Delta 9 Cannabis Inc

TSX:DN

Good morning, ladies and gentlemen, and welcome to the Delta 9 Q1 2024 Conference Call. [Operator Instructions]. Following the presentation, we will conduct a question and answer session. [Operator Instructions] This call is being recorded on Wednesday, May 15, 2024. I would now like to turn the conference over to Alexa Goertzen. Please go ahead.

Good morning, everyone, and welcome to the Delta 9 Cannabis Q1 2024 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.'s public filings, which are available on SEDAR. I would now like to turn the call over to Delta 9's Chief Executive Officer, John Arbuthnot.

Thank you, Alexa, and good morning, everyone. Thank you for taking the time to join us for Delta 9's Q1 2024 Earnings Call. With me this morning is the company's Chief Financial Officer, Jim Lawson; and our VP of Corporate Affairs, Ian Chadsey.

Our earnings press release, Q1 2024 financial statements and management discussion and analysis have now been made available on SEDAR and our company website. And with that, let's begin.

Over the past year, the Canadian cannabis industry has continued to deal with challenges relating to an oversupply of cannabis products, compressed cannabis wholesale margins inefficiencies at provincial crown distributors, oversaturation of the number of operating retail stores and capital markets volatility. In January last year, Delta 9 is management reacted to these difficult market conditions with a suite of strategic initiatives [ improved at aiming ] margins and cutting costs to drive profitability and operating cash flows to the balance of the year 2023.

We've now seen 4 consecutive quarters of material improvements in our business conditions for Delta 9 as well as the Canadian cannabis space. Wholesale prices appear to be stabilizing as the overall industry supply-demand imbalance begins to right itself. Margin stability in both our wholesale and retail businesses is beginning to show signs of strength and recent investor sentiment is showing signs of improvement.

In the past year, Canadian cannabis industry sales have continued to expand, posting monthly retail cannabis sales of $452 million in December last year, up 12.5% from a year earlier. Annualized retail cannabis sales now exceed $5.1 billion. Even with growth rates in the sector beginning to slow, we anticipate the Canadian cannabis industry will double in terms of retail cannabis revenues by the end of this decade.

We continue to see a steady beat of progress in the United States market in terms of material reforms at the federal level. Recently, the Department of Health and Human Services has ordered a Drug Enforcement Administration review of the rescheduling of cannabis from the current Schedule I designation, which currently classifies cannabis alongside heroin and MDMA and other substances with high potential for abuse, addiction with no accepted medical use to Schedule III as a drug with moderate to low risk of harms and with accepted medical uses.

The importance of this rescheduling, which is expected in the coming months cannot be overstated. Federal rescheduling of cannabis is seen as a gating item to allow firms like Delta 9 to participate in the upcoming United States cannabis market.

In other international markets, Germany and the Netherlands have made material progress on federal adult use legalization initiatives with early 2024 launches and international markets, such as Israel, Australia and Asia Pacific, as well as various countries in the EU continue to make progress on advancing more progressive medical and recreational use cannabis laws. We continue to believe that the growth rate in the Canadian cannabis market and the global reform of cannabis laws represent a generational market opportunity for companies like Delta 9 to grow and unlock significant value for investors.

I'm pleased today to be presenting you with Delta 9's Q1 2024 financial and operating results with many positive takeaways from today's results, which we will highlight as well as analyzing our misses, the challenges we've encountered and the changes we're making to continue to drive growth and create shareholder value.

We will begin with a discussion of operations and material milestones for the company achieved over the reporting period. On the cultivation or cannabis cultivation and processing side of our business, we will 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 the modular, scalable and stackable unit that we call our Grow Pod. Currently, the company has 297 Grow Pods licensed by Health Canada within our facilities.

Over the past several quarters, we've operated these assets at or above the design capacity of the facilities producing in the area of 10,000 kilos of cannabis annually. We've invested in continuous improvement initiatives to optimize the number of harvest rotations per year, average grams for harvest and overall potency in order to maximize results from these assets.

We note that in January last year, the company announced a number of cost-cutting measures as a part of the company's 2023 strategic plan with the goal of producing positive cash flow from operations, including reducing the company's production capacity of the Delta 9 facilities by 40%, laying off approximately 40 employees. Over 2023, the company was able to achieve between $3 million and $4 million in operating cost savings as a part of this plan, reducing our inventories of bulk cannabis material and contributing significant improvements in cash flow generation from operations over that period.

