Akerna Corp.

Good morning and welcome to Akerna's second quarter ended June 30th, 2021 financial results conference call. Today's call is being recorded. At this time, I would like to turn the call over to Erika Mannion, Investor of Director Relations for Akerna.

Thank you and welcome to today's second quarter ended June 30, 2021 conference call. On the call today are Jessica Billingsley, CEO and Chairman of Akerna, and John Fowle, CFO of Akerna. Before management begins with formal remarks, I'd like to remind everyone that during this conference call, certain statements will be made that are forward-looking statements within the meaning of the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Words such as estimate, projected, expect, anticipate, forecast, plan, intend, believes, seeks, may, will, should, future, proposed, and variations of these words or similar expressions or versions of such words or expressions are intended to identify forward-looking statements. These statements include, but are not limited to, statements regarding the future growth and prospects of ACRNA and statements regarding expected future revenue recognition. These forward-looking statements are not guarantees of future performance, conditions, or results, and involve certain known and unknown risks, uncertainties, assumptions, and other important factors that could cause actual results or outcomes to differ materially from those discussed, including risks related to changes in the cannabis market and risks related to the impact of the COVID-19 pandemic. These risk factors are more fully described in occurrence filings with the SEC. Forward-looking statements speak only as of the date they are made. Akerna undertakes no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by law. Now, I will turn the call over to Akerna's CEO, Jessica Billingsley.

