CA - Delta 9 Cannabis Inc. (DLTNF) Q1 2023 Earnings Call Transcript
2023-05-16 13:11:10 ET
Delta 9 Cannabis Inc. (DLTNF)
Q1 2023 Earnings Conference Call
May 16, 2023, 10:00 AM ET
Company Participants
Alexa Goertzen - Senior Executive Assistant
John Arbuthnot - Chief Executive Officer
Jim Lawson - Chief Financial Officer
Ian Chadsey - Vice President, Corporate Affairs
Conference Call Participants
Ven V - Research Capital
Presentation
Operator
Good morning, ladies and gentlemen. And welcome to the Delta 9 Q1 2023 Financial Results Conference Call. [Operator Instructions]
This call is being recorded on May 16, 2023. I would now like to turn the conference over to Alexa Goertzen. Please go ahead.
Alexa Goertzen
Good morning, everyone. And welcome to the Delta 9 Cannabis q1 2023 earnings call. At the time, all participants have been placed in listen-only mode. Following the presentation, we will open the line for a question-and-answer session for financial analysts.
Delta 9 would like to remind listeners that today’s call may contain forward-looking statements that reflect the company’s current views with respect to future events. Any such statements are subject to risks and uncertainties, which could cause results to differ materially from those projected in the forward-looking statements. For more information regarding risks and forward-looking statements, please refer to the Delta 9 Cannabis Inc. public filings, which are available on SEDAR.
I would now like to turn the call over to Delta 9’s Chief Executive Officer, John Arbuthnot. Please go ahead.
John Arbuthnot
Thank you, Alexa, and good morning, everyone. Thank you for taking the time to join us for Delta 9’s Q1 2023 earnings call. With me this morning is the company’s Chief Financial Officer, Jim Lawson; and our VP of Corporate Affairs, Ian Chadsey. Our earnings press release, Q1 2023 financial statements and Management Discussion and Analysis have now been made available on SEDAR and our company website.
And with that, let’s begin. Thus far in 2023, the Canadian cannabis industry has continued to deal with challenges relating to an oversupply of cannabis products, compressed cannabis wholesale margins, inefficiencies at provincial crown distributors and over saturation in the number of operating retail stores and capital markets volatility.
In the past year, Canadian cannabis industry sales have continued to expand, posting monthly retail cannabis sales of $426 million as of December last year and based on the most recent data from Statistics Canada. Annualized retail cannabis sales now exceed $5 billion. Even with growth rates in the sector beginning to slow, we anticipate the Canadian cannabis industry will double in terms of retail cannabis revenues by the end of the day.
Recently, we saw progress in the United States market in terms of material cannabis reforms at federal level. In October last year, President Biden announced that he would pardon certain individuals convicted with criminal records for cannabis possession, at the same time, announcing a sweeping review of the scheduling of cannabis under the Controlled Substances Act. The federal rescheduling of cannabis is seen as a gating item to allow firms like Delta 9 to expand to participate in the United States cannabis market.
In other international markets, Germany and the Netherlands have made progress on federal adult-use legalization initiatives targeting a 2024 launch in international markets, such as Israel, Australia, Asia-Pacific and various countries in the EU continue to make progress on advancing more progressive medical and recreational use cannabis laws.
We continue to believe that the growth rate in Canadian cannabis market and the global reform of cannabis laws represents a generational market opportunity for companies like Delta 9 to grow and unlock value for our investors.
I am pleased today to be presenting you with Delta 9’s Q1 2023 financial and operating results. These results include the first look at the company’s progress on our 2023 cost cutting and strategic plan.
We have many positive takeaways from today’s results, which we will highlight, as well as analyzing our misses, the challenges we have encountered and the changes we are making to continue to drive growth will create shareholder value. We will begin with a discussion of operations and material milestones for the company achieved over the reporting period.
On the cannabis cultivation and processing on this side of our business, we will begin with an update of activities at our Delta 9 facilities in Winnipeg. The primary purpose of these facilities is to cultivate, process and manufacture high quality cannabis products. The company’s proprietary cannabis production methodology is based around a modular, scalable and stackable production unit, which we call are Grow Pod.
