Flowr Corp

XTSX:FLWR

Earnings Call Transcript 2020-Q3

[Operator]

Ladies and gentlemen, thank you for standing by, and welcome to the Flowr Q3 2020 Earnings Conference Call. [Operator Instructions] Please be advised that today's conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Thierry Elmaleh. Thank you. Please go ahead, sir.

[Thierry Elmaleh, Head of Capital Markets]

Thank you, David. Participating on today's call are the Flowr Corporation's CEO, Vinay Tolia; Flowr's President, Lance Emanuel; and our CFO, Irina Hossu. Please note that throughout the call, we will refer to Flowr and the company interchangeably with the Flowr Corporation. Before management discusses results, I would like to remind participants that all amounts discussed on this call are denominated in Canadian dollars. Please also note that 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, 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. The 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 Q3 2020 financial statements and MD&A and Q3 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 Q3 2020, which includes reconciliations of the non-IFRS measures. It's now my pleasure to turn over the floor to Vinay, Flowr's CEO.

[Vinay Tolia, CEO & Executive Director]

Thank you, Thierry. Earlier this evening, we released our third quarter 2020 results, which we believe continued to show a growing market for the premium dried flower in the Canadian rec space. Before we dive into the specifics of our results, last month, we announced the strategic acquisition of Terrace Global. We've been working together with the Terrace team for the past 6 months on our JV in Portugal and are excited to be combining forces to create a global cannabis company. The Terrace team has deep cannabis expertise, including the founders of MedReleaf, Bedrocan and ICC Labs. Our Board of Directors voted unanimously in favor of this transaction, which was supported by a fairness opinion from ATB Capital Market. At the time of the deal announcement, the pro forma combined balance sheets of the companies totaled over $31 million in cash and marketable securities. With our significant assets around the world and a clean cap table, we'll be in a position to execute our strategic vision. Together with Terrace, we embarked on an ambitious plan in Europe with what will be the largest outdoor THC cultivation project in the EU to date. Growing in outdoor environment is inherently volatile given that one cannot control or regulate the growing climate, and we were doing it at this scale in this environment for the first time. Despite the hard work, we believe that most of the plants harvested throughout October will be high-THC biomass. The lessons we learned will enhance our knowledge base and equip us to succeed in the future. We have greenhouse-grown product being harvested now that may end up being worthy of GMP-certified finished product. In Canada, our thesis of a bifurcating market continues to play out with consumers showing not only a willingness to pay premium prices for quality products, but also cycling back to trusted brands. A recent consumer research report by the Brightfield Group highlighted Flowr as the #1 and #2 ranked brand in a variety of loyalty, brand promotion and satisfaction scores among the top 10 purchased brands in Canada. Furthermore, for the trailing 90-day period ended September 30, 2020, Flowr's 3.5 gram jar of BC Pink Kush was the #1 sold SKU in Ontario by dollar volume sales to retailers regardless of site. Retail sales and distribution points continued to expand nationwide and in Ontario, in particular. Industry fundamentals continue to improve and move in the right direction. We're looking forward to introducing innovative packaging as well as introducing additional cultivars in the coming months. Our K1 Facility in Toronto was fully operational in the quarter and produced approximately 1,300 kilos of dried flower, with over 50% of that being BC Pink Kush. The mother plant variability we described in the last quarter has been effectively managed as our most recent testing of dried flower has shown THC bands well within our internal quality specification guidelines. Now I'll turn it over to Irina to run through more of the financial details from our third quarter.

[Irina Hossu, Chief Financial Officer]

