Thank you for standing by. This is the conference operator. Welcome to the Vext Science, Inc. third quarter 2023 financial results conference call. As a reminder, all participants are in listen-only mode and the conference is being recorded. After the presentation, there will be an opportunity to ask questions. To join the question queue, you may press Star, then one on your telephone keypad. Should you need assistance during the conference call, you may signal an operator by pressing Star, then zero. I would now like to turn the conference over to Jonathan Ross. Please go ahead.
Thanks, operator. Good morning, everyone, and thanks for joining us today. Vext's third quarter 2023 financial results were released earlier this morning. The press release, financial statements, and MD&A are available on SEDAR+, as well as on the Vext website at vextscience.com. We would like to remind listeners that portions of today's discussion include forward-looking statements and that forward-looking statements are included in today's filings. There can be no assurance that these forward-looking statements will prove to be accurate or that management's expectations or estimates of future developments, circumstances, or results contained therein will materialize. Risks and uncertainties that could affect future developments, circumstances, or results are detailed in the MD&A and Vext's other public filings that are made available on SEDAR+, and we encourage listeners to read those risk factors in conjunction with today's call.
As a result of these risks and uncertainties, the developments, circumstances or results predicted in forward-looking statements may differ materially from actual developments, circumstances, or results. This call also includes non-IFRS financial information, and such non-IFRS financial measures are subject to the disclosure and reconciliation included in our press release disseminated earlier today. Forward-looking statements made during this conference call are made as of the date of this call. Vext disclaims any intention or obligation to update or revise such information, except as required by applicable law. Vext's financial statements are presented in U.S. dollars, and the results discussed during this call are in U.S. dollars. I will now pass the call over to Eric Offenberger, Chief Executive Officer of Vext.
Thanks, John. Good morning, everybody, and thank you for joining our third quarter 2023 financial results conference call. I am joined on the call today by Trevor Smith, CFO of Vext. I will start by providing a brief overview of our progress this quarter before turning it over to Trevor for an update on our financial performance. The market and consumer environments remain similar to what we have discussed over the past several quarters. While inflation has begun to moderate, challenges to consumers' discretionary income remain. From a market-by-market perspective, beginning with Arizona, pricing continued to decline in the quarter, primarily as a result of ongoing oversupply in the market and the consumer factors I've already mentioned. In Arizona, our near-term strategy continues to be to ensure that our cultivation footprint perfectly matches demand within our own retail footprint while executing well at a retail level.
This is a strategy designed to both drive results in a tough short-term environment while setting the company up even better on the other side of it. We have made significant progress against this strategy over the past several months. In quarter two, we sold down our outdoor inventory, which we expected would continue to decline in value. This enabled us to maximize cash flow from the product at the cost of margins in the quarter. In mid-October, we announced the sale of our Prescott Valley cultivation facility, which closed in mid-November. This brought us $6.5 million in additional cash that was reallocated to debt repayment and funding growth in Ohio, while ensuring our internal supply and demand are better matched on a permanent basis with supply coming out of our modular Eloy facility. The first harvest at Eloy is expected in quarter one of 2024.
From a retail standpoint, our focus in the current environment has been on driving traffic and volume through our stores, while managing gross margin and cost at the store level. Basket size has compressed across the market and Vext is no exception. Though the data we have seen suggests we are outperforming on key metrics, traffic, unit, and average sales per door, our strong view is that companies who can maintain their customer base and provide them value now will not only grow share in the short term, but be positioned to accelerate out of this current environment, both on top line and margin, as consumer spending improves, winter visitors return to Arizona and basket sizes begin to grow.
In quarter three, gross margins began to move higher compared with quarter two, and we expect this to continue through quarter four and into 2024 as we continue to flow more of our own product through our own retail stores and our supply and demand ratio starts coming into balance in the market. Turning to Ohio. In early November, Ohio voters approved a marijuana legalization initiative, which will make Ohio the 24th state in the U.S. to legalize adult-use cannabis. With a population of approximately 11.7 million, it is one of the top 10 states in the U.S. by population. Currently, 1.5% of the total population are on the medical program.