And as at the end of last year this year, the company had 297 of these Grow Pods licensed by Health Canada within our facilities. Over the past several quarters we have operated these assets at or above the design capacity of these facilities, producing in the area of 10,000 kilos annually and have invested in continuous improvement initiatives to optimize the number of harvest rotations per year, average grams per harvest and overall potency in order to maximize returns from these assets.
We note that on January 9th of this year, the company announced a number of cost-cutting measures as a part of our 2023 strategic plan with the goal of producing positive cash flow from operations, including reducing the company’s production capacity at these Delta 9 facilities by approximately 40% and laying off approximately 40 employees of the company.
The plan was developed such that there is no material impact on wholesale revenues or shipments for the company’s wholesale and retail customers. We anticipate that these cost-cutting measures will result in approximately 4 million in annualized cost savings in 2023 and we will continue to update the market on the progress of these cost-cutting and key growth drivers of the company, as we further develop our forward looking plans to the balance of 2023.
The company has identified three main growth drivers, which we feel will allow us to maximize the profitability of our cultivation and processing assets. First is refining our cultivation process and techniques to maximize THC potency and other quality features of our cannabis products, as cannabis consumers have become more discerning in their purchasing decisions over the past number of years.
We know that the success of our cannabis cultivation business will rest on our ability to produce the highest potency and highest quality cannabis products. We have made strides in the past 12 months in improving our average THC potency in our harvested cannabis flower products and we will continue to push our cultivation teams to pursue excellence in terms of our production outcomes.
Second, in January of this year, the company completed a project to automate our pre-roll manufacturing. Over the past 12 months, pre-roll SKUs have become Delta 9’s best-selling products in terms of units sold across numerous provincial markets.
However, we have been bottlenecked in our ability to produce these products internally and have often had to outsource to third-party manufacturers. Automating this manufacturing process allows the company to realize over 0.75 per gram in incremental contribution margin from our pre-roll product offering and will contribute excess capacity to this important category.
Thirdly, the company has begun a gradual retrofit and upgrade of our older technology lighting systems to new state-of-the-art LED systems, which the company has developed with its international lighting suppliers over the last two years.
These lighting upgrades are anticipated to increase our cultivation capacity to up to 20,000 kilos per year from our current capacity of approximately 10,000 seals annually. These upgrades are also anticipated to improve average THC potency and overall cannabis flower quality, in line with our first key growth driver.
We feel that this increased potency, quality and capacity will not only increase our average selling prices and contribution margins with cannabis wholesale sales, but should also assist in driving cost efficiencies and lower our cost per gram of production.
On our portfolio of cannabis products over the past four quarters, Delta 9 has been narrowing the scope of our cannabis cultivars under production to those that are in the highest demand and at the higher end of the potency range.
We currently produce approximately 12 different genetic strains of cannabis, each with its own unique chemical cannabinoid content, terpene and flavonoid profile and we have another 100 or more strains being stored in an on-site seed bank to provide for product optionality into the future.
We are continuing with our production pivot towards higher potency cannabis strains, which are the highest demand segment with the retail consumer. Over the past 24 months, the company has made -- have increased average THC and its harvested cannabis flower from less than 15% and to 23.5% in Q1 2023.
In Q3 last year, Delta 9 launched our new SCOOP Cultivar across key provincial markets, where we have seen encouraging success in our newer high potency and higher quality products. In Q1 this year, we launched our new Candy Chrome Cultivar, as well as limited time offers in our Cupid’s Private Stash and Paddy’s Private Stash for Valentine’s Day and St. Patrick’s Day.
Our product innovation pipeline launched our next Cultivar I-95 early in Q2 this year alongside limited time offers for the April 20th, 4/20 Cannabis holiday and we are planning multiple new high potency product launches over the next 12 months.
In terms of pre-rolls, cannabis pre-rolls have become an increasingly important category in the Canadian cannabis market as consumers have moved to smaller packaging sizes and saw convenience in a pre-rolled setting.
