Earnings Call Transcript - INCR Q4 2022

Operator, Call Operator

Thank you for standing by, and welcome to InterCure's Fourth Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker presentation, there will be a question-and-answer session. I would now like to hand the call over to Ori Mendelbaum, Investor Relations. Please go ahead.

Ori Mendelbaum, Investor Relations

Thank you, Latif, and good afternoon, everyone, and welcome to InterCure’s fourth quarter and Full Year 2022 results conference call and webcast. A copy of the company's earnings press release is available on the News & Events section of our website at intercure.co. With me on today's call are Alex Rabinovitch, InterCure's Chief Executive Officer; and Amos Cohen, the company's Chief Financial Officer. Today, we'll review the highlights and financial results for the fourth quarter and full year ended December 2022, as well as more recent developments. Following these formal remarks, we will be prepared to answer your questions. But before we begin, please let me remind you that during this conference call, InterCure's management may make forward-looking statements made within the meaning of applicable security laws. Forward-looking statements may include, but are not necessarily limited to, financial projections or other statements of the company's plans, objectives, expectations, or intentions. These forward-looking statements are based on current expectations that are subject to a number of risks and uncertainties that may cause actual results to differ materially from those expressed or implied in such statements. Also, please note that unless otherwise indicated, all amounts discussed in this call are expressed in Canadian dollars or new Israeli shekels. Additionally, please note that the results mentioned are deemed solely pertaining to the company's operation in the cannabis sector unless otherwise specified. And with that, I will turn over the call to Alex Rabinovitch, InterCure’s CEO. Alex, please go ahead.

