Good morning, everyone. Welcome to Rubicon Organics' Q3 2021 financial results conference call. As a reminder, this conference call is being recorded on November 17, 2021. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. Instructions will be provided at that time for research analysts to queue up for questions. I will now turn the call over to Marc Charbin, Investor Relations. Please go ahead, Marc.
Thank you, operator. Good morning, everyone, and thank you for joining us today. Rubicon Organics' Q3 2021 financial results were released this morning. The press release, financial statements, and MD&A are available on SEDAR, as well as on the company's website, rubiconorganics.com. Before we begin, I'll refer you to slide two of our presentation, which contains Rubicon Organics' caution regarding forward-looking statements. I'm joined on the call today by Jesse McConnell, Chief Executive Officer, and Margaret Brodie, Chief Financial Officer. I'll now pass the call over to Jesse.
Thank you, Marc, and good morning, everyone. We have been steadfast in our mission to grow the best cannabis on Earth and for the Earth, and we are beginning to reap the benefits of that focus. Q3 was a breakthrough quarter for Rubicon Organics as we achieved record revenues and gross profit, made significant market share gains, and established Simply Bare Organic as the number one premium brand in Canada in flower and pre-rolls. As the cannabis industry matures beyond mere production and distribution, we are beginning to see the emergence of durable consumer brands and the loyalty associated with them. Consumers and budtenders alike are singing the praises of Simply Bare Organic, and that chorus is growing louder. Consumers are looking for brands that resonate with them, and on slide three, we can see the results of their search.
Simply Bare Organic has emerged as the number one premium brand in Canada for flower and pre-roll, with a whopping 8.3% of the national premium market. We've made strong gains in the three largest markets, securing the number one position in Quebec and maintaining our pole position in our home province of beautiful British Columbia. Together, the flower and pre-roll market make up over 70% of the total market, and it continues to grow. It is the performance of the pre-roll segment that has been the most impressive, with year-to-date growth in 2021 compared to 2020 an astounding 77%. Pre-rolls are particularly appealing to the new legal market entrant, who is often less price-sensitive and prefers pre-rolls for the convenience.
In the premium pre-roll segment, Simply Bare Organic has an impressive 18.5% market share nationwide, and even more impressive, in our home province of British Columbia, home to some of the most discerning cannabis consumers in the world, we command over a quarter of the premium pre-roll market with a 26% share. The recognition of Simply Bare Organic as Canada's number one premium cannabis brand reveals its latent potential when you consider that cannabis markets are only now beginning to open up globally. There's been a lot of buzz in the premium market in Canada as of late. We've seen some M&A. We've seen some large LPs indicate they are planning to increase share in the space. We've also seen some smaller craft LPs come to market with decent product. Establishing brand recognition in the premium space takes a lot more than good intentions.
You need a facility that is designed to produce high-quality product profitably with a great genetic library. You need a strong marketing team to design and align the brand architecture and strategy with consumer insights. You need a supply chain team that can ensure the product is packaged properly at scale and is consistently available on the store shelves. You need a strong sales team to gain points of distribution and in-store brand placement that maximizes the shopper's journey, the communication of the brand's value proposition to the relevant stakeholders, such as buyers and budtenders. Ideally, you have a portfolio of brands so that the buyers are able to leverage their relationship with you to fulfill some of their needs outside of the premium segment. All of this takes significant working capital and time. This is why we are so bullish on Rubicon's positioning.
We have the right size facility to generate significant operating leverage. We have the perfect suite of brands to optimize margins across all of our cultivation. We understand the various consumer segments and our consumers in particular. We are expanding our brand umbrella to include our recently launched 2.0 product innovation in hash and live rosin, both of which I'd mentioned have garnered rave reviews. We have now been in market long enough that consumers are getting to know and love our brands and our company. The rest of the world is looking at the Canadian market as a testing ground for their own regulated cannabis markets. As the cannabis industry evolves into a global marketplace, there is a tremendous opportunity for Rubicon to build brand recognition and to create meaningful differentiation through our focus on organic production and sustainably marketed products.