The company’s pre-rolled products currently account for approximately 15% of our overall product offering with our Bliss and Twist pre-rolls making up two of our top 20 selling products in Delta 9 retail stores. In Q1 this year, we released our new 0.25 gram pre-rolls, offerings Canadian consumers a convenient personal use setting in the pre-roll category.
As noted, the company has completed our pre-roll automation project and plans to introduce multiple new pre-rolled products and settings through the balance of 2023 to increase our sales in this important category.
On the oils, extracts and derivative products, over 2021 on our initial launch of our derivative product line, we saw a successful initial sell-in in the market for our 2.0 product offering, including ingestible cannabis oils, vape cartridges and cannabis concentrates.
Late in 2022, Delta 9 relaunched all of our 2.0 product lines, including new products and new and improved formulations and leveraging partnerships with industry’s leading white label suppliers to drive margin improvements.
Our full 2.0 product portfolio now includes three formulations of ingestible cannabis oils, three formulations of vape -- 510 vape carts, cannabis kief and pressed hash in the concentrate format category. This is our belief that these categories will continue to become an increasingly important component of the medical and recreational use cannabis markets into the future.
In our retail stores, Delta 9 continues to carry the full complement of new 2.0 cannabis derivative products from the industry’s leading manufacturers. We believe that through our retail unit, we will be able to extract valuable intel on which of these new products and product formats are having a positive impact with the consumer and be able to pivot to capitalize on these new product opportunities in the future.
From a distribution standpoint, we continue to believe that the domestic market for recreational use cannabis presents a major growth opportunity for the company over the next several years. Wholesale revenues from the sale of recreational use cannabis are expected to make up a large component of the company’s overall business.
The company has undertaken a strategy to add new distribution markets incrementally as our increased supply capacity has come online over the last number of years in order to reach our ultimate goal of becoming a national distributor of recreational use cannabis products.
At the end of Q1 this year, Delta 9 was licensed for distribution in Manitoba, Saskatchewan, Alberta, British Columbia, Ontario and Newfoundland and Labrador. With these six province -- provinces representing well over 50% of the Canadian population.
In Q1 2023, the company made its first shipments into the Quebec market through a Quebec-based processor and plans additional product launches in that market throughout 2023. The company was also listed in the Yukon Territory in Q2 2023, is in the process of listing its products in every province and territory in Canada.
Delta 9 open also made strides in Q1 this year in its first international shipments of dried cannabis material, announcing on February 13th that we have completed our first wholesale shipments of cannabis to a customer in Australia.
The company has also received multiple additional export permits from Health Canada for shipments into the Australian market. The company intends to complete multiple shipments to Australia during the first quarter and second quarter of 2023.
We anticipate that these shipments will total in excess of 100 kilos of dried cannabis flower and several kilos of cannabis different material. We expect to announce expanded export activity in the near future as the company continues to pursue our international export expansion.
On vertical integration and retail cannabis sales. Over the past 36 months, Delta 9 has made significant progress in expanding our retail footprint. Delta 9 started the year 2020 with only four operating retail stores in Manitoba.
In late Q1 2022, the company announced a transformative retail acquisition to acquire all of the assets of Uncle Sam’s Cannabis Limited in connection with their 17 operating retail stores based on the province, Alberta and operating under the Uncle Sam’s Cannabis and discounted cannabis brands. The combination of the Uncle Sam’s Cannabis stores and Delta 9’s existing retail store network has made Delta 9 a leading multi-banner retail cannabis products in Canada.
In September last year, Delta 9 announced the closing of our Garden Variety acquisition in connection with their three operating stores in Manitoba. The $3.25 million all-stock transaction is anticipated to add approximately $8 million in annualized retail revenues and we anticipate this transaction will be immediately accretive to EBITDA.
Delta 9 opened our 39th cannabis retail store in December last year in Dauphin, followed by our 40th cannabis retail store at the Norwood Hotel in Winnipeg on January 3rd. We opened our 41st cannabis retail store on February 7, 2023 on Sargent Avenue in Winnipeg.
The company has and will continue to employ an aggressive growth strategy to actively acquire retail stores that will provide meaningful revenue growth and positive adjusted EBITDA. We are actively pursuing expansion opportunities in all Canadian provinces, which allow for privatized cannabis retail sales.
