Earnings Call Transcript - INCR Q2 2022

Operator, Operator

Good day, and thank you for standing by. Welcome to the InterCure Second Quarter 2022 Earnings Call and Webcast. I would now like to hand the conference over to your speaker today, Adam Haliva, Communications Officer. Please go ahead.

Adam Haliva, Communications Officer

Thank you, Michelle, and good morning, everyone, and welcome to InterCure's Second Quarter 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 www.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 first quarter ended June 30, 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. Factors that could cause actual results to differ materially include, but are not limited to, the risk factors contained in the company's filings with SEDAR and the Securities and Exchange Commission. Please also note, any forward-looking statements made here are as of today and, except to the extent required by law, the company assumes no obligation to update statements as circumstances change. Also, please note that all amounts expressed today and during this call are in Canadian dollars or new Israeli shekels, unless otherwise noted. And with that, I will turn over the call to Alex Rabinovitch, InterCure's CEO. Alex, please go ahead.

Alexander Rabinovitch, CEO

Thank you, Adam. Good morning, everyone, and thank you for joining us for our second quarter 2022 earnings call. I'm proud to report that InterCure has a record-breaking second quarter with quarter-over-quarter top line growth of 9%, reaching $37 million, more than double the revenue of our second quarter 2021. This marks our 10th consecutive quarter of high growth, representing an annual run rate of $150 million. Our momentum carried out over our last quarter, and our continued focus on execution and financial discipline resulted in another strong performance in the second quarter. Adjusted EBITDA grew by 4% to $9 million, which represents 23% of revenue. Additionally, gross profit increased by over 115% year-over-year and 16% sequentially to over $16 million during the second quarter. Q2 was also our eighth consecutive quarter with positive cash flow from operations as we exited the quarter with $96 million in cash. As I'm sure you're all aware, I'm very proud of our team delivering a solid performance. We continued to expand and grow our dynamic international supply chain, which now stretches across 4 continents, utilizing 6 high-end cultivation sites across the globe to supply the growing demand for our high-quality branded pharmaceutical-grade medical cannabis product. During the second quarter, we continued investing in scaling up our cultivation, production, and extensive operations. Our Southern cultivation site located near the area was able to remain 100% operational during the recent military conflict as we designed and built a layout that safeguarded 150 employees.

Adam Haliva, Communications Officer

Hi, everybody. Apologies, we had a connection problem and we got thrown out. But we're back, and we can continue from the prerecording that we started. Alex, go ahead.

