Fire & Flower Holdings Corp

TSX:FAF

Earnings Call Transcript

[Operator]

Good morning or good afternoon, and welcome to the Fire & Flower Second Quarter Fiscal 2022 Financial and Operational Results Call. My name is Adam, and I'll be your operator today. [Operator Instructions] I would now hand the floor over to Stephane Trudel to begin. Stephane, please go ahead when you are ready.

[Stephane Trudel, executive]

Thank you, and welcome to Fire & Flower Second Quarter Fiscal 2022 Conference Call. I am Stephane Trudel President and CEO. And joining me today is Judy Adam, our CFO. Earlier today, the company published its operational and financial results for the second quarter ended July 30, 2022. The results are available on the company's website and on SEDAR. Prior to beginning our call, I will direct listeners to the cautionary statement regarding forward-looking information published on the news release for the second quarter of fiscal 2022 as well as the company's filings on SEDAR.

Today, we will be providing commentary on the second quarter of fiscal 2022, along with an update on our operational improvements and new initiatives that will position the company for financial growth with the goal of generating free cash flow. We will also provide an update on our expansion plans across North America, leveraging our unique technology that enables acquiring customers converting to sales and building long-term loyalty. We will then conclude with the moderated question-and-answer period from equity research analysts that cover to Fire & Flower.

The second quarter of fiscal 2022 saw the launch of our new Spark member pricing program in mid-May across all our retail network. Our promise to consumers of the best products at the best price came to life with our team members aligning to deliver a clear message and compelling value to our members. The reaction to this program has been exceptional and reversed past trends, seeing increases in traffic in our stores, increases in unmet sold and significant improvements in our market share position as the quarter progressed and continuing in the current quarter.

Average annualized sales per store improved by 18% compared to last quarter, and our same-store sales grew by 10% in the month of July, while significantly closing the gap compared to last year, even when factoring in the industry-wide retail price compression and a decline in consumer price index of approximately 4% on Canada's products across Canada. As we had described last quarter, by leveraging our proprietary product power ranking algorithm from Hifyre data platform, we made selective investments in margin across a portion of our products to drive customers back to our stores, but kept our ability to extract higher margins by adding products to the customers' basket with a higher margin profile.

Full consolidated revenue across the segment of digital, retail and wholesale and logistics were $40.7 million, consistent with the previous quarter and a decrease of 6% to the same quarter last year. Our retail revenues increased 3% sequentially compared to the last quarter but saw a 5% reduction over the same quarter last year. We should note that we have seen a reduction in store count due to the closure of underperforming stores, which is a normal retail practice. This demonstrates our focus on an optimized store network with a maximum number of profitable stores within the network. At the [Technical difficulty] Fire & Flower represented one of the largest cannabis retail store networks in Canada with 92 stores open and operating.

Our Wholesale and Logistics segment revenues increased 9% year-over-year with the addition of Pineapple Express announced at $8.5 million. This segment includes medical and recreational B2B and B2C deliveries in addition to our wholesale distribution business in the province of Saskatchewan. We will also be launching cross-docking logistics operations shortly in the province of Manitoba. Our digital segment saw declines as we realigned our relationships with our strategic partners and invested in research and development to develop novel data offerings that are now commercialized. Our digital revenues were $1.9 million, down from $2.9 million in the previous quarter and $3.7 million in the same quarter last year.

While this was overall a challenging transitional quarter, I'm pleased to see that we have turned the corner on a lot of our fundamental retail metrics that continue to improve month over month. Coupled with the slowdown in new store openings across the industry, it supports our view that the next quarter's results are anticipated to show continuous improvement. We remain focused on improving key operational metrics, near-term financial performance and remain laser focused on our goal of positive free cash flow to position us to be active in potential market consolidation.

We continue to work to strengthen our balance sheet in the second quarter with our disciplined approach to inventory management, reducing our receivables and optimizing mark payables. We have prioritized our capital investment to ensure we can maximize our return on investment. We have launched the Get-To-Green program, a company-wide top line revenue and cost reduction programs. By looking at every possible opportunity, we expect to deliver sustainable improvements to our results while supporting our growth objectives. Judy will provide more details about our network evolution as we have figures to high grade our network during the quarter with the closure of lower-performing stores and the opening of new stores that are already showing their capacity to perform up to our expectations.