Good morning, everyone. Thank you for joining us today. Our second quarter results continued their momentum for 2021. with software revenue growth of 56% year-over-year and 17% sequentially. Our business as a whole grew 63% year-over-year and 22% sequentially, with a mix of both organic and inorganic software revenue and a rebound in consulting revenue compared to prior periods. Our total SaaS ARR is currently 17.3 million, a 53% increase over the same period last year. In addition to top-line growth, Our focus on cost containment and accretive acquisitions continues to deliver results, with adjusted EBITDA improving 54% year over year and 11% sequentially. We are encouraged by the pace of demand in the second quarter, and we look forward to continued growth in the quarters ahead. Our focus on the multi-state, international, and emerging enterprises in the more than $20 billion global cannabis industry continues to serve us well. Churn has improved by 48% compared to prior year, while consolidation continues with many of our larger clients significantly increasing their footprint. Our average B2B deal size has also increased by 27% year over year, adjusted for a one-time project in Q2 2020. B2B transactions tracked from our system increased by 104% year over year. Looking ahead to the growth drivers of our business, as we discussed in our last call, there are a series of opportunities ahead for Akerna, from new products to new markets to new regulations, and ultimately, legalization at the federal level. On today's call, I'd like to provide an update on two broad areas, namely industry trends within the current market landscape and the potential for new federal regulation. Starting with the market as it stands today, despite the fact that it's been 25 years since medical cannabis was first legalized in California, the U.S. industry is still very much an emerging one due to lack of federal reform. Emerging markets pose various challenges and opportunities, elevated by cannabis' status as a regulated substance, which in turn creates volatility in the supply chain. In most states, many smaller operators generally compete in just one part of the supply chain and rely on partnerships to bring product to market. Challenges emerge when a problem with a supplier or customer cascades through the supply chain. This can take the form of a product recall that has to be traced from the retail store back to the cultivation and through each stop in between. The management challenges and business disruptions that result from such an event contribute to increased costs. With many smaller operators not capitalized to endure such a financial hit, the supply chain may be even further disrupted and start the cycle all over again. Many operators have experienced the challenges of relying on others in the cannabis supply chain and have determined the best way to ensure the success of their business is to own the full vertical. The operators that have taken this approach have a significant advantage when expanding into a new legal market where they can replicate their model without the risk of depending on disparate operators. Another benefit of consolidation lies within a critical part of operating any cannabis business, compliance. Laws can vary significantly from one state to the next and even from one municipality to another, complicating compliant operation. To keep up with these variations, cannabis businesses need to dedicate significant time and money to ensure adherence to compliance with cannabis regulations. Failure to meet compliance is a daily risk that operators face, with potentially business-ending repercussions in the most severe cases. Large cannabis operations often employ a dedicated compliance role or outsource the regulatory work, but smaller operations rarely have the resources to do so. It is within this framework that Akerna's platform solves the complex needs of the industry. Given our longstanding leadership presence in the market, we have built an ecosystem. with the most comprehensive compliance and regulatory capabilities in the industry, able to serve off the shelf the requirements of the entire cannabis supply chain in more medical and recreational markets in North America and beyond than anyone else. The net result is a platform able to serve both small operators and large multi-state and emerging enterprises who are driving consolidation in the industry. As we've articulated on prior calls, Given the strategic importance of compliance within the cannabis market, we are focused on building out the ecosystem around our core compliance gateway to secure our leadership in this segment of the market. Our point of sale app, MJ Retail, which has completed its beta adoption and will now be broadly marketed to both existing clients and new prospects in the second half of the year, proves this concept by integrating a clean and streamlined app with our robust compliance, integration, and business intelligence available in our ecosystem. The Akerna ecosystem was developed to provide a wide range of solutions and insights to our clients and the cannabis industry at large. Our platform allows cannabis operators to manage every detail of their business, while our business intelligence helps them make the most impactful decision for their operations. With over 80 integration partners, we are able to provide the full range of services that enhance cannabis businesses, including integration with large-scale financial and tax management solutions, inventory management, online ordering, digital menus, and payment options, just to name a few. Demonstrating the success of our strategy to build an enterprise-grade platform, the tools we've built into our ecosystem have had an almost 100% adoption rate with our largest MSOs, who are largely signing on for multiple year contracts with Akerna Offerings. These MSOs rely on our premium offerings like MJ Analytics to make operations more efficient as they continue to grow and scale their businesses. Over the last year, the infrastructure improvements we've made and the acquisitions we've closed and acquisition strategy we continue to pursue positioned Ocarna to be one of the largest cannabis technology winners as legalization expands to new states. There is no denying this past year has seen significant strides in the legalization of cannabis. In the 2020 U.S. election, we saw Montana, New Jersey, South Dakota, and Arizona support legalization for the recreational use of cannabis. In March of this year, New York became the latest to join that ever-growing list And only a month later, Virginia became the first southern region state to begin the process for full legalization. Even the historically conservative Deep South has started to make steady gains, with Alabama joining Louisiana as states from the region to legalize medical marijuana. While the timing of each of these distinct opportunities varies based on factors such as the prior existence of a medical market and associated regulatory frameworks In general, we're seeing an uplift in our consulting backlog, indicating states are moving forward. With muted consulting results in the first half of the year, as some of the larger states were slow to start, we are encouraged to see the strength of planned projects in the second half. As these projects are completed, we would expect a corresponding increase in software revenue as licenses are granted and our consulting clients begin to build out their IT infrastructure in these new markets. Looking beyond our growth initiatives within the existing regulatory framework, we're encouraged to see the priority which has been placed on the recently proposed Cannabis Administration and Opportunity Act. As many of you know, on July 14th, Senators Chuck Schumer, Ron Wyden, and Cory Booker unveiled their 163-page bill draft, which, upon passage, would federally legalize cannabis in the United States. This is important legislation as it addresses crucial needs in cannabis, including decriminalization, social equity, taxation and regulation, consumer safety concerns, reform of baking laws, investment in research, authorized medical use access to veterans, interstate commerce, and economic empowerment to communities and individuals directly impacted by the war on drugs. These are the necessary categories to address the regulation of the cannabis industry and help propel American economic recovery in the wake of the COVID-19 pandemic. In addition to the broad beneficial implications of federal legalization for Akerna, this bill also includes language directing the Secretary of the Treasury to establish a federal track and trace system for cannabis products to prevent diversion as well as federal and state tax evasion. Given the B2G capabilities we have built with our leaf data systems offering and our recently announced federal software contract with St. Vincent and the Grenadines, as well as the breadth of our regulatory compliance across current states, we believe there may be an additional opportunity for us to pursue software sales at a federal level. While the proposal of this bill has been met with great support, many of those reporting on the topic have focused on the likelihood of bipartisan support. While a worthy point equally applicable to any proposed legislation given the current political environment, what is often overlooked is the evolution of bipartisan support on cannabis-related measures over the last few years. Using our own state of Colorado as an example, When recreational cannabis legislation was first introduced in 2014, it received harsh criticism from both the Democratic governor and Republican senator. After those initial objections and witnessing firsthand the economic benefits derived from such legislation, both became supporters, with Senator Cory Gardner co-sponsoring most subsequent cannabis-related bills. This is not an isolated event. Of the 37 states which have thus far passed some form of legislation around cannabis legalization, there is a large contingent of Republicans within those states who have similarly seen the benefits firsthand and are beginning to step forward. The most recent co-sponsor to add his name to the Safe Banking Act is Republican Roy Blunt of Missouri. While it is too soon to make predictions on the likelihood of the Cannabis Administration and Opportunity Act ultimately passing, the evolution of public and political perception on the topic of cannabis reform continues. With the priorities set in place by the current Congress, there's a strong chance that even if the current proposed bill does not move forward, it will pave the way for some form of meaningful legislation such as the SAFE Act, or safe plus tax reform to pass in the current session, further increasing the opportunity in front of us. In fact, the U.S. House of Representatives approved a package of spending legislation last month that contains similar language and provisions to the Safe Banking Act. Closing, we are very excited about the many value creation opportunities ahead and the business we have built to leverage the upcoming waves of growth. With the leadership position we have in our core business and capabilities we have integrated to take advantage of new opportunities such as new state initiatives and ultimately U.S. federal legalization, we strongly believe we are quickly approaching an inflection point in growth, both in the cannabis industry and Akerna's role within it. All our hard work and achievements to date have positioned us very well for this moment, and we look forward to driving long-term shareholder value as the path unfolds in front of us. Now, I'll hand the call over to John, who will take us through the details of our financial results. John, please take it from here.