We've now reached a point where we are selling more cannabis material than we are producing in January 2024, we announced that we have increased our production capacity in order to meet this increased demand and at prices we expect will support ongoing profitability in our wholesale cannabis business.

The company has identified 3 main growth drivers, which we feel will allow us to maximize the profitability of our cultivation and processing assets. First, we are refining our cultivation and processing techniques to maximize THC potency and other quality features of our cannabis products as cannabis consumers have become more discerning in their purchasing decisions over the last number of years. We know that the success of our cannabis cultivation business will rest on our ability to produce the highest potency and quality cannabis products. We've made strides in the last 12 months in improving our average THC potency in our harvested cannabis flower products and we will continue to push our cultivation teams to pursue excellence in terms of our production outcomes.

Second, in January last year, we completed a project to automate our pre-roll manufacturing over the past 12 months. pre-roll SKUs have become Delta 9's best-selling products in terms of units sold across numerous provincial markets. However, historically, we have been bottlenecked on our ability to produce these products internally and have often had to source third-party manufacturing. Automating this manufacturing process has allowed the company to realize over $0.75 per gram in incremental contribution margin from our pre-roll product offering and will contribute excess capacity in this important product category.

Third, the company has begun a gradual retrofit and upgrade of our older technology lighting systems to new state-of-the-art LED systems, which the company has developed with its international lighting suppliers over the past 3 years. These lighting upgrades are anticipated to increase the company's cultivation capacity measurably from our current 10,000 kilos capacity annually.

These upgrades are also anticipated to improve average THC potency in overall cannabis flower quality in line with our first key growth driver. We feel this increased potency, quality and capacity will not only increase our average selling prices and contribution margins from cannabis wholesale sales, which should also assist in driving cost efficiencies and lowered our cost per gram of production.

On our portfolio of cannabis products, over the past 4 quarters, Delta 9 has been narrowing the scope of our cannabis cultivars under production to only those that are in the highest demand and at the higher end of the potency spectrum. We currently produce approximately 12 different genetic strains of cannabis, each with its own unique chemical cannabinoid content, terpene and flavonoid profile. And we continue to maintain another 100 or more strains being stored on-site and a seed bank to provide for product optionality into the future. We are continuing with our production pivot towards higher-potency cannabis strains, which are the highest demand with the cannabis retail consumer.

Over the past several years, the company has increased its average THC potency in its cannabis flower from less than 15% in 2020 to over 25% in Q1 2024. Over the past 12 months, Delta 9 has launched its new Scoops, Candy Chrome and I-95 cultivars, which have seen encouraging success alongside our staple White Out, Sinaloa Gold and CBD Skunk Haze Cultivars. Our high potency limited time, seasonal and rotational product offerings for various holidays and events have become a source of higher margin revenues as retailers and consumers continue to prefer novel THC options as a part of their purchasing preferences. We plan on introducing numerous new cultivars over the next 12 months, and our strain selection and genetics development has begun to exclusively target high THC strains to maximize outcomes.

On pre-rolls, cannabis pre-rolls, as we have mentioned, have become an increasingly important category in the Canadian cannabis market as consumers have moved to smaller packaging sizes to see convenience in a pre-rolled product setting. The company's pre-rolled products currently account for approximately 15% of our overall offering and growing with many of our products making up our top 20 selling products within our Delta 9 retail stores.

The company has increased its presence in the pre-roll category over the past 12 months and expanded its SKU lineup to include new potencies, strain-specific pre-rolls and multipack pre-rolls settings now making up approximately 40% of the pre-rolled product category within our Delta 9 branded stores across the country. As noted, the company has now completed its pre-roll automation project and plans to introduce multiple new pre-rolled products and settings in 2024 to increase our sales in this important category.

In terms of our brand portfolio, in 2023, Delta 9 began to expand this portfolio of consumer branded cannabis products. Historically, the company's Delta 9 brand has seen success within its own branded retail stores. But moving forward, we believe the growth and success of Delta 9's wholesale cannabis business lies in reaching a broader retail and consumer base.