On business-to-business opportunities, the company derives a portion of our overall revenues from the sale of cannabis genetics, from the sale of Grow Pods, and from licensing and consulting activities provided to other licensed and pre-licensed cannabis companies.
We believe that these opportunities provide us with a number of benefits, including complementary business verticals, which produce diversified and high margin revenue streams, third-party validation of our proprietary growing platform, valuable partnerships with other pre-licensed and licensed cannabis companies, and the opportunity for international expansion through non-cannabis revenue streams.
To-date Delta 9 is licensed over a dozen third-party facilities, representing over 250 of our modular Grow Pods for our micro cultivation partners. To-date in 2023, we have announced Grow Pod projects, which we anticipate will lead to the sales of over 20 of our Grow Pods worth over $2 million and have a pipeline of projects developing domestically and internationally. We will continue to pursue and expand on these business-to-business revenue opportunities over the coming year.
The company is also continuing its pivot to expand its sales and marketing efforts for our B2B segment into the United States, as indicated with the announcement of our recent project in Alabama, we anticipate to see larger growth from our U.S. B2B sales in 2023 and beyond as this pivot continues to take effect.
Now on to the financial results. We will begin with an assessment of the balance sheet. The company ended Q1 2023 with $1.7 million in cash, inclusive of the company’s draw on its operating line of credit and showed a working capital deficiency of $20.5 million due to the reclassification of our CFCU loans as current.
We note that as of the end of the first quarter, the company was showing a breach of its debt service coverage ratio covenant for its credit facilities with connectFirst Credit Union, which required the classification of this debt as current on our balance sheet.
The company continues to make required interest and principal repayments on all of our existing credit obligations and we do not anticipate any deterioration of our credit condition. The company intends to secure additional or expanded waivers as necessary as the company works to improve its adjusted EBITDA results as demonstrated in today’s results and bring its covenants back into compliance.
On the company’s at-the-market equity facility, the company has raised approximately $350,000 in gross proceeds as of March 31st to support its liquidity position and continued expansion. We believe the company is currently capitalized to continue to execute on its expansion plans and can act opportunistically where assets become available that expedite our expansion, provide strategic value and improve the financial and operating performance of the company.
On key performance indicators for the company. In Q1 this year, we produced approximately 2.1 million grams of cannabis versus 2.2 million grams in Q4 last year. We anticipate harvest quantities will be lower in Q2 and moving forward as production cuts as a result of cost-cutting initiatives begin to take effect.
Production cost per gram decreased to 0.51 per gram versus 0.53 per gram in the fourth quarter of last year. We would highlight that these production cost figures are quite competitive even comparing to our largest competitors in the context of the current cannabis flower market. As the company continues to refine its production techniques, we anticipate that our economical cost base will be essential to improving gross profitability in upcoming quarters.
Total grams sold within the quarter were approximately 1.3 million grams versus 1.7 million grams last quarter. We note that our overall grams sold in the past four quarters represent a significant improvement over the previous 4 quarters.
The company’s average selling price remained steady at $1.70 per gram versus $1.69 per gram in Q4 last year. But demonstrating the overall weakness in average wholesale selling prices in the Canadian cannabis market.
We will continue to push to maximize production efficiencies to ensure that the company can be competitive in the current market environment. Continuing to address the company’s wholesale business and improving overall grams sold and average selling price will continue to be a focus for us moving forward.
The company recorded $368,000 retail transactions in Q1, down from $387,000 in Q4 last year due to anticipated seasonality from our retail division versus the Q4 holiday shopping season. Average transaction size trended higher in Q1 2023 and will be a key growth driver for Management Discussion and Analysis moving forward.
On revenue and revenue segmentation, total net revenues for the three-month period ending March 31st this year were $16.9 million, an increase of 35% year-over-year. From a segmentation standpoint, for Q1, the company recorded retail revenues of $14.6 million versus $10.1 million for the same period last year. Wholesale cannabis revenues were $2.2 million versus $2.8 million for the same period last year. And B2B revenues were $576,000 versus $121,000 in the same period last year.
