Flowr Corp

XTSX:FLWR

Earnings Call Transcript 2020-Q1

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to The Flowr Q1 2020 Earnings Conference Call. [Operator Instructions] Please be advised that this call is being recorded.I would now like to hand the conference over to your speaker today, Thierry Elmaleh. Please go ahead.

[Thierry Elmaleh, Head of Capital Markets]

Thank you, operator. Participating on today's call are The Flowr Corporation 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 all participants that all amounts discussed on this call are denominated in Canadian dollars. Please also note that 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 Q1 2020 financial statements and MD&A and Q1 2020 earnings press release for additional information, which are now filed on SEDAR.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 you to our MD&A for Q1 2020, which includes reconciliations of the non-IFRS measures. It is now my pleasure to turn the floor over to Vinay Tolia, Flowr's CEO.

[Vinay Tolia, CEO & Executive Director]

Thank you, Thierry. Earlier this evening, we released our first quarter 2020 results. As we alluded to in our last call, I believe Q1 marks the bottom in our Canadian rec sales. Going forward, we believe sales will increase substantially. Q2 sales will be markedly higher than Q1 and would have been substantially higher if not for COVID. We expect Q3 sales to be much higher than Q2. All in all, we believe our operations are well positioned and reiterate our objective to become cash flow positive in the second half of this year. As we guided on our last earnings call, Q1 revenues were challenged as we work through our legacy product assortment of low to mid-range THC strain. Q1 was the end of our legacy production as all products harvested after Q1 was high-THC core strains. We had no issues selling our BC Pink Kush product in the quarter. In fact, all of our sales in the quarter were BC Pink Kush. In February, we were sold out and unable to meet demand from our provincial partners. We continue to see strong demand for BC Pink Kush, which was highlighted by the OCS as their best-selling premium branded Pink Kush strain over the last 3 and 6 months. It's also worth noting that we haven't irradiated any BC Pink Kush since January of 2019, and our cannabinoid content range continues to tighten with products in the market that are consistently between 22% and 25% THC.Yields in the facility are also increasing, and we recently had a record harvest of over 80 kilos from a single room with nothing but BC Pink Kush. As we further fine tune our growing techniques and populate the rooms with single strains, we expect further yield increases. We're excited by our recently announced partnership with Terrace Global, who will be providing equity capital as well as be working closely together with us to develop our operations in Portugal. Flowr recently shipped approximately 14,000 cones to Portugal, with Terrace contributing over 30,000 high-THC strains to the partnership, and planting has already begun.We'll be able to optimize growing conditions as we test different cultivars and growing techniques, including new cultivars, we believe are best suited to the Portuguese climate. We're very optimistic about what we believe is the largest licensed cannabis cultivation anywhere in Europe, and we expect our first major harvest in Q3 or early Q4 this year. Recall that we received our EU-GMP certification at our indoor Sintra facility during Q1, and we're very excited to commercially leverage the asset in 2021. We recently closed a $21.5 million private placement, which was led by myself and our Chairman, Steve Klein, who contributed over $11 million. We believe that this level of financial investment further signifies our level of conviction in our business. As a reminder, management and insiders own nearly 60% of Flowr, and that group recently agreed to a voluntary 1-year lockup. This group, including myself, hasn't sold a single share to date. While COVID has clearly affected everyone, we're very encouraged by Ontario's most recent move to fully open dispensaries in late May. Flowr does well in a brick-and-mortar retail environment where customers can engage budtenders and see and smell the product. Now I'll turn it over to Irina to run through more of the financial details of our first quarter.

[Irina Hossu, Chief Financial Officer]