In the past year, the introduction of our new Busted Nugs milled product and pre-roll line has expanded our distribution in the cannabis flower market. Over the next 12 months, we plan to launch several new vape products under the company's new [ Razz ] brand, as well as an expanded line of infused pre-rolls and new infused milled cannabis products with the goal of seeing similar segment penetration as we have seen in 2023 with our pre-roll segment.

In our retail stores, Delta 9 is carrying the full complement of new 2.0 cannabis products from the industry's leading manufacturers. We believe that through our retail unit, we will be able to extract valuable intel on which of these new product formats are having a positive impact with the consumer and be able to pivot to capitalize on these new product opportunities.

From a distribution standpoint, we continue to believe that the domestic market for recreational use cannabis presents a major growth opportunity for the company over the next several years. At the end of Q1 this year, Delta 9 was licensed for distribution in Manitoba, Saskatchewan, Alberta, British Columbia, Ontario, the Yukon, Newfoundland and Labrador, Northwest Territories and New Brunswick. Delta 9 has also made strides over the past 12 months in making our first international shipments announcing in February last year that we completed our first wholesale shipment of cannabis to a customer in Australia.

For the balance of the year last year and into the first quarter of this year, we have received several additional export permits from Health Canada for shipments to Australia, and we expect to continue to develop international markets including New Zealand and Portugal for shipments into the European Union into the near future.

Expanding on the success in international markets, the company obtained its good agricultural and collection practices or GACP certification for our Winnipeg facilities in Q4 last year, which will expand our international market opportunities for higher-margin export sales. On vertical integration and retail cannabis sales for the past 4 years, Delta 9 has made significant progress in expanding its retail footprint. Delta 9 started the year 2020 with only 4 operating retail stores in Manitoba.

In Q1 2022, the company announced a transformative retail acquisition to acquire all of the assets of Uncle Sam's cannabis in connection with their 17 operating retail stores in the province of Alberta operating under the Uncle Sam's Cannabis and discounted cannabis brands. The combination of Uncle Sam's cannabis stores and Delta 9's existing retail store network has made Delta 9 a leading multi-banner retailer of cannabis products in Canada.

Expanding on this in September 2022, Delta 9 announced the closing of our acquisition of 3 Garden Variety cannabis stores in Manitoba. The all-stock transaction was anticipated to add $8 million in annualized revenues and the deal was immediately accretive to the company's EBITDA. Further in 2022 and into 2023, the company opened our 39th, 40th and 41st cannabis stores in the province in Manitoba.

In 2023 and now into 2024, we began to hone our pricing strategies across all geographies to enhance gross margins in our retail business. Addressing KPIs such as average transaction value, units sold per transaction, revenue per square foot and cross-selling opportunities into non-cannabis products will allow our retail segment to maximize profitability. The company has and will continue to employ a growth strategy to actively acquire cannabis retail stores that will provide meaningful revenue growth and positive adjusted EBITDA.

Now on to our financial results. We'll begin with an assessment of the balance sheet. The company ended Q1 this year with $1.3 million in cash. Delta 9 showed a working capital deficiency at the end of the first quarter of $39 million although we note that as of March 31, the company was showing a breach of our debt service coverage ratio covenant for its credit facility with connectFirst Credit Union, which required the classification of this debt as current on its balance sheet.

The company continues to make required interest and principal repayments across all of its existing credit obligations and does not anticipate any deterioration of its credit condition. The company intends to secure additional or expanded waivers as necessary as the company works to improve its adjusted EBITDA results and brings its covenants back into compliance.

We note as well, the company has begun a more aggressive deleveraging strategy of its balance sheet over the last 12 months. Repaying $2.7 million of borrowings over 2023 and a further $700,000 in Q1 2024, which have produced annualized interest savings in excess of $200,000. We plan to continue to address overall debt levels and expedite prepayments, certain tranches of debt through the balance of 2024. This deleveraging will assist in supporting free cash flow improvements into future quarters.

On the company's at the market equity facility, the company has raised approximately $4 million, $5 million in gross -- $4.5 million, excuse me, in gross proceeds over the past 24 months to support its liquidity position and continued expansion. We believe that the company is currently capitalized to continue to execute on its strategic plans.

