Earnings Transcript for FLWPF - Q2 Fiscal Year 2020

Operator: Ladies and gentlemen, welcome to The Flowr Q2 2020 Earnings Call. I will now turn the call over to your host today, Mr. Thierry Elmaleh. Thank you. Please go ahead, sir.

Thierry Elmaleh: Thank you, operator. Participating on today’s call are The Flowr Corporation’s CEO, Vinay Tolia; Flowr’s, President, Lance Emanuel; and our CFO, Irina Hossu. Please note that throughout the call, we will refer to Flowr and the company interchangeably with the Flowr Corporation. Before management discusses results, I would like to remind participants that all amounts discussed on this call are denominated in Canadian dollars. Please also note that the statements made during this call may include forward-looking information and future oriented financial information regarding Flowr, its business and disclosure regarding possible events, conditions or results that are based on information currently available to management, which indicate management’s expectations of future growth, results of operations, business performance and business prospects and opportunities. Such statements are made as of the date hereof and Flowr assumes no obligation to update or revise them to reflect events, disclosures or circumstances, except as required by applicable securities laws. Such statements involve significant risks and uncertainties that are not guarantees of future performance or results as a number of these risks and uncertainties could cause results to differ materially from the results discussed today. Given the risks and uncertainties, one should not place undue reliance on these statements and information. Please refer to the risk factors, forward-looking information and future oriented financial information sections of our public filings, including without limitation, our Q2 financial statements and MD&A and Q2 2020 earnings press release for additional information, all of which will be filed by the markets open tomorrow morning. In addition, this discussion may include certain financial performance measures that are not defined by IFRS and are used by management to assess the financial and operational performance of the company. These non-IFRS measures include, but are not limited to adjusted EBITDA. As there are no standardized methods of calculating non-IFRS measures, the company’s approach may differ from those used by others in the industry and may not be comparable as a result. Accordingly, these non-IFRS measures are intended to provide additional information and should not be considered independently or in substitution for measures prepared in accordance with IFRS. We refer to you our MD&A for Q2, 2020 which includes reconciliations of the non-IFRS measures. It’s now my pleasure to turn the floor over to Vinay, our CEO.

Vinay Tolia: Thank you, Thierry. Earlier this afternoon, we released our second quarter results, which showed progress against our financial and strategic objectives. In particular, sales momentum continued to build for us in our Canadian rec business. We believe that the fundamental thesis that we have been speaking about since we founded Flowr is playing out in the marketplace, specifically that people want high-quality cannabis and that there is a bifurcation of quality in the market. On the one hand, there has been a proliferation of value brands and offerings at the lower end of the market and on the flipside, where we compete and what we are seeing is a clear willingness for consumers to pay up for higher quality and differentiated products, such as our flagship, BC Pink Kush. We are proud to say that over the past 1, 3 and 6 months, our BC Pink Kush has been the number one selling SKU at the Ontario cannabis stores by dollar volume in sales to retailers. That’s the top selling SKU regardless of size. As retail distribution in Ontario continues to expand, we have increasing visibility and demand for our product as Ontario continues to be our biggest market. We have also made incremental investments in sales and marketing, which we believe will drive greater awareness and penetration throughout the country. In addition, we recently received our AMP approval from Quebec and expect to be in market in the fourth quarter. Our facility was fully operational in the quarter with all 20 of our grow rooms in production by mid-April. As such, we produced approximately 1,350 kilos of dried flower, with over 85% of that being BC Pink Kush. A good portion of that product was harvested in late June, which set us up – would set us up well as we entered Q3. Yields in the facility continued to improve and the trend is in the right direction. We have recently had a record harvest of over 88 kilos from a single room. In other production news during the second quarter, lab testing showed a wider dispersion of THC levels than historically observed in certain plants. We traced the dispersion to specific mother plants whose offspring were not consistently producing dried flower and the expected THC bands. We do not plan to use these mother plants for production beyond the third quarter. At this time, we are unable to confidently assess how much production will have lower THC levels and historically observed as a result of these issues. While we are taking steps to ensure these types of risks are minimized in the future, our facility design and the ability to isolate areas allows us to address these issues in a systematic way. We believe we have enough inventory on hand currently to meet demand and reiterate our objective of becoming cash flow positive in the second half of 2020. Now, I will turn it over to Irina to run through more of our financial details from the second quarter.