Alexander Rabinovitch, CEO

Thank you, Adam. 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. However, in July, almost 2,500 new patients have been added, and we expect to see this trend continue and the recruitment come back to the growth we've been accustomed to in the past 3 years. While we believe that the potential number of patients is about 5% of the population, according to the Ministry of Health, there are now about 168,000 medical cannabis patients in the country, representing only 1.3% of the population. The rise in patient count is naturally followed by a rise in demand for high-quality branded medical products. This is true not only in Israel, but we are seeing the same trend in our core targeted markets, Germany, U.K., Austria, and Australia, where we expect to launch our platform in the coming years. In parallel, we continue to experience rising demand for our branded medical products coming from many new territories around the globe, including Switzerland and even China. As part of our strategy to duplicate our model internationally, we are working with local regulators and evaluating local partnerships that can execute in these new and exciting markets. During this quarter, we've scaled up our upstream operation by enlarging the Southern facility's post-harvest, nursery, and other 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 12 new highly demanded strains into their growth cycles, including premium high THC Cookies cultivars, 4 of which have been successfully launched during the third quarter. Our strong internal distribution and extensive operations would dispense many of our own products. To meet the demand, we remain focused on increasing not only our local cultivation in Israel, but also utilizing our global exclusive strategic partnership. At the end of the second quarter, we'll be able, once again, to meet the strict 109 protocol and complete the first importation from our partners at Clever Leaves. These products have been processed and produced by our own local teams and launched during the third quarter under the Canndoc brand. With that said, we now face a new 109 protocol, which adds more barriers and complexity to an already complex import process, which may create a slowdown in importation into Israel. We are well prepared for these challenges as we invested heavily in scale, depth, and reach of our domestic supply chain as the largest cultivator in Israel. Furthermore, our teams have made progress with the top international pharmaceutical labs to meet these new requirements. I am confident that just as we were the first company to crack the previous 109, we will be the first to resume importation for patients under the new protocol. Although there is hardening of the importation process, there is easing on the exportation. Both the Ministry of Health and the Ministry of Economy have eased the process for exportation, enabling us to ship pharmaceutical-grade cannabis in any format to any legal medical markets in the world. Our teams have made great advancements, and we expect commercial export shipments to ramp up in the coming quarters. As our core markets are growing and evolving, to meet the demand for our branded products, we are also increasing the high-quality supply of our existing strategic partners and evaluating new potential strategic partnerships. We've built a unique international supply chain that can supply every core market, and we will continue to scale up our upstream operations in the coming quarters. Moving on to downstream, I'm also happy to report that we continued to expand our one-of-its-kind leading medical cannabis dedicated pharmacy chain during the second quarter. Together with the international Cookies team, we completed the grand opening of our flagship Cookies pharmacy in Be'er Sheva, the largest city in Israel's southern region, known as the Capital of the Negev. This cannabis monument is located at the center of Be'er Sheva in front of the city hall, in a unique building that covers an area of over 1,000 square meters and is painted entirely in the globally recognized Cookies baby blue. As far as I know, this is the largest medical cannabis dedicated pharmacy in the world. The pharmacy is uniquely adapted to serve Israel's medical cannabis patient community, which includes, amongst all other things, the largest pharmacy safe room in Israel with a capacity to store over a ton of medical cannabis products. It took us 2 years to complete building the pharmacy and acquiring all the necessary approvals and licenses. We had a grand opening celebration, which included live music, food trucks, deals, and special offers for all patients living in Be'er Sheva and the surrounding towns. For the first time, patients in the South have access to highly demanded products, including Cookies brands cultivated in our Southern facility. Additionally, by the end of the quarter, we've added a medical cannabis dispensing pharmacy located in the northern city of Nahariya, which is currently the only pharmacy in the area approved to dispense medical cannabis, supplying not only the city residents but also the surrounding regions. The addition of the Nahariya location and the opening of Be'er Sheva now brought our medical cannabis dedicated pharmacy chain to 25 locations, of which 17 are actively dispensing pharmaceutical-grade medical cannabis. We expect that by the end of the year, we will receive medical cannabis dispensing licenses for most of the remaining 8 pharmacies and add new locations to our leading chain. In June, we also made another big advancement in our global expansion with the successful opening of our first flagship Cookies store in Austria located in the heart of Vienna. This flagship location offers Cookies' unique CBD value available for the first time in Europe as well as cannabis-related lifestyle products. In the future, as regulations evolve, pharmaceutical-grade medical cannabis will be available for Austrian patients, including Cookies new GMP THC products. This successful launch represents the spearhead of our expansion into additional European countries as we continue our mission to supply the highest-quality branded cannabis products in communities across the globe. We are also progressing with duplicating our winning model in the U.K., Germany, and Australia. All of these markets are in their early stages, a few years behind the Israeli market, which is the largest and most advanced in the space. 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 the call over to Amos, I want to note that June 30 concluded our best half year ever, and we couldn't be prouder. During H1 2022, InterCure achieved record revenues of approximately $72 million, 130% more than the revenues of the first half of 2021. Our gross profit increased over 120% year-over-year to over $30 million. Adjusted EBITDA increased 100% year-over-year to $17 million, and profits before taxes for the first half were just under $16 million, 188% growth year-over-year. We expect this growth to continue while we remain focused and committed to expand our unique platform, building shareholder value, and improving the quality of life for the patient community. Now I will turn the call over to our CFO, Amos Cohen, following which we will open the line for Q&A. Amos, the floor is yours.