A recent 4-year NYU Stern study of consumer purchase behavior reveals that sustainably marketed products delivered 7.1 x faster growth than products not marketed as sustainable and enjoyed a significant 39.5% price premium. This was particularly true for upper-income, college-educated urban millennials, who represent a large target segment for Rubicon Organics. In a global marketplace, there's every reason to believe that these macro consumer trends will apply equally to the cannabis industry. On slide 4, you can see that in the organic flower and pre-roll market in Canada, Rubicon has the dominant brand portfolio in every province for which we have reliable data. Organic isn't just a stamp we place on our product, and it's more than the story of sustainability that underpins it. Organic production creates real physical attributes that translate into a premium value proposition.
Savvy consumers report an enhanced and longer-lasting experience, better flavors and aromas from the elevated terpene profiles, and smoother vaporization. It is the coming together of these characteristics, along with emerging consumer values, that create leadership in the premium sector. We continue to explore how to best position our brands in the international markets, and as we previously indicated, we built EU GMP capability into our facility. We are currently awaiting inspection from the German auditors, and we anticipate receiving our certification in Q2 2022. In addition to Germany, we're exploring other international markets in the EU and elsewhere, and expect to make an announcement to that effect in Q1 2022. Rubicon had an outstanding quarter, registering record net revenue growth of 54% sequentially over Q2 2021, and over double the net revenue from this time last year.
Coupled with this was an increase in gross profit of nearly CAD 2.2 million from the previous quarter, which demonstrates how significantly we benefit from operating leverage as we drive the top line. A big part of these results is what we have worked so hard to achieve this past year, which is the national rollout of our good, better, best brand portfolio strategy. This enables us to optimize margins across all the products we produce. In the upcoming quarters, you'll see the implementation of the next phase of our strategy, where we will focus on increasing our flower production and the percentage of the product and brand mix that is sold through our premium brands.
In early Q3 , we had 1964 Supply Co, our premium brand, and Homestead, our mainstream brand, accepted for listing at a number of large provinces, and we rolled those out over the course of the quarter. In Ontario, by far the largest cannabis buying market in Canada, 1964 hit the shelves in September and Homestead in October. Subsequent to Q3, with our entire portfolio of brands in market and with coast-to-coast distribution, we became a top 10 LP with a national market share of 2.2% for the three months ended October 31, and we've achieved this by producing at a single facility with our own sales and marketing team and without any wholesale sales. On slide 5, we can see some of the brand assets that we send to the provinces.
Going forward, we are focused on increasing our yield with a plan to deliver an 11,000 kg run rate by Q4 2022. You can also expect to see a number of line extensions under our existing brand portfolio as we introduce exciting new high-THC and high-terpene strains, like our recently launched Island Pink Kush Insiders Cut, with a range of 24%-26% THC and nearly 5% terpenes. All of which will be strategically positioned relative to our brand value propositions and to the buying preferences of different regions. Of course, we will never stop innovating. We continue to push the boundaries of quality, flavor, and format in our aptly named Dreamworks Theater, from which we have already dropped small batches into the market of some of the best, if not the best, live rosin available.
In early 2022, we anticipate bringing new products to market, like infused pre-rolls and live rosin vapor cartridges. Our strategy of staying focused on the premium segment with a vision to build a portfolio of global premium cannabis brands is paying off with record revenues, gross profit, and consumer recognition. With that, I will pass the call over to Margaret.
Thank you, Jesse, and good morning, everyone. I'm very pleased to report that in the Q3 of 2021, Rubicon Organics reported record net revenue of CAD 7.1 million. This is a 54% or CAD 2.5 million sequential increase relative to Q2, and a 124% or CAD 3.9 million dollar increase over Q3 in 2020. The month of September 2021 was Rubicon Organics' highest-ever month of revenue achieved. As compared to 2020, the increase in our net revenue is attributable to our expanded SKU count for our super premium brand, Simply Bare Organic, the rollout across Canada of the premium brand, 1964 Supply Co, and the launch of our mainstream brand, Homestead, in a number of provinces.
