Earnings Call: Q2 2021

Aug 16, 2021

Earnings release

Greetings. Welcome to the Lowell Farms Inc. 2nd Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. Please note this conference is being recorded. I will now turn the conference over to your host, Bill Mitulis, Investor Relations. Thank you. You may begin. Thank you, Hillary. Good afternoon, and welcome to the conference call to discuss Lowell Farms Financial Results for the Fiscal Second Quarter of 2021. Before we begin, please let me remind you that during the course of this conference call, Lowell Farms Management may make forward looking statements. These forward looking statements are based on current expectations that are subject to risks and uncertainties that may cause actual Results to differ materially from expectations. These risks are outlined in the Risk Factors section of our Form 10 filed on EDGAR And our listing statement filed on SEDAR. Any forward looking statements should be considered in light of these factors. Please also note That any outlook we present is as of today, and management does not undertake any obligation to revise any forward looking statements into the future. This call includes George Allen, Chairman of the Board Mark Ainsworth, Co Founder and Chief Executive Officer As well as Chief Financial Officer, Brian Scheer, who will go into detail about the company's financial results for the quarter later in the call. The Q and A portion of this call will be open to analyst questions to provide further insight into the company's performance, operations and go forward strategy. For those of you who may happen to leave our call before its conclusion, be advised that this conference call will be recorded and archived on our Investor Relations Web And now with that, I'll hand the call over to George. George, please go ahead. Thanks, Bill. Good afternoon, everyone. I'm grateful to give you a report as to our progress and indeed there's much to talk about. The 2 acquisitions that we've done this year have transformed our company and positioned us well for the future. The acquisition of the Lowell brand and the acquisition of our flower processing facility in Salinas, both acquisitions give our investors A strong indication as to where your management team believes the industry is headed. They are also both entirely unique Without equal in the industry and as such position us differently than any other cannabis company in the world. None of this could have happened without the relentless commitment from this team. I want to thank them for their continued willingness to give this company, Our shareholders and each other everything they have. Now as to Q2 performance, I was very pleased with our progress. 37 percent sequential revenue growth Was extremely strong and squarely in the range that we had previously guided. Our profitability as measured by EBITDA was slightly ahead of guidance as well. Mark and Brian will go into more details on the quarter, but there's really a lot to be proud about. Our flower production at the greenhouse ramped steadily during the quarter and we exceeded our guidance of flower production of 8,500 to 9,000 pounds during the quarter With a total output of 9,553 pounds. Additionally, our plan to restore the Lowell brand to health Was met with resounding success during the quarter. Sales of Lowell branded products rose 166% Over the Q1 driven by an increase of 125% in pre rolls and 3 86% in packaged flower. We opened approximately 210 new doors during the quarter for Lowell, and we've just launched a marketing campaign That we believe highlights the Lowell brand in a fresh and novel manner. We've also relaunched our Quicks product during the quarter, which offers smaller serving sizes. Now there's a lot to do with the Lowell brand. Our mission is to migrate wallet share from packaged flower Into the pre roll category and ultimately into our wallets. And we have a plan as to how we're going to do it. The plan involves Product innovation, vast quantities of flower, large scale pre roll and packaging automation And a marketing campaign that empowers change in consumption. Now the good news is that we're bringing a larger audience to this conversation. Our recent launch in Illinois has exceeded our expectations at the very early stage. Launched in only 8 stores within the state, Which has approximately 110 stores. We sold over 5,000 packs in the 1st 9 days, approximately double our expectation. Later this month, we'll begin wholesaling our product to other dispensaries across the state. Now in anticipation of that launch, our team was on the ground this weekend Meeting with dispensaries and the demand is enormous. I'm extremely excited to be joining the moment that cannabis is having in Illinois. The momentum here suggests that this is an extremely compelling start. And if we're correct about the viral nature of this product and its iconic Packaging, we should see demand escalate as awareness grows. Now it's conceivable that volumes in Illinois exceed that of California As soon as the end of this quarter, to put that in context, we're currently selling approximately 50,000 units a month in California. So in Illinois, this isn't a sideshow, it's an exhibition. Now