Delta 9 Cannabis Inc. (OTCQB:DLTNF) Q2 2023 Earnings Conference Call August 15, 2023 11:00 AM ET
Company Participants
Alexa Goertzen – Vice President-Sales
John Arbuthnot – Chief Executive Officer
Conference Call Participants
Operator
Good morning, ladies and gentlemen, and welcome to the Delta 9 Q2 2023 Financial Results Conference Call. [Operator Instructions] This call is being recorded on August 15, 2023.
I’ll now turn the conference over to Alexa Goertzen, please go ahead.
Alexa Goertzen
Good morning, everyone and welcome to the Delta 9 Cannabis Q2 2023 earnings call. At this 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.
John Arbuthnot
Thank you, Alexa, and good morning everyone. Thank you for taking the time to join us for Delta 9’s Q2 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 Q2 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.
Over the past few years, the Canadian cannabis industry has continued to deal with challenges relating to an oversupply of cannabis products, compressed cannabis wholesale margins, inefficiencies of provincial crown distributors, oversaturation in the number of operating retail stores and capital markets volatility. For the first time in the past several quarters, I can confidently say that we are now seeing the light at the end of this long tunnel for Canadian cannabis.
Wholesale prices appear to be stabilizing as the overall industry supply and demand imbalance begins to right itself. Margin stability in both our wholesale and retail business is beginning to show signs of strength and while we feel it will take time for investor sentiment in the space to swing, we have seen the early signs of correction starting to play itself out. In the past year, Canadian cannabis industry sales have continued to expand, reaching an annualized revenue run rate that exceeds $5.1 billion. Even with growth rates in the sector beginning to slow, we anticipate the Canadian industry will double in terms of retail cannabis revenues by the end of the decade.
Recently, we’ve seen progress in the United States market in terms of material cannabis reforms at the federal level. And Q4 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 cannabis under the Controlled Substances Act. The federal rescheduling of cannabis is seen as a gating item to allow firms like Delta 9 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 adult-use cannabis laws. We continue to believe that the growth rate in the Canadian cannabis market and the global reform of cannabis laws represent a generational market opportunity for companies like Delta 9 to grow and unlock significant value for investors.
I’m pleased today to be presenting you with Delta 9’s Q2 2023 financial and operating results. These results include our second quarter of operations reflecting 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’ve encountered and the changes we’re making to continue to drive growth and create shareholder value.
We’ll begin with a discussion of operations and material milestones that the company has achieved over the reporting period. On the cannabis cultivation and processing side of our business, we’ll 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 our modular, scalable, and stackable production unit that we call the Grow Pod.
As of the end of the second quarter, the company had 297 of our 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 the facilities, producing an excess of 10,000 kilos of cannabis annually. And we continue to invest in continuous improvement initiatives to optimize the number of harvest rotations, average grams per harvest and overall potency in order to maximize returns from these assets.
We note that on January 9th 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. This included reducing the company’s production capacity at our Delta 9 facilities by approximately 40% to approximately 6,000 kilos annualized and laying off approximately 40 employees of the company. This plan was developed such that there is no material impact on wholesale revenues or on shipments to the company’s wholesale and retail customers.
We anticipate these cost cutting measures will result in $3 million to $4 million in annualized cost savings, and we will continue to update the market on the progress of these cost savings later in today’s presentation. 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 and processing 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 quality cannabis products. We’ve made strides in the past 12 months in improving our average THC potency in our harvested cannabis flower products and we’ll continue to push our cultivation teams to pursue excellence in terms of our production outcomes.
Second, in January 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 bestselling products in terms of units sold across numerous provincial markets in which we operate. However, we have been historically bottlenecked on our ability to produce these products internally and have often had to source third-party manufacturing. Automating this manufacturing process will allow 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 product category.
Third, the company has begun a gradual retrofit and upgrade of our older technology lighting systems to new state-of-the-art LED lighting systems, which we have developed with our international lighting suppliers over the past number of years. These lighting upgrades are anticipated to increase the company’s cultivation capacity to up to 20,000 kilos per year from our current capacity of approximately 10,000 kilos. These upgrades are also anticipated to improve average THC potency and overall cannabis flower quality, in line with our first key growth objective.
