Lowell Farms Inc.
Q2 2021 Earnings Call Transcript

Published: 16 Aug 2021

[Operator:]

Greetings. And welcome to Lowell Farms Inc Second Quarter 2021 Earnings Conference Call . Please note this event is being recorded. I'll now turn the conference over to your host, Bill Mitoulas, Investor Relations. Thank you. You may begin.

[Bill Mitoulas:]

Thank you, Hillary. Good afternoon and welcome to the conference call to discuss Lowell Farms' financial result 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 and they cause actual results to differ materially from expectations. These risks are outlined in the Risk Factors section of our Form-10 field 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 as that of today and management does not undertake any obligation to revise any forward-looking statements into the future. This call has includes George Allen, Lowell Farms' Chair of the Board; Mark Ainsworth, Co-Founder and Chief Executive Officer; as well as Chief Financial Officer, Brian Shure, who will go into the details about the company's financial results for the quarter later in call. The Q&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. Those of you who may happen to leave our call before its conclusion, please be advised that this conference call will be recorded and archived on our investor relations website page. And now with that, I'll now hand the call over to George. George, please go ahead.

[George Allen:]

Thanks Bill. Good afternoon, everyone. I'm grateful to give you a report as to our progress and the there's much to talk about. The two acquisitions that we've done this year have transformed our company and positioned as well for the future. The acquisition of the Lowell brand and the acquisition of our Flower processing facilities in Salinas, both acquisitions give our investors a strong indication as to where your management team believes the industry is headed. They're also both entirely unique, without equal in industry and as such position as differently as 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% 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 would 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 lbs during the quarter with a total output of 9,553 lbs. 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 first quarter of driven by an increase of 125% in pre rolls, and 386% in packaged flower. We opened approximately 210 new doors during the quarter for Lowell. And we 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 eight stores within the state which has approximately 110 stores, we sold over 5,000 packs in the first nine 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 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 law. And it is a foundational element of many best-in-class brands throughout history. A Lowell joint is not something you hide. It's something you share. It's a badge and it's a badge for those who get it. Roll is how cannabis comes into the party. Not working around out back in the parking lot around on the fire escape. Lowell is something you share when you 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 five times the size of pre rolls into Lowell 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 two markets launched and they 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 positioned Lowell to be successful in incredibly competitive operating environments. The recent launch of Lowell farm services, a business that has dual purposes. It gives a 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 the 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 Farm Services. We already have a pipeline of customers that goes well beyond our ability to satisfy. The other side of this coin however, is that the increased canopy has put downward pressure on flower prices. Flower that was trading for well over $1,100 per pound only a quarter ago is now trading for under $800 a pound. Obviously, we're exposed to this price drop. During the second quarter $5.7 million of our revenues came from the sale of access or bulk flower from our greenhouse. This pricing headwind is going to have an impact on revenues during the third quarter 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?

[Mark Ainsworth:]

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 finished with an outlook for Q3. Let's start with updates on the farm. 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 increase the net weight overall. The net wet weight per room used to be 1,900 pounds. And now we're averaging 2,800 plus pounds. And as George mentioned, we exceeded our flower guidance production in the second quarter. We were able to do this by cutting down our turn times in the greenhouses. The ability to turn the rooms faster and with the right genetics gave us additional harvest throughout the quarter comparatively. In 1, 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 pounds of yield from the cultivation. 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 in each greenhouse reacted to the initial out of box programming from the manufacturer, the team employed a specialist to help them tweak the environmental in each room to ensure optimal yield and potencies. We added additional shading in the common areas of each greenhouse. And that helped dropped the temperature in the first 15 feet of each room by 20 degrees. And the plants are a little cooler; we were 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 across all harvests. 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 performed 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 learning and improvement as well as the positive impacts on our annual harvest run rate. Moving to CPG, we continue to be pleased with the messages and comments from dispensaries and customers who feel that there's a drastic change and a resurgence of excitement about our marquee brands, Lowell Herb Co. And as I just mentioned, we are constantly improving the quality of the materials going into the Lowell product line. And that has clearly played 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 skews and a reintroduction of Quicks back into circulation, our Quicks, our 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 Lowell, we would launch two strains at a time, because that's the cadence of which things are coming out of our cultivation. But because of efficiencies at the cultivations, we were able to offer six or seven 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 Lowell brands, dispensary partners that have previously been ordering legacy products have now added more product to their orders, and vice versa. This has resulted in a positive trend on our average order value as 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 shows that after the merger of the two sales forces, our team has integrated well and each individual has brought value to the team. 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 software marketing campaigns focused on budtenders and consumers. The third item I wanted to touch on the newly launched Lowell Farm Services, the new first of its kind facility in Salinas will process all cannabis grown at our cultivation operations. Our new business unit will also engage in fee based processing services for regional growers from the Salinas Valley area and beyond, one of our largest and fastest growing cannabis cultivation regions. The facility currently includes eight environmentally controlled segregated drying rooms, each capable of accepting an excess of up to 30,000 pounds 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 labor 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 it own dedicated Vice President and right now it's one of the highest priorities for the leadership team. With all that being said, there's no doubt there's major market compression in California right now, as George mentioned, we have seen a decline in both sales, and it is unclear as to how long that decline will last. But the team is working very hard to shift gears into pushing all of that biomass into our CPG product lines. The team will continue to utilize every asset the company has to maximize revenue for the coming quarters. 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.