Just as important as the increase in brands and SKUs was that in Ontario, retail stores have begun returning to more normalized buying patterns. We also made tremendous improvements towards profitability in Q3. On net revenue of CAD 7.1 million, we reported CAD 1.8 million in gross profit before fair value adjustments. This is a quarter-over-quarter improvement of CAD 2.2 million. This calculates to a gross margin of approximately 25%. Our accounting methodology of expensing and not capitalizing our production costs allows for significant operating leverage, and this is clearly evident in Q3 2021. Consistent with what I have said in the past, our cost of goods sold are expected to remain relatively fixed as compared to the current levels with the growth margin coming in from increased net revenue and throughput of our facility.
We are focused on bringing products to market that drive higher growth margin under our Simply Bare Organic and 1964 Supply Co. brands. We reported an adjusted EBITDA loss of CAD 600 thousand in Q3 2021, a substantial improvement of CAD 2.8 million versus Q2 2020. The improvement in profitability reflects the operating leverage we realized on the gross profit line and a full quarter impact from the restructuring we announced in May. We ended the quarter with approximately CAD 12 million in cash and CAD 23 million in working capital. We are feeling very confident in our financial position, especially given the way revenue is trending over the medium term and our very tight cost base. From a capital perspective, we have recently taken delivery of six new HVAC units, of which three are fully installed, the last just yesterday.
The remainder are expected to be installed by the end of January 2022. These HVAC units are part of our strategic plan to deliver an 11,000 kg production rate by Q4 2022. The next significant budgeted project is the BC Hydro grid connection, expected to be completed by the end of the Q2 of 2022. The BC Hydro connection is expected to reduce operating costs by over CAD 1 million annually and drive us towards meeting our ESG goals. Turning to our financial objectives, I am very proud to say that we hit our goal of becoming monthly adjusted EBITDA positive for the first time in September of 2021. This leads to the question of whether we will be adjusted EBITDA profitable in Q4.
As of today, we do not think we'll be quite there as we are experiencing a transition period and some timing lags between when our new genetics for Simply Bare Organic and 1964 Supply Co. become available on show, as well as the impact of our new capital CAPEX installation. Continuing on our positive trajectory, we forecast being cash flow neutral in Q4 as we see cash unlocking from our investments in working capital over the last year. Our outlook is bright for 2022. Next year, we have a plan to achieve 11,000 kilo run rate at Delta while continuing to cultivate the best cannabis on Earth and for the Earth. We expect to see revenue growth and increasing margins from having our whole brand portfolio in market. We will be introducing more product SKUs and innovations under our Simply Bare Organic and 1964 Supply Co. brands.
All while our operating cost base is expected to remain essentially flat, enabling us to continue to deliver operating leverage. On the international front, we are in close communication with our German audit partners, and with COVID travel restrictions easing, we are expecting to receive our EU GMP on-site audit in the near term. In parallel with that, we are expecting to announce other international routes to market, the details of which will be released soon with our first deliveries expected in the H1 of 2022. All told, we expect that Rubicon Organics will be adjusted EBITDA and cash flow positive in 2022. It has taken a lot of hard work to develop our brand, optimize our cultivation, and remain vigilant in allocating our financial resources.
We are, and I am, thrilled to be in the position where we can say with confidence that we plan on achieving adjusted EBITDA and cash flow profitability next year. With that, operator, please open the line for questions.
Ladies and gentlemen, if you would like to ask a question, please press star one on your telephone keypad. We'll pause for just a moment to compile that Q&A roster. Your first question comes from the line of Rahul with Raymond James.
Morning, Jesse, Margaret. Thanks for taking my questions and congratulations on this really strong quarter. Really well done.
Thank you, Rahul.
My first question really is, you know, focusing on that top line or staying with that top line. You know, we saw an announcement from one of your much larger competitors this morning, you know, driving hard in the super premium segments, and obviously likely putting, you know, some of the weight of their balance sheet behind it. You know, now you have been a significant player and continue to be a more and more significant player in the super premium space. You know, this is becoming a more and more competitive space. A lot of your peers are recognizing that margins are much higher here. Given the growth that you've seen, how do you plan on, you know, not only defending your existing market share, but also, you know, continuing to expand it given the competition?
Thanks, Rahul. That's a great question. We've been saying for quite some time that we believe in the premium segment and that that is where the margin is. We also believe that over time, the premium segment is going to continue to grow with the maturation of consumers' taste preferences. We've seen that in other marketplaces.