If we were to use similar markets as a model for what to expect, we can conservatively say that around 10% of the state's population are cannabis consumers, indicating an increase of potential consumers of 522% in Ohio, becoming an estimated $4 billion market within the next four years, as reported by MJBizDaily.... I cannot overstate the importance of this development to Vext. We expect Ohio to be a big driver of growth for us over the next several quarters, and we have taken several important steps since our quarter two results to solidify our position in the state in preparation for adult use in 2024. In October, we completed the acquisition of Appalachian Pharm Processing and Cultivation, making us fully vertically integrated in Ohio.
The results of the Appalachian Pharm entities will be included in our quarter four 2023 numbers. Based on current performance, we anticipate that they will generate free cash flow for the remainder of the year and into 2024. Shortly after the end of the quarter, we also announced agreements to acquire 2 additional dispensaries in Ohio. This transaction will position us with a meaningful retail footprint in the Ohio market and provide us with the scale necessary to generate sustainable long-term results. Upon completion of this transaction, which is expected to occur in 2024, Vext will have an operating Tier One cultivation facility, an operating manufacturing facility, and four dispensaries in the state.
During quarter three, our Jackson dispensary experienced temporary sales pressure resulting from new retail locations being added in the market and a slowing or retraction of medical consumers, which is typical of any state with an impending recreational cannabis program. We saw a similar trend in Arizona prior to the commencement of adult-use sales. With regard to the Columbus, Ohio, dispensary, we are awaiting approval of our ownership transfer application from the Ohio Board of Pharmacy and expect to receive it before the end of the year. Under the new adult-use statutes in Ohio, the cap on dispensary license per ownership group will increase to eight. Tier One cultivation facilities are granted three additional adult-use retail licenses.
We believe that when the law is finalized, our existing dispensary in Jackson and the pending acquisitions will give Vext access to a total of four dispensaries licensed to cater to both medical and adult-use customers. Additionally, we should also have access to another three adult-use retail licenses, providing us with the opportunity to operate a total of seven dispensaries in the state. Overall, with the closing of the pending transactions and the start of adult-use sales in Ohio, we will be a larger, diversified operator with fully vertically integrated footprints across two limited-license states with significant potential. While our current focus remains primarily on our Arizona and Ohio operations, we are monitoring market developments in other areas of our joint venture portfolio and remain well positioned to act on developments aligned with our strategic plan.
We are particularly encouraged by the developments in Kentucky regarding a medical cannabis program and are awaiting further guidance on regulation and timing. On the whole, I am very pleased by our team's performance during a challenging period for consumer-facing companies. While the results on the P&L aren't what we would like to see on an ideal world, we are heading in the right direction and expect 2024 to be a very important year for Vext from both growth and profitability perspectives. With that, over to Trevor for a quick review of the financials. Trevor?
Thank you, Eric. Q3 marks my first quarter as CFO of Vext, and I'm pleased to share highlights from what was an eventful period for the company. Diving into the results, in the third quarter of 2023, Vext generated revenue of $8.1 million, a 6% increase over Q3 of 2022, and a slight decrease compared to the $9.1 million in the previous quarter. The sequential decrease in revenue can be attributed to weakness in the Arizona wholesale market and Ohio retail, as additional dispensaries came online during the quarter, as Eric previously mentioned. Gross margin before fair value adjustments for quarter three was 39%, compared to 30% last quarter, a significant improvement. During Q3, we made the decision to execute more promotions to continue to attracting steady traffic to our stores in a seasonally slower period.
This enabled us to move more inventory to retail than typical for Q3, and despite the higher volume levels and continued pressure on basket sizes, effective promotions by the team and concerted efforts to drive mix back where possible enabled the sequential growth in margin. We expect to see continued gross margin recovery from Q2 levels throughout the remainder of the year and going into the new year. We recorded $1.1 million in adjusted EBITDA for quarter three, which was up compared to $1.0 million in the previous quarter. During the quarter, EBITDA came in at $0.4 million, making it our fourteenth consecutive quarter of positive EBITDA and positive adjusted EBITDA. In Q3, EBITDA was down significantly as compared to the previous quarter. This has to do primarily with the ERC tax credit, which reduced operating expenses during Q2.
