Earnings Transcript for DLTNF - Q1 Fiscal Year 2022

Operator: Good morning, ladies and gentlemen, and welcome to the Delta 9 Q1 2022 Financial Results Conference Call. [Operator Instructions] This call is being recorded on May 16, 2022. I would now like to turn the conference call over to Ms. Alexa Goertzen. Please go ahead.

Alexa Goertzen: Good morning, everyone, and welcome to the Delta 9 Cannabis Q1 2022 earnings call. At this time, all participants have been placed in listen-only mode. Following the presentation, we will open the line for a question-and-answer session for financial analysts. Delta 9 would like to remind listeners that today’s call may contain forward-looking statements that reflect the Company’s current views with respect to future events. Any such statements are subject to risks and uncertainties, which could cause results to differ materially from those projected in the forward-looking statements. For more information regarding risks and forward-looking statements, please refer to the Delta 9 Cannabis Inc. public filings, which are available on SEDAR. I’d now like to turn the call over to Delta 9’s Chief Executive Officer, John Arbuthnot.

John Arbuthnot: Thank you, Alexa, and good morning, everyone. Thank you for taking the time to join us for Delta 9’s Q1 2022earnings call. With me this morning is the Company’s Chief Financial Officer, Jim Lawson; our Senior Vice President of Capital Markets and Strategy, Dr. David Kideckel and our VP of Corporate Affairs, Ian Chadsey. Our earnings press release, Q1 2022 financial statements and management discussion and analysis have now been made available on SEDAR and our company website. And with that, let's begin. In the past year, Canadian cannabis industry sales have continued to expand, posting monthly retail cannabis sales of $336 million as of the most recent statistics Canada data. Annualized retail cannabis sales are now approaching $4 billion. And with the market plan to increase at compound annual growth rates of approximately 10% over the next five years, the industry is expected to double in terms of retail cannabis revenues by the end of this decade. The industry continues to deal with challenges relating to an oversupply of cannabis products, generally compressed wholesale gross margins, growing pains at provincial crown distributors and overall saturation in cannabis retail stores and market volatility. We continue to believe that the growth rate in the Canadian cannabis market alone as well as the global reform of cannabis laws, represents a generational market opportunity for companies like Delta 9 to grow and unlock significant value for shareholders. I'm pleased today to be presenting you with Delta 9s Q1 2022 financial and operating results. These results include several transformative, financing and M&A transactions, which we feel position Delta 9 for material growth into the back part of 2022. We have many positive takeaways from today's results, which we will highlight as well as analyzing our misses, the challenges we have encountered and the changes we're making to continue to drive growth and create shareholder value. We'll begin with a discussion of operations and material milestones for the company achieved over the reporting period. On the cannabis cultivation and processing side of the business, we'll begin with an update of activities at our Delta 9 facilities in Winnipeg. The primary purpose of these facilities is to cultivate, process and manufacture high-quality cannabis products. The company's proprietary cannabis production methodology is based around a modular, scalable and stackable unit that we call the Grow Pod. And as of the end of Q1 this year, the company had 297 of these Grow Pods licensed by Health Canada and in operation within our Delta 9 facilities. We're now operating these assets at or above the original signing capacity of our facilities and are beginning to assess efficiencies in terms of the number of harvest rotations per year, average grams per harvest and overall potency in order to maximize the return of these assets. We will continue to update the market on expansion progress as the company further develops its forward-looking expansion plans through 2022 and beyond, and as licensing approvals are received from Health Canada. On our portfolio of cannabis products, Delta 9 currently produces approximately 30 different genetics of cannabis, each with its own unique chemical cannabinoid content, terpene and flavonoid profiles, and with another 100 or more strains being stored in an onsite seed bank to provide product options into the future. We're continuing with our production pivot towards higher potency cannabis strains, which are the highest demand segment with the retail cannabis consumer. Over the past 12 months, the company has increased its average THC in its harvested cannabis flower products. The company continues to improve processes for drying, curing and processing of dry cannabis flower material and will continue to strive to produce the highest quality cannabis products at scale. Cannabis pre-rolls have become an increasingly important category over the past two years as consumers have moved to smaller packaging sizes and saw convenience in a pre-rolled setting. The company's pre-rolled products currently account for approximately 15% of our overall product offering with our Bliss and Twist pre-rolls making up two of our top 20 selling products in Delta 9 retail stores over