Thanks, Jessica. Today, I'll provide an overview of our financial results and key business metrics for the second quarter ended June 30th, 2021. As a reminder, these results are discussed in further detail in our Form 10-Q, which will be filed shortly with the SEC. Financial results reported today are preliminary. Final financial results and other disclosures will be reported in our quarterly report on Form 10-Q and may differ materially from the results and disclosures today due to, among other things, the completion of final review procedures, the occurrence of subsequent events, or the discovery of additional information. We encourage you to review the filing in detail. Moving along to business updates, this past quarter we continued to deliver on our core objectives. of investing in innovation and revenue growth opportunities, including the acquisition of Viridian Sciences, optimizing our operating infrastructure, and improving profitability. With software revenue up 17% sequentially and 56% year-over-year, approximately 900,000 of new ARR bookings, and the average booking amount up 27% year-over-year, adjusted for a one-time transaction in Q2 2020, The growth momentum of our business continues as larger multi-location and multi-state operators increasingly implement our solution to solve their business needs. Transaction volume was up 57% year over year. Retail order value was flat year over year. However, in Q2 of 2020, retail order value was up 90% against the same period, 2019, as consumers stocked up on product ahead of potential shutdowns related to COVID. Our strong demand pipeline, generated by both client growth and organization-wide implementation plans, gives us confidence in our ability to grow our revenue and profitability as we prepare for the upcoming industry catalyst Jessica mentioned earlier. Now let's review the financial results for the quarter. As a reminder, and unless otherwise noted, all metrics are non-GAAP. A reconciliation of GAAP to non-GAAP financials is included in our earnings release and posted on our investor relations website. We encourage you to review the reconciliations there as well as review our financial statements for the quarter ended June 30th, 2021 contained in our form 10Q to be filed with the SEC shortly. Total revenue grew 22% on a sequential basis and 63% year over year to 4.9 million through a combination of organic and inorganic growth, including strength in our consulting business, new software product lines and partnership revenue, and the revenue contribution from acquired assets. Software revenue was up 17% sequentially to $4.5 million and up 56% compared to the prior year. We currently have approximately $1.2 million of ARR backlog pending go-live. Consulting revenue more than doubled sequentially to approximately $400,000 as a result of project timing in the prior period. Progress on new state initiatives continues to be mixed. However, as Jessica previously mentioned, with our current backlog and growing pipeline of opportunities, we believe the second half will be meaningfully stronger than the first half. Gross profit was $3 million for the quarter and represented a 62% gross margin compared to a gross profit of $2.6 million and a 64% gross margin in the prior quarter. Our gross margin percentage was slightly impacted by the Viridian acquisition as we have not fully realized the cost synergies. Throughout the second half of the year, we'll continue to focus on driving leverage from our infrastructure, and we expect our margin profile to return to the mid to upper 60% range near term as cost synergies are realized, consulting revenue rebounds, and as our software revenue grows, adding a higher contribution margin to our revenue mix. Moving to operating expenses, total operating expenses increased approximately $236,000 sequentially, mainly a result of the acquisition of Viridian, offset by the continued execution on cost management and operating efficiencies. In the quarter, operating expenses increased only 5% from the prior quarter, even though revenue increased by 22%, demonstrating our ability to drive significant leverage out of our total cost structure. The net effect of increased revenue while leveraging cost was an improvement in our adjusted EBITDA margin of 27 percentage points sequentially and 72 percentage points year over year. These are sustainable changes that will drive our operating margins higher over time. These efforts include productivity enhancements through system and process improvements and improved allocation of human capital. Product development expense increased approximately 140,000 or 12% from the prior quarter, mainly a result of the Viridian acquisition. In the quarter, we capitalized approximately $1.2 million of software development as we continue to accelerate our product roadmap. We continue to invest in product development that we believe will deliver the complete compliance experience for our clients. Sales and marketing expense similarly increased 80,000 or 5% sequentially with incremental expenses related to the Viridian acquisition offset by the continuing refinement of our go-to-market strategy. While we continue to be pleased with our sales and marketing efficiency as we continue to deliver new business growth with improving client acquisition costs, we plan to make incremental investments in the second half of the year to enhance our marketing messaging, create alignment across our portfolio of brands, and capitalize on our key development initiatives. General and administrative expenses were flat sequentially and down 9% year over year. In the quarter, adjusted EBITDA was negative 1.6 million compared with negative 1.8 million for the quarter ended March 31st, 2021, an improvement this quarter of 11%. and compared with negative $3.6 million for the prior year, a year-over-year improvement of 54%. We believe adjusted EBITDA, when considered with the financial statements determined in accordance with GAAP, is helpful to investors in understanding and comparing our performance. As of June 30, 2021, our cash balance was approximately $11.8 million. We continue to be prudent with our spending levels, and we've maintained a healthy cash position to manage the business. Cash on hand and access to the capital markets positions us well to execute on our strategy, which is a significant advantage over many of our competitors. We expect continued improvements in our financial performance as we continue to scale and drive towards profitability. In closing, the tailwind of cannabis reform and consumer adoption is growing, but in some cases offset by short-term budget constraints, largely a result from the uncertainty presented from COVID-19. However, we are optimistic about our product roadmap and our new software solutions coming to market. We continue to develop more platform capabilities and expand market reach. We believe our strategy positions us well within our industry. We continue to have a strong balance sheet and we're well positioned to invest in the growth we expect going forward. This concludes our prepared remarks. We are happy to take any questions you may have. Please keep in mind that the forward-looking statement disclaimer discussed at the beginning of this call applies equally to the Q&A session. Now, let's turn the call over to the operator for questions. Operator?