Irina Hossu: Thank you, Vinay and good evening everyone. As Vinay touched upon, we made significant progress towards our stated objectives in the second quarter. Gross revenue was $2.9 million for the quarter, which represented a 192% increase from our fiscal first quarter and was our highest quarter since our initial sell into the rec market in 2018. Net revenue was $2.3 million, which was above expectations. Similar to other organizations, COVID impacted our sales in Q2. While we did see a recovery late in the quarter, the closing of retail locations was a revenue headwind in Q2. We sold 419 kilos of product in the quarter, of which over 80% with our flagship BC Pink Kush and overall average price of $5.88 per gram. Price per gram was impacted by form factor mix such as packaged versus bulk versus pre-rolls. Excluding bulk sales, the Flowr branded price per gram was $6.69, reflecting our positioning in the premium segment. We continue to be confident in our pricing strategy and do not expect price erosion in the near-term on our Flowr branded products. The total cost of sales, were $2.9 million for the quarter. Costs remained somewhat elevated in the quarter given that we sold inventory, which was harvested in Q1. As you may recall, only 10 growers in the first quarter were operational versus 20 rooms in the second quarter. Due to less fixed cost dilution and minimal automation, inventory produced in the first quarter had a higher cost base, which impacted our second quarter profit sales. The normalized cash cost per gram sold in the quarter, which exclude depreciation, amortization share-based compensation and one-time adjustments, was $3.58 compared to $4.91 during Q1 as the company began to see the benefits of this automated packaging line during the quarter. The benefits of automation are expected to be fully realized in Q3. By way of example, our Q2 bulk cash of goods manufactured was sub $2 per gram, which proves our thesis that we should expect a material improvement in the cost of goods sold in Q3 and we will have these two tailwinds at our back. The company impaired 461,000 of products in the second quarter pertaining primarily to legacy strains. We do not expect any significant legacy strain impairment going forward. Selling, general and administrative expenditures, consisting primarily of salaries and professional fees, were approximately $4.6 million in the quarter compared to $6.3 million in Q1 as the company saw the benefits of the global restructuring program announced in March and tighter expense management. As Vinay mentioned, given our leading market position, we have begun investing in our sales and marketing activities in order to drive increased distribution and deeper penetration nationally and expect the investment to continue through the balance of the year. Adjusted EBITDA in the first quarter, which excludes certain non-cash expenditures and restructuring costs, was a loss of $2.9 million as compared to a reported loss of $6.9 million during the first quarter of 2020. The decrease in loss was largely due to both improved revenue and lower SG&A cost. As we noted during our last call, the organization closed $21.6 million non-brokered private placements of convertible debenture units led by management insiders in the second quarter. The private placement allowed us to bolster our balance sheet position while driving towards becoming cash flow positive in the second half of this year. We will do so by increased demand driven sales, scale and operational efficiencies and the SG&A measures previously discussed. Achieving positive cash flow will be the first step to achieving our targeted adjusted EBITDA margin of 25% in 2021. The company did not expect any further material CapEx investments in K-1 this year as the facility is operationally complete. However, we do expect some modest CapEx investment in the third quarter to complete the R&D facility, which is expected to be fully completed and operational in the early part of the fourth quarter. You may recall in our Q4 financials, the company financially impaired all of Flowr Forest inventory pertaining to our Health Canada review of a regulatory interpretation. Based on the outcome of the review which was recently finalized, the company plans to destroy and dispose of the Flowr Forest inventory in the fourth quarter of 2020. It is important to note that there is no impact to either of the company licenses based on the outcome of its review and no restrictions have been placed on our operation. Portugal is expected to begin contributing to revenue and profitability in early 2021. We are extremely excited about the progress with the crops in Aljustrel and are enthusiastic about the Terrace Global and Flowr partnership. To-date, we have received approximately $1.3 million in funding from the partnership and expect additional funding to support the operation in the third quarter. In terms of the third quarter, the organization is expecting revenue growth of at least 30%. I will now turn the call back to Vinay for closing remarks.