the past 12 months. In Q3 last year, Delta 9 launched a new 14 pre-roll multi-pack of our best selling Bliss and Twist pre-rolls in Manitoba and Saskatchewan, and we plan launches of these multi-packs across additional provincial markets in the coming quarters. The company also plans to release several other pre-roll and infused pre-roll products in the coming quarters in an effort to increase our overall market share in this important category. In Q1 this year, Delta 9 released our new 0.25 gram pre-roll, offering Canadian consumers a convenient personal use setting, again, in this important pre-roll category. On oils, extracts and derivative products, over the past year, Delta 9 saw a successful initial sell-through in our various markets for our cannabis 2.0 products, including ingestible cannabis oils, vape cartridges and cannabis concentrates. In 2022, we will relaunch all of our 2.0 product lines, including new products, new and improved formulations and leveraging partnerships with the industry's leading white label suppliers to drive margin improvements. Our full 2.0 product portfolio will now includes three formulations of ingestible cannabis oils, three formulations of 510 vape carts, cannabis kief, and pressed hash in the concentrate formats category. It is and continues to be our belief that these categories will continue to become an increasingly important component of the medical and recreational use cannabis markets into the future. In our retail stores, we carry the full complement of these 2.0 cannabis derivative products from the industry's leading manufacturers. We continue to believe that through our retail unit, we will be able to extract valuable entail on which of these new product formats are having a positive impact with consumers and be able to pivot to capitalize on these new product opportunities. From a distribution standpoint, we believe that the domestic market for recreational use cannabis presents our most major growth opportunity for the company over the next several quarters. Wholesale revenues from the sale of recreational use cannabis are expected to make up a large component of the company's overall business. The company has undertaken a strategy to add new distribution markets incrementally as our increased supply capacity has come online over the past few years in order to reach our ultimate goal of becoming a national distributor of branded recreational use cannabis products. At the end of this past quarter, Delta 9 was licensed for distribution in Manitoba, Saskatchewan, Alberta, British Columbia, Ontario and Newfoundland, with these six provincial markets, representing well over 50% of the Canadian population. The company is currently undertaking license applications in additional Canadian markets and we highlight the Quebec market as our next key planned market entry, as well as exploring international distribution opportunities in Australia, Israel, the EU and Latin America to expand our distribution potential into 2022. On vertical integration and retail cannabis sales, over the past two years, Delta 9 has made substantial progress in expanding its retail footprint. Delta 9 started the year 2020 with only four operating stores in our home market in Manitoba. In Q1 this year, Delta 9 successfully opened its 17th cannabis retail store on Portage Avenue in Winnipeg. Most notably in Q1 this year, the company announced a transformative retail acquisition to acquire all of the assets of Uncle Sam's Cannabis Limited in connection with their 17 operating retail cannabis stores based in the province of Alberta. The Uncle Sam's and Discounted Cannabis retail cannabis stores acquired in this transaction have demonstrated significant revenue, EBITDA and earnings growth over their past two years of operations. We do expect the Uncle Sam's transaction to be immediately accretive in 2022, while the acquisition represents an attractive revenue multiple of approximately 0.6x annualized revenue. The combination of the Uncle Sam’s Cannabis stores in Delta 9s existing store network as made Delta 9, a leading retailer of cannabis products in Canada. As of today's date, Delta 9 operates 35 cannabis retail stores across Canada and is positioning as one of the country's largest vertically integrated cannabis retailers. The company has an aggressive growth strategy to actively acquire cannabis retail stores that will provide meaningful revenue growth and positive adjusted EBITDA. We plan to open and operate several additional retail locations and jurisdictions which allow for privatize cannabis retail over the next 12 months, investors can look forward to numerous store openings throughout 2022. On business-to-business opportunities, the company derives a portion of our overall revenues from sales of cannabis genetics, sales of Grow Pods and from licensing and consulting activities provided to other licensed and pre-licensed cannabis companies. We do believe that these opportunities provide a number of benefits to the company, including giving us a complementary business vertical, which produces diversified and high-margin revenue, third-party validation of the company's proprietary Grow Pod platform, valuable partnerships with other pre-licensed and licensed cannabis companies and exposure to international expansion through this non-cannabis revenue stream. To-date, Delta 9 has licensed almost two dozen third-party facilities across Canada and North America representing almost 200 Grow