Thank you, Vinay, and good evening, everyone. As expected, Q1 performance was impacted by constrained availability of our BC Pink Kush strain. We sold 122.5 kilos of product in the quarter, all of which was BC Pink Kush at an average price of $6.93 per gram. The price per gram was favorably impacted by package form factor as 13% of sales were in pre-roll format.Gross revenue was $1 million for the quarter, which was in line with expectations. Net revenue was $776,000, which included returns and price concessions of $73,000. As noted during our last call, given our adjusted strategic priority of producing high-THC and demand-driven strength out of our Kelowna 1 facility, the negative impact of strain mix should be minimized in future quarters. The total cost of sales were $1.7 million for the quarter. Relative to our gross sales, cost of sales remain elevated as we brought online 10 additional grow rooms in the Kelowna 1 facility, but had no harvest from these rooms in the quarter. The normalized cash per gram sold for the quarter, which excludes depreciation, amortization, share-based compensation and onetime adjustments was $4.91 for Q1 compared to $4.52 in Q4. Package form factor mix, for example, less bulk and more pre-rolls, impacted our cost of sales by approximately $0.40 per gram compared to Q4. Therefore, our cost of goods per gram was in line with prior quarter. We expect further operational efficiencies due to our new automated packaging line to improve our cost per gram by $0.50 to $0.70 per gram beginning in late Q2 2020 to be fully realized in the third quarter. Further cost per gram efficiencies are expected as fixed costs will be diluted across larger production volumes.Inventory impairment of legacy midrange THC strains was $666,000 in the quarter. We harvested the last term of our legacy strains in January 2020, and current and future production is dedicated to high-THC strains. Selling, general and administrative expenses, consisting primarily of salaries and professional fees, were approximately $6.3 million for the quarter compared to $6.9 million in Q4 and were in line with management expectations. In March of this year, the organization undertook a global restructure of approximately 25% of its workforce, which we expect to generate material annualized savings.Adjusted EBITDA in the first quarter, which excludes certain noncash expenditures and restructuring costs, was a loss of $6.3 million as compared to a reported loss of $8.3 million in the fourth quarter of 2019. The decrease in loss is largely due to improved revenue due to lower returns provisions and lower SG&A costs. The company continues to believe we will be cash flow positive in the second half of 2020, driven by increased demand-driven sales, scale and operational efficiencies and the restructuring measures previously discussed. Achieving positive cash flow will be the first step to achieving our targeted adjusted EBITDA margins of 25% to 30% in early 2021. The K1 Facility was substantially complete in Q1 of this year, and all 20 rooms were in production by mid-April. The company does not expect further material CapEx investment in K1 of this year. However, we do expect some investment in the third quarter to complete the R&D facility.Holigen is expected to begin contributing to revenues in the early first quarter of 2021. We are very excited that the planting is underway in Aljustrel and are enthusiastic about the Terrace Global and Flowr partnership. We announced yesterday the first tranche of funding for the partnership and expect incremental funding to support the operations in the third quarter. As Flowr exited the first quarter, we were in technical breach of 2 of our financial covenants for which we have received a waiver. As a result of the breach, the long-term portion of our ATB loan has been reclassified as to current debt in our financial statements. Given that a waiver has been granted, the debt will be reclassified as long term in the second quarter. To bolster our balance sheet position, we recently closed on a $21.58 million nonbrokered private placement of convertible debenture units, led by management and insiders. As was noted earlier, we feel that this capital will enable us to become cash flow positive in the second half of this year. As Vinay mentioned, Q1 revenues were suppressed due to the final harvest of low to mid-THC strains. However, we sold through all available BC Pink Kush. With the Kelowna facility fully operational and the shift in strains complete, we believe Q2 will be an inflection point for our business. We have already started to see the early improvements to our revenue profile, with Q2 revenues expecting to be one of the highest quarters to date. Despite a stronger Q2, as Vinay discussed, our business is not immune to the impact of COVID-19. The pandemic affected sales with the closing of Ontario retail locations, however, we have seen a healthy return as the province begins to open back up. I'll now turn the call back to Vinay for closing remarks.

[Vinay Tolia, CEO & Executive Director]

Thanks, Irina. I'd like to close by saying, although we believe Q1 will mark a low point in the company's operating performance for all the factors we detailed, our overall value proposition is still intact and recent data proves it. We believe that we'll be one of the pioneers in developing a premium segment in the Canadian cannabis market and that customers demand quality product. Recent industry trends with greenhouses shuttering validates this. May sales data showed that BC Pink Kush was one of the top 5 selling 3.5 gram SKUs in English Canada, and this is prior to us rolling out sales and marketing initiatives. With dispensaries increasing in Ontario and our Québec market entry imminent, you can see why we're so bullish on the second half of this year. We remain excited about the size of the global market and continue to lay groundwork, particularly in Europe. Crops in the ground, as I mentioned, at what we believe is the largest licensed cultivation anywhere on the continent. We're now happy to answer any questions you may have. Operator, please open the line for questions.

[Operator]

[Operator Instructions] Your first question is from David Kirk (sic) [ William Kirk ] of MKM Partners.

[William Joseph Kirk, Executive Director]

So others seem to be fighting it out in the value segment. Can you remind us why you're confident you don't have to join that fight? And as they go there, are you seeing less effort on the competitor's behalf to compete over product quality?

[Vinay Tolia, CEO & Executive Director]

Yes. Good question. So we -- I mean, we've seen so many entrants into the value segment. And we believe that it's really a byproduct of the difficulty in growing product that you can -- that can be considered premium. We also believe that the value segment is one that's going to be dominated by scale and really, the ability to withstand very low margin. Retailers don't like value product. I mean it's a -- it takes up the same amount of shelf space, and it's a -- it's far less margin to the retailer.So retailers aren't going to stock lots of value product. They're going to choose just a handful of players, and we just don't want to play in that game. So it's one of the things that we've always been opposed to and all the recent data shows that with competitors flocking to that segment that we are -- that we're -- actually, our whole proposition of sticking to the premium segment has been right all along.

