Flowr Corp

XTSX:FLWR

Earnings Call Transcript 2019-Q3

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Flowr Q3 2019 Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Thierry Elmaleh, Head of Capital Markets.

[Thierry Elmaleh, Head of Capital Markets]

Thank you, Josh. Participating on today's call are Flowr Corp.'s CEO, Vinay Tolia; our CFO, Alex Dann; and available for Q&A is our Founder and Managing Partner, Tom Flow. 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 indicates 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, future-oriented financial information section of our public filings, including, without limitation, our Q3 2019 MD&A, our Q3 2019 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 Q3 2019, which includes reconciliations of the non-IFRS measures. It's now my pleasure to turn over the floor to Vinay Tolia, our CEO.

[Vinay Tolia, CEO & Executive Director]

Thanks, Thierry. Earlier this evening, we released our third quarter results and provided a comprehensive corporate update to supplement those results. I'll begin by highlighting our strategic and operational progress before Alex reviews our Q3 2019 financial results. Let me start by saying that our third quarter revenues were short of expectations as we continued to manage construction and production activities as well as ramp-up sales and marketing. While we're disappointed in the delay of our commercial ramp up, we're excited to be exiting 2019 with our infrastructure now in place globally, and we're confident in our ability to effectively scale our business in 2020. In particular, we've made good progress building out our infrastructure in Canada and throughout the globe.In Canada, we produced 447 kilos of dried cannabis in the third quarter, a slight decrease quarter-over-quarter. The lower production was due to the use of 2 of the rooms within our indoor facility, Kelowna 1, to support clone production for Flowr Forest and for shipments to our facilities in Portugal. Production activities resumed in these rooms during the third quarter. This reduction was also occurring while we were building out the remaining 10 of our 20 grow rooms. We're pleased to say that Kelowna 1 is now substantially complete and the evidence package and amendment application for licensing has been submitted to Health Canada. We're excited to exit 2019 with the heavy lifting of construction now complete on our flagship indoor facility. In terms of sales, we sold approximately 227 kilos at an average price of $8.03. We continue to see strong demand for our core Pink Kush strains as well as other high-THC products, which leads to an important point. Coming into the first year of rec legalization, production planning was hindered by the lack of reliable consumer insights. We make production decisions based on the available information, and with time, we're getting more insights into consumer demand. Going forward, we are prioritizing data acquisition to ensure our product offerings are driven by consumer insights and address consumer demand. Furthermore, we're excited by the introduction of new genetics in 2020, which we think will augment our overall product assortment and support higher yields out of Kelowna 1. We're also excited that completed our first -- the first harvest of Flowr Forest, our poly-film shade-house and outdoor grow that is located on our Kelowna campus. We planted crop during the third quarter, and have now completed the harvest of approximately 3,189 kilos of dried flower equivalent. The reason for this equivalency is that we -- flash grows over 13,000 kilos of wet cannabis at the time of harvest. Flash freezing is a first step in our live resin extract process, which will differentiate our extraction offerings planned for 2020. We pushed out the launch of our extraction product lines in the second half of 2020, as we pursue a more modest development schedule. All in all, we believe our Canadian operations are well positioned to focus on cash flow generation in 2020. In Europe, we've been focusing on construction of an indoor cultivation and processing facility in Sintra, Portugal and a large-scale outdoor cultivation and partial processing facility in Aljustrel, Portugal. Together, these facilities are the cornerstone of our global medical strategy. During the third quarter, Sintra underwent its final GMP inspection, and we are awaiting our certification, which we anticipate in early 2020. With an EU-GMP certification, we'll be ideally positioned to distribute our Holigen-branded medical cannabis products across the globe. At Sintra, the regrow -- growings were operational, with the remaining 3 to be complete in Q1 2020. We expect the harvest from the first grow -- from our first grow room to occur by year-end. The oil extraction infrastructure in Sintra is expected to be installed and operational in the second quarter of 2020, and products to be available for sale under GMP in Q3. At Aljustrel, our outdoor grow facility, we propagated 12,000 clones at 100,000 square feet. This initial harvest is expected to be completed by the end of the year. This is an initial harvest and part of our -- a part of the phased development for this 7 million square feet of cultivation area. In 2020, we expect to achieve 2 harvests at Aljustrel and ramping the cultivation area to have 1 million square feet for each of the harvest. Altogether, we are on track for our European operations to ramp up revenue in 2020. This progress in Europe is bolstered by our GMP packaging license in Australia, which was recently renewed. Now I'll turn it over to Alex to run through some financial highlights.