We feel that this increased potency quality and capacity will not only increase our average selling prices and contribution margins from our 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 with another 100 or more strains being stored in an onsite 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 increased average THC and its harvested cannabis from less than 15% to over 23% in Q2 2023. In terms of new product development in Q3 last year, Delta 9 launched its new SCOOP Cultivar across key provincial markets where we have seen encouraging success in our newer higher 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 new Cultivar I-95 in Q2 this year, alongside limited time offers for the April 20th or 4/20 Cannabis holiday, and we continue to plan multiple new high potency product launches over the next 12 months.
Cannabis pre-rolls have become an increasingly important category in the Canadian cannabis market as consumers have moved into smaller packaging sizes and seek 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.
As noted, the company has now completed our pre-roll automation project and plans to introduce multiple new pre-roll products and settings throughout 2023 to increase our sales in this important category. On oils, extracts, and derivative products, in 2021, Delta 9 saw successful initial sell-through in the market of our Cannabis 2.0 product offering, including ingestible cannabis oils, vape cartridges, and cannabis concentrates.
Last year, we relaunched all of our 2.0 product lines, including new products, new and improved formulations, and leveraging partnerships with the industry’s leading white-label suppliers to drive margin improvements. Our full 2.0 product portfolio currently includes three formulations of ingestible cannabis oils, three formulations of vape, 510 vape carts, cannabis kief, pressed hash as well as other infused pre-rolls in the concentrate formats category. It is our belief that these categories will continue to become an increasingly important component of the adult-use cannabis market into the future.
In our retail stores, Delta 9 is carrying the full complement of these derivative cannabis products from the industry’s leading manufacturers. We believe that through our retail segment, we will be able to continue to extract valuable intel on which of these new product formats are having a positive impact with the consumer and be able to pivot to capitalize on these new product opportunities.
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 products are expected to make up a large component of our overall business. The company has undertaken a strategy to add new distribution markets incrementally as our increased supply capacities come online over the last number of years in order to reach our ultimate goal of becoming a nationwide distributor of recreational use cannabis products.
At the end of Q2 this year, Delta 9 was licensed for distribution in Manitoba, Saskatchewan, Alberta, British Columbia, Ontario, the Yukon Territory, Newfoundland and Labrador with these seven provincial and territorial markets representing well over 50% of the Canadian population. In Q2 this year, the company also 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 Northwest Territories in Q3 and is in the process of listing its products in every provincial market and territory in Canada. Delta 9 also made strides in Q1 this year in our first international shipments announcing in February that we completed our first wholesale shipment of cannabis to a customer in Australia. The company has also received multiple additional export permits from Health Canada for additional shipments to Australia.
We’ve made multiple shipments throughout 2023 and expect to continue to develop international market opportunities into the future. On vertical integration and cannabis retail sales, over the past 36 months, Delta 9 has made significant progress in expanding our retail footprint. We started the year 2020 with only four operating stores in Manitoba. Fast forward to late Q1 of last year, 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 in the province of Alberta and operating under the Uncle Sam’s Cannabis and discounted cannabis brands.
The combination of Uncle Sam Cannabis stores and Delta 9’s existing store network has made Delta 9 a leading multi-banner retailer of cannabis products in Canada. In September last year, we announced our next acquisition of three Garden Variety cannabis stores in Manitoba. The 3.25 million all stock transaction added over $8 million in annualized retail revenues, and the deal was immediately accretive to EBITDA. Delta 9 opened its 39th cannabis store, again, growth from four operating stores in early 2020, at the end of 2022 in Dauphin, Manitoba followed – excuse me, followed by our 40th cannabis retail store at the Norwood Hotel in January this year, and we opened our 41st cannabis retail store in February, 2023 on Sergeant Avenue in Winnipeg.
The company has and will continue to employ an aggressive growth strategy to actively acquire retail cannabis stores that will provide meaningful revenue growth and positive adjusted EBITDA. We are actively pursuing retail expansion opportunities in all Canadian provinces that allow for privatized retail cannabis sales and will continue to expand on our vertical integration into the retail segment.
On business-to-business opportunities, the company derives a portion of our overall revenue from the sales of cannabis genetics, sales of grow pods and from licensing and consulting activities provided to other licensed and pre-licensed cannabis companies. We believe that these opportunities carry a number of benefits, including complimentary business verticals, which produce diversified and high margin revenue streams, third-party validation of the company’s proprietary Grow Pod platform, valuable partnerships with other pre-licensed and licensed cannabis companies, and the opportunity for international expansion through our non-cannabis revenue streams.