[William Joseph Kirk, Executive Director]

That makes sense. And then to get a sense of maybe what 3Q could look like, you gave some harvest numbers in the release for April and May, and you gave some yields for 1 recent room. How do we think about how much harvest levels can increase maybe from those April and May numbers?

[Vinay Tolia, CEO & Executive Director]

So I think we said last time that our run rate was around 6,000 to 7,000 kilos a year. And I think that's still accurate. The -- we -- I mentioned the record harvest that we had, 82-kilo room of Pink Kush. That would equate to an annualized production of over 9,000 kilos. So that -- again, that was our highest harvest to date. Not every room has been -- that's not our average room. But as we continue to creep higher, we think that we'll get to that -- our stated terminal -- our stated goal, and I think we can even get higher than that eventually of 10,000 kilos a year. I think for modeling purposes, I still think that using a 7,000 to 8,000 kilo annualized run rate is fair for the second half of this year.

[Operator]

[Operator Instructions] Your next question is from David Kideckel of AltaCorp.

[Frederico Yokota Choucair Gomes, Associate of Institutional Equity Research]

This is actually Frederico chiming in for Dave. Congrats on the quarter, guys. Just wondering if you could provide any color in terms of your assumptions for turning cash flow positive in the second half of 2020. So what needs to happen for you to turn cash flow positive, top line and margin-wise and also in terms of capital requirements?

[Irina Hossu, Chief Financial Officer]

Sure, absolutely. Thank you so much for the question. We spent quite a bit of time over the past few months really taking a deep dive in evaluating our business model. And what's incredibly exciting about our business is that we have enormous demand for our products. But we don't have a heck of a lot of overhead within the business. So if we look at a sort of monthly run rate, and assuming no revenue, we need somewhere between $1.8 million to $2.3 million depending upon, obviously, the harvest activities that we're doing. But anywhere between $1.8 million to $2.3 million in monthly sales in order to turn to cash flow positive. Quite frankly, we would have been able to do that much sooner, had it not been for COVID, we believe. Certainly, the shutdown of Ontario certainly impacted April and May, but we're quite bullish on June and going into the third quarter. So I would -- we still feel very confident to be able to hit the cash flow positivity, again, just given that our monthly expenditures are not reasonably high. From a raise perspective and a capital infusion perspective, we believe, again, in a non-COVID constrained environment that we are -- our balance sheet is quite healthy, and we do not expect to require further infusion. The other point that I would note that is very interesting to us and important to note is that over the next few months, we do have some plans to enter into the Quebec market. That is a market right now that has not been tapped for us. And given the overall size of the market and the demand in the market, we do expect that to help us to reach the cash flow positivity.

[Frederico Yokota Choucair Gomes, Associate of Institutional Equity Research]

That's very helpful. And just 1 more for me. In terms of your average price per gram, so it's close to $7 now. Can you provide further color in terms of what you think is driving this price? And if it's sustainable over the long term?

[Irina Hossu, Chief Financial Officer]

Yes, absolutely. So our average price per gram is $6.93 for the quarter, and it really was skewed up because of mix. So if we're thinking about it on a per gram perspective, our price per gram is in and around $6.60. We were skewed up about 13% of our total sales in the first quarter was on a pre-roll basis, and we achieved just over $9 per pre-roll. We do not expect any price compression in this space, given that we've been extremely successful. And to Vinay's earlier point, it's extremely difficult to grow consistent product as we have historically done. There continues to be a very strong demand and we do not expect price compression certainly for this year.

[Vinay Tolia, CEO & Executive Director]

I'll just -- I'll add to that for a little clarity, the $6.60 number that Irina was referencing to, that's our average price per gram for dried flower.

[Irina Hossu, Chief Financial Officer]

For dried flower, yes.

[Vinay Tolia, CEO & Executive Director]

So -- and remember, that's -- we have never come down on price. That's what it's been for the last 1.5 years. And we have no issue selling at that price. So any kind of shift you'll see in price per gram, at least for our branded product, is purely a mix of pre-roll versus jarred product.

[Operator]

There are no further questions at this time. I will turn the call back over to the presenters for closing remarks.

[Vinay Tolia, CEO & Executive Director]

Thank you, everyone, for the time. As I mentioned, we are extremely bullish about the second half of this year. Given all the demand that we're seeing for Pink Kush, be as it may the tailwinds, we believe with the expansion of the dispensary universe in Ontario and in Québec, we think that we have what it takes to prove out that model -- this model of being one of, if not, the premium kind of high-end premium cannabis brand in all of Canada. Thank you.

[Operator]

This concludes today's conference call. Thank you for your participation. You may now disconnect.