Amos Cohen, CFO

Thank you, Alex, and good morning, everyone. I'm pleased to share with you today some details on our financial results for the second quarter of 2022. Our focus continues to be execution, expansion, and scaling up our unique vertically integrated platform globally. We just reported another record revenue quarter with total revenue of $37 million or ILS 95 million, more than double compared to the second quarter of 2021, revenue of $18 million or ILS 45 million, and up by 9% sequentially compared to the first quarter of 2022. Revenue growth during the second quarter of 2022 reflects increased market share and growing patient demand for our branded products, same-store sales growth and the strength of our medical cannabis dispensing operations, which we continued to expand and reached 25 pharmacies. 8 of those are still in the process of obtaining medical cannabis dispensing licenses. As the efficiencies of our vertically integrated structures continue to positively impact our gross margin, our gross margin for the quarter reached 44% compared to 43% in the second quarter of 2021 and 41% in the first quarter of 2022. As Alex mentioned, we have invested in our upstream operations and successfully achieved this growth while keeping our G&A costs at the same level as the previous quarter at $3 million, representing an effective 9% to 10% of revenue; and $11 million for the full year of 2021, which was 12% of revenue. Our reported IFRS operating profit for the quarter reached $7 million, representing over 100% growth year-over-year. Turning now to adjusted EBITDA. We believe adjusted EBITDA of the cannabis sector and non-IFRS measures provide valuable insights into our operating performance. Adjusted EBITDA excludes from net income as reported interest, tax, depreciation, amortization, noncash expenses, share-based compensation, acquisition and transaction costs, fair value step-up of inventory, and other income or expenses. For the second quarter of 2022, adjusted EBITDA was $9 million or ILS 22 million, which is 23% of revenue, 90% more than the second quarter of 2021, which ended with $5 million or ILS 12 million. We are proud of our eighth consecutive quarter with a positive cash flow from operations, demonstrating the strength of our platform and our financial discipline. We finished the quarter with one of the strongest balance sheets in the space with $96 million or ILS 245 million cash on hand. Looking at our half-year results, we achieved total revenue of $72 million or ILS 183 million and adjusted EBITDA of $17 million or ILS 43 million, which is 23% of revenues compared to the first half of 2021 with total revenue of $31 million or ILS 78 million and adjusted EBITDA of $9 million or ILS 22 million. This represents revenue growth of over 130% and nearly doubling our adjusted EBITDA. Looking forward, we expect revenue growth to continue throughout 2022. With a proven track record of executing profitable growth, we are well-positioned to continue scaling up and building shareholder value as the leading cannabis company outside North America. This concludes our prepared remarks. We would like to thank everybody for joining us on today's call, and I would like to open the line for questions.

Operator, Operator

Our first question comes from the line of Vivien Azer with Cowen.

Victor Ma, Analyst

This is actually Victor Ma on for Vivien Azer. So my first question is on inventory. Given the IMCA's stance in limiting cannabis imports, can you comment on current inventory levels in Israel and how much excess foreign inventories in the system?

Alexander Rabinovitch, CEO

Victor, so there are no official data regarding inventory, total inventory in Israel. We appreciate that most suppliers are with official numbers. So it's hard to speculate. I would say there is no shortage of inventory on the low and medium quality. But if the new 109 regulation keeps importation out and there is no importation, we will be missing high-quality products shortly in Israel.

Victor Ma, Analyst

Great. And then just a follow-up. We've recently heard of increased discounting in the Israeli market from some of your peers. What has your response been to the intensifying price competition, especially in light of weaker patient growth?

Alexander Rabinovitch, CEO

Victor, can you repeat the question, please?

Victor Ma, Analyst

Yes, sure thing, Alex. So we've recently heard of increased discounting in the Israeli market from some of your peers. What has your response been to the intensifying price competition, especially in light of weaker patient growth?

Alexander Rabinovitch, CEO

Yes. Okay. So Israeli market, of course, as you know, pharmaceutical grade is the leading market in the world. We are competing here with basically all the players. I don't think there is any player that doesn't ship or try to ship to Israel or cultivate in Israel. So it's a competitive landscape. I would say we have a big edge on competition. We are, first of all, vertically integrated with a very strong distribution and dispensing system, which I think, by far, is the leading one in Israel. And we are still far away from reaching the demand for our products. So the way we see it right now, the real competition is not affecting us. We still need to produce more products and sell more products, and this is our main focus. Regarding patient counts, yes, we had, I would say, 2 quarters with a very slow pace of recruitment. It doesn't come from the demand side; it comes from a regulatory step that our regulators took against a couple of physicians. But in July, we saw the demand coming back and the recruitment with the addition of 2,500 new patients. I don't think there is any question about the demand. The demand remains solid. We estimate the potential patient count in Israel to be about 3% to 5% of the population, which aligns with the Ministry of Health's estimates. Looking forward, I don't think there is a question regarding the market. Having said that, of course, we are seeing more and more companies with kind of a weak balance sheet trying to get rid of products and cash out, which puts some pressure on low- to mid-quality products. We are seeing those trends, so this may affect the market. Canndoc is totally focused on the highest grade, and we do not produce or intend to produce medium- or low-quality products. So at the moment, we don't see any effect on our business.

