Lowell Farms Inc

Hello and welcome to the Lowell Farms 2022 fiscal third quarter earnings call. All participants will be in listen only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touch tone phone. To withdraw your question, please press star then two. Please note, this event is being recorded. I would now like to turn the conference over to Bill Mitchellis. Please go ahead.

Thank you. Good afternoon, and welcome to today's conference call to discuss the Lowell Farms Incorporated financial results for the fiscal third quarter of 2022. Before we begin, please let me remind you that during the course of this conference call, Lowell Farms Incorporated's management may make four looking statements. These four looking statements are based on current expectations that are subject to risks and uncertainties that could cause actual results to differ materially from expectations. These risks are outlined in the risk factor section of our Form 10 filed on EDRA and our listing statement filed on CDAR. Any four 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 in 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 is open to analyst questions. 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, please be advised that this conference call will be recorded and archived on our investor relations website page. And now I'll hand the call over to George. George, please go ahead.

Good afternoon. Thanks for your time. There is much to discuss here, given the disappointing results we're presenting today, and I will be speaking for Mark tonight as he's lost his voice with a cold. He's on the call, and we'll be able to answer questions at the end. Conditions in California are tenuous at best, and there's an overwhelming sense that something is going to break. Specifically, we've seen a continuing decay in retail demand, coupled with a general lack of health among retailers. Since May of last year, sales across the state, according to Headset, are down 16%, led by a 19% decline in flower sales, the largest sales category. What's more surprising is that unit volume over this period is down 2%, meaning that the decline in prices has not created any demand response from the consumer. There's two possible explanations for this. Either we're seeing a decline in cannabis consumption, or there is a secular shift into an alternative purchase channel namely the legacy or illicit market. We suspect the latter, but supporting data is indeed elusive. Now, against this backdrop, retailers are struggling to pay their bills, and the round-robin approach to running up tabs across vendors has kept them alive so far, but we know that they're running out of room to maneuver as tax bills catch up with them. In response to profit pressures, we see a concerted effort from retailers to raise their markups in an attempt to that make up for declining traffic, and while we cannot be sure, we fear that this is further driving consumers into alternative channels. In this context, we see a handful of strategies that other operators are embracing for survival. Most of our peers are focused on either massive economies of scale or a retail-first vertical integration strategy as a vehicle for success. If you've been following our story, you know that our path is somewhat different in that we see much of our future in product innovation. Indeed, this is how we arrived at the Lowell 35 launch. Only two product categories have experienced sales growth over the last 18 months, and that's pre-rolls and beverages. Given the relatively small revenue base in the beverage category, the only real opportunity for growth has been in pre-rolls. And thus, we've seen a lot of our competitors come searching for revenue growth in the pre-roll category. While we continue to enjoy the number one market status in flower pre-rolls and overall number two status in pre-rolls overall, we are seeing more competition. Luckily, most of our competitors are focused on the infused category, which is adjacent to but not immediately competitive with our core book of business at Lowell. Now, I'm very, very pleased with the early success of the 35's product, which I'm going to go into in detail in a minute. But unfortunately, the success of the 35's product is not the only trend in our business. California cannabis continues to be in an oversupply mode, and prices for flour continue to fall. We've seen some slippage in bulk prices, and CPG packaged flour continues to be trench warfare with fly-by-night brands making momentary sales space with unsustainable pricing only to disappear and be replaced by another contender moments later. As you will recall, we didn't see the logic in following prices downward, and our sales in packaged flour had been softer than expected, most notably in our value brand house weed, but also in low flour. While our market share in pre-rolls has maintained relatively stable, according to Headset, We have seen sales attrition there as well, perhaps attributable to seasonal buying patterns given the very tight working capital conditions we find in our retail partners. We also face challenges within our LFS business as we appear to be the victim of an uneven playing field as enforced by local regulators who have looked the other way as operators continue to flagrantly violate building codes with non-compliant drawing facilities. Collectively, the poor operating performance continues to put pressure on our balance sheet and liquidity precisely at the moment when we perceive the most opportunity in our business. The confluence of factors is making it difficult for us to achieve our target of self-sufficiency. Cost containment is obviously a priority during this time, and given the decline in revenues, the drop in adjusted EBITDA from the to a loss of 1.7 million is disappointing, but also reflective of our efforts to eliminate extraneous expense at this time. Against this backdrop, we continue our efforts to raise capital, and we are in discussion with several interested parties, but we have also decided to commission a strategic alternatives committee of the board to initiate a strategic review in light of some acquisition interests we've had in the business. While it is premature to discuss the prospects for this committee's work, we think it is an important step given the current market environment and our liquidity. Next, I'm going to start with some detail around our Lowell 35 launch as they launched it at the very end of the quarter. We launched the Lowell 35s on September 29th at a price point that is below 88% of flour sales in the state, and our thesis was that we could attract consumers from flour into pre-rolls. The new 35's form factor encourages cannabis snacking for heavy users with all the flavor of flour and the convenience of a vape pen. Another aspect behind the product launch is the deep body of knowledge and IP that we are building around the product manufacturer. This product is extremely complicated to produce, and the knowledge that we have acquired through the all-good transaction, as well as built up over time, gives me great confidence that we will have some running room before we see a lot of competition in this SKU. We launched the first three SKUs within a select group of 16 stores. Three weeks later, we opened up the sale of the product to all stores within the state. The launch of the 35s has been the most successful in company history. In the five and