Alex Rabinovitch, CEO

Thank you, Ori. Hello everyone, and thank you for joining us for our fourth quarter and full year 2022 earnings call. 2022 was a rather successful year for InterCure as we continued to solidify our position as the largest, fastest growing, and profitable cannabis company outside North America. In line with our profitable growth strategy, we executed well on all fronts. This resulted in strong financial and operating results while further positioning InterCure for continued growth. In 2022, our revenue exceeded $150 million with adjusted EBITDA of $32 million, a significant achievement considering pharmaceutical-grade recognition was only introduced less than five years ago and our first GMP prescribed product was dispensed in the pharmacy only in late 2019. Our remarkable profitable growth is proof of our team's ability to execute with strong dedication to excellence, as demonstrated by our successful implementation of skilled professional decisions, capital investments, and strategic legal and regulatory victories. I'm very proud of our team delivering continued solid performance. These strong results are especially impressive when you take into account the slowdown in new patient procurement in Israel during the first half of 2022. This was mainly due to the loss of physicians responsible for more than 20,000 market prescriptions as the Ministry of Health halted their license to prescribe medical cannabis. In the early days, we chose to focus first on leading the Israeli market as we believe that any global leader has to dominate its home market before expanding internationally. Although Israel is well known for its medical cannabis research, it's also developed and implemented the most advanced medical cannabis regulation to become to date the biggest and most advanced pharmaceutical-grade market globally with about 45 tons dispensed yearly. After four years since it was introduced, pharmaceutical cannabis represents about 15% of all prescribed pharmaceuticals in Israel with a clear runway for this goal to continue. We expect market growth to resume as the Ministry of Health announced a new reform known as the prescription reform that will cancel the need for a special license and will allow any physician to prescribe medical cannabis under the public health care system. Of the latest INCB U.S. guidance, the Israeli Ministry of Health is expecting major growth of the market in 2023 to 85 tons, up from 49 tons in 2022, marking expected growth of over 70%, assuming this reform is implemented. As the new government in Israel is assembled, the new Ministry of Health stated that the new reform would be implemented soon and while patients are suffering from the current bottleneck of lack of prescribing doctors, many companies in the industry are struggling with continued losses and lack of capital. Companies are exiting the market and liquidating their products with some short-term effects, especially on low and mid-quality products, which Amos will elaborate on regarding the financial results. Eventually, for 2022, patient count grew only 18% while InterCure grew 77%, emphasizing the strength of our leading platform and we believe this condition represents an opportunity to grow our leading share organically and inorganically even before barriers are lifted and the market growth resumes. During 2022, we've also scaled up our upstream operation by upgrading the southern facilities post-harvest nursery and growing areas. This further solidified Canndoc's southern cultivation site as one of the largest and most advanced facilities of its kind in the industry. Our expert teams have also successfully added and produced tons of new highly demanded strains into their growth cycles, including premium high THC Cookies cultivars and some of the industry's top shelf products. In total, during the day, we successfully launched more GMP products than any other company in the industry. To meet the demand, we remain focused on increasing not only our local cultivation in Israel, but also our global exclusive strategic partnership. During the year, we have again been the first company to meet the strict new 109 protocol and resume importation from our partners to Israel. Although the Israeli regulators are constantly hardening the importation process, we are well prepared for future evolving regulations with the best strains and pharmaceutical labs globally. As our core markets are growing and evolving, we are also increasing the high-quality supply of our existing strategic partners and evaluating new potential strategic partnerships. We have extended our successful exclusive partnership with Organigram, a world-leading indoor grower, to supply us with up to 20 tons of our chosen genetics, extending its reach into our core markets in Europe and the UK. We also announced the expansion of the company's partnership program forming a collaboration with the leading cannabis brand Binske to develop and offer a range of non-flower cannabis products, which we believe will significantly enhance our product portfolio and further strengthen our market position. Both the Ministry of Health in Israel and the Ministry of Economic have eased the process of exploitation, enabling us to ship pharmaceutical-grade cannabis products in any format to any legal markets in the world. I am happy to update that our teams have made great achievements and successfully completed exports of InterCure's products to our EU hub, preparing for EU GMP commercial launches in the UK and Germany. We expect commercial export shipments to ramp up in the coming quarters. We have built a unique international supply chain that can supply every core market with our winning branded product portfolio and we will continue to scale up our upstream operation in the coming quarters. Moving to downstream, keeping with our seed-to-sale model, we've expanded our one-of-a-kind dedicated medical cannabis dispensing operation during 2022. As of December 2022, our specialized medical cannabis pharmacy chain was comprised of only three locations. This has now increased to 28 locations. We have developed 26 locations across major cities in Israel, 20 of which are actively dispensing medical cannabis and six are in the process of obtaining the license to dispense. Growing our cannabis dispensing footprint more than nine times in the last three years has positively impacted our business, while ensuring patients receive the highest quality service from more than 90 highly trained specialized pharmacies. In 2023, we expect to add several more locations and with that all currently 26 will be fully operational, ensuring our leading pharmacy chain will have a national footprint. During 2022, we also established two new locations outside Israel, which includes a Cookies branded shop in Vienna, Austria, which is up and running and the pharmacy under development in the heart of London, UK. Our international supply chain is one of our primary goals ahead. As most of the world has taken a medicalized approach towards cannabis, a rapidly growing number of countries are adopting our unique and strict pharmaceutical cannabis regulations. In fact, this includes more than 40 countries that are in various stages of adoption. Pharmaceutical-grade cannabis regulation is indeed becoming a world standard. Improving by avoiding other companies' mistakes, we carefully expand our reach by duplicating our winning model in the UK, Germany, and Austria. All of these markets are in early stages, a few years behind the Israeli market in product quality, but with similar competition and regulation. Our 15 years of know-how and execution, proven model, and leadership position set us up to succeed in every territory with a supportive regulatory framework. Before I hand over the call to Amos, I want to note that 2022 has concluded 16 years of organic growth and has been one of our best years to date. During 2022, InterCure achieved record revenues of approximately $150 million, 77% more than the revenues of 2021. Our gross profit increased to over $60 million, representing 41% of revenue, and adjusted EBITDA increased to $32 million, representing 22% of revenues. Net profits after tax were just under $70 million, generating $20 million cash flow from operations, and we ended the year with $95 million cash in hand and a solid balance sheet. As our target markets evolve, we remain focused on execution with financial discipline, while navigating through regulatory barriers and market challenges. While favorable regulatory cannabis reforms are on the horizon in Israel, Germany, and many other markets, we expect our growth journey to continue as we remain focused and committed to expanding our leading platform, building shareholder value, and improving the quality of life for patients and communities across the world. And now, I will turn the call over to our CFO, Amos Cohen, after which we will open the line for Q&A. Amos, the floor is yours.