In parallel, we expect to have 10 co-located stores with Circle K in the next 12 months, expanding our asset-light development model in high-traffic stores in Western Canada and continue to evaluate accretive store acquisitions in existing markets to leverage our capacity to scale with limited investments in overhead. This quarter, in addition to expanding our high-care digital platform with new data offerings such as our product distribution and our customer insight data modules, we have launched personalized product recommendation in our Spark Perks member e-mail communication, leading to increased customer engagement and sales.

We've also invested in marketing to launch the member pricing program and expand our Firebird Delivery service in key Ontario market. These strategic investments showing up in SG&A are immediate to long-term value contributors and near-term differentiators. Our customers are voting with their action and the velocity of sign-ups to Spark groups member program have increased with the member base that now over 480 per members. Our prior bird delivery service and our other e-commerce customer touch points consistently generate higher basket and transaction sequences.

Data from our Spark group and Fire & Flower in our B2B customer base in the Hifyre IT platform. This quarter, we've made changes to our leadership team that has already started to demonstrate results by bringing more operational focus to retail, and powering our employees to act as owners and aligning our commercial functions under one of this, ensuring that we act as one team to create sustainable value for our customers and shareholders. I would now like to turn the call over to Judy to discuss our financials and provide a more detailed overview for the second quarter financial results. Judy.

[Judy Adam, executive]

Thank you, Stephane, and good morning, everyone. I'm happy to provide a financial overview of Fire & Flower and our operations after to the markets earlier this morning. To begin, I remind everyone that Fire & Flower follows the retail calendar with every quarter consisting of 13 weeks. Today, I will be speaking to the second quarter of fiscal 2022, which ended July 30, 2022. For the second quarter of fiscal 2022, consolidated revenue was $40.7 million, consistent with the prior quarter and a decrease of 6% from $43.3 million in the prior year. The Retail segment generated revenue of $30.4 million. The wholesale Logistics segment generated revenue of $8.5 million and the digital segment generated revenue of $1.9 million.

Consolidated gross profit dollars this quarter was $9.7 million and a gross margin percentage was 24% compared to gross profit dollars of $16.2 million and a gross margin percentage of 37% in the prior year. Consolidated adjusted revenue this quarter was negative $6 million compared to positive $3.1 million in the prior year. As Stephane mentioned earlier, Q2 was a transitional quarter as we reset for growth and focus on financial discipline with a goal to deliver positive adjusted EBITDA and free cash flow. While significant process was made in the quarter on launching key strategic initiatives, the positive financial contribution was only partially realized in Q2 and will become more apparent in subsequent quarters.

Now moving on to an overview of segmented results. Starting with retail. Our Q2 results reflect several significant changes that occurred in the quarter. First, with the launch of our innovative Smart Perks member pricing program in mid-May. Secondly, one of our get-to-green initiatives is too high-grade our retail network. As a result, in Q2, we closed 11 underperforming retail stores and opened 2 additional stores that we anticipate to be positive contributors, ending the quarter with a retail network across Canada of 92 stores compared to 101 stores at the end of the previous quarter and 91 stores at the end of Q2 fiscal 2021.

And last, on May 19, we launched Firebird Delivery, a virtual marketplace in several -- in 7 Ontario cities with cannabis product sales fulfilled by the company's retail network. Retail revenue for the 13 weeks ended July 30, 2022, was $30.4 million, reflecting an increase of 3% from the previous quarter despite the net reduction of nonretail stores in the quarter and the continued competitive pressures in the Cannabis recon market. This quarter-over-quarter increase is attributable to the launch of our Smart Perks member pricing program in mid-May, which drove an increase of 18% in average annualized sales per store in Q2 compared to Q1 2022.

In terms of year-over-year, total retail revenue in Q2 2022 declined 5% from $31.8 million in the prior year. On a same-store sales basis, comparing 87 stores with operations throughout both Q2 2022 and 2021, sales decreased 14%, which is a significant improvement from the trends we've experienced over the past several quarters and can be attributable to the new member pricing program, which drove higher traffic in stores. We've seen improvement in same-store sales each month since launch of our member pricing program in mid-May with same-store sales increasing 10% from June to July 2022, reflecting a positive trend in the last quarter -- last month of the quarter.

As access to our member pricing program and Firebird Delivery options require Smart Perks membership, we are seeing a significant increase in Smart Perks member sign-ups since May to more than 485,000 members today. Gross profit for retail in Q2 2022 was $7.1 million and gross margin declined to 23% compared to 28% in the previous quarter and 34% in the prior year. The decline in gross margin percentage was quite and reflects the investment in the initial launch of our member pricing program. Subsequent to quarter end, the retail segment is already seeing improvement in both gross profit dollars and margin percentage driven by increased number of transactions and units sold per store.