The company saw relative strength in its retail segment in Q1 despite seasonal weakness in Canadian cannabis retail in Q1, while price and margin compression continue to impact cannabis wholesale revenues due to over competition in the Canadian cannabis industry.
Our B2B segment began to see an uptick in revenues relating to announced projects against the backdrop of an uncertain overall business environment, which we see impacting business sentiment and capital investment.
In the upcoming quarters, we will focus on three main initiatives to drive revenue growth. First is a focus on same-store sales and KPIs aimed at driving revenue growth from our existing retail store chain.
We have spoken about key improvements and investments that the company has planned in our cultivation and processing business, which we feel will help us drive momentum, increase revenue and improve margins in our cannabis wholesale segment with a focus on expanding product distribution within the company’s existing provincial markets. We will look to add new provincial markets through new listings, as well as through bulk wholesale agreements with other licensed cannabis companies.
And finally, we will continue to expand our B2B revenues through a focus on creating relationships Canadian micro cultivation industry and expansion into emerging markets such as the United States.
We continue to believe that given the relative novelty and uncertainty the global cannabis industry, the company’s diversified revenue and vertical integration approach will allow us to better react to market challenges than our competitors with single business strategy.
Gross profit before accounting for changes in the fair value of biological assets for the three-month period was $4.2 million or 25% margin versus $3 million or a 24% margin for the same period last year.
We attribute the overall increase in gross profit to improvements in the company’s retail and B2B segments, although we continue to see overall weakness in the company’s cannabis wholesale segment due to overall industry price and margin compression. Gross margin was impacted in Q1 by one-time items, product impairment costs and write-downs totaling approximately $412,000.
We do expect that as production cost per gram continues to trend down and with the introduction of sales of higher margin cannabis products in 2023 that the company will experience a general improvement in gross profitability from our wholesale cannabis segment.
We have seen relative stability in our retail cannabis segment over the past few quarters and we will continue to address KPIs such as average transaction size, average units sold per transaction and opportunities for higher margin product sales to continue to improve our retail margins. We would also highlight that as our B2B segment begins to produce more meaningful revenue contributions to the company’s overall consolidated gross margin is expected to improve.
Operating expenses for the three-month period ending March 31st were $7.4 million versus $6.5 million last year. The most notable increases in operating expenses were in amortization and personnel expenditures. The increase in overall operating expenses is largely due to the increase in the number of operating retail stores versus the previous year.
We note that operating expenses trended down by over $800,000 from $8.2 million in Q4 last year as cost-cutting measures are beginning to take effect in the reporting period. We continue to place our focus on cost reductions and are on pace to meet our $3 million to $4 million annual reduction in SG&A announced in Q1 2023.
Company’s loss from operations for the three-month period ending March 31st was $1.2 million versus a loss from operations of $2.9 million in the previous year. We have seen significant improvement in our operating loss over the previous year, as well as over Q4 last year and we are confident that our renewed focus on revenue growth, profitability and prudent cost controls will return the company to profitability over the coming quarters.
The company’s adjusted EBITDA loss for the three-month period ending March 31st was $475,000 versus an adjusted EBITDA loss of $1.7 million for the same period last year.
We note that operating cash flows have improved materially versus the previous year, again, relating to the company’s cost-cutting initiatives. Cash used in operating activities was $89,000 versus $2.9, excuse me, $2.5 million for the same period last year.
As we look forward to the balance of the 2023 operating year, we feel the company is positioned to continue to execute on our vertical integration and growth strategies. In our production and wholesale segment, the company will continue to push forward to maximize the utility and efficiency of our existing assets, pushing to operating cash flow positive on the back of our recently announced cost-cutting initiatives and increasing our ability to supply volumes of cannabis across our provincial markets.
In our retail segment, we will add to our retail and distribution capacity by adding new stores where existing chain. We will continue to position as a retailer of choice for both retail customers and suppliers seeking the best locations and positioning as the most competitive LP owned retail in the cannabis space.
And in our B2B segment, we will continue to cultivate long-term and value-added relationships with our B2B customers, as we deliver on Grow Pods projects across North America, while deploying resources into international markets to position our non-plant touching business to realize growth on the ever growing cannabis opportunity globally.