Victor Ma, Analyst

Understood. And just a follow-up with a third question. With the opening of your first international store in Vienna, do you expect the higher sales and marketing expense in 2Q to reflect normal operations going forward?

Alexander Rabinovitch, CEO

Okay. So the opening is kind of a spearhead. We intend to, of course, open more retail locations across Europe in the coming years. Again, I mean we are operating a bit differently from other companies. We have a very strong financial discipline, and we don't expect to see any material impact coming from that. Actually, I can share with you that since the opening, the retail location is performing according to expectations, and it's even profitable. So I don't see any negative influence on our future performance.

Operator, Operator

And our next question comes from the line of Pablo Zuanic with Cantor.

Pablo Zuanic, Analyst

Alex, look, I mean, obviously, you've answered the question about the demand and supply dynamics in the market. But I was surprised that one of your partners or one of your suppliers, Tilray, would sound so negative in the last call about the Israeli market. It sounded like they were not supplying you anymore. So maybe just remind us of your current relationships, I guess, Organigram, Clever Leaves, as you look forward.

Alexander Rabinovitch, CEO

Pablo, I can't get into details regarding specific remarks of partners. It's still a very fragmented market, and each one of the partners is using a bit of a different approach. I can say that the relationships with all partners are very healthy, and most of the partners are applying our QA approach. Clever Leaves, of course, is a new partnership. We need to ramp up our production with them. We just made the first shipment into Israel. But of course, it was just to start the relationship. With Clever Leaves, we intend to use some of their facilities with our genetics and our know-how and scale up our production lines. It will take a bit of time. With all others, I would say the relationships are very healthy.

Pablo Zuanic, Analyst

Okay. And then I don't know if you disclosed this, but in terms of your total sales, can you say how much is retail and how much is wholesale? Or is pretty much all your production being sold through your own stores and you're not net wholesaling?

Alexander Rabinovitch, CEO

Pablo, thank you for the question. We operate in a vertically integrated model. At this time, we will move into more integrated models with more retail reach. Currently, we do not disclose additional information about how much was sold inside our vertically integrated system and how much we sold to third parties. But you can guess from the gross profit that shows this quarter, we had more sales internally as our retail reach is growing.

Pablo Zuanic, Analyst

Right. But again, you don't have to disclose, but of your total retail sales, if I look at your retail business, would your own brands be like 1/4 of your retail sales right now? Would they be 75%? Can you just give a rough range?

Alexander Rabinovitch, CEO

So the rough range is about, I would say, about 40% to 45%, sometimes 50%. But again, it may be a little bit volatile as we ramp up our production and as the demand for our products remains strong and solid.

Pablo Zuanic, Analyst

Okay. Look, I'm going to ask you a couple of follow-ups. I don't know if there's many other people on the line here on the queue, but can you maybe give more color on your e-commerce capabilities? I mean we saw IMC buy the Panaxia online business. I'm just trying to understand your omnichannel and the way you're able to work online and maybe deliver if that's a growing segment in the market.

Alexander Rabinovitch, CEO

Yes, of course. I would like to give more color on that. So in Israel, online, including call center, is about, I would say, about 10% to 15% of the market. I don't see it growing that much, as that's been traditionally the number. We are also focused on that segment. I would say that we are leading this segment in Israel. In Israel, all deliveries must come from a physical pharmacy, so there is no online pharmacy like the German model. So it's a bit of a challenge, and the regulation is much tighter. Every delivery has to be directly to the patient's official home. It's a very, very tight and strict regulation, and it's been traditionally about 10% to 15% of the market. With this, I would say, we just launched the first app, which can give patients the ability to order their pharmaceutical-branded product directly from their phone or the app. This is the first app in Israel, and it's up and running. The last 2 launches we made were only to the app, which is ramping up the downloads of the app. We intend to keep our leading position also in the online segment.

