Emerald Health Therapeutics, Inc. (OTCQX:EMHTF) Q2 2020 Earnings Conference Call September 1, 2020 10:30 AM ET

Company Participants

Bernie Hertel – IR

Riaz Bandali – CEO

Jenn Hepburn – CFO

Conference Call Participants

Graeme Kreindler – Eight Capital

Operator

Good morning, and welcome to the Emerald Health Therapeutics 2020 Second Quarter [ph] Financial Results Conference Call. All participants will be in a listen-only mode. Following the presentation, we will conduct an analyst only question-and-answer session. Please note this event is being recorded today, September 1, 2020 at 10:30 a.m. Eastern Time. An archive of this call will be available on Emerald’s website following the meeting.

I would now like to turn the conference over to Bernie Hertel, who is responsible for IR and Communications. Please go ahead, sir.

Bernie Hertel

Good morning. We filed our results on SEDAR and issued a news release for what are the second quarter financials yesterday, after the market close, which can be accessed in the Investors’ section of our website at emeraldhealth.ca.

Leading today’s call will be Riaz Bandali, President and CEO of Emerald’s, and Jenn Hepburn, Chief Financial Officer.

Today’s call may contain certain forward-looking statements. Certain material assumptions are applied in providing these statements, many of which are beyond our control. These forward-looking statements are based on current information, assumptions and expectations that are subject to change and involve several risks and uncertainties that may cause actual results to differ materially from those contained in the forward-looking statements. These and other risk factors are described in our periodic filings made with SEDAR.

You are cautioned not to place undue reliance on these forward-looking statements and the company disclaims any obligation to update such statements.

I will now pass the call to Riaz Bandali.

Riaz Bandali

Good morning, everyone. Let me start by saying that I’m pleased to report that with respect to COVID-19, we’ve continued to keep our cultivation and processing facilities fully operational. I, again would like to sincerely thank our entire Emerald team for their tremendous effort to keep our operations progressing.

To begin, I want to make a statement that I could not previously make at any time since I joined Emerald in August of 2019. The statement is, I’m very pleased with the operational and financial performance and the trajectory of the company in the second quarter. Emerald is turning the corner and I’m excited to share some of the highlights with you today.

The second quarter was a very solid quarter in all aspects of our business. It was a quarter that marked a fundamental and notable shift in our financial performance, significant progress in all aspects of our operations, the launch of new brands and new products, and importantly, substantial progress delineating our go forward strategy and vision. It should be noted that these significant accomplishments occurred during the height of the COVID pandemic, which brought additional uncertainty into the market and the world.

The fact that we were able to deliver so well on all of these objectives during these unprecedented times, is a testament to the tremendous effort of our new team and the systematic discipline that we have placed on improving every aspect of our operational and financial performance, which has been the focus of our entire team since I joined the company 13 months ago.

Now let me provide you with an overview of our numerous accomplishments. During the last quarter and give you some visibility into the current quarter, while also giving you my perspective of what turning the corner means to me. One of our focal points over the last four quarters have been building a company with two types of strongly performing operations, and a complementary set of assets.

The first asset base which consists of our 100% owned facilities in Richmond and in St. Eustache, Quebec, focus on the defined scale production of premium cannabis products. And we use this production to develop distinctive science driven value added products in our Victoria facility and be our strategic partnerships.

Our goal in the first-half of this year was to get the full scale production capability, and thereafter to transition our sales, the input for products coming from these two facilities. I’m very pleased to report that our success in growing and selling unique high-quality, dried flower and oil products from these two facilities. And the processing efficiency in our Victoria facility has led to an impactful progress in our financial performance in the second quarter.

The second key operation and assets is our Pure Sunfarms joint venture. One of Canada’s leading, if not the leading large-scale value segment focused cannabis production operation. With its ability to drive key industry performance benchmarks, Pure Sunfarms is a highly competitive and valuable asset. No other company in Canada with a valuation comparable to Emerald has such a prominent stake in such a compelling operation and asset, period. It should be noticed that we hold a 41.3% equity stake in Pure Sunfarms, and we have 50% of the board seats.