Now turning to the wholesale Logistics segment. Wholesale logistics revenue of $8.5 million for the second quarter of fiscal 2022 was an increase of 9% from $7.8 million in the prior year, primarily due to the acquisition of Pineapple Express delivery offset by lower wholesale revenue from Open Fields, reflecting maturing in the Saskatchewan market. Gross profitable wholesale logistics in the current quarter was $0.9 million and gross margin was 11% compared to gross profit of $1.6 million and gross margin of 21% in the prior year. The decline in gross profit is primarily due to an increase in delivery cost of sales, specifically higher gas prices and labor costs relating to munching Firebird Delivery in the first quarter.

We anticipate gross profit dollars and margin improvement as operating delivery services become more efficient with economies of scale. We also anticipate launching our cross-stocking logistics services in the province of Manitoba in the coming quarter, which we anticipate to be a positive contributor in future quarters. Turning to the Digital segment. Digital Platform revenue was $1.9 million in the second quarter of fiscal 2022 compared to $3.7 million in the prior year. The year-over-year decline is primarily due to a delay in renewals of data subscription agreements and reduced project-based data and analytics work in the current quarter as we prioritize development in new products that have now been launched in Q3.

We anticipate substantial renewal of data subscription agreements to be completed in the back half of 2022 through more favorable economics for data subscription customers, thereby stabilizing monthly recurring revenues in future quarters. In addition, we anticipate receiving licensing revenues in future quarters from co-located types and U.S. expansion at Fire & Flower U.S. We also continue to build and monetize new products in a Hifyre digital platform, including the recently developed consumer insights and product distribution modules, which are anticipated to generate incremental revenue in coming quarters.

Consolidated SG&A expense for the 13 weeks ended July 30, 2022 were $16.9 million compared to $14.6 million in the prior year. SG&A expense, excluding share-based compensation and acquisition and strategic initiative professional fees, for Q2 was $15.7 million or 39% of revenue compared to $13.1 million or 30% of revenue in the prior year. The year-over-year increase in the current fiscal quarter was primarily driven by the addition of Pineapple Express Delivery and PotGuide acquisitions, investments made to expand the Hifyre platform and marketing expenditures for the launch of Firebird Delivery and Smart Perks member typing.

As we mentioned earlier, we recently launched our Get-To-Green initiative focused on optimizing the company's cost structure and improving operating efficiency. The cost saving initiatives are company-wide and are anticipated to contribute meaningfully by reducing SG&A in subsequent quarters. Consolidated adjusted EBITDA for the company for the second quarter of fiscal 2022 was negative $6 million compared to positive adjusted EBITDA of $3.1 million in the previous year. The year-over-year decline reflects both ongoing headwinds in the cannabis industry and strategic investments in Smart Perks member pricing program, Hifyre digital platform and launch of Firebird Delivery in the quarter.

Free cash flow burn in Q2 2022 was $9.8 million, primarily driven by negative cash from operating activities before changes in noncash working capital of $7.6 million. In addition to our Get-To-Green program to drive positive adjusted EBITDA, diligent working capital management is also critical in driving our objective of generating free cash flow. In this quarter, our efforts on AR collections, optimizing inventory buying and payables resulted in significant improvement in working capital, which was a source of cash of $1.9 million in the quarter. Our balance sheet also reflects our strong financial discipline and the benefits of our strategic partnership with ACT.

As of July 30, 2022, we had $2.4 million of debt in the form of a convertible debenture and cash on hand of $18.6 million. Last, we announced today that we have changed our company's fiscal year end from our company's fiscal year from a 52- or 53-week period ending the Saturday process to January 31 to a calendar 12-month period ending December 31. This adjustment will be made in the fourth quarter this year and will reflect the operating results from October 30, 2022 to December 31, 2022. Thank you. And I'll turn it back to Stephane. I look forward to questions from the participants on the call.

[Stephane Trudel, executive]

Thank you, Judy. Some concluding remarks before we move on to questions from research analysts covering Fire & Flower. I would first like to thank our team at Fire & Flower. Since I joined just over 3 months ago, I have found our team members to be extremely [Technical difficulty] together as one team. I've already visited 27 of our 92 stores and met engaged individuals [Technical difficulty] had the chance to visit our Hifyre, Open Fields, Pineapple Express and shop support center teams. All of our team members have found a home at Fire & Flower and their leadership in the front line to act as owners will be the key to our success going forward. As we strive to continue our path to free cash flow generation, we remain convinced that market consolidation is inevitable and will bring opportunities for companies with strong balance sheet, scalable infrastructure, strategic partnerships and engaged people.