Pods for our micro cultivation partners. We will continue to pursue and expand these business-to-business revenue opportunities over the coming year. The company is also continuing its pivot to expand its sales and marketing efforts for its B2B segment into the United States. We anticipate to see larger growth from our US B2B sales into the back part of 2022 and beyond as this pivot begins to take effect. On to financial results. We'll begin with an assessment of the balance sheet. The company ended the quarter with approximately $13 million in cash inclusive of the company's draw on its operating line of credit and showed approximately $15 million in working capital. During our Q4, 2021 earnings call, we highlighted balance sheet strengthening as a major near-term focus for management and during Q1 2022, we announced two material financing and refinancing transactions. The first is the company's closing of a $32 million credit facility from connectFirst Credit Union. These credit facilities include a $23 million commercial mortgage facility, a $5 million acquisition facility, used for the Uncle Sam's retail transaction and a $4 million authorized overdraft facility. These facilities mature over five years and amortize over a 12-year term. This facility is anticipated to be established in multiple tranches and advancing at various times and for various purposes, including $11.2 million for the repayment of the Company's previous Canadian Western Bank credit facilities and $11.8 million for repayments of the Company's existing convertible debentures. The interest rate under these facilities is a five-year fixed rate of 4.55%. The Company has already used a portion of these facilities to repay again, our facilities with Canadian Western Bank. And we do expect to repay our $11.8 million convertible debentures on the maturity date of July 17 this year. As noted in our press release, February 1 this year, these facilities provide an attractive and industry-leading interest rate, annualized interest and principal repayment savings and expansion in operating capital through the acquisition and working capital facilities. The second material financing transaction is the Company's closing of a $10 million strategic financing from Sundial Growers in the form of a three-year $10 million secured convertible debenture. The financing provides acquisition capital as well as capital for general corporate and working capital and growth purposes. The result of these two transactions is a balance sheet, which provides significantly improved working capital, alleviating concerns around the current maturity of the Company's unsecured convertible debentures and positioning Delta 9 with two new strategic partners in connectFirst and Sundial Growers to help facilitate the next stage of the Company's growth. Total assets at the end of Q1 totaled $106.8 million, up from $74.7 million as of the end of last year. We believe the Company is currently well capitalized to continue to execute on our expansion plans and can act opportunistically where assets become available, which can expedite expansion, provide strategic value and improve the financial and operating performance of the Company. On key performance indicators, in Q1 this year, the Company produced approximately 2.5 million grams in line with production numbers from Q4 last year. As the Company continues to improve its production efficiencies, we expect that these production numbers will continue to increase over the coming quarters. Production costs per gram decreased to a record $0.57 versus $0.61 in the fourth quarter last year. We would highlight that these production cost figures are quite competitive even comparing versus our largest competitors in the context of the current Canadian cannabis flower market. As the Company continues to refine its production techniques, we anticipate that our economical cost base will be essential to improving gross profitability in the upcoming quarters. Total grams sold decreased to approximately 900,000 grams in Q1, down from $2.2 million last quarter. Although, we do note that our overall grams sold in the past four quarters represents significant improvement over the previous four quarters. The Company's average selling price increased in the quarter to $3.14 per gram from $2.07 per gram. We have seen average wholesale prices stabilize over the past several quarters and feel that Delta 9 can reach sustainable profitability from our wholesale cannabis segment at these current price levels. Continuing to address our wholesale business and improving overall grams sold and average selling price will be a continued focus for us over the upcoming quarters. While we saw fewer overall transactions in our retail stores in Q1 due to seasonal weakness on the back of the holiday shopping season in Q4 last year, our average cart size appears to be stabilizing around the $42 to $43 per transaction level over the past few quarters. On revenue and revenue segmentation, total net revenues for the three-month period were approximately $12.5 million versus $13.2 million for the same period last year, a decrease of 6%. Sequential net revenues decreased 27% from $17.1 million in Q4 last year. From a revenue segmentation standpoint, for Q1 this year, the company recorded retail revenues of $10.2 million, wholesale cannabis revenue of $2.8 million, and B2B revenue of $121,000. The company encountered challenges in our material revenue segments in Q1 this