Now I’d like to discuss what I meant by stating the Q2 demonstrated to me that Emerald is turning a corner. In our last two financial reports, I highlighted the five key strategic initiatives that we have focused on, to get Emerald’s business and financial position restructured, and reshaped for long-term success. Could be readily apparent that our focus and progress on each one of these strategic factors, when combined has served to immensely improve our financial position in Q2.

The particularly notable improvements in our financial results are, the gross margin from our 100% owned Emerald operations in Q2 significantly improved. This monumental improvement in gross margin was due to a few key factors. Firstly, a shift away from cannabis supplied secured at a high fixed price from the Pure Sunfarms’ supply agreement, which has been completely terminated, the cannabis secured from our own cultivation facilities.

Secondly, significantly higher per gram yield than anticipated at both facilities, coupled to very tightly controlled cost, which led to an average all in growing cost per gram including depreciation of $0.99, which is a phenomenal accomplishment by the team.

Our EBITDA from our wholly-owned operations in Q2 was negative $1.2 million, which marks a significant improvement of $2.7 million versus Q1 of this year. Again, a fantastic quarter-over-quarter improvement in our operational profitability. Jenn will provide more details on the tremendous progress in our financial performance during Q2 shortly.

Let me now spend a few minutes outlining some of the other significant steps that we’ve made on our five key strategic initiatives. The first strategic initiative was improving our overall cost structure. In Q2, we started to realize the impact of significant actions we’ve taken over the last three quarters to rationalize our cost infrastructure and our SG&A headcount. We expect to continue to decrease our SG&A expenses through Q4, and to be at our target level at the end of this calendar year.

Our second key initiatives related to optimizing our strategic partnership and JV agreements. Q2 was the first whole quarter under our restructured relationship with our joint venture, Pure Sunfarms and our joint venture partner Village Farms. As per above, we’ve seen the significant benefits and enhancements in our gross margin through the elimination of the supply agreement.

Subsequent to the quarter, we terminated an independent contractor agreement and the loan agreement with Emerald Health Sciences, a controlled person of Emerald, and our joint venture Emerald Health Naturals, terminated the supply and distribution agreement with Avricore.

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Consequently, Emerald has only one remaining related party agreement with our Emerald Health Sciences NAV. This agreement is a pure play per use agreement with a world class scientific team based in Spain, that can provide us with unique expertise on how to develop additional new products that impact the endocannabinoid system, in novel ways that can be IP protected.

Our third initiative was reshaping our entire strategic plan, and defining the businesses in the segments that we intend to compete in and build. In July, we entered into a share purchase agreement with Quinto Resources to purchase 100% of our Verdélite operation in Quebec for CAD21 million in cash. As this transaction represents a change of business for Quinto, various steps to fulfill Toronto Venture Stock Exchange, regulatory requirements and approval have taken longer than originally anticipated, and are still being completed. That being said, we still anticipate that this transaction will be completed in the next eight weeks.

Once completed, we will use the proceeds of this transaction in a very targeted and well-defined manner to improve our balance sheet, by adding to our cash position, reducing our payables, eliminating the deferred payment balance and decreasing our debt position.

Furthermore, we view this sale as a transformational transaction that further simplifies our organizational structure and footprint, and that will allow us to further refine our strategic focus into only those segments that we believe will provide the greatest potential for profitability and value enhancement. We’ll be providing more information about this over the next few months.

As previously reported in Q1, we signed a letter of intent with Sigma Analytical Services to acquire our Avalite cannabis testing operation. Both parties are working to close this transaction which had been delayed due to COVID-related delays and other priorities. We’re aiming to complete this transaction in the fourth quarter.

Our fourth strategic initiative is the development of novel science-driven and differentiated products for use in the medical, adult recreational and health and wellness segments of the market. This capability is and will be a core capability and a key foundation of Emerald’s future plans.