Thank you. We will now be having our question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may also press star two if you would like to remove your question from the queue. One moment, please, while we now poll for questions. Our first question comes from Brian Kintzlinger with Alliance Global Partners. Please proceed with your question.

Hi, good morning, guys. Thanks for taking my questions. Good morning, Brian. Morning, Brian. Morning, Jessica. Hi, John. You mentioned you expected the ramp in consulting in the second half as many states are looking to regulation and some are slow to start. Can you help frame that? Well, we see quarters similar to 2019. And do you expect demand will be sustained in 2022 based on the timelines that states plan to launch? I know consulting has been lumpy, you know, a couple quarters good, a couple quarters down. And so I'm just trying to understand the sustainability also.

Great question. Thanks, Brian. We do expect continued rebound, although I do want to note that states can and often do make changes to their programs that can delay initiatives. And we've, you know, just speaking to the delay, we've seen some states delay as they focus on perceived higher priority initiatives and continued response to COVID. to see issues from RFPs over the, you know, given the state timing, we should probably talk in terms of, you know, coming quarters, we would expect to see those RFPs.

Okay. Lastly, can you quantify, John, maybe revenue from Viridian Ample? I think this is the last quarter where Ample, you know, wouldn't be part of organic as it's been about a year since the acquisition. And then, although it's been a little bit slower, during the pandemic, can you maybe provide a general update on the Canadian market?

Sure. Maybe, Jessica, if you want to touch on the Canadian market overall, I think, and then I can certainly touch on the Viridian and ample revenue. Maybe talk more strategically first.

Sure, sure. So we are seeing some more activity just over the past year given COVID. We've seen more activity and opportunities domestically versus Canada due to the mostly stricter COVID regulations in Canada. For example, Health Canada did place a hold on issuing any new licenses for a meaningful portion of the year. With that said, in the mid to long term, as situations formalize, we remain very excited about our opportunities in Canada, particularly with our enterprise partnerships, including Shoppers Drug Mart. And we are starting to see Health Canada begin to issue some new licenses again.

Yeah, and then Brian, I guess back to your other question. So starting in Canada, I think COVID's actually impacted Canada quite a bit. As we know, they've probably been a little more shut down than here in the U.S. I think we're happy with the work we've done. in Canada with Ample, and we're seeing really good penetration and continued market opportunity there. So I think overall, in spite of some pretty difficult headwinds north of the border, we continue to execute and deliver on that platform. I think here in the U.S., I think we're really excited about the Viridian opportunity. It's a significantly larger opportunity for us. Sorry, that platform and the SAP platform solution I think for us is pretty significant and they had a really strong quarter and we're starting to see some of our customers display some interest in the Viridian product and we're excited about where we can take that here in the year ahead.

And would a million and a half be in the ballpark of the contribution in the quarter from these two acquisitions?

Yeah, not having the right number, the exact number in front of me, I think it's a fair way to think about the two contributions of that business. Great. Thanks so much, guys.

Thank you.

Thanks, Brian.

There are no further questions at this time. I'd like to turn the floor back to Jessica Billington for any closing remarks.

Thank you, Operator. We are the technology ecosystem for cannabis, serving operators, governments, and brands. Our ecosystem strategy and strategic investments are focused on locking up the tech spend of the enterprise cannabis businesses, and solving with technology the growing demand for increased supply chain transparency among consumers and governments. We thank you for your interest in Akerna, and we look forward to sharing our progress with you as we move forward.

Ladies and gentlemen, this concludes today's webcast. You may now disconnect your lines at this time. Thank you for your participation, and have a great