Thank you, Vinay, and good evening, everyone. As Vinay touched upon, we continue to make progress towards our stated objectives in the third quarter. Gross revenue was $3.5 million for the quarter, which represented a 15% increase from our fiscal second quarter and was our highest quarter since our initial sell into the rec market in 2018. Net revenue was $2.8 million in the quarter, which was a touch below expectations due to the timing of the fulfillment of an order which leaked into the fourth quarter. However, this represented a 22% increase versus prior quarter. We sold 552 kilos of product in the quarter, approximately 70%, which is our BC -- which is our flagship BC Pink Kush at an overall price of $5.25 per gram. Price per gram was impacted by mix of package versus trim. Excluding trim sales, the Flowr-branded price program was $6.54, reflecting our continued strong positioning in the premium segment. We continue to be confident in our pricing strategy and do not expect price erosion in the near term on our Flowr-branded products. However, we do acknowledge competitive pressure and believe there is an opportunity to educate consumers on the key differences between value-priced, greenhouse-grown product and premium indoor-grown product. The total cost of sales for the company was $3.9 million for the quarter. If normalized for approximately $2.1 million of Holigen nonrevenue-generating and onetime costs, cost of sales in Canada are $1.8 million. Our Canadian gross margin, therefore, is approximately 36% on an adjusted basis. This is a significant milestone for us as we work towards our gross margin target of 45%. We have clearly begun to see the material benefits from automation and fixed cost dilution over a larger amount of production. The normalized cash cost per gram sold for the quarter, which excludes depreciation, amortization, share-based compensation and onetime adjustments, was $2.91, which represents a 19% improvement over the $3.58 figure in Q2, as we benefited from efficiency gains. The company impaired $1.5 million worth of products in the third quarter, pertaining to offset products that didn't meet our quality standards as described during our call in Q2 as well as staged inventory in Portugal from our initial test indoor harvest from earlier this year. Selling, general and administrative expenditures, consisting primarily of salaries and professional fees, were approximately $3.7 million for the quarter versus $4.6 million in Q2, as the company continued to see the benefits of the global restructuring program announced in March and tighter expense management. As we mentioned on our last call, we have begun investing in our selling and marketing activities to drive increased distribution and deeper penetration nationally and expect the investment to continue through the balance of the year and the operating leverage to accelerate into 2021. Adjusted EBITDA in the third quarter, which excludes certain noncash expenditures and restructuring costs, was a loss of $3.5 million versus a loss of $2.9 million during the second quarter of 2020. The increase in loss was largely due to both the impairments that we took and the costs associated with the Portugal harvest, though the cost per gram improvement discussed earlier was a positive offset. I would also like to echo Vinay's enthusiasm about the Terrace acquisition, the team and what it means for Flowr going forward. Terrace Global has been nothing short of great partners in our European joint venture, and we are very excited by what's yet to come. To date, Terrace has funded $4.8 million towards the JV in Europe. This transaction puts us in a stronger financial position, better equips us to execute on our strategic objectives and will allow us to capitalize on opportunities as they become available. At the time we announced the transaction, the 2 companies, on a pro forma basis, would have had in excess of $31 million of cash and cash equivalents on the balance sheet. In an environment where capital is both scarce and expensive, this transaction will give us the [ run release ] from a liquidity perspective. In addition, we expect to realize approximately $2 million in cost synergies from combining our companies. You may recall in our fourth quarter 2019 financials, the company financially impaired all Flowr Forest inventory, pending a Health Canada review of a regulatory interpretation. Based on the outcome of the review which was finalized in Q3, the company recently destroyed and disposed of the Flowr Forest inventory. It is important to note, however, that there is no impact to either of the company's licenses at K1 or Flowr Forest based on the outcome of this review, and no restrictions have been placed on operations. Given the recent heightened COVID restrictions, particularly in Ontario, as well as the delay of entry into Québec and a new cultivar, Black Cherry, being on shelf in January, the company has decided not to provide specific guidance for the fourth quarter, other than to say we will not achieve our cash flow breakeven this quarter. The company was disproportionately affected during the last shutdown, given that we have traditionally performed better in a bricks-and-mortar setting, and the shutdown affects several of Ontario's most popular cities right before the holiday season. In addition, previous guidance assumed Q4 entry into Québec and the company's latest estimate in early 2021. Based on a normal operating environment without COVID restrictions, the company would expect to become cash flow positive from Canadian operations in the first half of 2021. Shortly after the close of the transaction, the new combined Board combined of -- comprised of Flowr and Terrace will meet to reaffirm our 2021 strategic priorities. Lastly, the company ended the quarter with $3.5 million in cash on the balance sheet. Shortly after the close of Q3, the company received a $1 million loan from Hawthorne to complete construction activities and another $1.5 million from Terrace in joint venture funding. The company's cash position today is substantially higher than at the end of Q4. I'll now turn the call back to Vinay for closing remarks.