We were pleased to yesterday announce the launch of our first Cannabis 2.0 product, our SYNC Nano Fast Action Spray product line. Last week, we made our first shipment over SYNC SYNC 15 Nano THC product to Alberta and Saskatchewan, and this product should hit the retail shelves this week. We’re also preparing to launch our SYNC 15 Nano CBD product and to expand distribution of this product into additional provinces.

The SYNC Nano product line represents an important step on our path, the value added product development based on science driven innovation. The manufacturing of the SYNC Nano relies on a proprietary process to achieve nano size droplets, that significantly multiply bioavailability and absorption in the body, compared to the normal path of ingestion of cannabis, edible and oil products.

Such nano emulsions are currently safely being used in the drug delivery, pharmaceutical, cosmetics and food industries to improve the delivery and stability of ingredients. In the context of cannabis, this technology enables the onset of effects in as little as 10 to 20 minutes, and can result in the duration of effect of two to four hours, which are both very favorable compared to edibles and oils. This provides the consumer with much greater predictability and control over their cannabis consumption and its desired effects.

Provided in a spray bottle for sublingual usage, this product format is discreet and convenient. Our research indicates that this product meets a notable unmet market need and is an attractive offering. We are pleased to bring the benefits of this proven, high performance technology to the cannabis industry.

We have a firm commitment of resources to innovation, which is remained unaltered over the last four quarters. We are actively considering how to increase our focus, scale and investment in this segment of our business. And we look forward to additional new product launches over the next quarters.

Our fifth focus is the guiding principle that operational excellence will drive sustainable profitability. As I detailed above and as Jenn will overview very shortly, in Q2, we made monumental progress on this front and realized the results of this principle, with the excellent focus and commitment of our whole team under challenging circumstances, to produce high-quality cannabis and garner appropriate pricing for these products, in different provincial markets across the country.

Jenn Hepburn, our CFO will now comment further.

Jenn Hepburn

Thanks, Riaz, and good morning, everyone. The figures that I’ll be reviewing today are in Canadian dollars unless otherwise noted, and they can be found in our condensed interim consolidated financial statements and MD&A for the three and six months ended June 30, 2020, which were filed yesterday August 31. Note that all financial information has been prepared under IFRS.

As Riaz mentioned earlier, we reported net revenue of CAD2.5 million, CAD0.4 million lower than the previous quarter of the current fiscal year. Revenue for the quarter was driven by increased revenue from dried flowers in the adult use market, where sales were up 16% and volume sold in kilograms were up 23% as compared to Q1, 2020.

Lower average net selling price per gram of dried flower CAD3.39 per gram in the current quarter versus CAD3.84 per gram in the previous quarter, offset some of the positive impact of the increase in volume sold.

A CAD0.5 million decrease in revenue from cannabis oils explained a significant portion of the overall decrease in revenue in the current quarter. In fact, as we were switching the manufacturing of our adult use cannabis oil under the SYNC product line, [Indiscernible] in Q2, 2020, we had a temporary gap in product supply in the month of May. As a result, close to 60% in the quarters oil revenues from SYNC were only realized in June.

Overall, our revenue was comprised of approximately 73% flower and 26% oil, versus 59% flower and 38% oil in Q1, 2020.

As we just launched our first Cannabis 2.0 products in the adult use market last week, we anticipate our ratio of flower versus value added product mix to change in the coming quarters. We’ve realized 86% of our sales in the adult use market, consistent with 85% from the previous quarter.

During the current quarter, we had a strong presence in BC, Quebec and Alberta, where we realized close to 70% of our volumes in this segment. We have achieved significant milestones in the second-half of the current quarter. While we successfully executed on our partnership with Valens, which enabled us to expand SYNC to the province of Quebec. We also successfully launched our Souvenir brand in the same province. As a result, our volume sold into Quebec increased by more than 100% in the month of July.

For the first time since legalization, we are reporting overall positive gross margin over net revenue of CAD1.0 million or 41%. We have been pursuing breakeven on our cost of production and we are very pleased to report these figures to you this quarter.