There would be no surprise that we would see that in the Canadian marketplace as well. Further to that, what I'd say is, I think it's difficult in this space to build the mainstream Coca-Cola of cannabis. What we see is a fairly fragmented marketplace where quality and brand recognition is standing out, and many of the consumers are looking to identify with smaller LPs, smaller to mid-sized LPs, where they can manage the quality more easily and where you know akin to what you see in things like craft beer. I expect to see that segment growing. I'm sure we'll see some additional competitive pressures in there, but we're very confident with the position we have of Simply Bare.
Our point of difference here, both in terms of the physical attributes of organic production and our focus on sustainability, I think is gonna stand us apart from the more traditional hydroponically conventionally produced products.
Great. That's the color. Thanks, Jesse. As a follow-up and sort of, you know, moving, looking further down, you mentioned that you are looking to balance inputs into your Homestead, 1964 and Simply Bare as a way to optimize your cost of goods and as a result, margins. Can you maybe give us a little bit more color there in terms of what that strategy is, how you're doing that? Also just kind of as a part two to that question, how do you expect the product split? What is the contribution of Simply Bare today, and how do you expect the contribution from each of these three different verticals to play out over the longer term?
Another great question. The sell-through in Q3 for us and the use of Homestead, it is tactical. We've always talked about a good better, best strategy, but our resources are focused on Simply Bare and 1964. Homestead is a great avenue to move some of our slower moving products or products that don't meet the quality standards and our expectations for our other two brands. We can very quickly cycle through that. Going forward, we're not anticipating having, as our quality has improved significantly over the last two quarters in the aggregate, we won't have the same level of production available for Homestead. It would be 1964 and Simply Bare, which are currently supply constrained, will take up the majority of that production.
As for market mix, I really see that mirroring what we see in the marketplace today. You know, Simply Bare as a super premium position brand has outsized market share relative to the size of the super premium market. I would, if I was to put a number behind it, reluctantly, being that I can't predict the future, that Simply Bare would have approximately 20%-25% of the sales of 1964, about a third. Look, something between that and 40%. It's really difficult to predict that right now given the amount of time that 1964 has been in the marketplace, but we've seen tremendous uptake for it. If we can- i f we can maintain the production needed for the demand in 1964, then that's about what you can expect. You know, 2/3, 1/3 mix.
I think I would add to that, Rahul, we have no intention of cultivating for Homestead. We cultivate for specific strains for 1964, and we cultivate for Simply Bare. We are targeting a much lower percentage of Homestead going forward, which means for consumers it will be unlimited, the limited time.
Right. That's perfect color. Then just a final sort of quick question for you, Margaret. You mentioned that the essentially incremental sales margins and costs and some CapEx in Q4 would probably be the rate limiting step to getting to EBITDA positive. Can you give us a sense of what we should expect there in terms of what we should be calculating there for our models, in those incremental costs, but particularly in what we should be expecting for CapEx in Q4? I'll leave it there.
Yeah. We have some timing issues in Q4 coming up, and actually not helped by what we found out in the last two days, which is Vancouver is effectively an island. We are gonna be hit by some additional shipping costs as well to air freight our product to the east, obviously not being able to go down through the U.S., like other products can. The rail and trucking lines out of Vancouver at this stage are shut down, and look to be for a while. In terms of the actual crop availability, it's just a timing issue. We believe that the crops that we have coming down will be really available in Q1, and it's timing with the product on with listings with the provinces as well.
With CapEx and the HVAC and various things happening at site, obviously, if you're working overhead of plants, you know, we don't want anything going into any plants, so we take a safety approach. It will hit us a little bit in this quarter. We're working on identifying exactly what that is. We'll come back to you, Rahul, and we can speak after this as well about some of the details on that.
Great. Thanks so much. I'll leave it there. Congratulations again on the quarter.
Thank you, Rahul. Appreciate your calls.
Your next question comes from John Chu with Desjardins Capital.
Hi, good morning. Can you maybe just talk about these timing factors into a bit more detail here? I mean, is there a risk it's gonna spill into the Q1 of next year?