the end game with Lowell and the Lowell consumer is to catch them with an idea that they haven't heard before. And that idea is that smoking cannabis can be sexy. They've heard that smoking weed is legal. They've heard that smoking weed might have gotten a bad rap and they've heard it can even be medicinal, but they haven't yet been convinced that smoking weed can be sexy. And that's the essence of Lowell and it is a foundational element of many best in class brands throughout history. A low joint is not something you hide. It's something you share. It's a badge and it's a badge for those that get it. Lowell is how cannabis comes into the party, not lurking around out back in the parking lot or out on the fire escape. What was something you share and show off? Now that's the message we deliver our consumer. Alongside that message, We're going to deliver a product that replicates the price point and selection of flower. And that's how, in short, we plan to migrate share from flower, A category that's approximately 5 times the size of pre rolls into low smokes. As to our launch in other states, We're still on track to launch Massachusetts later this quarter. We've also had multiple requests to launch Lowell in new markets. We're evaluating all those alternatives now and fully expect to add more markets in the very near future. Our strong instinct is to get these 2 markets launched And to use that experience and momentum to inform the next few launches. Most importantly, I am highly encouraged By the willingness of MSOs to allow outside brands onto shelves in their limited license markets. And I think this is telling us something about an important shift in the balance of power in cannabis. Over in California, We're positioning Lowell to be successful in an incredibly competitive operating environment. The recent launch of Lowell Farm Services, a business That has dual purposes. It gives the company an alternative line of business, which has very strong fundamentals And a very long future that is fundamentally intertwined with the inevitable outcome whereby California becomes the epicenter of cannabis cultivation in the United States. It also gives us access to vast quantities of flower that we can use for inputs in our CPG business. Coupled with our existing farm, LFS gives us access to all the flower we need Without having to make large capital bets on commodity prices over the long term. Now this isn't to say that we're not going to acquire any more cultivation, but it will be done opportunistically. Now, as you will recall, we pivoted into this strategy after analyzing The pipeline of new supply coming online in California. Indeed, we estimate now that total Canopy in California grew over the last 12 months by 59%, fueled by an explosive increase for outdoor canopy of 94%. Now what's important to know is that virtually none of this outdoor canopy has any legally compliant way of drying their flower. And that is why we commissioned the launch of Lowell Farms Services. We already have a pipeline of customers It goes well beyond our ability to satisfy. The other side of this coin, however, is that the increased Canopy has put downward Flower that was trading for well over $1100 per pound only a quarter ago is now trading for under $800 a pound. Obviously, we're exposed to this price drop. During the Q2, dollars 5,700,000 of our revenues came from the sale of excess or bulk flower from our greenhouse. This pricing headwind is going to have an impact on revenues During the Q3 as we ramp up LFS. This is the tempest that we saw coming and we prepared for it, but nonetheless, we will feel its impact. Altogether though, I'm very pleased with our positioning and execution. With that, I'm going to turn it over to Mark. Mark? Thank you, George, and good afternoon, everyone. I would like to start by giving an update on the operational progress and the cultivation. I will then go into CPG progress and give you Insight into our newly launched Lowell Farm Services and finish with an outlook for Q3. Let's start with updates on the farms. The team at the farm is working extremely well together under the current structure. They were able to leapfrog the quality of the flower and the processes in the nursery to be able to come out of our vegetative state With plants that are twice the size of the plants that we use to harvest, which in turn increased the net weight Overall, the net wet weight per room used to be £1900 and now we're averaging £2,800 plus And as George mentioned, we exceeded our flower guidance for production in the Q2. We were able to do this by cutting down our turn times The ability to turn the rooms faster and with the right genetics gave us additional harvest Throughout the quarter comparatively. In Q1, we had 36 harvests compared to 40 in Q2. So these indicators show that we are on the right path and we are now on a trajectory of achieving the 40,000 plus We also spent a good portion of Q2 dialing in our automated environmental systems. Q1 came with a lot of learnings. And once we understood how each flowering room and each greenhouse reacted to the initial Out of box programming from the manufacturer, the team employed a specialist to help them tweak the