I want to thank everyone for taking the time to join our call this morning. And with that, I will turn the call back over to the Operator for any questions we might have.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] The first question comes from Ven V of Research Capital. Please go ahead.
Ven V
Well, thank you, Operator. Thanks for taking my question. Hi, John.
John Arbuthnot
Good morning.
Ven V
So my -- morning. My first question is about gross margins. So I see that your gross margin is increasing from the last three quarters. So you said that automation of your pre-rolls in the beginning of this year would further improve the gross margin. So can you just guide us like where can we see the gross margin trending towards by the end of this year?
John Arbuthnot
Yeah. Good question, Ven. When we look at gross margin in the cannabis wholesale segment, generally speaking, was a weak quarter for us. Reported non-adjusted gross margin for our wholesale segment was negative 4% within the period. Now when looking at adjusted gross margin that improves to closer to 20%.
Again, factoring back in product impairments or one-time cost or charges associated with that. When we consider our pre-roll manufacturing and the incremental 0.75 per gram in contribution margins that we are now seeing from that automated pre-roll manufacturing, we would see margins within that segment on a non-adjusted basis into the 30% range.
So, overall, we do anticipate that as the company moves through some of this older aged inventory material, which we feel will be fully sold through by the end of the second quarter this year that we will see margins rebound materially in our cannabis wholesale segment, and again, seeing growth in our sales and contribution margins in our pre-roll segment as a high growth segment for us is obviously a key driver for the company moving forward.
Ven V
Yeah. Thank you. And regarding this group or the contract, in British Columbia. So you said that the purchase order is worth $1.2 million is there any timing, can we expect this in Q2 or Q3 or maybe end of this year? When can we expect this to hit your statements?
John Arbuthnot
Revenue recognition then on that project, we would anticipate would span, I guess, originating to a small extent in the first quarter and to a larger extent into Q2 and then the balance of the deliveries on that project in third quarter. And likewise, on the announced Alabama project to anticipate revenue recognition in the second quarter and third quarter this year.
And look forward as well as the company receives further purchase orders, we will be pre-releasing that project pipeline for our B2B segment moving forward. So giving investors a degree of visibility on the company’s forward activities and order pipeline through our B2B segment.
Ven V
Okay. And you also mentioned that about the cost-cutting measures, which might result in around $4 million of annualized cost savings. So I would assume on a quarterly basis, it would be a reduction of around $1 million operating expenses per quarter. So when can we see the impact commencing from, can we expect the operating expenses reducing by $1 million in Q2?
John Arbuthnot
So you would have seen then operating expenses in the first quarter already down by approximately $800,000 versus fourth quarter and the third quarter similarly last year. So have seen a large impact already into the first quarter this year.
We do assume given those cost-cutting measures, including layoffs played out throughout the first quarter that there will be further SG&A savings that we look to see into the second quarter this year. But already seeing material progress in terms of those cost-cutting initiatives and savings in key categories for us like personnel expenditures.
Ven V
Okay. So based on this, so do you have any tentative guidance for the timing of hitting positive adjusted EBITDA?
John Arbuthnot
No forward guidance at this time, Ven. But obviously encouraged to see the, I would say, material improvement in adjusted EBITDA $475,000 loss versus…
Ven V
Yeah.
John Arbuthnot
… $1.7 million last quarter. So I think directionally we are obviously seeing this trend in the right direction, including operating cash flows again significantly improved from previous quarters, but again, no formal guidance to provide at this time.
Ven V
Okay. That’s great, John. Thanks a lot for taking my questions and all the best for your Q2.
John Arbuthnot
Thank you, Ven.
Operator
Thank you. [Operator Instructions] There are no further questions at this time. I will turn the call back over to John Arbuthnot for closing remarks.
John Arbuthnot
If there are no further questions, I again want to thank everyone for joining us for the call this morning and we will turn things back over to the Operator to close out.
Operator
Thank you. Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.
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Delta 9 Cannabis Inc. (DLTNF) Q1 2023 Earnings Call Transcript