Unit economics will improve as weaker players cannot continue to invest to provide the services that customers will expect. The retail cannabis market in Canada and in the U.S. continues to grow regardless of past price deflation that has made it competitive with the illicit market. Our end-to-end customer ownership through our use of our scalable Hifyre technology gives us a competitive advantage as we look to scale our operations to an anticipated 200 profitable stores in the coming years to capture meaningful and sustainable market share in this growing market. I would like to finish by thanking our loyal investors for your continued support Fire & Flower. We're excited about our future and value the trust you put in this industry and our team. I would now like to turn it over to the operator for questions.

[Operator]

[Operator Instructions] And our first question today comes from Frederico Gomes from ATB Capital Markets.

[Frederico Yokota Gomes, analyst]

Stephane and Judy, my first question is just on your store footprint, quite a substantial reduction there in terms of the number of stores. So, I understand that you're trying to optimize your network. But should we expect any more material store closings during this quarter? Are you through most of this restructuring and back to growth mode now?

[Stephane Trudel, executive]

Frederico, thanks for the question. So, as we said before, we will really continue -- it's a constant process to be looking at our store network. We anticipate opening -- as we said, we've got new stores under construction right now. We anticipate new stores to open. We're also looking at opportunities to high-grade our network through M&A, which will increase the number of stores. But at the same time, we continue to be selective and look at everyone or in terms of profitability and opportunity to grow locally.

So, we anticipate the network to grow from this point on, especially as we onboard our co-located stores with Circle K, where we've got a target of ten stores in the next 12 months. There are already a handful that are built and just awaiting licenses to start operating. So, this will support the growth of our network.

[Frederico Yokota Gomes, analyst]

Okay. And I guess my second question is just in your -- on Firebird Delivery. So, you launched it this quarter, it seems like delivery is a key part of your strategy. So, could you comment on how you see the economics of delivery in Canada right now? I know that some of your competitors are a bit more cautious in terms of investing in delivery. So just curious how you view the economics there and how attractive is that opportunity for Fire & Flower?

[Stephane Trudel, executive]

Thank you. Definitely, it's a great question, and it is one that we constantly look at. We've been careful not to expand too fast in too many markets. So, we've made selective made choices entered markets and invested marketing dollars to open up these markets. But we've been selective also in how much we've invested in each of these markets and selected within that group of markets, one or 2 to really go hard in. And in those selected markets, we're seeing some very positive trends with a majority of people selecting more and more to elect take -- to invest in the rush delivery fees.

So, paper for faster deliveries. So, we're seeing customers show value for high-speed delivery. And we definitely think that there is a profitable business model there when it can get executed well in selected markets with the right foundational element. So, we believe this is our competitive advantage in these markets. We have -- we control the full tech stack from beginning to the end. We understand who our customers are. We can talk to them directly. We can scale these platforms. We can also add other products to on board to scale and reduce our unit economics. So, there's definitely a path for profitability, but it has to be a really carefully planned deployment in these markets.

[Operator]

The next question comes from Andrew Semple of Echelon.

[Andrew Semple, analyst]

First of all, I just want to ask on the uptake that you saw in the members' pricing program within the second quarter. Do you have any data that you'd be willing to share on which proportion of sales were at the store level, we're utilizing that program as of quarter end or where that might change today.

[Stephane Trudel, executive]

Andrew, thank you [indiscernible]. So, we're starting to see -- actually, we've really seen since the launch of the program in mid-May, we saw an acceleration of our transactions being recorded on the member pricing program. So right now, we're hovering between 65% and 70% of transactions being on member pricing. And as we evolve the program, we're offering -- we're looking at the performance and the customer behavior and continue to evolve the program to make sure that we stay within that range and look to improve our margin profile by adding higher-margin product to these baskets. So, while a lot of these transactions are done with members, it's important to note that not all our products are member priced and some carry a higher margin profile. So, we believe that, that's the key also to improvements in our performance.

[Andrew Semple, analyst]

Understood. That's helpful. Just want to switch gears maybe to what's been happening a little bit more recently. We've seen some logistical issues in Ontario and BC that we appear to be moving past, but I just wanted to ask if that might have had any impact in the quarter -- in the fiscal third quarter coming up? How those statistical impacts have those having impacts at the store level?