[Vinay Tolia, CEO & Executive Director]

Thank you. To repeat some of what Irina said, although we received market authorization from Québec, we're waiting on license from our distribution partners so we can finally ship product into the second most populous province in the country, which we still expect imminently. The launch of our second cultivar, BC Black Cherry, is expected to occur in January. It's also worth mentioning that as part of our integration with Terrace, our Board of Directors will change. The new Board will have input in shaping our 2021 strategic objective and budget. Given all these factors, we're moving our target date for achieving cash flow breakeven to 2021, as Irina mentioned, and we'll further refine it once the Terrace deal closes. We're extremely pleased to say that in early October, we completed the first 4 of the Scotts -- the Flowr, Scotts Hawthorne R&D center and have begun conducting research activities in the building. We anticipate that the for Flowr Hawthorne R&D center will be beehive of activity soon will be fully operational in the spring of 2021. The company believes that the 50,000 square foot R&D facility will be North America's first dedicated cannabis R&D facility, focused on cultivation techniques and systems, including growth medium, nutrient formulations, irrigation, lighting systems, plant genetics and integrated growing systems. The facility is world class and will keep Flowr at the forefront of cannabis IP for the years to come. I'm now happy to answer any questions you may have. Operator, can you please open the line for questions?

[Operator]

[Operator Instructions] Your first question comes from the line of William Kirk with MKM Partners.

[William Joseph Kirk, Executive Director]

So on the profitability headwinds cited of Québec timing and the new Ontario restrictions, Vinay, you touched on, I guess, the Québec timing itself. But how are you thinking about the size of that opportunity? And second, on Ontario, why do you think it is the brands do better in the physical stores than maybe they would in an online-only model, especially considering some of the brand awareness studies that you've cited?

[Vinay Tolia, CEO & Executive Director]

Yes. Good question. Irina, you want to take that?

[Irina Hossu, Chief Financial Officer]

Sure. So thanks so much for the question. Why don't I go ahead and just, first of all, answer the Ontario question. I think there's a couple of reasons. Certainly, we are a premium product, and there's an enormous amount, I think, of education and budtender engagement that we see traditionally when it comes to our product. Budtenders are an incredibly useful tool for us. They're incredibly invested, quite frankly, in our product versus others. And we find that we just do better because there's an enormous amount of discussion that's had with budtenders. There's -- we do quite well with budtender recommendations, so that would be sort of the reasons why.

[Vinay Tolia, CEO & Executive Director]

I'll add to that, that there's a magazine here, Kind Magazine, where we just placed as the #1 most recommended brand for budtenders. So there is an element when you're in the stores and you're able to talk to someone and look at the product and smell it that favors us. And although there is more brand recognition, it's still de minimis compared to more traditional industries. So that's why, again, we don't know how this will -- that this shutdown will affect us. I think -- we think it will affect us less than the one in May because this one only affects the city of Toronto, and this time around, retailers will be allowed to offer curbside pickup, and they'll be better equipped to manage than the shutdown we had in May. So that's on the -- that's -- but it does increase uncertainty. It certainly increase uncertainty. The Québec, the size of the Québec opportunity that we feel that the Québec market is underserved on the premium side. If you look at the biggest selling premium brand in Québec, it's a brand that in every other jurisdiction that we are -- that we go head-to-head with them, we outsell them 4:1 in an upwards of 9:1. So we're pretty confident on our ability to sell in Québec once we get in there. In kind of steady state, we'd expect them to -- we expect that to be our second largest province right behind Ontario.

[William Joseph Kirk, Executive Director]

Okay. That's super helpful. And then there's a line in the press release about competition intensifying, and Irina alluded to it in the prepared remarks. So just hoping for some more detail on what you mean. Is it that the other LPs are shifting strategy away from the lower-priced product and toward premium? Or what does that mean when you say competition's intensifying?

[Vinay Tolia, CEO & Executive Director]

I wouldn't say that. I think there's still lots of LPs that are focused on the value product. The real thing is that there are people growing -- there are people that are starting to grow high-quality product with high THC. And for the first time, we've seen -- well, not the first time, but we've seen a number of new entrants that have a high-quality product. And coupled with the fact that we had some issues with our mother plant, the variability issue that we had in Q3 where our THC was a little lower than we would hoped, it is -- it certainly affected our business. But in the long run, we think that this is only going to help increase the overall size of the premium market.