Amos Cohen, CFO

Thank you, Alex, and good afternoon everyone. I'm very pleased to be sharing with you today our financial results for the fourth quarter and year-end of 2022. Our focus continues to be execution, expansion, and building our unique vertically integrated model centered on our high-quality branded products, while keeping financial discipline. We delivered record full-year revenue of $150 million, or NIS389 million, an increase of 77% compared to $85 million in 2021, an impressive growth as patient count grew only by 13%. During 2022, we continued to expand our vertically integrated platform, scaled up our cultivation production facilities, expanded our logistical capacity, and added eight new locations to our leading medical cannabis dedicated pharmacy chain, exiting the year with an industry-leading platform of 28 locations, out of which 20 are actively dispensing medical cannabis and for the first time, two international locations. We also reported another record fourth-quarter revenue of $41 million, or NIS106 million, an impressive growth over 30% greater than the fourth quarter of 2021's revenue of $31 million, or NIS80 million and up by 6% sequentially compared to the third quarter of 2022. Revenue growth during the fourth quarter of 2022 reflects increased market share and growing patient demand for our branded products and expansion of the strength of our medical cannabis dispensing operations. Our gross margin for the year 2022 reached 41% compared to 44% in 2021. For the first quarter, the gross margin was 35%. During the fourth quarter, we've witnessed financial weakness affecting many players in the industry. Financially struggling companies and companies exiting the market sold low to medium quality products at lower prices to liquidate their inventories. This had an impact primarily on our ultra-medical and legacy products, while the prices for our top-selling high-quality products remained stable. In the first quarter of 2023, we continued to see strong demand for our high-quality products and continued shift from legacy mid-quality to value products. We believe that these market conditions and completing the licensing of the eight pharmacies which are yet to dispense medical cannabis will position us to further increase our leading market share and will revert in the coming quarters as the market consolidates and the prescription reform passes through. Turning now to adjusted EBITDA. We believe adjusted EBITDA of the cannabis sector, a non-IFRS measure, provides valuable insight into our operating performance. Adjusted EBITDA excludes from net income as reported interest, tax, depreciation, amortization, non-cash expenses, share-based compensation, acquisition and transaction costs, fair value step-up of inventory, and other income or expenses. For the full year of 2022, adjusted EBITDA was $32 million, or NIS84 million, which is 22% of revenue compared to $22 million, or NIS57 million for 2021. For the first quarter of 2022, adjusted EBITDA was $7 million or NIS19 million, which is 80% of revenue, a slight decrease compared to $9 million or NIS22 million for the third quarter of 2022, demonstrating the strength of our platform and our ability to execute. We continue to invest in scaling up our platform; CapEx in 2022 totaled $18 million or NIS48 million. We expect 2023 CapEx will be at least 50% lower than 2022, focusing mainly on our global expansion as we expect to launch our branded products in Germany, the UK, and other territories and continue the development of our leading medical cannabis dedicated pharmacy chain to about 35 locations. We are very proud of our third consecutive year with a positive cash flow from operations generating in 2022, $20 million or NIS51 million, proving our financial discipline. We ended the year with a solid cash on hand of $95 million, or NIS246 million, compared to $83 million, or NIS217 million in 2021. In addition, our balance sheet includes $25 million of loans granted to companies, mainly associated with several uncompleted M&A transactions. We are financing about 70% of our CapEx with long-term loans from Tier 1 banks in Israel. As the interest rate environment changes, we are constantly revising our financing structure. With the strength of our balance sheet and our solid performance, including cash flow generation, we are well-positioned to continue executing our profitable growth strategy, leveraging the foundation and leadership we have built to capitalize on global expansion and consolidation opportunities. For further information on our financial and operating performance, I encourage you to review the company's financial statements and management discussion and analysis, which are available under the company's profile on SEDAR and through EDGAR. This concludes our prepared remarks. We would like to thank everybody for joining us on today's call and would now like to open the line for questions. Operator, please open the line for questions.