Our ability to consistently generate profitability on the EBITDA line, even in tougher environments, is evidence of Vext's culture of fundamental operational excellence. Operating expenses were higher in the quarter compared to Q2, primarily due to the previously mentioned one-time ERC credit in Q2, as well as an increase in depreciation related to investments made in the Ohio cultivation facility, which didn't come with any revenue offset in Q3. Excluding these two items, overall operating expenses were down slightly in Q3 compared to the previous quarter. Cash flow from operations was $3.8 million in the nine months ended September 30th.
We expect cash flow from operations to return to growth moving into Q4 and into 2024, as margins stabilize in Arizona and Ohio assets are progressively added into the P&L. From a free cash flow perspective, it's important to note that we don't have any material unfunded growth capital expenditures planned for the year, as the expansions in Arizona and Ohio have already been completed or are already currently fully funded. Vext ended the quarter with $3.6 million in cash as of September 30th. Subsequent to the end of the quarter, we announced and closed an $11.5 million private placement to support the retail expansion in Ohio. That placement was primarily funded by an existing institutional shareholder, along with management and members of the board of directors.
After the quarter, we also announced and closed the sale of our Prescott Valley cultivation facility in Arizona, as Eric mentioned, for cash proceeds of $6.5 million, which was earmarked primarily to pay down existing debt. With that, thank you everyone for joining us for our Q3 2023 financial results conference call. I'll turn it over to the operator for your questions.
Thank you. We'll now begin the question and answer session. To join the question queue, you may press Star, then one on your telephone keypad. You'll hear a tone acknowledging your request. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, please press Star, then two. Our first question is from Andrew Semple with Echelon Capital Markets. Please go ahead.
Good morning. Thanks for taking my question. First off, maybe with the acquisition of APP closed, could you potentially speak to the contribution you expect from APP, subsequent to quarter end? What sort of incremental revenues would you expect that to bring in, and how would the margin profile that compare to your existing Arizona operations?
Good morning, Andrew. The revenue, it's primarily a manufacturing, and the cultivation is getting going there. So my gut feeling is it's going to increase the revenue probably 10% on the top line, roughly for the quarter, maybe a little bit less, as you know, it's still ramping up, in particular. The issue in Ohio continues to be, you know, the lag time between you're a recreational versus you're a medical, and the patients knew that they were going to be voting, and some of the people haven't been renewing their cards. So you see a little bit of a stagnation, if you would, or a drop off on customer base. That said, their margin profile is higher than Arizona's right now. Obviously, there's not an oversupply in the market, that's a fundamental oversupply.
It's an oversupply based upon their regulation right now in Ohio, which is putting pressure on the stores and stuff because they're adding more retail stores. But from the APP side, that's a positive because there's actually more outlets to be able to sell product. So we think it's going to be a contributor, and it'll continue to ramp up over the next couple of quarters, and we'll see a little bit of clarity from the state December seventh. So we'll get a better idea of what the actual implementation is going to be as a law.
That, that's helpful color. Thanks for that, Eric. And then maybe with-
Yeah.
The votes that we saw, the successful adult use ballot that we passed, have you shifted or made any changes to your plans for investing in Ohio? Have you thought about any additional ways that you could deploy capital in the state, or do you think that the assets, as they stand, are ready to go for the adult use market?
Well, we think that the assets that we have right now are ready to go. Obviously, we're waiting for some clarity. So, you know, within the legislation, you know, it looks like they're going to be... Existing stores will be grandfathered so that they get a adult use and a medical in the same dispensary type of operation. If a dispensary was independent, it'll get an additional adult use license, that it can open somewhere. If you're a Tier One, which we are, you'll get three additional adult use licenses, and they'll take the cap up to eight. The way it exists right now, we see ourselves at seven, but it really depends how they do the dispensaries. We think we should hit the cap.