year. However, we remain bullish that the company's recent completed acquisition of the Uncle Sam's Cannabis Limited Alberta assets, position the company as one of Canada's largest and fastest-growing retail chains will deliver significant revenue growth for the company in Q2 this year and beyond. In the upcoming quarters, we are focused on three main initiatives to drive revenue growth. First, being a continued expansion of the company's retail store chain, including further acquisitions as the company continues to execute on its retail roll-up strategy; building momentum in our cannabis wholesale segment with a focus on expanding product distribution in our six existing markets; adding new provincial markets through new listings as well as through bulk wholesale agreements with other licensed cannabis companies. And finally, expanding our B2B revenues through a focus on creating relationships in the Canadian micro cultivation industry and expanding into emerging markets, including the United States. We continue to believe that given the relative novelty and uncertainty of the global cannabis industry, the company's diversified revenue and vertical integration approaches will allow us to better react to market challenges than our competitors with single business strategies. Gross profit before accounting for changes in the fair value of biological assets for the three-month period was $3 million or 24% of net revenue. This compares with $3.7 million or 28% of net revenue for the same period last year. We attribute the decrease in gross profit and gross profitability to the overall decrease in revenue versus the previous period and again, note that we remain bullish on a meaningful revenue rebound, which should contribute to improved profitability in Q2 this year. In the company's wholesale cannabis business segment, we would note that the company has continued to see downward trending in program production costs as a result of incremental efficiencies and labor costs and overall economies of scale as production output has scaled over the last 12 months. We expect that as production cost per gram continues to trend down and with the introduction of sales of higher-margin cannabis derivative products in 2022, the company will experience a general improvement in gross profitability from our wholesale cannabis segment. In the company's retail cannabis business, we anticipate that the introduction of higher-margin cannabis extract and additional stock of ancillary cannabis products will insist in improving overall gross profitability again over the coming year. We also highlight that once our B2B segment begins to produce more meaningful revenue contributions, the company's overall consolidated gross margin is expected to improve. Operating expenses for the three-month period were approximately $6.5 million versus $5.7 million for the three-month period one year ago. The most notable increases in overall operating costs were amortization, an increase of $280,000 insurance, legal, professional, consulting and investor relations fees and personnel expenses, which we note were an increase of $430,000. The increase in personnel expenses were largely due to the increase in the number of operating retail stores versus the previous year. The company's loss from operations for the three-month period was $2.9 million versus a loss from operations of $3.2 million, a modest improvement over the previous period. This also compares with a loss from operations of $3.5 million for the sequential period ending December 31 last year. We are confident that our renewed focus on revenue growth, gross profitability and prudent cost controls will return the company to profitability over the coming quarters. The company's adjusted EBITDA loss for the three-month period was $1.7 million. This compares with an adjusted EBITDA of approximately $7,000 for the same period in 2021. We attribute the adjusted EBITDA loss in the period of lower-than-anticipated revenues and lower-than-anticipated margins as noted above. Again, we remain confident in the company's recent acquisitions and renewed focus on growth and profitability will return us to a positive adjusted EBITDA position over the coming quarters. As we look forward to the balance of 2022 operating year, we feel the company is well-positioned to continue to execute on its vertical integration and growth strategy. In our production and wholesale segment, the company will continue to push forward to maximize the utility and efficiency of our existing assets, increase production output and increase our ability to supply volumes of cannabis across all of our provincial markets. In our retail segment, we will add to our retail and distribution capacity by adding new stores to our existing chain. We will continue to position as a retailer of choice for both retail customers and suppliers, seeking the best locations and positioning as the most competitive LP-owned retailer in the Canadian cannabis space. And in our B2B segment, we will continue to cultivate long-term and value-added relationships with our B2B customers, as we deliver on Grow Pod projects across North America, while deploying resources into international markets to position our non-plant touching businesses to realize growth in the ever-growing cannabis opportunity globally. I want to thank everyone for taking the time to join our call this morning. And with that, I will turn the call back over to the operator for questions.