Pablo Zuanic, Analyst

Okay. And then just a follow-up. So maybe you can expand on your confidence that the demand for medical cannabis in Israel will start to pick up or accelerate. I want to get more color there, if you can provide, please.

Alexander Rabinovitch, CEO

The demand is solid. The government stated that 27% of adult Israelis are consuming cannabis, and medical cannabis demand is robust. The big question has always been regulation and the process to obtain the license and the prescription. Right now, as you know, Israel is in a political situation. We don't have a stable government in the last 5 years or so, with elections almost every year. In that environment, it's hard to implement new regulations. The Minister of Health formed a committee to assess the process of obtaining the prescription for medical cannabis. The result of this committee was that, first of all, you have to ease the process and cancel the need for a license. Currently, new patients need to obtain a license and a prescription, and the committee suggested that GPs could prescribe medical cannabis, making it a regular prescribed product. Currently, only authorized specialists can prescribe and give a license. The Minister of Health controls the recruitment by giving those physicians the number of licenses every month. This committee finished its work, and this has already been approved by the Minister of Health. We are still waiting for a new government to form and implement those regulations. Once those regulations are implemented, I believe that the market will get to between 3% to 5% of the population.

Pablo Zuanic, Analyst

Got it. And one last one. If you can expand on your ability to operate in Europe, particularly Germany. You talked about your CBD store in Austria, I suppose CBD only, but I'm trying to understand, if I am company X in Portugal or in Australia or Denmark and I'm trying to enter the German market, I would try to work with the people that are established there, such as licensing portals, distributors, or even producers like DEMECAN. So I'm wondering what your approach is, particularly to Germany, and what you can bring to the party to be successful.

Alexander Rabinovitch, CEO

Yes, again, thanks for the question. I have to be careful with what I'm saying due to strategy reasons. But I can share some insights. Our strategy is to duplicate the same model, the same structure we have here in Israel to core markets. Germany is one of our core markets. We've been working with leading companies in Germany for the last 2 years. When we launch products in Germany, we want to ensure that we have as much integration as possible and not only sell our products to distributors. Duplicating our structure and model from Israel takes time. Currently, we're still missing products even for the Israeli market. We aim to make a significant impact in Germany, of course, with local partners, and by building the same structure using the same systems, products, and product lines that we have here in Israel. We want to launch the best products that won the Israeli market in the German market. The German market right now is very similar to what the Israeli market was about 3 years ago in terms of product quality, competition, and players.

Operator, Operator

And our next question comes from the line of Yewon Kang with CGF.

Yewon Kang, Analyst

I just had a quick question on if you could provide some color on how the Cookies branded dispensaries have been performing compared to InterCure's branded retail stores? And if you could also provide some commentary on the rollout plan for the rest of the year in terms of expanding your retail dispensary count in Israel?

Alexander Rabinovitch, CEO

Yewon, thanks for the question. I would say that we are a company that really believes in branding, and Cookies is one of our top brands. We've seen that once you put the right brand and market it correctly, you get better economics and better traffic. We have 4 Cookies branded retail pharmacies focused on dispensing medical cannabis in Israel, and those are performing better than any other pharmacies in our system. It was a big investment for us, and we choose prime locations for those pharmacies. They bring a different experience, and some of the products are exclusively sold at those pharmacies. They are performing well and attracting more customers.

Operator, Operator

And we have a follow-up question from Vivien Azer with Cowen.

Victor Ma, Analyst

This is Victor Ma on for Vivien Azer again. I just have one more. So with increased competition in Israel, can you just remind us of your current market share position over the quarter and how much it increased sequentially or year-over-year?

Alexander Rabinovitch, CEO

Again, there are no official numbers in Israel, so I need to be careful with the information. I can't give you the exact market share again, with no official numbers. But as you know, patient count almost didn't grow in the first half. We grew 9% or 10% sequentially quarter-over-quarter, so you can understand that we increased our market share. Again, with no official numbers, I have to be really cautious about the information I provide.

Operator, Operator

Thank you. And I'm showing no further questions, so this does conclude today's question-and-answer session. Ladies and gentlemen, this also concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a great day.