environmentals in each room We added additional shading in the common areas of each greenhouse And that helped drop the temperature in the first 15 feet of each room by 20 degrees. And the plants are a little cooler, We're able to leave the lights on a bit longer to give them more supplemental lighting. This is allowing us to have continuous increase in output, Which is reflected on the harvest report and we're seeing a more balanced potency at approximately 22 plus percent across all harvest. Why are we talking so much about environmental at the farm? Well, for a couple of reasons. When we look at our genetic library, we know that Some of our star performers over the years thrive in certain environments. So what we're doing right now is collecting a lot of data and dialing in What times of the year each of those rooms are going to provide the optimal temperature to grow that particular genetics. The data has shown that our specific genetics perform better In one house than another, and we are focused on ensuring we provide the best environment for each cannabis strain to flourish to its best potential. This is an exciting phase and we look forward to reporting back to you on how our learnings and improvements as well as the positive impacts on our annual Moving to CPG. We continue to be pleased with And comments from dispensaries and customers who feel that there is a drastic change and a resurgence of excitement about our marquee brand, And as I just mentioned, we are constantly improving the quality of the materials going into the Lull product line, And that has clearly made a positive impact on the brand. We have meaningfully increased our presence in California with Lowell, And we went from being in 189 dispensers at the end of Q1 to 399 at the end of Q2. We have also evolved our core offering With the addition of strain specific SKUs and a reintroduction of Quix back into circulation, our Quix are pre rolls with smaller serving sizes. With the increased output from the farm, we've also been able to better time our menu selection. For instance, when we first acquired Lull, We would launch 2 strains at a time because that's the cadence of which things are coming out of our cultivation. But because of efficiencies at the cultivation, we're able to offer 6 or 7 different strains at a time and every time we do that, we see an increase on order values from our dispensary partners. Simply put, The bigger the menu, the more they order. With the high desirability of the Lowe brands, dispensary partners that have Previously have been ordering legacy products have now added mold products to their orders and vice versa. This has resulted in a positive trend on our average order value It has increased from $3,900 at the end of Q1 to $5,800 at the end of Q2. Our revenue numbers from the quarter also show that after the merger of the 2 sales forces, our team has integrated well and each individual has brought value to the Also, and as George spoke about earlier, our big focus for our team is going to be on trade marketing and consumer engagement Through creative activations and thoughtful marketing campaigns focused on bud tenders and consumers. The third item I wanted to touch on is the newly launched Lowell Farm Services. The new first of its kind facility in Salinas We'll process all cannabis grown at our cultivation operations. Our new business unit will also engage in fee based processing services Regional Growers from the Salinas Valley area and beyond, one of our largest and fastest growing cannabis cultivation regions. The facility currently includes 8 environmentally controlled segregated drying rooms, Each capable of accepting in excess of up to £30,000 of wet cannabis plant material per month. Additionally, the facility has A dedicated footprint for bucking and trimming, which is done by a combination of mechanized and hand trimming stations. As we discussed at the time we announced the new venture, we see an enormous benefit to providing these services to neighboring farmers, And we have a backlog of customers who are looking to onboard at the facilities. LFS came from the pressing need in the market For which we see no other solution in sight. And so far, that business unit is doing well. We are learning a lot quickly, And we've already made enhancements to the process from all aspects of post harvest processing and working through label efficiencies. The business unit has incredible potential and we haven't even scratched the surface. LFS is quickly becoming an important part of our business. We've named its own dedicated Vice President and right now it's one of the highest priorities With all that being said, there is no doubt there is major market compression in California right now. As George mentioned, We have seen a decline in bulk sales and it is unclear as to how long that decline will last, but the team is working very hard to shift gears And to pushing all of that biomass into our CPG product lines. The team will continue to utilize every asset The great thing about this team and this company is that we all have a strong sense of commitment And we are compelled to succeed and support one another to do so. And with that, I turn it over to Brian. Thank