That said, you know, one of the reasons that we made, obviously, you know, with Stephan leaving and that, we looked at our direction of what we're going, and Trevor's much more data analytical driven, like I am, and utilizes a lot of the tools. So we've done a lot of modeling, Andrew, of how to make sure that we have the supply out in Ohio, matching what we anticipate the demand, and making sure that we don't end up into a not enough, but also not too much. So we've been working on balancing that. So from a capital standpoint, yeah, you're going to deploy some capital to build out your additional licenses, but you'll get to the max relatively quick.
You know, if Ohio works like every other state, you know, the next couple of years is a nice runway for a return on the capital investment. It's just been slow. The best analogy I can give you is Ohio built a bunch of multifamily housing, and we've been waiting for the state to give us the permission to operate and let the people in. So we're just waiting on that. We have the housing already ready to go, so we think that's going to be a good thing. In Arizona, the opposite occurred. They built a bunch of multifamily housing, and the economy has gotten really struggled on the inflationary front, so people are spending more of their income on the housing than they were previously. So it's making their demand a little bit tighter or their trade down, if you would.
That's what happens in Arizona. It's a trade down.
... Got it, helpful. Thank you for taking my questions. I'll hop back into queue.
Okay, thank you.
The next question is from Donangelo Volte with Beacon Securities. Please go ahead.
Good morning, and thank you for taking my question. Tying in with the prior question, if you're looking to reach the capital eight locations, can you actually touch on what valuation expectations are looking like in, in Ohio? Have they climbed because of the adult use vote, or have more vendors come to the table? Thank you.
Well, I think if you're a seller, you think they've climbed. If you're a buyer, you think they've stagnated, or you said, "Hey, it's a little bit cloudy out there. I want to see what kind of starts to open up in the, you know, where the sun's going to shine and stuff like that, to get a better reflection of what it's going to do." We're not as focused on trying to acquire another license. We think that we did that within the right framework. I think we're more waiting to see how those three licenses that should come along with the Tier One are going to be used and take our capital and invest in those. We think that's a better use than saying: Okay, we want to be two to eight, let's go buy one. I think you'd make a mistake.
The other problem you have in Ohio is I'm waiting to see some clarity on the zoning laws and stuff. Within their existing legislation, they don't have like a, a regulation where you can't put a store within a certain geographic distance of another store. So the last thing you want to do is go buy a store at a premium or a multiple, but, you know, it doesn't make sense because you think it's a great location, and then the next guy set a store down right by you, and now you're into a, a margin struggle or a price struggle, you know, because that's how people compete, is with price. So we're looking for a little bit more clarity, and we've identified our geographic territory in Ohio, based upon logistics and distribution and stuff along those lines.
So we have a good feeling for where we want to go with the three additional licenses. It's just a matter of, you know, doing that, judiciously.
Okay, perfect. Thanks for the clarity on that.
Once again, if you have a question, please press Star, then one. The next question is from Yewon Kang with Canaccord Genuity. Please go ahead.
Hi, good morning. This is Yewon Kang from Canaccord Genuity. Thanks for the question. My question is just on the gross margin before impact of biological assets, which sequentially improved about 900 basis points this quarter. I wanted to ask if this was more just a function of recovery from the inventory liquidation in Arizona that happened in the prior quarter, or was this more supported by the increased verticality of your branded products at your retail, retail stores in Arizona? Thanks.
That's a good question. The way I'd answer that, and Trevor might add a little insight on this too, it's primarily a function of what we did in the second quarter of trying to get that outdoor inventory moving through the system, which means, you know, we processed more of it in-house and tried to get it moving through. You know, we didn't want it deteriorating or anything like that, or to be subject to as much pricing. So a lot of that went through the system, and that had an impact on margin. In the second-- In the third quarter, it started to return on the margin. You were fight-- You were fighting more of the headwind of the seasonality. You know, Arizona set records on temperatures and stuff along those lines.
So, that was more of what the headwind was in that quarter. We've also aligned our inventory more and stuff along those lines. That, you know, but what I'll really tell you has been the biggest impact on margin in Arizona is the fact that the wholesale market is pretty much gone. So the wholesale market in Arizona, where we were never big in that, we still participated, and we did a lot of contract manufacturing. With the oversupply and all the brands that came rushing in with adult use, you have that period of time where they're weeding themselves out and stuff along those lines. We feel like we're getting to the bottom of where wholesale is going to be, but we still aren't prepared to call it. But it's been a significant impact on the margin profile in the dollars.