Operator: Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Venkata V [ph] with Research Capital. Please go ahead.

Unidentified Analyst: Thanks a lot for taking my first questions. Good morning, everyone. So my first question is about growth outlook for next quarter. So we see that last year in Q2, Delta 9 rebounded strongly with a sequential growth of 26% over Q1. So this time around, do you guys see similar kind of growth in Q2?

John Arbuthnot: Yes. Thanks, Ven, and good question. I think in terms of outlook for the second quarter, we have generally seen the seasonal rebound in our cannabis retail segment. Obviously, do anticipate seeing that seasonal slowdown in the first quarter. And again, we've seen now I think those conventional shopping patterns start to rebound into the second quarter as well, again, as we've seen in the last two years. The disruption in purchasing patterns from provincial purchasing boards around the holiday shopping season, which impacts Q1 results has started to, again, shift back into growth mode. So I would anticipate meaningful rebounds in both our cannabis retail and wholesale segments into the second quarter here. On B2B, this segment for us, obviously, has been the most disrupted in the last 24 months by COVID and overall market conditions as well would be the one segment for us that has been impacted by supply chain issues. And that's really what you're seeing in terms of project delays and revenue recognition in the first quarter here. Again, we do see that smoothing into the back part of this year and overall will rebound, we would say, meaningfully from the Q1 results into Q2. So overall, across the board here, I anticipate, again, a meaningful rebound into the second quarter. We will be in a position to provide formal guidance to the market in the coming weeks on our Q2 revenue results.

Unidentified Analyst: Okay. Perfect. So I'm trying to understand your adjusted EBITDA. Usually, Delta 9 was the only company, which continue -- I mean, reported positive EBITDA for eight quarters in a row. I think this time around due to seasonality and slightly higher operating expenses, the EBITDA was a bit lost, marginal loss. So I wanted to understand when do you think Delta 9 will be back to positive EBITDA?

Jim Lawson: You know, I think too early for us to guide on the second quarter than formally in terms of that rebound or adjusted EBITDA profitability, although, again, as we've seen historically, the company reaches between $15 million and $20 million in quarterly revenue. We've seen sustainable results above adjusted EBITDA breakeven. So with it in mind that we do anticipate revenue to rebound meaningfully more towards the $20 million quarterly revenue mark for the second quarter here. And again, with prudent cost controls in mind as the company has demonstrated over the past two years, feel that, that rebound to adjusted EBITDA profitability is not far off.

Unidentified Analyst: And yes, and you mentioned in your presentation that in 2022, also the key focus would be retail expansion. So can you add more color like which provinces will be key focus? And if you can add more about -- if you have any target number of retail stores by the end of 2022, that would be great.