Vinay Tolia: Thanks, Irina. As Irina mentioned, we haven’t – we didn’t talk much about Europe and I would like to share my excitement around the upcoming harvest in Portugal in late Q3, early Q4. The crops look extremely impressive and the scale of the project is simply enormous. We believe this is the largest outdoor THC cultivation harvest in European history and are looking forward to towards commercializing the business in 2021 with our JV partner, Terrace Gobal. Back to Canada, as the industry hits more of a steady state, we see the value in building the premium segment of the dried flower market. Brands will matter and if more new stores open, they will seek to carry products they are confident will sell through just like any other retail space. A recent consumer research report by the Brightfield Group highlighted Flowr as the number seven ranked brand by awareness in Canada and had Flowr ranked number one or two in a variety of loyalty, brand promotion and satisfaction scores among the top 10 purchase brands in Canada. We are beginning to compile more data related to our consumer disposition funnel. We are seeing market increases and prompted awareness and trial use for our brand, especially in the coveted young adult demographic. The data speaks for itself. We are in the segment of the market where we want to be and we are expecting the numbers to increase with further distribution and product awareness. There is plenty of work to do, but with roughly 1,100 stores in the country, a number which is increasing rapidly, the data shows that our brand is increasingly addressing the need for a high quality experience. We are now happy to answer any questions you may have. Operator, please open the line for questions.

Operator: [Operator Instructions] Our first question comes from the line of William Kirk. And you are live.

William Kirk: Yes, thanks everybody for taking the question. I guess my first question is it seems like you have ample supply now for quarters that can be much larger than 2Q. So, I guess my question is I am wondering why the 3Q revenue guidance can’t be higher than it is?

Vinay Tolia: Yes, thanks. Good question. The big turning point there is Quebec is when we enter into the Quebec market, that we just received our authorization to get into Quebec, I think it was last week. And so we expect to have shipment product in Quebec in hopefully September.

William Kirk: Okay. And then I guess this is related, I think previously you have said it takes about $2 million in monthly sales to be cash flow positive. I know you are still saying cash flow positive in the back half of 2020. Does that still mean you expect about $6 million per quarter in revenue in the back half?

Irina Hossu: So, we have previously said it takes between 1.8 to 2.3, it really depends on where we are at in the harvest cycle. And to be very direct to answer your question, I would say that, that sort of $6 million mark is would be the trend at the back end of Q4, yes.

William Kirk: Okay, I will hop back in the queue. Thank you for taking the question.

Irina Hossu: Thank you.

Vinay Tolia: Thanks Will.

Operator: Your next question comes from the line of David Kideckel with ATB Capital Markets.

Unidentified Analyst: Thank you, operator. This is [indiscernible] sitting on behalf of David. Firstly, congrats on the quarter. I have a couple of questions. Yes, we noticed that Flowr’s BC Pink Kush has very impressive performance in terms of brand awareness and consumer preferences. So, just trying to understand what differentiates your BC Pink Kush from the PC Pink Kush strength of other companies?

Vinay Tolia: Yes, a good question. So, as we have said, these strains aren’t created equally. The chemical composition of the plant depends highly on the genetics and in the condition in which it’s grown. Our expertise is only – really on the cultivation side and where we can control basically every variable to have a very consistent and create a plant that really expresses the full genetic potential of the particular phenotype. So, you can give a handful of people, the exact same genetic study material and we can end up with wildly different product. So, I would say that our product is different than other Pink Kushes on the market. And then in particular, Pink Kush really needs a – as I mentioned before, we are doing a lot more data on the consumer and this is all data where that hadn’t been available over the last year. And we are seeing that primarily people are using the product during the evening to unwind and that’s really an occasion that suits the kind of characteristics of Pink Kush. So, it’s – we are in a space when we kind of – the usage occasion space that we want to be in and we are in that space which – with the product which we believe is the highest quality product in that category.

Unidentified Analyst: Make sense and thanks for the insights. And just want to know if you have plans to introduce other premium strains into the market in addition to Pink Kush?

Vinay Tolia: Absolutely. We will be – we will be releasing some additional strains in end of Q3 early Q4.