Operator, Call Operator

Our first question comes from Vivien Azer of Cowen. Please go ahead, Vivien.

Vivien Azer, Analyst

Thank you. Good afternoon, good evening. I wanted to talk about the dynamics that you guys referenced in the Israeli market, please. Understanding that some of the wholesale discounting that you were seeing with some competitors is going to be short-lived in nature. Can you offer some color on what the mix for the category looks like today by price point and how that compares to your own portfolio? Thank you.

Alex Rabinovitch, CEO

Hi, Vivien. Thanks for the question. Basically, we don't have official numbers for the Israeli market categories. I mean, we have some BI and internal evaluation. We think the market is probably about 70% on the high-quality, some people call it premium, and about 30% is on more discounted products. And I mean, yes, I must elaborate about it. I mean, we've seen a trend of struggling companies exiting the market selling their inventories in lower than cost sometimes and affecting the market. We are seeing this trend since Q4 affecting the market prices and movement towards those more value products. Eventually, the mix didn't really change. I mean, the mix is still about 70-30, but this reflects our portfolio. I would say our portfolio is close to the market portfolio, about 70% of our product is high quality and above 30% are more on the side of what we call ultra-medical or legacy products. And basically, Amos also stated that we have seen this trend into also 2023. Eventually, we expect those inventories either to be sold out or to expire as eventually the market will clean up. We have expiration dates on pharmaceutical products and also we are seeing most of those players exiting the market. So basically, we are expecting the cleanup to occur towards the mid of the second half of 2023.

Vivien Azer, Analyst

Thank you. That's helpful. And certainly that helps to explain some of the margin degradation that you guys saw sequentially in Q4. But as I reflect on kind of the evolution of your gross margin on a multi-year basis, it would seem reasonable to think that there's also a margin drag from your international operations. So, can you just talk about your perspective on gross margin from here? How much of a recovery can we see as the Israeli market gets cleaned up? And then the offset, of course, being what kind of incremental gross margin headwinds should we expect from your international expansion efforts? Thank you.

Alex Rabinovitch, CEO

So yes, we think again, like, it's hard to speculate right now. I mean, there's a couple of trends that may affect gross margin. We expect the prescription reform to be implemented and this might have a crucial positive effect on the gross margin, but it is really hard to speculate when this reform will be implemented. Regarding our international expansion, we are seeing prices in Germany and in the UK that are much higher than the Israeli market, sometimes doubling with much lower quality. So we expect a positive impact on our gross profit margin as we scale up and launch more products in those territories.

Vivien Azer, Analyst

Okay. That's helpful. And then just my last question, sticking with international. I think it's been our experience that progress in international and in this instance European cannabis market has certainly been slower to progress, which clearly informs what your differentiated strategy is to be sure. But can you just reflect back on what your expectations were for international progress heading into 2022 and how you may have tempered your expectations around regulatory change in Europe for 2023? Thank you.

Alex Rabinovitch, CEO

Yes. As I stated, we are taking careful steps toward our international expansion, learning from basically the markets and other companies' mistakes. There are some niche markets at the moment for us in Europe. The German market is about developing at the moment, and we are expecting a new reform there. So for us, Germany is a nice target market where we are competing basically with the same competition that plays here in Israel, supplying the market in Israel. But the quality in the German market, I would say, is where Israel used to be about two years ago. Israel is much more competitive in terms of quality. The UK market is in its initial stage but growing fast, representing a good opportunity for us also. But again, it's a small market yet. We are launching the first pharmacy in the heart of London to actually have a physical inventory. We've seen a significant change in Israel once we launch a high-quality product in the market. We've seen the market grow because of that offering. And yes, we believe that once medical cannabis products in high quality will be offered in the UK market at decent prices, in accordance with local market conditions, we will obtain a good market share and eventually, the market will grow because of the same trends that we've seen in Israel in the early days.

Vivien Azer, Analyst

Understood. Thank you very much.

Alex Rabinovitch, CEO

Thank you, Vivien.

Operator, Call Operator

Our next question comes from Matt Bottomley of Canaccord. Please go ahead, Matt.