[Irina Hossu, Chief Financial Officer]

And Bill, if I can just jump in here for one moment. I can't recall if we spoke of this during the last briefing or if you and I spoke about this sort of one-on-one, but I would say that there's certainly an opportunity, and we're certainly seeing it for increased education for the customer level. We're seeing some competition come through now for greenhouse-grown products versus through indoor grown, which is what Flowr is known for. And we think that we're reaching an inflection point now where there is a true opportunity to educate the consumer on the differences between in-house -- sorry, greenhouse-grown versus indoor-grown, the differences between THC and all the other properties of the cannabis plant, and this is really where we're planning on making some investments, I think, going into the later half of this year and going into next year.

[Operator]

[Operator Instructions] Next question comes from the line of [ Andre Dennucci ] with Jefferies.

[Unknown Analyst]

I'm filling in for Owen today. I just had 1 question on the quantity sold. So of the 550 kilograms, roughly like that, that much -- that's how much was sold, 370 kilograms was Pink Kush sold. So would it be fair to assume that the remainder was biomass and trim?

[Irina Hossu, Chief Financial Officer]

The majority, yes. The majority would have been biomass and trim, yes.

[Vinay Tolia, CEO & Executive Director]

There is also...

[Irina Hossu, Chief Financial Officer]

There's a small bulk sale. Yes, there was a small bulk deal, but the majority of that is biomass and trim.

[Unknown Analyst]

Understood. And just a quick follow-up on that. If you could just tell us what the average selling price on that one was and for bulk as well, that would be quite helpful.

[Irina Hossu, Chief Financial Officer]

Sure. So on the biomass and trim, average selling price is just under $2 a gram.

[Unknown Analyst]

Understood. That's helpful.

[Vinay Tolia, CEO & Executive Director]

And on the bulk, it was $4. Good. Yes.

[Operator]

[Operator Instructions] Your next question comes from the line of Frederico Gomes with ATB Capital Markets.

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

Congrats on the quarter. So just my first question is regarding inventory. So I guess when you look at the amount of kilograms that you're harvesting in K1 and compare that to the brands that you're selling, there appears to be a mismatch here. So just wondering if you can talk a little bit on that and if we can expect any further impairments in inventory down the road?

[Irina Hossu, Chief Financial Officer]

There certainly was, I think -- and I think it's an astute observation, so thank you for raising the question. We spoke a little bit in Q2, and I think we just spoke a bit about it more now about how we did have some mother health challenges in Q2. We just very recently just finalized sort of the last of the rooms. Everything that we're growing from this point forward is actually looking very, very strong. And we're very pleased to be able to say that we're over the majority of the hump. In terms of future impairments, it's a little premature for us to say right now because the last rooms literally just came down within the past couple of days. So we're in the process right now of doing some preliminary testing on the room.

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

Okay. Okay. Yes, that's helpful. And one more for me. In terms of your international strategy, if you could maybe provide us some more color on that. Any comments regarding distribution? Potential partners? Which markets are you going to tackle first? And when can we expect sales to start?

[Vinay Tolia, CEO & Executive Director]

Yes, good question. So we are -- we're primarily focused on Germany, and that being obviously the biggest market in Europe. We have been talking to some partners in Europe. It's premature for me to speculate on whether or not that will result in revenue near term. But we have been discussing some partnerships to extract our biomass as well as, as I mentioned, we have some product coming down from the greenhouses that could be -- that could end up being finished product GMP certified. So we're discussing with some third parties on potentially getting some revenue there in the first half of next year. I think that we -- with our harvest, what we did prove is that we can grow the product at [ all just draw ] and hit the high-THC threshold that we predicted. Now there was always going to be some trial and error to figure out which phenotypes were best suited for that environment. And so we learned a lot from that. But I think right now, what we're going to do is really focus on closing the Terrace transaction given their expertise on the international markets and reassess our European strategy with the new Board in the coming weeks.

[Operator]

There are no further questions at this time. I will turn the call back over to Mr. Elmaleh.

[Thierry Elmaleh, Head of Capital Markets]

Thank you very much for joining us on today's call, everyone. And to all of our American friends and family, Happy Thanksgiving.

[Operator]

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