Also, you know, you've experienced it on the top line, with the consumer having less to spend and less disposable income, as we alluded in our, our prepared comments, that the consumers are in the stores. There's more transactions that we're handling. We're doing a good job that way. The teams are really executing. They're focused in on what they're doing, but you're having to sell more products to be able to get those margin dollars, which means the margin percentage is a little bit less. That, I'll comment, and I'll give you my little spin on, of... My little spin is this, is people can chase a margin percentage, but you still need a certain amount of dollars to cover the whole operation, right?
So I can give you a 50% margin, but I'm not going to give you enough dollars to cover the fixed expenses that are inherent within the operation. So it's trying to get that balance. We continue to move the margin up, and we think the margin will start to be more realistic for what we should see in the market, but we don't think we'll return to the historic levels in Arizona for a while, for the foreseeable future, until that supply gets in balance. You know, the population is continuing to grow, the underlying economics are decent, but that fundamental factor of supply and demand is a reality. Trevor, is there anything you would add to that?
Yeah. In Arizona, as well as in Ohio, we have a focus on not only driving more our own products through our own retail doors, but also keeping an eye on the unit economics by each product category.
... So that's kind of a renewed focus that we would see, just kind of natural margin improvement at the retails. But I also think the Eloy, Arizona cultivation facility should be having better production outcomes than any of the prior Arizona cultivation facilities, which also help with margin improvement in Arizona.
Got it. Thank you. Just the second question on your expansion plans in Ohio. Could you provide some color over the expected timeline of acquiring and onboarding of the three additional stores that you mentioned in Ohio?
Yeah. The one, one of them, we're waiting on Pharmacy. Once Pharmacy gives us the operational approval, then we'll go through the paperwork process and do the final funding of that one. And then we'll have that on board. So we anticipate, still, we're hoping, hopeful by the end of the year. The Ohio team is ready to go, and they're chomping at the bit for that. The other two, that again, is in Pharmacy, and that's waiting for the Board of Pharmacy to give us operational ability to work with that and start those locations more. You guys saw those were Big Perm locations, so we're very familiar with the team that is at Big Perm because they're all Arizona-based, so we've known them for a while. So we think that's gonna be productive.
The issue really is you've got politics going on in Ohio. Pharmacy is out, and it's gonna go to Commerce, which is beneficial to us and the market, but you're in the holiday season, and bureaucracies tend to slow down in the holiday season, especially if they're not gonna have any long-term stake. So our guess is as good as yours of when we'll get notification from them. That said, supposedly by December fifteenth, we're supposed to know exactly on the two additional ones we announced, how we can operate with them and what we can do. So it's a waiting game. Now, we are getting our products into some of those stores, though, which is nice, and we think that that's gonna be helpful.
As I said, the Ohio teams are working together, and, you know, we're trying to integrate them within the concepts of what the law allows and doesn't allow.
Got it. Thank you so much for the color. I'll jump back into the queue.
Thank you.
Once again, if you have a question, please press star, then one. Our next question is from Pablo Zuanic with Zuanic & Associates. Please go ahead.
Good morning, everyone. Look, can I just ask on the subject, 280E and cash management? So regarding 280E, how are you thinking about your tax provisions, right? Some companies are starting to provide just for the normal corporate tax, not factoring 280E. Others are, you know, delaying payments on 280E, hoping on refunds. It's all unclear how it would play out, but some people are taking a more aggressive stance, and it may pay off for them. So it'd be nice to hear how you guys are thinking about 280E in terms of provisioning and in terms of your liabilities.
Then, you know, in terms of cash management, it's something that probably we have never asked before, but given what happened on another company, you know, can you comment, you know, where is your cash and how is it managed? Thank you.