The current quarter’s gross margin improved CAD1.9 million from negative gross margin of CAD0.9 million realized in the previous quarter. Looking more closely at gross margin on a cash basis, when we removed the effect of noncash items from cost of sales, such as amortization of CAD0.6 million and gain on changes in the fair value of biological assets of CAD0.8 million, we report a positive gross margin of CAD0.7 million or 30%. The significant gross margin improvement is due to the larger proportion of higher margin products or cultivated at Emerald’s own facilities, processing efficiencies and the lower cost base of input material as compared to Q1, 2020.

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As Riaz mentioned earlier, we are achieving an all in growing cost of flour of CAD0.99 per gram, and a cash growing cost of flower of $0.78 in the current quarter.

We reported SG&A expenses of $3.5 million this quarter, a $2.5 million or 42% decrease from the previous quarter. We are now starting to realize the impact of the company’s efforts in cost reduction during the latter half of fiscal 2019.

The cash component of SG&A represented in the general and administrative, sales and marketing and research and development line items of our P&L statement decreased by $1.5 million, or 37% as compared to the previous quarter. We expect further improvements in our SG&A expenses as we continue into 2020, and realize further efficiencies across the board.

A net loss of CAD18.9 million was recorded for the period and was largely a result of a CAD17.1 million impairment of the Verdélite cash generating unit. Here, as a result of our intention to sell the asset at June 30, as well as other market indicators, we evaluated the Verdélite asset for impairment.

The impairment was calculated as the fair value less cost of disposal Verdélite, which approximates the net disposal proceeds at CAD21 million. The impairment loss resulted in a CAD14.7 million loss being allocated to the intangible assets, and a CAD2.4 million impairment being allocated to PPE of Verdélite.

Pure Sunfarms’ Q2, 2020 results continue to stand out in the industry as it realized its seventh consecutive quarter of positive EBITDA. And it did so well transitioning from selling entirely into the wholesale market, to now predominantly branded retail segments. We disclosed an adjusted EBITDA of CAD2.6 million for the joint venture. The quarter also saw Pure Sunfarms expanding its credit facility to a full CAD459 million, strengthening its position to execute on its Cannabis 2.0 strategy, which as we released last week has commenced with the shipment of Pure Sunfarm base and oil products.

2019 and 2020 restructuring efforts were coupled with disciplined cash management in our operations and investment decisions. The result was significant on our cash utilization quarter-over-quarter, but also year-over-year. In the current quarter, we saw CAD1.7 million net cash used in operating activities, versus CAD3.2 million in the previous quarter, and CAD9.5 million in Q2, 2019.

This decreasing trend was also reflected in our investing activities, where we reported cash use of CAD0.7 million in the current quarter, as compared to CAD1.4 million in the previous quarter, and CAD12.8 million in Q2, 2019.

As Riaz has mentioned before, we believe that operational excellence will drive sustainable profitability, and we have seen tremendous progress in the current quarter. In the current fiscal year, we’ve raised CAD9.4 million from private placement offering, share for debt financing and exercise of warrants. We have also recently established an aftermarket equity program that allows us to raise up to CAD3.25 million in gross proceeds.

In addition, we expect the sale of the Verdélite asset to have a significant impact on our working capital and overall financial position, as we expected to support an improvement in our cash position, while helping to extinguish some of the liabilities on our balance sheet.

In conclusion with the reliance on our own cultivation capabilities moving forward, the launch of new products both in dry and extracted form, and with overall efficiencies being realized at all levels of the organization, we continue to work towards positive impact on our operating numbers.

And with that, I’ll turn it back over to Riaz.

Riaz Bandali

Thank you, Jenn. Clearly, our primary attention over the last year has been on stabilizing and solidifying our core operation, rationalizing our corporate structure and relationships to achieve a sharply focused, lean entity position for growth, profitability and upside in our investment value.

We’re starting to see solid progress on all of these fronts, and we firmly believe that Emerald has significant, underappreciated and unrealized value in its business. But as Jenn noted, this doesn’t mean our work is done. It’s still ongoing every hour and every day. Be assured our effort will continue through the third and fourth quarters and beyond.