you, Mark, and good morning, everyone. Before I begin, please note that we are reporting our Q2 results in U. S. GAAP and a portion of my commentary will be on a non GAAP basis. So please refer to today's earnings release for a full reconciliation of GAAP to non GAAP results. We report all figures in U. S. Dollars unless otherwise indicated. And I would also note that our quarterly report As Mark highlighted, we reported Q2 revenue of $15,200,000 Up 37% sequentially and up 53% year over year. Revenue in the quarter reflects significantly improved yields from cultivation in the quarter, Benefiting from new genetics and yield enhancement efforts implemented in the past 6 months. Q2 revenues included over $5,800,000 in Lowell brand Sales resulting from our acquisition of the Lowell Brands effective February 25, while year to date revenues included $6,700,000 in Lowell Branded Sales. I should also note that revenues were impacted by the decision to significantly reduce lower margin third party agency and distributed brand sales and focus primarily on higher margin owned brand products. In Q2, Agency and Distributed Brands declined $700,000 or 55 sequentially and $2,100,000 or 77 percent year over year. On a year to date basis, we reported revenue of $26,200,000 An increase of $6,800,000 or 35 percent over the same period last year. We anticipate revenues in Q3 to be Roughly in line with Q2 at approximately $14,000,000 to $16,000,000 given the headwinds that are impacting bulk and CPG pricing. We also expect initial billings by Lowell Farms Services in Q3 as a result of our acquisition at the end of June, And we expect initial license revenue to be realized in Q3 resulting from the Ascend Wellness launch of Lowell Smokes pre rolls in Illinois in the quarter. While Lowell Farm service and license revenue is not expected to be significant in the Q3, we are pleased to realize these revenue sources, which are expected to grow for the balance of We will be reporting a new metric starting in Q3. GMV or gross merchandise value, a pro form a metric Turning to gross margin. Gross margin as reported was 38% in the 2nd quarter compared to negative 13% both sequentially and year over year. The margin improvement over the Q1 this year and Q2 last year was due primarily to yield improvements experienced in cultivation, as well as a reduction of lower margin agency and distributed brand revenue. We expect to see gross margins contract Somewhat from Q2 levels given some of the pricing compression we are experiencing along with investments we are making to ramp up Lowell Farm Services. I should also note that gross margin is impacted by GAAP for finished goods purchased in an acquisition since finished goods acquired are 3 percentage points in both Q2 and year to date. All acquired inventory was sold by the end of Q2, so there will be no continuing margin impact Operating expenses were $6,200,000 or 41 percent of sales for the quarter Compared to $4,200,000 or 38 percent of sales in Q1 and $3,500,000 or 36 percent of sales in the Q2 last year. Operating expenses in the Q2 reflect a full quarter of selling and administrative staffing associated with the Lowell brand acquisition And the impact of new marketing initiatives focused on the loyal brands. As noted earlier, loyal brand revenues were $5,800,000 in Q2 and $6,700,000 year to date. The operating loss in the second quarter was $473,000 compared to an operating loss of 5 point $7,000,000 sequentially $4,800,000 year over year. The operating loss year to date was $6,200,000 compared to $11,900,000 in the same period last year. Net income for the Q2 was $731,000 which included income from insurance claim proceeds of $2,600,000 which compares to a net loss of $6,700,000 in the 1st quarter And a net loss of $8,800,000 in the Q2 last year. Adjusted EBITDA in the second quarter, which excludes The $2,600,000 in insurance proceeds was $740,000 compared to negative adjusted EBITDA of $4,600,000 sequentially And negative adjusted EBITDA of $7,200,000 year over year. Turning to the balance sheet. Working capital was $22,000,000 at the end of the second quarter, comparable to the amount at the end of the Q1, and the company had $9,100,000 in cash Compared to $13,600,000 at the beginning of the quarter, inventory supplier advances and excise and cannabis tax payments Increased $2,700,000 in the quarter, while accounts receivable declined $900,000 reflecting continued aggressive collection activities. Capital expenditures of $200,000 were incurred in the quarter. As noted earlier, at the end of June, we completed the acquisition of the 40,000 We're a foot processing facility that will house Lowell Farm Services operations. The acquisition was funded by a $9,400,000 mortgage loan And the issuance of approximately 8,000,000 subordinate voting shares. With that, I'll turn the call back to Mark. Mark? Thank you, Brian. I'm incredibly thankful for the team's passion to execute at the best of their abilities. I am also thankful for our investors who quarter after quarter continue to double down on their support. I look forward to sharing more with you as we continue to solidify Our positioning within the California market and beyond. Thank