan going forward and our hopes though that with the new growth and business plan opportunities. I feel confident in our approach, and I'm looking forward to updating you on our progress in the new year.
With that, I'll turn the call back over to George for closing remarks.
Thank you, Vaani. In summary, we capture some point of sales milestones, and we fully expect to see steadier growth moving into the remainder of the year. Packaging and distributing color, Saturday, Starseed and our newest syndicated products [indiscernible] and within a low-cost structure, continuing to meet our proven record fill rate and delivery targets and continue to partner with industry peers, playing on our strength to propel the industry forward. We believe all of this will provide Entourage with a firm foundation to continue our growth trajectory into the remainder of 2022.
Now I'll turn it over to Marianella.
Thank you, George and Vaani. This concludes our opening remarks, and we are now ready for the question-and-answer period. Gaylene, please proceed with instructions to call in.
Certainly. [Operator Instructions] As there appear to be no questions, I'd like to turn the conference back over to Mr. George Scorsis, CEO of Entourage Health for closing remarks.
Thank you all again for joining us on today's call and for your continued support and confidence. We look forward to sharing our progress with you in Q4 as we grow and evolve further into 2023. For those of you in the U.S., here's wishing U.S. safe and half the U.S. Thanksgiving this coming weekend and for our Canadian international listeners, all the best as you get ready for the upcoming holiday seasons.
If you have further questions, please reach out to Marianella and our Investor Relations team. Thank you, and have a great day.