To date, Delta 9 has licensed almost two dozen third-party facilities representing over 250 Grow Pods for our micro cultivation partners across North America. To date in 2023, we’ve announced Grow Pod projects, which we anticipate will lead the sales of over 20 of our Grow Pods worth over $2 million and have a pipeline of projects developing domestically and internationally. We’ll 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. We anticipate to see larger growth from our U.S. B2B sales in late 2023 and beyond as this pivot begins to take effect.
Now onto the financial results, we’ll begin with an assessment of the balance sheet. The company ended Q2 2023 with $3 million in cash, up from $1.7 million at the end of Q1 this year. Delta 9 showed a working capital deficiency of $19.7 million, an improvement from $21 million in Q1 this year. We note that as of the end of the quarter, the company was showing a breach of our debt service coverage ratio covenant for our credit facilities with Connect First 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 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 and bring its covenants back into compliance.
On the company’s at-the-market equity facility, the company’s raised approximately $1.7 million in gross proceeds as of June 30th to support its liquidity position and continued expansion. We believe that the company is currently capitalized to continue to execute on its expansion plans and can act opportunistically where assets become available, which can expedite expansion, provide strategic value and improve the financial and operating performance of the company.
On key performance indicators in Q2 this year, the company produced approximately 1.6 million grams. This is down from 2.1 million grams in Q1. This decrease in harvest quantities was anticipated in the wake of cost cutting measures and decreased capacity, which we announced in January. Production cost per gram increased to $0.77 per gram versus $0.51 per gram in Q1 this year. We would highlight though that these production costs remain quite competitive in the Canadian cannabis industry, and the company anticipates that when production capacity is ramped back to meet demand as the industry continues to correct, we would anticipate production cost per gram to return to previously low levels.
Total grams sold in wholesale reached a record 2.2 million grams in Q2 versus 1.3 million grams in the first quarter this year. We note that overall grams sold in the past four quarters represent a significant improvement over the previous four quarters.
The company’s average selling price declined to $1.35 per gram versus $1.70 per gram in Q1 this year. While this marks a measured decline from the company’s previous levels, we note that one-time sales of aging cannabis inventory material resulted in the decline. These types of sales are not expected to recur over the long-term. We will continue to push to maximize the production efficiencies of our facilities to ensure the company can be competitive in the current market environment and continuing to address the company’s wholesale business and improving overall gram sold and average selling price will continue to be a focus for us moving forward.
The company recorded a record 402,000 retail transactions in Q2 this year, up from 367,000 in Q1 and surpassing our previous record of 387,000 from the Q4 holiday shopping season last year. Average transaction size has trended lower to $37.81 from $39.64 in Q1. Average transaction size and units sold per transaction are key growth drivers of focus for Delta 9’s retail division through the balance of 2023.
On revenue and revenue segmentation. Total net revenues for the three and six month period ending June 30 were $18.3 million and $35.1 million. That’s an increase of 4% and 17% respectively versus the same periods last year. Sequential net revenue increased 8% versus Q1 this year. From a segmentation standpoint for Q2, the company recorded retail revenues of $15.2 million versus $13.1 million in the same period last year. Wholesale cannabis revenue was $3 million versus $3.8 million in the same period last year, and B2B revenue was $411,000 versus $1.2 million for the same period last year.
The company saw relative strength in its Retail segment in Q2 this year, and as sales rebounded from a seasonal – seasonally weak period in Q1, price compression continues to affect cannabis wholesale revenues due to over competition in the Canadian cannabis market. Our B2B segment began to see an uptick in revenues relating to announced projects against a backdrop of an uncertain overall business environment, which we see impacting business sentiment and capital investment in the near-term.
In the upcoming quarters, we’ll focus on three main initiatives to drive revenue growth. The first is a focus on same store sales and KPIs announced aimed at driving revenue growth from our existing retail store chain. We’ve spoken about key improvements and investments and the company has planned in our cultivation and processing business, which we feel will help us drive momentum, increased revenue and improve margins in our Cannabis Wholesale segment with focus on expanding product distribution in the company’s existing provincial markets, as well as adding new provincial markets through new listings, as well as through bulk wholesale arrangements with other licensed cannabis companies.
And finally, we’ll look to expand our B2B revenues through a focus on creating relationships in the Canadian micro cultivation industry and expanding into emerging markets in the United States.