you. And with that, I turn it back to the operator. Thank you. At this time, we will be conducting a question and answer session. Our first question is from Jason Zandberg of PI Financial. Please state your question. Thanks for taking my question. Just given the The success of the L'Oreal Smokes and the L'Oreal brand, do you anticipate at some point In the next number of quarters that the biomass that you're growing will be Enough to that you won't have to be selling in the secondary market, the wholesale market Or just I know you're increasing that production output, so just wondering whether they'll ever intersect here in the coming quarters or whether This wholesale revenue you expect to be doing for the foreseeable future? Hey, thanks, Jason. I'll take that question. And I will generally say that obviously your hope is to think we think of it as excess flour, right? So your hope is To put as much of it is out there in the hands of consumers directly and have your soldiers fighting your fight and not somebody else's. I think the reason for why it doesn't always get in that end product is because There's only so much shelf space that you can occupy in dispensaries and it's very hard To sort of keep a price point where it is and increase volume sort of all at once. And so we had we nearly doubled the output in flower Out of the farm and so we went from no excess flower to a lot of it. The hope is that I think one thing that we really like about LFS is it gives us visibility into several £100,000 of Quality Flower that's moving through and it gives us access to that product in a way that allows us to Take some smalls here to add and complement our line and pre rolls over here allows us to take some large flower over here to So I think the general idea is that As we move back and forth, we are going to be a participant always in this wholesale market because the LFS business Somewhat always going to be having activities in that market. But The ideal scenario is to build the branded products as far and as fast as you can And not be handicapped by a lack of flower like we were in the Q1. And so as we invest in our future On these brands and work really hard to put the branded products out there, the worst thing you can do is generate the demand and not have the product. And so our biggest fear is asymmetric that you don't have enough versus having too much. And so what we've secured in LFS is The ability to basically have a variable amount of or an infant amount of flower to satisfy our demand, That's more of the pressing issue. But I will say that, yes, of course, we fully anticipate that our branded products business will Continue to grow and can overwhelm even the production volume of our current farm. Okay. No, that's great. Just turning to gross margins, just a fantastic improvement over the Q1. I did hear That sort of guided for maybe a little bit of a weaker quarter next quarter due to this nature of this wholesale. Do you I guess my question is post Q3, where would you Like to see margins where do you think they could get in sort of the next number of quarters outside of this next quarter, which you've already sort of pre guided to that will be a bit lower? Hey, Tom, just like long term runway model. I think our gross margins this quarter are indicative. I think there was a handicap this quarter of a couple of points from the acquisition accounting. But I think beyond that, I think the gross margins this quarter are indicative of what we think long Term potential gross margins can be, if not even higher. Obviously, I think we would try to be pretty explicit and talk to investors about what we think It may happen this quarter. There's definitely some chop in the marketplace right now as some of the weaker players who don't have branded products Are going to really, really struggle to move product. Yes, absolutely. Okay. And just finally my last question. You put in some new technology to offset any risk of wild Fires and the associated smoke. I don't believe there were any wildfires near Salinas area, but I could be wrong. Have you had to utilize that technology this summer or have you been fairly free of wildfires in that area? Mark, why don't you take that? Yes. There's been a few small ones in the general vicinity. We have not yet had to utilize any of the safety features that we built in after last year. We kind of have a couple Different protocols, all generated through the ARGUS system and some other systems that we have. But no, we have done the mock drills, but we have not had to actually utilize it due to smoke. Okay. That's great. Good to have it, probably even better than not to use it. All right. Thanks very much. A confirmation tone will indicate your line is in the question One moment please while we poll for additional questions. There are no more questions at this time. We have reached the end of the question and answer session. I will now turn the call back over to Mark Ainsworth for closing remarks. Thank you again for joining the call and for taking the time to get on and get an update of our business. We look forward to talking with you on our next earnings call. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation and have a great day.