[Brian Shure:]

Thank you, Mark, and good morning, everyone. Before I begin please note that we are reporting our Q2 results in US 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 US dollars unless otherwise indicated. And I would also note that our quarterly report has been filed with the SEC and CSD today. As Mark highlighted, we reported Q2 revenue of $15.2 million, 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 six months. Q2 revenues included over $5.8 million in Lowell brand sales resulting from our acquisition of the Lowell brands effective February 25. While year-to-date revenues included $6.7 million 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 $0.7 million, or 55% sequentially, and $2.1 million, or 77% year-over-year. On a year-to-date basis we reported revenue of $26.2 million, an increase of $6.8 million, or 35% over the same period last year. We anticipate revenues in Q3 to be roughly in line with Q2 with approximately $14 million to $16 million given the headwinds that are impacting bulk and CPG pricing. We also expect initial billings by Lowell Farm 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 licensed revenue was not expected to be significant in the third quarter, we are pleased to realize these revenue sources which are expected to grow for the balance of the year. We will be reporting a new metric starting in Q3. GMV, or Gross Merchandise Value, a pro forma metric to capture realized revenue and wholesale price revenue for licensing agreements. Turning to gross margin; gross margin as reported was 38% in the second quarter compared to negative 13%, both sequentially and year-over-year. The margin improvement over the first quarter of this year in second quarter 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 valued at selling price less the sales expense incurred and selling the product. This adversely impacted margins by approximately three 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 for the balance of the year. Operating expenses were $6.2 million or 41% of sales for the quarter, compared to $4.2 million, or 38% of sales in Q1 and $3.5 million or 36% of sales in the second quarter last year. Operating expenses in the second quarter 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 Lowell brands. As noted earlier, Lowell brand revenues were $5.8 million in Q2 and $6.7 million year-to-date. The operating loss in the second quarter was $473,000, compared to an operating loss of $5.7 million sequentially, and $4.8 million year-over-year. The operating loss year-to-date was $6.2 million compared to $11.9 million in the same period last year. Net income for the second quarter was $731,000, which included income from insurance claim proceeds of $2.6 million, which compares to a net loss of $6.7 million in the first quarter and a net loss of $8.8 million in the second quarter last year. Adjusted EBITDA in the second quarter, which excludes the $2.6 million in insurance proceeds was $740,000 compared to negative adjusted EBITDA of $4.6 million sequentially, and negative adjusted EBITDA of $7.2 million year-over-year. Turning to the balance sheet; working capital was $22 million at the end of the second quarter, comparable to the amount at the end of the first quarter, and the company had $9.1 million in cash, compared to $13.6 million at the beginning of the quarter. Inventory supplier advances and excise and cannabis tax payments increased $2.7 million in the quarter, while accounts receivable declines $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 square foot processing facility that will house Lowell Farm Services operations. The acquisition was funded by a $9.4 million mortgage loan and the issuance of approximately $8 million subordinate voting shares. With that, I'll turn the call back to Mark. Mark?

[Mark Ainsworth:]

Thank you, Brian. I'm incredibly thankful for the team with passion to execute at the best of their abilities. I'm 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.

[Operator:]

Our first question is from Jason Zandberg of PI Financial.

[JasonZandberg:]

Thanks for taking my question. And just given the success of the Lowell Smokes and Lowell brand, do you anticipate at some point in the next number of quarters that the biomass that you're growing will be enough to know -- that you won't have to be selling in the secondary market, the wholesale market? Or just, I know, you're increasing net 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?

[GeorgeAllen:]

Hey, thanks, Jason, I'll take that question. And I will generally say that it did, obviously, your hope is to think -- we think of it as access flower, right. So your hope is to put them as much of it as out there in the hands of consumers directly. And have your soldiers fighting your fight, not somebody else's. I think the reason for why 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 access flour 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 thousand pounds of quality flower that's moving through, and it gives us access to that product in a way that allows us to take some small -- to add, and complement our line pre rolls over here allows us to take some large flower over here to complement our line of flower over there. So I think the general idea is that as we move back and forth, we're going to be a participant always, in this wholesale market, because the LFS business is 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 first quarter. And so as we invest in our future on these brands, and work really hard to put the brand and 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 because 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 infinite 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.

[JasonZandberg:]

Okay, no, that's great. Just turning to gross margins. It's just a fantastic improvement over the first quarter. I did hear that sort of guided for maybe a little bit of a weaker quarter, next quarter, due to this, the 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 that it'll be a bit lower.

[BrianShure:]

It's jump which is like long term runway model. I think our gross margins of this quarter are indicative. I think there's 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 -- we try to be pretty explicit and talk to investors about what we think may happen this quarter, there's definitely some choppy 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.

[JasonZandberg:]

Yes, absolutely. Okay. Just finally, my last question. You put in some new technology to offset any risk of wildfires and then the associated smoke. I don't believe there were any wildfires near this area, but I could be wrong. Did were you -- have you had to utilize that technology this summer or have you been fairly currently free of wildfires in that area?

[GeorgeAllen:]

Mark, why don't you take that?

[MarkAinsworth:]

Yes, there was -- there have 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.

[Operator:]

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.

[Mark Ainsworth:]

Thank you again for joining the call. If you're 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.

[Operator:]

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation and have a great day.