John Arbuthnot: Yes. So our core market focus then, in terms of retail acquisitions will be the Prairie markets, Manitoba, Saskatchewan and Alberta, I feel that there is a good opportunity to really play the role of consolidator across these markets. We are now seeing a shakeout in terms of those markets having reached, call it, peak saturation in retail. We are beginning to see store closures across those markets. And at the same time, we do see that there have been quality operators and assets developed over the last few years across those markets, significant activity on the back of the Uncle Sam's acquisition. So I think that has certainly been successful in positioning us as acquirer for those markets. Look for us to continue to focus on the Alberta market, in particular, expanding outside of the Edmonton market, I think, becomes a key focus for us then and taking a more meaningful presence in key markets like Calgary, Lethbridge and beyond in the Alberta market and as well looking to put a more substantial footprint into the Saskatchewan market, which has been a little bit smaller for us historically.

Q – Unidentified Analyst: Yes. And finally, do you see any regulatory changes or legislation coming that may impact the cannabis -- Canadian cannabis industry positively over the near term or long term?

A – John Arbuthnot: We do anticipate then on the back of the Health Canada reviews, which are anticipated for this year in terms of the overall Cannabis Act and Regulations. So we will likely see modest opening up of restrictions relating to milligram restrictions in edible products, as well as purchasing restrictions around drinkable cannabis products. So overall, should improve the landscape for those two product categories, which I don't feel have been fairly represented in terms of overall industry revenues. So expect modest improvements in our view, more material elements which government may consider over the medium to long term would be excise tax reform, although we are not bullish that those types of changes will be coming on this round of Health Canada review.

Q – Unidentified Analyst: Okay. Perfect. Thanks a lot John. That's it from me.

A – John Arbuthnot: Thank you

Operator: [Operator Instructions] your next question comes from Mark Filion [ph] and he’s a shareholder. Please go ahead.

Q – Unidentified Analyst: Hi, John. I've got a question about the distributor license you obtained in Manitoba. I'm wondering if you could shed some light on how this might improve market share in the Manitoba market or how this will impact revenues? If you can add any color on that, please?

A – John Arbuthnot: Yes. Thank you, Mark. Good question. So company announcing early on in Q2 here that, we have been successful in obtaining a distribution and cross-stocking license from the Province of Manitoba. Unique market dynamic in the Manitoba market and that while MBLL, our provincial Crown Corporation here does act as provincial distributors. They do not actually receive physical deliveries of product in the market means that shipments are going direct from suppliers to retailers in many cases. And this does introduce an element of market inefficiency in small shipments coming from outside of province to individual retail stores, particularly rural stores in Manitoba. So the real thought process behind this distribution license is allowing out-of-province suppliers to consolidate orders through a single cross docker or distributor operating within the province. Delta 9 has already begun to provide now these services, to several outside of market producers, contributing to the overall efficiency of the space. Our goal will be to expand that business meaningfully into the back part of 2022. Although, too early for us to provide formal, I would say, guidance around where we feel that, that revenue picture will lap. But overall, I think this plays to bit, to the company's vertical integration strategy, really wanting to participate in as much of the overall value chain from seed through to end sale and end consumer, within the cannabis space. Also, I would say, opportunity for us to take this outside of Manitoba, into markets like Saskatchewan, which again allow for privatized distribution functions. Company's goal as we expand our retail footprint into the Saskatchewan market, would be then to look at out-of-province opportunities for distribution as well.

Unidentified Analyst: Okay. Great. Can you also tell me the recent news release regarding a shareholder loan of some nearly $5 million, if there was no description in the news release in terms of for what purposes that amount would be used?

John Arbuthnot: For now, Mark, it's simply general corporate and working capital purposes, really wanting to ensure that the company's working capital position is providing for flexibility for the company's balance sheet as well. Obviously, the company has been active in terms of retail M&A and want to ensure that there's a sufficient cash balance, there to be meaningfully investing in those assets from the back of M&A – any M&A transactions. So obviously, more announcements to come as definitive agreements are reached in terms of any forward M&A deals, but we would say use of proceeds would be targeted towards working capital as well as future acquisitions.

Unidentified Analyst: Terrific. Thanks, John.

Operator: There are no further questions at this time. Please proceed.

John Arbuthnot: There being no further questions, I want to thank everyone again for joining us for today's call. And we will turn things back over to the operator.

Operator: Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.