Unidentified Analyst: And you have some data related to the last 1 month and 3 month and 6 months, highest selling SKU, so is this data available publicly somewhere?

Vinay Tolia: This is data from the OCS. And the data that we get from the OCS, I don’t know if they issue it publicly, but it’s just it’s impressive that even they were the number one selling SKU, this is specifically the sales to retailers at the OCS. And as I mentioned before that includes all product sizes, so that’s including the ounce bags and the other value products, we are still the number one zone SKU in terms of dollar sales.

Irina Hossu: I don’t believe the OCS data is available publicly, but the Brightfield Group report, which is incredibly insightful, is available publicly.

Unidentified Analyst: That’s great. And finally, yes, one, this time we see that you have sales of bulk cannabis, is it wholesale to other LPs and can you provide more color on that? And is it a recurring agreement or a one-time sale?

Irina Hossu: So, we do have – so I will answer that couple of ways. So yes, it is to another LP. In Q3, it was predominantly a one-time albeit we are in discussions for longer term partnerships. What’s exciting about some of the agreements that we had is that we are selling through on our BC Pink Kush, but we are also selling through as part of our agreement some legacy strains as well. So, it’s a combination of a couple of different strains that we are selling through.

Unidentified Analyst: Okay, thank you. That’s helpful.

Operator: [Operator Instructions] Your next question comes from the line of Jeff Reisner with Fiduciary Financial.

Jeff Reisner: Hi, there. Could you speak into what happened with Flowr Forest a little more?

Vinay Tolia: Sure. Lance, you want to take that one?

Lance Emanuel: Yes. So with Flowr Forest we produce successful production in Flowr Forest last year. And due to just the way we were operating the production of it and just a misinterpretation with respect to the guidelines, we decided to originally impair the product, but ultimately now we will destroy the product in Q4 of this year.

Vinay Tolia: And just to add to that, so this was as Lance said, this was an interpretation of the guideline specifically around drying and processing plants out in the field. And while we have to – while we will destroy this product, it does not impede us from using Flowr Forest next year or it doesn’t – there was no impact on our license going forward.

Jeff Reisner: And is there any impact on the effect that you anticipate with respect to second half cash flow positivity?

Vinay Tolia: No, because we – earlier this year when we did our restructuring, we put a pause on our live resin forecast. And that product that we had at Flowr Forest was intended to be used for live resin. So, this product was in none of our numbers when it came to hitting cash flow positivity.

Jeff Reisner: Perfect. Thank you.

Vinay Tolia: Thank you.

Operator: We have David Kideckel again with ATB Capital Markets.

Unidentified Analyst: Hi, guys. This is [indiscernible] again. Just wanted to have more color on your European harvest, you mentioned that it’s expected in the Q4. So, do you have any visibility on distribution deals or anything like that, any additional color would be helpful?

Vinay Tolia: Yes, so this is a tricky one. So the plants look great. We have roughly 40,000 plants out in the field. We are going to be harvesting them late September, early October. The issue on distribution deals is it’s hard to get signed distribution deals without Certificate of Analysis. So, without knowing the exact chemical composition of the plant, it’s hard to secure deals. What I can say is that we have seen lots of interest in the product. So, we are confident that if these plants come in to the spec to which we believe they will, that will have no issue selling the product. And Lance do you want to add some color to that, that would be great?

Lance Emanuel: Sure. Yes, we have spoken with over 25 different distribution partners over the past 6 months. Everyone is chomping at a bit to partner with us. Obviously, there is a lot of visibility on what we are doing in Portugal and large part because of the partnership with Terrace and they have been great partners with us. And we do not expect any problem selling any GMP product that we produced this year, particularly product that ends up becoming high THC, high THC being defined as north of 20% THC. I mean, there is just endless demand for that product in the market. And we are also in deep conversations with several players to become strong distribution partners to us to get into pharmacies and build relationships with physicians. It’s really exciting. There is, again, endless opportunities with it.

Unidentified Analyst: Okay, Thank you. That’s helpful.

Operator: And we have no further questions at this time. Ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect.

Vinay Tolia: Thank you.

Lance Emanuel: Thank you.