We continue to believe that given the relative novelty and uncertainty, the global cannabis industry, that our company’s diversified revenue and vertical integration approaches will allow us to better react to market challenges than our competitors with single business strategies.
Gross profit before accounting for changes in the fair value of biological assets for the three and six month period ending June 30 was $5.2 million or 29% gross margin and $9.4 million, a 27% gross margin. This compares with $4.6 million or 27% margin and $7.6 million, a 25% margin for the same periods last year. Overall, gross profitability improved by 2% of net revenues for both the three month and six month period showing improvements over the previous year. Gross profit also improved versus $4.2 million in Q1 this year.
Our management has been undertaking a thorough assessment of our pricing and margin across our various business segments, and we’ll continue to look to maximize outcomes by tuning these strategies where necessary. We would attribute the increase in overall gross profit and gross profitability to improvements across all three of our Material Revenue segments.
We expect that the introduction of sales of higher margin cannabis products in 2023 will contribute to general improvement in gross profitability from our Wholesale Cannabis segment. We have seen relative stability in our Retail Business segment over the past several quarters and will continue to address KPIs such as average transaction size, units sold per transaction and opportunities for higher margin product sales to continue to improve retail margins.
We would also highlight that once the company’s B2B segment begins to produce more meaningful revenue contributions, the company’s overall consolidated gross margin is expected to improve. Operating expenses for the three month period ending June 30 was $7.1 million, this compares with $7.4 million or a decrease of 4% from the same period last year. The most notable changes in these categories were an increase in amortization, offset or more than offset by a decrease in legal, professional and public company costs, personnel expenditures, utility costs, and supplies and materials. The decrease in overall operating expenses year-over-year is largely due to the cost cutting measures implemented by management in January 2023.
Operating expenses for the six month period ending June 30 were $14.5 million, an increase from $13.9 million in the same period last year. The most notable increase for that period was amortization and depreciation. The increase in overall operating expenses for the six month period is largely due to the increase in our operating Retail Store segment over that period from 34 operating stores to 41.
We note that quarterly operating expenses have now trended lower by over $1 million per quarter from $8.2 million in Q4 2022 prior to the announcement of our cost cutting measures. This places us on pace to meet our stated goals of between $3 million to $4 million in annualized SG&A cost reductions.
The company’s loss from operations for the three month and six month period was $3.5 million and $4.7 million versus $3.4 million and $6.3 million for the same period last year. This also compares with a loss from operations of $1.2 million for the three month period ending March 31st this year. We are confident that our renewed focus on revenue growth, gross profitability and prudent cost controls will return the company to profitability from operations over the next number of quarters.
The company’s adjusted EBITDA for the three month and six month period was $1.4 million positive and $886,000 positive versus a loss of $391,000 and $2.1 million for the same period last year. This also compares with an adjusted EBITDA loss of $475,000 in the first quarter this year. We attribute the improvement in adjusted EBITDA within the period to higher overall net revenues and gross margins as noted above from our Material Business segments as well as savings as a result of the company’s cost cutting measures announced in January. We are confident that the company’s recent acquisitions, cost cutting initiatives and renewed focus on revenue growth and profitability will continue to place the company in a strengthened adjusted EBITDA position in coming quarters.
We note that this marks the company’s return to positive adjusted EBITDA, which is our main barometer of profitability for the company. We see this result as materially positive milestone for Delta 9.
We note that operating cash flows have also improved materially versus the previous year, again, relating to the company’s cost cutting initiatives. Cash generated from operations in the first half of 2023 was $2 million versus cash used in operations of $5.3 million for the same period last year.
As we look forward to the balance of the year 2023, management feels the company is well positioned to continue to execute on its 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 to our existing chain. We will continue to position as retailer of choice for both retail customers and suppliers, seeking the best locations and positioning as the most competitive LP-owned retailer in the Canadian cannabis space. And in our B2B segment we will continue to cultivate long-term and value add relationships with our B2B customers as we deliver on Grow Pod projects across the country, while deploying resources into international markets to position our non-plant touching businesses to realize growth in 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
[Operator Instructions] There are no questions at this time. I will turn the call back over to John for closing remarks.
John Arbuthnot
If there are no questions from the audience, I want to thank you for taking the time to join our call this morning. And we’ll turn things back over to the operator to close up.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for joining and you may now disconnect your lines.