All right, I, I'll take it from a general standpoint, Pablo, and then we'll let Trevor maybe talk a little bit about it, too. We focus a lot on treasury management because just the nature of, you know, who we are and, you know, how I've done things for my whole life. So we focus on it a lot and pay attention to it. With that said, on 280E, what we're doing is we've had audits through 2019, 2018, I think, and we've reached that. I don't see that coming back up where, you know, they're, they're gonna go back and do a retroactive or anything. So we're finishing the final payments on that kind of stuff and cleaning that up, the remainder of that. So that'll be addressed. 2019, 2020 are under review.
We filed appropriate documents, you know, to be in the queue to depend on what the IRS ultimately rules and how that goes with scheduling and everything like that. So I think we're taking a—I don't want to say we're taking an aggressive approach or a passive approach. I think we're taking what I consider to be a reasonable approach to make sure we're protected and we don't end up, you know, putting any undue risk upon the, upon the corporation of a lien or something along those lines. So I'll comment that in that comment. On cash management, we focus on it quite a bit. Ohio's been a challenge, without a doubt, just from the standpoint of Arizona continues to generate cash and stuff along those lines where it funds itself.
But a lot of that's been funneling to the Ohio operation in order to support the Ohio operation as we tried to ramp up and make the capital investments to be prepared. So we've used a lot of existing cash to go over to Ohio. As the sales have tapered off in Ohio or in Arizona, it's been more challenging. A lot. Arizona's made a lot of adjustments in staffing according to the marketplace and stuff along those lines, and we continue to watch it. So I'd say that.
But more specifically, in terms of cash holdings, would that be like with regional banks, credit unions, or investment advisors?
Oh, that-
Along those lines. Yeah, sorry.
Yeah, well, we have good cash at regional banks and stuff along those lines. They have good cash management there. We're not exposed like what you're talking about on some other companies that's announced recently. We don't have any exposure to that. We've used traditional banking. We did the debt packages by securing against the assets. We still think that's the best way to do it. We have a lot of the funds are in interest-bearing accounts. The one thing that I would like to see as a treasury type of look, it would be some type of concentration accounts within the cannabis industry. We haven't seen that come up yet. We're looking for that through a SAFER Banking and then trying to find that, and constantly are asking for that. We haven't seen that yet. So I think our funds are protected, are secured.
I feel really good about our banking relationships. So they're larger banks, well capitalized. You know, that'd be all I can say on that.
Right.
Trevor, anything you would add?
Go on. Go on, yeah, go on.
No, just to echo Eric's comments. We have three regional banks that we have great relationships with and really value their partnership and support. As Eric would say, we always want to make sure we're doing it above the line when it comes to treasury management.
That's great. And look, just one last one on Arizona. It's a two-part question. I'm hearing from people that, I mean, the illicit market or the flow of illicit product from California to Arizona, I think has always been an issue. But some people are saying that that's getting worse in terms of product flowing into illicit market, getting worse. But also some people are saying that some of the illicit product is making into illegal stores, which I find hard to believe. But do you have any thoughts on that? Thanks.
Well, yeah, I mean, my thoughts on it, Pablo, you know, you and I have talked before, and I guess I'm a little bit more salty or cynical than other people. I believe that wholeheartedly. I mean, the illicit market's there. You've got a 17% excise tax on the product and stuff along those lines, and people are going to, when they're tight on consumer dollars, they're gonna want to continue to use the product. And the product's not an issue as far as demand, the product's an issue more on the supply side. So you've got overcapacity in it, and it's an agricultural product. It's gonna try to find its home and somebody that's growing it, that's not gonna want to throw it away or have spoilage or anything. They're gonna try to do what they can to turn it into cash.
Now, are people bringing it in through the back door, so to speak, into the stores on a legal basis? That's hard to say. But my speculation is, I would be naive to say that's not happening or it's not possible to happen. You know, I think, you know, if it was, if you could prevent all of that stuff, you wouldn't have tax stuff, you wouldn't have bootlegging with cigarettes or alcohol or any of that stuff. So I think it's the reality. That said, we don't focus on it and don't worry about it because it's not something we can control. We only can control what we do in the stores and make sure that we aren't doing it.
Right. Okay, thank you.
This concludes the question and answer session. Today's conference call, you may disconnect your lines. Thank you for participating and have a pleasant day.