[Stephane Trudel, executive]

Yes. Certainly, it was a challenging past few weeks to keep our stores stocked. But the team worked tirelessly to find alternatives and to really focus on delivering value to our customers and just the fact we've got this -- our frontline employees have great relationships with our customers, facilitated the transitions to other products. So, while we -- while it's been challenging, we've been [Technical difficulty] we've had some great weeks. Our stores have performed really well through August and Labor Day. So, it's behind us. I think certainly, as an industry, how dependent we were on one -- had a single point of failure as an industry. So, I think it's certainly something that is a concern to the whole industry. But as to Fire and Flower, I think we weathered the storm and are coming out of it in pretty good shape.

[Operator]

Our next question comes from Justin Keywood from Stifel GMP.

[Justin Keywood, analyst]

Just on the Hifyre digital platform on the softer sales in the quarter. Is that a function of distress with the end customers? I know there was also mentioned, subsequent to quarter, there were renewals. And if there's any context there on what's a good revenue run rate going forward for that segment?

[Stephane Trudel, executive]

I'll let maybe Judy give a bit more detail on the numbers, but it's certainly not a sign of distress at all. We have built along the years, some great relationships with our LP partners. I think in the past, we might not have been as focused as we could in our communication with our LP partners. Part of the changes we've made internally in how we operate is really to bring all our commercial functions under one roof under our EVP of Commercial and Growth, Chris Bolivar. And that will -- that enables us to speak with one voice to our LT partners. And we're already seeing this pay dividends to us because now we've re-established the relationships with the LPs really on a constructive basis and are looking forward to our results, normalizing on the digital side. But maybe I'll hand it over to Judy to talk about the -- give a bit more color on digital.

[Judy Adam, executive]

Yes, sure. Yes, in terms of the year-over-year decline, we had benefited from some significant project work in the prior year. And we didn't see that occurring this year primarily because we were prioritizing our resources to develop several new data offerings that we've now commercialized the market. When you look at the year-over-year variance, about 60% of that variance was related to project were 40% related to just the monthly recurring revenue. But we think that with the renewals and the subscription agreements that we're seeing, we'll be able to get a run rate back stabilized at around $3 million a quarter.

[Justin Keywood, analyst]

Okay. That's very helpful. And then on the comments on the company's Get-To-Green initiative to generate positive EBITDA and cash flow, does that coincide with the goal of 200 profitable stores that was mentioned earlier in the opening remarks. And I guess to be more direct, the 200 stores need to be in Fire & Flower network to achieve profitability?

[Stephane Trudel, executive]

Not at all. No, not at all of that. We're -- the aspiration of 200 stores really is really to capture meaningful market share in this growing industry. And I think that if you look at the industry, a very overall healthy industry in the sense that it continues to grow with a 20% year-over-year and as we see the capacity of the market to grow at this space, we're seeing the -- there is a path for consolidators to capture meaningful market share, and that's really where the aspiration is. But definitely, we have a pack to profitability that doesn't require our network to go up to 200 stores. And maybe I don't know if, Judy, you can add a bit of color on the Get-To-Green initiatives.

[Judy Adam, executive]

Yes. Maybe just a couple of comments. Definitely, the Get-To-Green initiative, it's very broad-based and spans company-wide. And the focus is really just about -- twofold, rightsizing our cost structure and improving operational efficiency. What you've seen in the last couple of years is that we've been making -- we've made significant investments in our overhead infrastructure, so investment in people, particularly in the shared services area, and we've been working hard on implementing the new ERP system. So now that's done, and we're now starting to see the benefits of those investments. And so, part of the Get-To-Green initiative is now leveraging the new ERP system, and we're seeing efficiencies there as well as we work through the sort of organizational changes, we see some cost reductions on that front as well as we're integrating our new acquisitions like Pineapple Express, we're able to consolidate redundant facilities.

We've already consolidated 2 warehouses. So, it's -- those are some of the things that we're doing on the Get-To-Green initiative. But scale is important, right? And as we scale the business, we don't -- won't necessarily have to invest more in our overhead infrastructure. So, as we scale the business, we should see the benefits of the investments we've made over the last couple of years through improved operating leverage, and that will result in more of the incremental gross profit falling to adjusted EBITDA.

[Operator]

[Operator Instructions] So we have no further questions, I'll hand it back to Stephane for any closing remarks.

[Stephane Trudel, executive]

Thank you very much for participating in the call this morning, and we look forward to connecting with you next quarter and provide you with some view of our evolution as we continue to improve our profitability and grow our performance. Thank you very much.

[Operator]

This concludes today's call. Thank you very much for your attendance. You may now disconnect your lines.