[Alexander Dann, Chief Financial Officer]

Thank you, Vinay, and good evening, everyone. Net revenue in the quarter was approximately $1.3 million, reflecting 227 kilos sold at an average realized price of $8.03 per gram. On a year-to-date basis, our average realized price is $7.23 per gram. The company recognized provisions of $400,000 related to product returns and price reduction initiatives with its customers. The total cost of sales was $1.3 million for the quarter or an average of $5.33 per gram. This compares to $2.1 million or an average of $6.22 a gram in the prior quarter of 2019. The cash cost per gram sold for the quarter, which excludes depreciation and amortization, was approximately $5 per gram compared to $5.44 last quarter. The company continued to manage the construction and operations at Kelowna 1 concurrently. With more rooms coming online, the completion of the Kelowna 1 facility and the installation of an automated packaging line, management expects the cost per gram to decline. The automated packaging line hardware and installation is pending a licensing of the packaging area of the Kelowna 1 facility. Selling, general and administrative expenditures, consisting primarily of salaries and professional fees, were approximately $6.1 million in the quarter compared to $5.3 million in Q2 2019. This is in line with management's expectations. The higher SG&A is due to the expansion across all functional areas to support the increasing production platform in Canada, and the build-out of our global business with the acquisition of Holigen. Share-based compensation in the quarter was $3.4 million, which is comparable to last quarter. The company posted a net loss of approximately $15 million in the quarter, which was driven by the continued development of Flowr's infrastructure to support the Canadian and international business; onetime costs of approximately $1.1 million associated with the Holigen acquisition; and a $7.1 million noncash loss related to the fair valuation of Flowr's investment of Holigen prior to the acquisition date of August 20. Adjusted EBITDA in the third quarter, which excludes noncash expenditures, was a loss of $5.6 million compared to a loss of $4.7 million for the second quarter of 2019. The increase in loss is primarily due to the ramp-up of cultivation, operating and support activities. With the acquisition of Holigen, the company currently has a head count of 264 employees compared to 192 employees at the time of our last earnings call. Flowr ended the quarter with a net working capital balance of approximately $18 million, including a cash balance of approximately $25 million. To bolster our financial position, we recently closed on a $25 million credit facility at favorable pricing, with the first tranche of gross funding of approximately $20 million drawn down. During the third quarter, Flowr continued with its capital programs with the development of the Kelowna campus and the construction of facilities in Portugal. This resulted in total capital expenditures of approximately $15.9 million, with approximately $12 million -- excuse me, $12.8 million and $3.1 million relating to Kelowna and Portugal, respectively. I'll now turn the call back to Vinay for closing remarks.

[Vinay Tolia, CEO & Executive Director]

Thank you, Alex. I'd like to close our prepared remarks by focusing on our value proposition and positioning based on today's market conditions. Since the beginning, we've been focused on business fundamentals and investments that have the highest probability of generating value. In a little over 2 years, we're proud to have been granted 2 site licenses from Health Canada, constructed a purpose-built indoor facility, executed on one of the first outdoor grow in Canada and expanded our footprint internationally. To go from 0 to over 7 million square feet of licensed cultivation space is something we take great pride in. Our strategy is to have right-sized facilities for the markets we're targeting to ensure that we can cultivate products that meet our customers' demand. This avoids pursuing scale for the sake of scale and allows us to prove out the business in what we believe to be a capital-efficient way. In Canada, we're committed to the premium end of the dry flower market. Products in this category that deliver on consumer expectations, such as our Pink Kush are achieving impressive sell-through rate. We expect the same to be true for our extract in concentrate product. In the global medical market, EU-GMP and access to scale will be critical differentiators. In Europe, we have that scale but are pursuing development in a prudent manner that will increase with demand. By establishing sales and distribution channels in Europe and Australia, we're augmenting our Canadian sales channels and expect to root products to those markets with favorable supply-demand dynamics. We continue to see a massive opportunity globally and believe our efficient footprint puts us in a unique position to exploit opportunities as they arise. We're pleased with our strategic progress and are confident that we're positioned for significant growth in 2020. We're now happy to answer any questions you may have. Operator, please open the line for questions.

[Operator]

[Operator Instructions] Your first question comes from Noel Atkinson with Clarus Securities.

[Noel John Atkinson, VP & Research Analyst of Growth and Innovation]

First off, so congrats on the harvest at Flowr Forest, so that's a meaningful amount of flower that you guys are able to take off there. You mentioned that half was flash frozen for your extracted products. Do you have any plans to sell any of that as dried flower of the remainder?

[Vinay Tolia, CEO & Executive Director]

Of the flash-frozen products?

[Noel John Atkinson, VP & Research Analyst of Growth and Innovation]

The product that wasn't flash frozen.

[Alexander Dann, Chief Financial Officer]

1,200 kilos.

[Vinay Tolia, CEO & Executive Director]

That's primarily going to be used for a different extraction -- for different extract product. So that's -- again, if you think about the way we've always characterized the market, the 2 sides of the hourglass, the 1 side, the premium flower for smokable rec products, and on the other side as product heading for extraction, the outdoor product will be on the bottom side of the hourglass.

[Noel John Atkinson, VP & Research Analyst of Growth and Innovation]

Okay. Can you just talk a little bit about where you guys stand with getting the sales license for processed products? You mentioned that you were going to do live resins like, I guess, second half of next year. Are you going to do any processed products ahead of that?