Matt Bottomley, Analyst

Good evening. Thank you for the insights provided so far. I have a question regarding the gross margin situation. While you've explained some of the market dynamics causing challenges, Q1 is behind us now. Usually, when we experience price erosion or other difficult pricing issues, it tends to last more than just a single quarter. I know you've touched on this previously, but I'm curious if you could provide any indications regarding margins or other guidance, whether quantified or not, about how Q1 has progressed and what expectations you have for the latter part of the year concerning pricing trends in Israel.

Alex Rabinovitch, CEO

Hi, Matt. So, as I said, it's really hard. And again, we are not providing any guidance. So I can provide some colors and try to speculate a little bit about the trends. As we stated, we are seeing the trend into the first quarter of 2023, and again, it’s hard to speculate where the market will clean up and when the new reform will be implemented. The best guess of ours right now, this is the best we can provide is in the second half of 2023. As we are seeing companies exiting the market, some consolidation processes have already started, eventually leaving more room for us to grow our market share. But again, it's hard to speculate right now about in what quarter we will see the inflection point.

Matt Bottomley, Analyst

Okay, got it. Thanks for that. And then my other question just relates to the potential for pretty significant growth profile into next year on legislative changes for prescriptions. So one, can you just give us any description of how this process relates to other legislative endeavors in the past? I know for the last couple of years there's been speculation about maybe adult use; that's kind of been kicked down the road and there have been various elections in the interim that have probably delayed that, but sort of how concrete is the actual catalyst of sort of easier access to patients when it comes to those that can prescribe? And the second is just the ability to service that, assuming that it does happen, an overall 70% increase in market demand. Is that something that would require more capital investment? Is it something that you think, although it might alleviate pricing pressure, is something that the operators in general overall in Israel can support that level of growth in one year, should it occur?

Alex Rabinovitch, CEO

Okay. Thanks for the question. So the prescription reform is based on about two years in the Ministry of Health. They've examined the biggest bottleneck in the medical cannabis market, which is the doctor prescribing licenses. In Israel, the physicians need to have a license to prescribe, also the patient needs a license, but the main bottleneck is this license to prescribe, which has been given to about 200 physicians. Out of them, we have about a couple of tens which are actively prescribing. So we have about 123,000 patients, and that means doctors have to dispense about 240,000 prescriptions per year divided among 45 or 50 physicians, creating a huge queue. The regulation calls for a maximum cost for each prescription, which is about $70, while the actual price, because of demand on supply, is sometimes triple the price. This has caused a lot of constraints. Many doctors charge much more than the regulation. From time to time, the Ministry of Health has halted and canceled licenses of several doctors who were in charge of 20,000 patients, which essentially brought the market to a stable line with our growth. We saw this happen again in the beginning of 2023. This will continue unless we solve this bottleneck. A committee was called, and it is unpolitical and totally professional. This committee concluded as the Minister of Health announced this reform. Then we went into elections, and in the new government, the new Ministry of Health on their first day stated that this reform will be implemented. It is a huge concern for patients, and also a big concern for the industry. The patient community in Israel is also a big political power. Yes, we have all the reasons to believe that this reform will be implemented soon. Again, no crystal ball for the timing, but this is a big concern and a big surprise for the patient community.

Matt Bottomley, Analyst

Got it. Appreciate it. And just on the part of the question regarding the ability to service the market, if there's a 70% increase, I know you have relationships for various import arrangements out of Canada, but just how you're situated should that growth come in faster than you're anticipating relative to your own capacity internally?

Alex Rabinovitch, CEO

Okay. I didn't explain that the reform will cancel the need for a specific license, and basically every physician under the public system, under the Israeli healthcare system, would be able to prescribe at least the second and go on prescription. This, of course, will eliminate the bottleneck. The Ministry of Health is expecting the market to grow by 70%. This is an official number. So yes, I have to say that we are preparing ourselves for this reform. We scaled up our operations, cultivation operations here in Israel. We signed with third parties also and scaled up our supply agreements with Organigram and other international partners. So I would say we are basically ready for this reform. And I hope that this reform will be implemented soon so we can alleviate demand.

