Lowell Farms Inc

Greetings. Welcome to the Lowell Farms Inc. Second 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. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. I will now turn the conference over to your host, Bill Metoulas, Investor Relations. Thank you. You may begin.

Thank you, Hillary. Good afternoon. Good afternoon. 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 four looking statements. These four 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 filed on EDGAR and our listing statement filed on CDAR. 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 Schur, who will go into detail about the company's financial results for the quarter later in the 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. 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 website page. 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 two 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 prostitute facility 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 the industry and as such position us differently than any other cannabis company in the world. Now, 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. 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 will go into more details on the quarter, but there's really a lot to be proud about. Our flour production at the greenhouse ramped steadily during the quarter, and we exceeded our guidance of flour 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 first quarter, driven by an increase of 125% in pre-rolls and 386% in packaged flour. 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 Quix 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 flour 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 flour, 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 week and 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 Lowell 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, Lowell is 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 flour. And that's how, in short, we plan to migrate share from flour, 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 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 Canada's cultivation in the United States. It also gives us access to vast quantities of flour that we can use for inputs in our CPG business. Coupled with our existing farm, LFS gives us access to all the flour 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 require 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 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 excess or bulk flour 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?

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 low farm services and finish 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 increased 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 for 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 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 pounds of year 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 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 to ensure optimal yield and potencies. 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 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 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 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 brand Low 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 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 quicks back into circulation. Our quicks 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 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 cultivation, we're 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 low brands, dispensary partners that have previously been ordering legacy products have now added low product to their orders and vice versa. This has resulted in a positive trend on our average order value as that 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 showed 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 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 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 facility. 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 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 bulk 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.

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 has been filed with the SEC and CSC 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-branded sales resulting from our acquisition of the Lowell Brands effective February 25th, 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 focused 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 at approximately $14 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 low farm service and license revenue is 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 margins. 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 this year and 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 price and compression we are experiencing today. along with investments we are making to ramp up low farm services. I should also note that gross margin is impacted by gap for finished goods purchased in an acquisition. Since finished goods acquired are valued at selling price less the sales expense incurred in 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 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 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?

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. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment, please, while we poll for questions. Our first question is from Jason Zandberg of PI Financial. Please state your question.

Thanks for taking my question. Given the success of the Lowell Smokes and the Lowell brand, do you anticipate at some point in the next number of quarters that the biomass that you're growing will be enough 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. I will generally say that obviously your hope is to think, we think of it as excess flour, right? So your hope is to to put as much of it 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 keep a price point where it is. and increased volume sort of all at once. And so we nearly doubled the output in flour out of the farm, and so we went from no excess flour to a lot of it. The hope is that, you know, I think one thing that we really like about LFS is it gives us visibility into several hundred thousand pounds of quality flour that's moving through, and it gives us access to that product more uh, in, in a way that allows us to take, take some smalls here to add and compliment our line and, and, and pre-rolls over here allows us to take some, uh, large flower over here to compliment our line, uh, a flower over there. So I think the general idea is that, um, as we move back and forth, we are going to be a participant always in this wholesale market because the LFS businesses is somewhat, uh, someone 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 flour like we were in the first quarter. And so as we invest in our future on these brands and work really hard to 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 or an infinite amount of flour 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, that's great. Just turning to gross margins, 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 the nature of this wholesale situation. I guess my question is, post Q3, where would you like to see margins? Where do you think they could get in the next number of quarters outside of this next quarter, which you've already pre-guided to be a bit lower?

I think our gross margins this quarter are indicative. I think there's a handicap this quarter of a couple points at 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 try to be pretty explicit and talk to investors about what we think 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.

Absolutely. Okay, just finally my last question. You put in some new technology to offset any risk of wildfires and the associated smoke. I don't believe there were any wildfires near the 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?

Yeah, 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 mock drills, but we have not had to actually utilize it due to smoke.

Okay, no, that's great. Good to have it and probably even better not to use it. All right, thanks very much.

As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. 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.