The timing issues, good to hear from you, John. The timing issues really have to do with the installation of our HVAC. As Margaret mentioned, we've got three of the six very large HVAC units installed on site and commissioned now. Put in perspective for callers, they're the size of a school bus. As we commissioned and installed these, we saw some delays sequentially on each crop. Let's say there's two-week delay approximately for each one of those installations. The result of that is some of those crops, by the time they are fully hang-dried, trimmed, and available for the consumer, some of those crops are gonna slip into Q1.
I think the exacerbation of that is that the recent news here in Vancouver of the extreme flooding that we've experienced. Not at our site, to be clear. There's no issues on our site. As Margaret mentioned, Vancouver is legitimately an island.
We're assessing this.
The U.S. border officials don't take kindly to truck-tractor trailers of cannabis coming over the border to get around those issues. Looks like we'll be air freighting along with everybody else here in Vancouver. There's that issue, the issue of some of the timing of the crops. Then with the OCS listings that we achieved and we spoke about in our, not our operational update, the updates prior to that, the OCS then went and pushed back a lot of the timing of those listings. Product that we expected to have on shelves in December is now gonna be landing in January. You know, there's some impact to that from the OCS.
Effectively, we will have cultivated, and then the sale comes a bit later.
Okay, great. Maybe just a little bit more details on the pipeline of new products you have coming in. I think you said, infused, pre-rolls, but can you maybe talk about what else you might have coming down the pipeline and timing of that?
Yes. We spend a lot of time working on innovation. As you've seen, with the achievement of our premium capturing the first place in premium in flower and pre-rolls, as you can imagine, we spend a lot of time working on genetic innovation. We have literally gone through hundreds of trials with our various genetics, and some of those are beginning to come to fruition. Just to give you an example of that, if you test 50 genetics, you'll find one of those genetics that you think have all the attributes that the consumers are looking for, while still having the characteristics to drive, you know, revenue and profitability through their yields and pressure resistance.
You'll see a lot of new genetics coming in Q1 and Q2, you know, the latter half of Q1 . As to the 2.0 innovations, things like infused pre-rolls, or what we like to call the Jeffrey, is something we've been working really hard on. We spend a lot of time working on stability of our products. We hear from consumers time and time again that things like live rosin cartridges work great for a week, and then they stop working. We spend a lot of time working on our stability, ensuring that the consumer experience is gonna be excellent. You'll see a variety of live rosin products come to market. You'll see the infusion of some pre-rolls, and there's a few other things that I'd rather just hold back right now, and surprise you later, Q1 , Q2 .
Okay, great. Just last question, maybe as a follow-up to one of your earlier questions. Maybe just talk about just the market size of the premium flower and the premium pre-roll market. I know the pre-roll market has been gaining a lot of momentum, but maybe just talk about the premium market as a whole. Are you finding that category is gaining market share in the industry, or is it maybe in certain pockets across Canada?
Well, I mean, of course, there's gonna be, you know, different regional aspects of it, but the macro trend we've always held is the same. It mirrors all of the other market shares in cannabis. Frankly, this is just a trend in CPG, is the move towards premiumization. I don't wanna get into specifics on the premium market share versus the total market share, 'cause you have access to that data in the same way I do, John. Exactly how one wants to define premium is always a question here.
If we look at some of the industry leaders and where they've talked to that, you know, Canopy coming out today talking about the Canadian premium flower market continuing to grow, accounting for more than 25% of all recreational market sales in Q2 , with, you know, volume increase over Q1 of 12%. We're expecting to see this segment continue to grow. It's in line with the transfer of consumers coming out of the black market, many of which who were premium consumers and weren't in the legal market, frankly, because of the lack of available quality and choice, and the natural evolution of consumers' taste preferences. As consumer becomes more accustomed to the product, the first time they try it, they're likely not going out and paying for that super premium experience.
They become more adept in the categories, they're looking to enhance that experience in the same way we see things like wine and other consumer packaged goods. We're very bullish in the premium segment. I'm expecting to see it continue to grow. And I am expecting to see a little bit of competitive pressure in that space as other LPs realize that that is the future of margin and of the flower category.
Okay, great. That's it for me. Thank you.
Thank you, John.
Your next question comes from the line of Colin George with Haywood Securities.