It is however important to note that we are now at a juncture, where anticipated capital outflows for funding our ongoing operations are significantly reduced. And we have demonstrated that we can create notable leverage and a big swing in our financial performance. We’re working hard to get cash flow neutral and thereafter cash flow positive, and have made substantial progress on this front.

The Verdélite sale which should be completed in the next several weeks, and access to a CAD3.25 million ATM facility, which as of today is completely unused and available will help to strengthen our working capital position.

Lastly, the significant improvement in our cost structure and our financial performance in Q2, coupled to the attractive and underappreciated value of our assets has led to multiple strategic and financing discussions, that we continue to actively explore.

Finally, our progress is also providing a clearer picture for investors to see the value of Emerald’s promising assets, including our 41.3% holding in Pure Sunfarms.

Thank you for your support and for attending this call.

Question-and-Answer Session

Operator

Thank you. We will now have a question-and-answer session with a covering analyst. We have on the line Graeme Kreindler with Eight Capital. Please go ahead with your questions.

Graeme Kreindler

Hi, good morning. And thank you for taking my questions here. Just wanted to start out as a matter of housekeeping. At the end of the quarter, the ownership share in the Pure Sunfarms JV that was 41.3%. So at this point in time, are there any other sort of events or clauses where that ownership percentage could change? Or is that staying static for the time being? Thanks.

Riaz Bandali

Hi, Graeme. How are you? It’s Riaz. To answer your question, no, that is staying static. All of the elements of the settlement agreement that we reached at the beginning of March with Village Farms or Pure Sunfarms are all enacted. The only remaining amount that’s owed is the CAD952,000 balance, that was part of that settlement agreement, but in terms of the equity ownership and the board position, all of that is staying intact.

Graeme Kreindler

Okay, understood. Thank you. Then the next question I had with respect to following up on the comments about closing of the transaction of Verdélite and getting those proceeds and investing into the high value add segments of the business. I know there will be some more details provided in the future. But how should we be thinking about investment in those initiatives? Is that going to be CapEx dollars into the existing facilities? Is that more sort of R&D initiative as you’re looking to bring on new products?

Or is this really just working capital investment, where you’re going to continue to rollout some of these other products, that you’re able to do so at a faster rate? How should we be thinking about that?

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Riaz Bandali

Graeme, I’ll take that one as well. And so just to be clear, with regards to the proceeds from the Verdélite sale, we’re going to be using that in a very disciplined and systematic manner. So that’s actually going to be used to enhance our cash position and our working capital. It’s going to be used to eliminate the deferred payment amount, dropdown our AP, and very likely is going to be used to reduce some of our long-term debt obligations. That’s what we’re targeting that proceeds usage for.

With regards to our commitment to new product development and science-driven innovation, that’s something that we’re really focused in on, and view as a core capability of the company moving forward. I wouldn’t view that as a loss of capital expenditure on our facilities, it’s going to be more focused in on building our capability with regards to people, resources, intellectual property, and looking at ways that we can again drive for new science to be incorporated into novel products, like we’ve just announced on the launch of our Nano SYNC line of products that I spoke about.

Graeme Kreindler

Okay, I appreciate the color there. Just to shift gears a bit. So in the press release you mentioned you harvested 3,000 kilograms of flower and trim combined this quarter. As we think about the core assets that fit within the Emerald umbrella here, as you’re working to get more efficiencies here. Would you describe those facilities being at full capacity right now?

Or to ask that question in another way, looking at the acceleration in the revenue growth, the expectations of growth. Does that come from an increase of about a quarter of products? Or does that come more from a shift mix as you look to sell more value add derivative products? What’s the proper way to think about, where that acceleration is expected to come from?

Riaz Bandali

So I can start off, and again, Jenn could add some color with regards to output of the two facilities. So, yes, 3,000 kilograms is what we’ve produced in the second quarter. I think we’re being very, very prudent and pragmatic now about making sure that we’re looking at demand and supply dynamics efficiently. And we’re looking at that on a regular basis. And our whole focus here isn’t to try to drive maximum capacity utilization at either one of the facilities.