[Vinay Tolia, CEO & Executive Director]

I think we are going to be leading with the live resin product. We were constructing our extraction facilities adjacent to Kelowna 1 right now. This is all dependent on Health Canada licensing. So, as you know, sometimes it's out of our control. We will likely submit our application for the flower for -- for the extraction facility right after we get our -- the finished 1,400 and 1,500 of K1. So again, that's why I'm targeting potentially Q2, Q3. It's because so much of this is dependent on licensing.

[Thomas Flow, Co]

I mean I know -- this is Tom speaking. We actually already -- on our K1 Facility, already have obtained our processing license many months prior. So now working through the subclass. So we have a pretty detailed plan in getting the subclass for extracts added as well as our new product notices to be able to launch all the live resin products in the second half of the year.

[Noel John Atkinson, VP & Research Analyst of Growth and Innovation]

Okay. Can you talk a little bit about the CapEx budget for Portugal for the 2 facilities in terms of -- in order to get to finishing Sintra and the first harvest for the other facility? And how much more CapEx do you have to spend?

[Alexander Dann, Chief Financial Officer]

Sure. Yes. No, it's Alex. Yes, we're looking at approximately CAD 10 million for completing the facilities in Portugal. They have access to a credit facility that they will be drawing down as well, so the impact on our cash will be less.

[Noel John Atkinson, VP & Research Analyst of Growth and Innovation]

Right. And then how about for Canada between the extraction facility and anything else you need to do at Kelowna 1 -- or not just Kelowna 1 -- Kelowna campus, I apologize.

[Vinay Tolia, CEO & Executive Director]

Kelowna campus. So yes. So combined, we're looking at about $10.9 million for Kelowna. The extraction and storage facility is approximately $5.6 million, and as of September 30, we had $5.3 million to spend on Kelowna 1.

[Noel John Atkinson, VP & Research Analyst of Growth and Innovation]

Okay. Great. Can you talk at all about the concessions that were incurred during the quarter? Are you seeing this happening at any particular province or through your medical channel or -- and like what are you seeing now in terms of flower demand through the Canadian channels as Q4 ramps up?

[Vinay Tolia, CEO & Executive Director]

Sure. So this goes back to our -- the comment we made about consumer insights. So this is a particular product in BC and Alberta. Again, we have products like Pink Kush that we can't keep on the shelves, and we have other products that is not moving as fast. That's why we are kind of adjusting pricing to get it to move that out of the channel. And really, going forward, we are adjusting our production planning to come out with more of those strains in more of those cultivars, where we find lots of demand. And going forward, you read about supply glut and all this. And while that's true on a macro level, we are still seeing very strong demand for that premium high-THC products, again, like I mentioned, the Pink Kush.

[Noel John Atkinson, VP & Research Analyst of Growth and Innovation]

Okay. Great. And then just finally, before I go back in the queue, I apologize if you've said it before, but Sintra, for the first 3 grow rooms that are coming online, can you give us a sense of how much capacity per year those rooms could achieve?

[Vinay Tolia, CEO & Executive Director]

So when the -- I'll give you a run rate for all 6 grow rooms, all 6 grow rooms, I think, again, it really depends on your yield assumption. But I would -- and I'll give you a range to be -- a conservative range is anywhere from 2,000 to 3,000 kilos.

[Operator]

And your next question comes from Bill Kirk with MKM Partners.

[William Joseph Kirk, Executive Director]

So we spent a lot of time thinking about the supply curve for product to be sold in Europe. Can you guys spend a little bit talking about the demand curve, maybe in terms of its size, its timing and in what regions you're expecting it to come from?

[Vinay Tolia, CEO & Executive Director]

Sure. Maybe the big limiting factor in Europe right now is having GMP product. There's just simply not a lot of it available in Europe. I mean we are seeing very, very strong demand, primarily from Germany for GMP dry flower. We would -- it again goes back to getting that -- the GMP certification. So obviously, timing would depend on that. But we are seeing far more demand for product in Europe right now than we'll be able to produce out of Sintra and out of our initial -- out of our initial plantings in Aljustrel.

[William Joseph Kirk, Executive Director]

I guess related, can the product grown outdoor in Portugal, can that become GMP if it goes through Sintra? Is there a process for that to be GMP?

[Vinay Tolia, CEO & Executive Director]

The product is going in a greenhouse, yes, because it's still GACP.

[William Joseph Kirk, Executive Director]

Okay. And then I was going to ask, I think you previously expected the GMP for Sintra by year-end, now I think you said early 2020. So what's the -- what pushed that out?

[Vinay Tolia, CEO & Executive Director]

Just delays on the government. We're just waiting to hear from them. We've been -- we've been bugging them, and we're just -- I'm just being conservative with timing, I think it will happen in January.

[Operator]

[Operator Instructions] There are no further questions at this time. I'll turn the call back to Thierry for closing remarks.

[Thierry Elmaleh, Head of Capital Markets]

Thanks, everyone, for joining us. Have a great evening.

[Operator]

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