Matt Bottomley, Analyst

Okay. Well, thanks so much. I’ll step back.

Alex Rabinovitch, CEO

Thank you.

Operator, Call Operator

Thank you. Our next question comes from the line of Pablo Zuanic, of Zuanic and Associates. Your line is open. Pablo?

Pablo Zuanic, Analyst

Hello, Alex. Look, just one question regarding this prescription reform. Obviously, it sounds like a big catalyst for the industry, but I guess, I'm thinking in the case of Germany, all the doctors there are able to prescribe, but very few do, right? And in the case of Israel, we are calling this a bottleneck, but these doctors there that didn't have a license, they were free to try to get a license to prescribe cannabis, right? So explain to us why is this different and why it would be such a big catalyst?

Alex Rabinovitch, CEO

Okay, Pablo. Thanks for the question. So there’s a big difference between the Israeli regulations and the German regulations. Most doctors in Germany have the ability to prescribe; however, very few do. In Israel, there’s this clinical practice where doctors can use this green book and be protected. We have to understand that most doctors didn't learn about medical cannabis in their universities, so yes, the big difference is this clinical practice that Israel is using. And again, I mean, Israel is much more advanced in terms of accepting medical cannabis. Medical cannabis has become the first line of treatment in some indications, unlike in Germany where you have to use many other pharmaceuticals first and only if that doesn’t help you, the doctor can then prescribe medical cannabis. So there is a big difference. I think eventually Germany, not only Germany, many other countries including the FDA are looking into the Israeli regulation and the Israeli practice. We are expecting a new book that will be issued soon by the Ministry of Health that will be more scientific and in English. Many regulators around the world in Australia, Germany, and even the U.S. are waiting for this book. This is, I would say, the most advanced regulation in the world.

Pablo Zuanic, Analyst

Thank you. And I think you said that there's only 200 doctors in Israel who had this license. Why do you think the number was so low? I mean, was it very difficult or expensive to get the license, is there a time that we have to spend to get the license? Can you explain that?

Alex Rabinovitch, CEO

Again, it's hard to explain why there are only 200 physicians that got the license. Probably it's because of the process. The Minister of Health needs to go for a special course and then take exams. We are seeing the young generation of physicians accepting that, but the older generation usually won't follow those steps. Physicians in Israel are accepting medical cannabis, but to prescribe medical cannabis, as I mentioned, you need this specific license; you need to report. It's a biometric process, and it’s not like prescribing regular narcotics. You have to be connected to the Ministry of Health with a special system. All these bureaucratic processes are impacting the market and, in turn, causing a lot of patients to suffer.

Pablo Zuanic, Analyst

All right. It sounds like a big catalyst. So just to be clear, in terms of stores, you are at 20 in Israel and I think you aim to finish with 26 by the end of 2023. Is the opening of the stores going to depend a bit on when the prescription reform comes in? Or do you have already pretty much the schedule lined up for the year?

Alex Rabinovitch, CEO

In Israel, we have 20 actively dispensing pharmacies and another six that are in development. The development phase of those pharmacies does not depend on the reform. It's a very bureaucratic process; sometimes it can take six months, other times it can take two years depending on the district in Israel. So, yes, this reform might open the bottleneck for pharmacies, but it is not the biggest constraint. We expect to end up with more than 26 active dispensing pharmacies.

Pablo Zuanic, Analyst

Thank you. And one last one. I saw you canceled the deal in Australia with Better. Can you just remind us what was the original logic of that deal and what could you be doing in Australia in the future? Thanks. That's it.

Alex Rabinovitch, CEO

Yes. Right now, the issue with Better is because we loaned some $2 million to $2.5 million to Better. This issue is currently on hold. Unfortunately, this did not mature due to many reasons not related to InterCure, and I don't want to dive into it because it's currently in court.

Pablo Zuanic, Analyst

Okay. Thank you.

Alex Rabinovitch, CEO

Thank you.

Operator, Call Operator

Thank you. Ladies and gentlemen, that concludes today’s Q&A session and today's conference call. Thank you for your participation. You may now disconnect.