Right now, it’s looking at it from a very pragmatic viewpoint of what are the products we think are going to resonate in the marketplace, what is the biomass that we need with regards to our product development efforts, including extractable products, and then trying to match supply and production to the best extent we can to drive efficiency. We’re not really focused in on full scale production at either one of the facilities. And that’s not what we are doing in Q3 right now. That hasn’t been our focus.

Jenn, do you want to add some more comments to that?

Jenn Hepburn

Yes, thanks, Riaz. Hi, Graeme. I’d just like to essentially say that going forward, some of our focus that we’re expecting to see is just a larger product mix. We’re really trying to focus on leveraging our R&D, specifically the nano emulsion technology. So as we start to see some of a shift, I mean, obviously flower is there and we’re cultivating it internally and you’re seeing that really show in our expenses and our cost of goods sold. But on the revenue side, I think that we expect to continue to see a larger product mix, as we expand into the Cannabis 2.0 market.

Graeme Kreindler

Okay, understood. I appreciate the color there. And then last question I had was with respect to the current cash position. I was wondering, could you provide what the approximate or expected monthly burn rate from operations is currently? And then just provide an update on after the announcement of the renewed ATM program, how much of that so far has been used since that was announced mid-month? Thanks.

Jenn Hepburn

Hi, Graeme, I’ll start on the answer here. So, we are currently looking at, as you’ve seen from our results, decreasing our monthly burn rate. And right now, I can’t really give too much color on that, because I think it’s going to significantly change with the completion of the sale of Verdélite. But we are managing tight cost control, and currently right now, we are keeping in line with the current cash that we have.

With regards to the ATM, we have not yet utilized that at all. We’ve set it up. We extinguished our previous ATM and facilitated this new equity program. And as of today, we have not delved into it. It’s a nice — it’s a good to have. And our intention right now is to manage as we’re able to with internal cash, but if they aren’t available for us to use if we still desire to see the fit. [ph]

Graeme Kreindler

Okay, got it. And actually, I’ll sneak one more. Just with respect to the launch of the Souvenir brand, which was then, I guess, later in the quarter, can you discuss just from a high level how the uptake of that brand has been in the Quebec market? And whether — what the expectations are moving forward? What the demand picture looks like, as you navigate both just the general supply demand dynamics and the industry, in addition to any other challenges brought on, or tailwinds brought on by COVID-19 for that matter? Thanks.

Riaz Bandali

Graeme, I’ll start off and again, Jenn can add color, right. So the Souvenir brand has been very, very well received. We launched it at the very end of Q2, literally with a week left in the quarter. It had a great receptivity. I think the positioning of that product for being a high quality product focused at Quebec consumers, manufactured from a craft facility in Quebec, marketed under a very focused brand that’s really kind of resonating with the Quebec consumers has been better than we thought. We’ve got nothing but positive feedback from consumers as well as the SQDC on the launch of that product.

Till about August 12, so it had already sold over CAD1.5 million or so of product sales. So we started to really accelerate the week after the launch. And we’ve seen consistent product demand coming from the SQDC since the launch of that product, and we’re anticipating to see that at least hold steady over the next several months.

Jenn, again, do you want to add in any more color?

Jenn Hepburn

Sure, Riaz. So just to reiterate, we’ve seen a consistent demand gram coming out of the SQDC since the Souvenir launch. And we’ve currently got two strains in the market, and we’re excited to be launching our first strain in the coming months. So, from our perspective, we’re expecting to see continued demand into the coming quarters out of Quebec.

Operator

Thank you. This concludes our question-and-answer session. I will pass the line back to Bernie Hertel.

Bernie Hertel

Thank you for attending today’s presentation. If there are further questions, please e-mail us at invest@emeraldhealth.ca. We appreciate your interest in Emerald Health Therapeutics. Have a great day.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect.



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