On key performance indicators, in Q1 2024, the company produced approximately 1.1 million grams of cannabis in line with Q4 2023. This decrease in harvest quantities versus prior quarters was anticipated in the wake of the cost-cutting measures and decreased capacity announced in January last year. Although this is expected to rebound strongly into Q2 2024 on the back of the company's announcement to begin to ramp up production.

Production cost per gram increased in the first quarter to $0.70 per gram versus $0.55 in Q4 last year. We would expect that as output increases in the coming quarters, this cost per gram will trend downward. Total grams sold in our wholesale cannabis segment was 1.2 million grams which exceeded grams produced for the fourth consecutive quarter, allowing the company to continue to draw down inventory levels and improve our turnover ratios in our wholesale business. We note that overall grams sold in the past 4 quarters represent a significant improvement over the previous 4 quarters.

The company's average selling price per gram increased in the quarter to $1.94 per gram versus $0.94 per gram in the fourth quarter last year. We note that the company's inventory levels of older and aging products have been drawn down and the company is now able to focus on sales of higher-priced and higher-margin cannabis offerings. Continuing to address the company's wholesale business and improving overall grams sold and average selling price will continue to be a focus for us moving forward.

The company recorded 372,000 retail transactions in the first quarter of 2024, down from Q4 last year, which was anticipated for the seasonally slow post holiday period in Q1. We also note improvement versus 367,000 transactions for the same period last year. Average transaction value increased to $39.04 per transaction in the quarter. Average transaction size and units sold per transaction are key growth drivers of focus for Delta 9's retail division to the balance of 2024.

On revenue and revenue segmentation, total net revenues for the 3-month period ending March 31 were $16.5 million versus $16.9 million, a decrease of 2% for the same quarter last year. Sequential net revenue decreased 6% versus Q4 last year. Although, again, we note this is anticipated with lower overall retail shopping activity typically in the first quarter of the year.

From a revenue segmentation standpoint, for the quarter, the company recorded retail revenue of $14.3 million versus $14.6 million in the same period last year. Wholesale cannabis revenues were $2.4 million versus $2.2 million in the same period last year, and B2B revenues were $83,000 versus $576,000 for the same period last year.

In the upcoming quarters, management will focus on 4 main initiatives to drive revenue growth. The first is a focus on same-store sales and KPIs aimed at driving revenue growth from our existing retail store chain. We've spoken about key improvements and investments that the company has planned in its cultivation and processing business, which we feel will help us drive momentum, increased revenue and improved margins in the cannabis wholesale segment with a focus on expanding product distribution in the company's 10 existing provincial and territorial markets.

We plan on adding new provincial markets through new listings as well as through bulk wholesale agreements with other licensed cannabis companies. Lastly, we plan to expand our international market wholesale sales through access to new international medical market opportunities.

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 it 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 3-month period was $4.7 million or a 28% gross margin, compared with $4.2 million or a 25% gross margin in the same period last year, an increase of 10%. Overall gross profitability trended higher by 3% as a percentage of revenue versus the prior year. Delta 9's management has been undertaking a thorough assessment of our pricing and margin strategies across our various business segments. We'll continue to look to maximize outcomes by tuning these strategies where necessary. We would attribute the overall increase in gross profit and gross profitability to improvements across the company's retail and wholesale segments.

We expect the introduction of sales of higher-margin cannabis products in 2024 will contribute to a general improvement in gross profitability from our wholesale cannabis segment. The company has seen relative stability in its retail cannabis business segment over the past several quarters, and we'll continue to address those KPIs again, such as average transaction size, units sold per transaction and opportunities for higher-margin product sales to improve those retail margins.

In operating expenses, we note that on January 9 last year, again, the company announced a number of cost-cutting initiatives as part of the company's 2023 strategic plan with the goal of producing positive cash flow from operations. including reducing the company's production capacity at our Delta 9 facilities in Winnipeg and reducing our staff count. These cost-cutting measures resulted in more than $3 million in annualized cost savings in 2023. We are now continuing our cost savings plan into 2024 and plan to eliminate in excess of $1 million of additional cash SG&A expenses in 2024. We'll continue to update investors on these cost-cutting initiatives, there forthcoming.