a half weeks since launch, Lowell has penetrated over 130 doors within the state. The Lowell brand is currently active within 389 stores and delivery depots across California, thus implying that we've already achieved a 33% penetration with this new SKU. I can't emphasize enough how challenging this is to do in the current environment. Retailers are flush with inventory and very hesitant to bring on new SKUs, which are likely to render existing inventory old or obsolete. Since launch, we have experienced a nearly 2x lift in pre-rolled market share across our launch stores out of the gate. This means that the sales volume of our new products are rivaling that of our legacy products without substantial cannibalization. That's great news. Additionally, the 35s have already surpassed the consumer loyalty benchmarks set by our legacy products as measured by repeat purchases within a 14-day period. This is a very important factor since we feel that our brand awareness will compel consumers to try the product at least once, but our sales ambitions require that we foster loyalty and habitual usage among consumers in order to drive real revenue growth. Using proprietary retail analytical tools that we have built, we see that the vast majority of sales of the new 35's products came at the substitution of some product other than pre-rolls. Nearly 60% of 35 spend came from consumers shifting from flour. Only 23% of 35 spend came from consumers substituting for some other pre-roll choice. This early data substantiates our assertion that the 35's product will be a vehicle for growing the pre-roll category. An important factor for us given our already leadership position within pre-rolls. While it's early, I think the sales momentum we're experiencing within the product gives us confidence that over time, this SKU will produce us meaningful revenue growth. While forecasting demand is more arced and signed at this stage, we estimate retail sales for these first three SKUs of approximately between $40 and $50 million annually at retail price points once the product is fully distributed across the state. Now, this is going to take time. We further believe that the acceptance of the product will grow further as consumers get accustomed to the convenience factor of the product, and thus sales potential will rise beyond that. Against this rising demand profile, we have a product pipeline which will expand to bring more diversity to the consumer offering beyond these first three initial SKUs. Over the upcoming few months, we'll be expanding our 35 offering in various stages, including the addition of new blends, two new infused lines, and various brand co-lab launches with other popular brands in California cannabis. Since we launched the 35s at the end of the third quarter, revenues for the period were relatively minimal. Now I'm going to turn my commentary to Q3 CPG revenue performance, which was only minimally impacted by this 35 launch. During the quarter, we changed the accounting for how we account for slotting fees paid to retailers And we now treat those fees as deductions from revenues instead of sales and marketing expense. The change also resulted in a deduction in reported Q3 revenues for slotting fees associated with prior periods. The net effect is that the accounting change exacerbated our sequential revenue decline in CPG sales. Normalized for this change in accounting, CPG sales fell 9% sequentially during the quarter. Much of this decline pertains to the weakness in what we call our non-core CPG categories that include our SKUs outside of flour and pre-rolls, as we have become less price competitive in those categories with the advent of competition. In general, we have fought very, very hard not to follow the market downwards on price, as we have found that the detrimental impact to margin is generally not recoverable with increases in volumes. We've also learned that price decreases are never a two way street. As an alternative, we're working to address the opportunity with further brand extensions so as not to cannibalize our existing book of business with lower priced offerings. This takes time, but we know how to do it and ultimately it preserves value over the long run. Turning to bulk. The bulk market continues to show weakness heading into the final quarter as pricing pressures accelerated relative to the trends we witnessed between Q1 and Q2. During the quarter, we sold nearly 5,400 pounds of bulk flour versus 6,300 pounds in the prior quarter, a 15% decline sequentially. In addition to a decline in volume, we witnessed a 20% decline in our realized price per pound quarter on quarter. Although the decline in our realized price per pound was partially due to a higher attribution of weight sold in the form of lower grade flour relative to the prior quarter. The pricing pressure in the bulk channel coupled with the launch of the 35s prompted us to stockpile a record amount of biomass into the fourth quarter. This contributed as well to the decline in sales. Now on to low farm services. Much of the sequential decline in LFS revenues pertain to the fact that last quarter we liquidated $1.6 million in flour acquired from third parties that was sold to satisfy receivable balances from those customers. The sales came at minimal margin, and that phenomenon did repeat itself this quarter after we liquidated the inventory in question left over from last year's Q4 harvest. But more troublesome is that our servicing revenues have declined over the quarter by 56%, reflecting a difficult market environment for cultivators. We've been anticipating a tidal wave of demand driven by county-level enforcement of building codes But unfortunately the County has extended deadlines into the new year for compliance and turned a blind eye towards rampant code infractions. We do see a near term opportunity for processing outdoor flower this quarter, given the seasonal harvest schedule, but a steady stream of service revenues throughout the year will require that the County ultimately make enforcement a priority among the greenhouse community within the County. We are watching this situation very carefully. Next, I'm going to turn to out-of-state. We are very excited that this month, Lowell Smokes will finally go on sale in both Colorado and New Mexico with our partner, Schwoz. During the quarter, we did experience a modest decline in royalty revenues offset by packaging revenues, but more encouragingly, we saw early signs within the monthly data that our efforts to grow sales in Illinois and Massachusetts has begun to take hold. Lastly, I wanted to talk about a new offering that we're going to try this quarter in an effort to accelerate CPG sales and help our retail customers. Now, we hear from many of our customers that cannot meet our order minimums for delivery service. Other customers are tight with cash and need to buy their inventory on a moment's notice, thus they can't wait for our delivery route. In response, We're going to try opening up our distribution centers in both northern and southern California for a cash and carry sales by appointment business. It's basically a B2B storefront. Buyers must pass a compliance check during onboarding of their account. We believe that this will help some of our clients who are working capital constrained, and we are very optimistic about its prospects. With that, I'm going to turn the call over to Brian. Brian?