Good morning, Jesse and Margaret, and thanks for taking my questions.
Morning, Colin.
Just maybe building off one of the prior questions there relating to gross margins. When you take a look at inventory expense, as a portion of sales, that's been relatively constant at 43%-44% quarter-over-quarter. You would have maybe thought there might have been a bit of a drag with Homestead introduced to the market, but doesn't seem to be the case there. With your kind of target split, do you think this is a level that's maintainable around like low 40%, or will there be a bit of a compression as you get more Homestead sales and there's more competition in the market? Understanding there's volatility on a quarter-to-quarter basis.
You know, frankly, we actually think that we're going to see that number decrease as a percentage. Throughput is absolutely key, so operating leverage and the increased amount that we are going through will be more efficient. We are also seeing, you know, improvement because we've now been operating for longer, so we're able to grind in and look at optimization of processes. I believe that percentage will start to reduce.
Okay. Thank you. Then maybe just another question here. With regards to your restructuring, Don, it looks like it's paid dividends pretty quickly, run rate down by almost CAD 2 million annually. Is there more optimization that could be done there, or do you think that this is probably the new level to build off of as the business expands here?
Can you just ask that again and clarify a little bit more?
Your SG&A costs have came down quarter-over-quarter.
Oh, SG&A.
Quite a bit. Yeah.
Yeah.
It looks like the about CAD 2 million annually in savings already realized from the restructuring done. Do you think this is the appropriate level to build off of, or is there more, synergies and optimizations that could be made?
I actually think what we're going to see is SG&A changing, increasing a little bit with some of the economic pressures that we're seeing. We obviously see significant inflation in wages, and that pressure is coming in this industry as well. We're seeing increased costs in things like insurance. While we significantly de-risked the business, our quotes and coverage continues to get lower with higher fees. You know, if we can hold fire or grow moderately, I think that's a win.
To add a little bit more color to that, Colin. We're not anticipating increases in the SG&A through headcount increases in any significant way. We are built for significantly higher revenues. In fact, you know, that restructuring we did two quarters ago was precisely a result of the impacts of COVID and having been geared, because our philosophy is, hire early, get people aligned, and then have that team that is ready to drive at the rate that we're looking to drive this business. We're not adding a lot of headcounts, but exactly to Margaret's point here, there is some inflationary pressures out there that are real around wages.
Some of the specifics of operating this industry and the joys of increased insurance premiums are some of the things that are gonna come through in the same way that they'll come through for all of our competitors.
Okay. Thank you. Yeah, that makes sense. No, it's all very helpful. Maybe just one last one from me. With regards to the timing in Q4 and the trajectory there, is it more so just a temporary stall in growth Q4 and then return to growth in 2022, or is it possible that we could see just a slight decline in the last quarter just due to the timing and shipping issues we spoke about?
Yeah, if we were a private company, we wouldn't be talking about a decline in the growth rate. This has got to do with the timing issues on how crops fall and when they're expected to be in market. As an example of that, we're pushing and working with the OCS to try to get more product in before Christmas. As you can imagine, you know, with the great sales on a seasonal basis. If the labs are overloaded right now as that big push is on, we wouldn't be surprised to see some of those things slip into January. It's very much a tactical timing thing, not a trajectorial thing.
Okay. Yep, that makes sense. Thanks for taking my questions, and congrats on a really strong quarter here.
Thank you very much. Appreciate it.
Again, if you would like to ask a question, please press star one on your telephone keypad. We have no further questions in queue. Do you have any closing comments or remarks?
I'll make one comment here. I'm really proud of the team for the delivery of this quarter. This really is accumulation of a lot of hard work, getting our good, better, best strategy into marketplace. Seeing the reviews for Simply Bare and 1964, and actually frankly for Homestead, I think has really been tremendous for the team. Really impressive that in such a short period of time with a company that has raised significantly less capital than our competitors, we've been able to secure the number one spot in flower in the country in premium. That's really a testament to the vision, the focus, and the quality of the product out there and the hard work of everybody in Rubicon Organics to secure that. I really just wanna say thank you to the Rubicon Organics team for a job well done.
This does conclude today's conference call. Thank you for your participation. You may now disconnect your line.