Operating expenses, excluding share-based compensation for the first quarter were $7.1 million versus $7.4 million a year ago, a decrease of $300,000 or approximately 4%. The most notable changes in operating expense categories for the 3-month period ending March 31 were amortization, insurance and personnel expenditures. The company's loss from operations for the 3-month period ending March 31 was -- excuse me, $3 million versus $1.2 million for the same period last year. This also compares with a loss from operations of $4.3 million for the sequential quarter ending December 31 last year.

The company's adjusted EBITDA for the 3-month period ending March 31 was $5,200 versus a loss of $475,000 for the 3-month period ending last year. This also compares with adjusted EBITDA of $1.5 million for the sequential quarter ending December 31. We attribute the improvement in adjusted EBITDA versus the prior year period to higher overall gross margins as noted above from our material business segments as well as savings as a result of the company's cost-cutting initiatives.

We are confident that the company's recent cost-cutting initiatives and renewed focus on revenue growth and profitability, we'll return the company to a strengthened adjusted EBITDA position in the coming quarters. We note that this marks the company's fourth consecutive quarter of positive adjusted EBITDA, which is our main barometer of profitability for the company. We see this result as a materially positive milestone for Delta 9.

As we look forward to the 2024 operating year, we feel confident that the company is positioned to continue to execute on its vertical integration and growth strategies in our production and wholesale segment. The company will continue to push forward to maximize the utility and efficiency of our existing assets, pushing to operating cash flow positive on the back of our recently announced cost-cutting initiatives and increasing our ability to supply volumes of cannabis products across all of our various 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 consumers and suppliers, seeking the best locations and positioning as the most competitive LP owned retailer in the cannabis space.

And in our B2B segment, we will continue to cultivate long-term and value-added relationships with our B2B customers while deploying our resources into international markets were necessary to position our nonplant testing businesses, to realize growth in the ever-growing cannabis opportunity globally. I want to thank everyone for taking the time to join the call this morning. And with that, I will turn the call back over to the operator for any questions we may have.

[Operator Instructions]. And your first question comes from the line of [ Punkaralanti ].

You said the wholesale prices was $1.90 for this quarter. Do you expect wholesale cannabis prices to stay elevated going forward?

Yes. Good question. And I think to provide some overall commentary on the wholesale segment. Generally speaking, what we've seen in terms of bulk wholesale pricing for Delta 9 in the last 12 months has been that prices are trending up, not immaterially over that period. We would expect that as the industry continues to see a shift in the overall supply-demand imbalance?

And thematically here, obviously, you're seeing the number of licensed producers in the Canadian space that have shuttered capacity over the last several years is starting to contribute significantly to improving that supply-demand imbalance that we will see continued improvements in overall wholesale pricing.

Now to note our financials specifically when we report wholesale cannabis pricing, that is a blended mix on a volume-weighted average basis of both bulk cannabis sales, so that would be sales to other Canadian as well as international market producers, as well as sales into the consumer packaged goods market here in Canada.

So you are seeing a blend of that pricing. And again, more thematically towards our own financial statements. You're seeing that the company is now depleted effectively it's aged cannabis inventory, which would have historically been sold at prices less than $1 a gram.

You're now seeing a higher proportion of that overall revenue mix coming from the consumer packaged market and as well, I would point to the supply agreement that the company announced in January this year with a large Canadian license producer where we are now seeing those contract growing and manufacturing opportunities at what we would consider sustainably profitable pricing. So I think similar or not dissimilar to our retail segment, which saw substantial margin improvement in the calendar year 2023, we will see similar themes play out in the cannabis wholesale segment in 2024 and beyond.

Okay. One follow-up question. Regarding the agreement that you have with the licensed producer, can you talk, if possible, more about the structure of this agreement?

We are -- I'd just say that we're bound by confidentiality for a number of the business terms of that agreement. What we have released publicly is that we anticipate the dollar value of that agreement on a forward 12-month basis from the point of announcement to be in the area of $4.5 million. But again, would position that versus our cultivation cost per gram we would anticipate average selling price per gram to be sustainably profitable above that level. And that is something that we have not historically seen in the Canadian bulk cannabis market up until this year.

[Operator Instructions]. And there are no further questions at this time. I would like to turn it back to John Arbuthnot for closing remarks.

There being no further questions, I want to thank everyone for joining us for our Q1 2024 earnings call, and I will turn the call back over to the operator to conclude.

Thank you, presenters. And ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.