Delta 9 Cannabis Inc. (OTCQB:DLTNF) Q3 2023 Earnings Conference Call November 15, 2023 11:00 AM ET
Company Participants
Alexa Goertzen – Vice President-Sales
John Arbuthnot – Chief Executive Officer
Jim Lawson – Chief Financial Officer
Ian Chadsey – Vice President, Corporate Affairs
Conference Call Participants
Lev Zentner – National Bank
Operator
Good morning, ladies and gentlemen. And welcome to the Delta 9 Third Quarter 2023 Financial Results Conference Call. [Operator Instructions]
This call is being recorded on November 15, 2023. I would now like to turn the conference over to Alexa Goertzen. Please go ahead.
Alexa Goertzen
Good morning, everyone. And welcome to the Delta 9 Cannabis Q3 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 statement. For more information regarding risks and forward looking statements, please refer to the Delta 9 Cannabis Inc. public filings which are available on SEDAR.
I would now like to turn the call over to Delta 9’s Chief Executive Officer, John Arbuthnot. Please go ahead.
John Arbuthnot
Thank you, Alexa, and good morning, everyone. Thank you for taking the time to join us for Delta 9’s Q3 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 Q3 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 year, the Canadian cannabis industry has continued to deal with challenges relating to an oversupply of cannabis products, compressed cannabis Wholesale margins, inefficiencies at provincial crown distributors, oversaturation in the number of operating retail stores and capital markets volatility. We have now seen two consecutive quarters of improvement in business conditions for the Canadian cannabis space.
Wholesale prices appear to be stabilizing as the overall industry supply 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 some 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, boasting monthly retail cannabis sales of $427 million in June of this year, up 11% from a year earlier. Annualized retail cannabis sales in Canada now exceed $5.1 billion. Even with growth rates in the sector beginning to slow, we anticipate the Canadian cannabis industry will double in terms of retail cannabis revenues by the end of this decade.
We continue to see a steady beat of progress in the United States market in terms of material cannabis reforms at the federal level. In Q4 last year, the White House announced that they would pardon certain individuals convicted with criminal records for cannabis possession, and at the same time, announcing a sweeping review of the scheduling of cannabis under the Controlled Substances Act.
News of the U.S. Department of Health and Human Services’ recommendation for the rescheduling of cannabis to Schedule III from Schedule I in Q3 this year sparked renewed capital markets’ interest in the U.S. sector. 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 expansion.
In other international markets, Germany and the Netherlands have made progress on federal adult-use legalization initiatives targeting a 2024 launch. And international markets such as Israel, Australia, Asia-Pacific and various countries in the EU continue to make progress on advancing more progressive medical and recreational use cannabis laws.
We continue to believe that the growth rate in the Canadian cannabis market and the global reform of cannabis laws represents a generational market opportunity for companies like Delta 9 to grow and unlock value for investors.
I’m pleased today to be presenting you with Delta 9’s Q3 2023 financial and operating results. These results include our third 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 have encountered and the changes we are making to continue to drive growth and create shareholder value.
We’ll begin with a discussion of operations and material milestones for the company 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.
As at the end of the third quarter, the company had 297 grow pods licensed by Health Canada within our Delta 9 facilities. We note that on January 9, 2023, the company announced a number of cost-cutting initiatives as a part of our 2023 strategic plan with the goal of producing positive cash flow from operations, including reducing the company’s production capacity at our Delta 9 facilities by 40%, to approximately 6,000 kilos annually from our previous 10,000 kilos and laying off approximately 40 employees.
This plan was developed such that there is no material impact on our Wholesale revenues or shipments to our Wholesale or Retail customers. We anticipate that these cost-cutting initiatives will result in between $3 million and $4 million in annual cost savings and we’ll continue to update the market on the progress of these cost-cutting initiatives, as well as key growth drivers as the company further develops our forward looking plans through the balance of 2023.
The company has identified three main growth drivers which we feel will allow us to maximize the profitability of our cultivation and processing assets. The 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 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 best-selling products in terms of units sold across numerous provincial markets. However, historically, we have been bottlenecked on our ability to produce these products internally and we have often had to source third-party manufacturing.
Automating this manufacturing process has allowed us to realize over $0.75 per gram in incremental contribution margin from our pre-roll product offerings and will contribute excess capacity to this important product category.
Finally, the company has begun a gradual retrofit and upgrade of our older technology lighting systems to new state-of-the-art LED systems, which the company has developed with our international lighting suppliers over the last three years.
These lighting upgrades are anticipated to increase the capacity of our facility to up to 20,000 kilos per year from our current capacity of 10,000 kilos. These upgrades are also anticipated to improve average THC potency and overall cannabis flower quality in line with our key — first key growth driver.
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 only those in the highest demand and at the higher end of the potency range.
We currently produce approximately 12 different genetic strains of cannabis, each with its own unique chemical cannabinoid content, terpene and flavonoid profile, and with another hundred or more strains being stored in an on-site seed bank to provide for product optionality into the future.
We are continuing our production pivot towards higher potency cannabis strains, which are the highest demand segment. Over the past 24 months, the company has increased its average THC potency in its harvested cannabis flower from less than 15% to over 22% in Q3 2023.
In terms of product development, in Q3 last year, the company launched its new SCOOP Cultivar across key provincial markets and we have seen encouraging success in our newer, higher potency and higher quality products.
Moving to 2023, the company 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 of this year, alongside limited time offers for the April 20th 4/20 Cannabis holiday.
Continuing on this success, we have launched several dried flower LTOs into the fall of 2023, including our Halloween launch for Halloween, which was sold out across numerous markets and we are planning multiple new high potency LTOs into the holiday season and for the forward 12 months.
In pre-rolls, cannabis pre-rolls have become an increasingly important category in the Canadian cannabis market, as consumers have moved to smaller packaging sizes and seek convenience in a pre-rolled setting.
The company’s pre-rolled products currently account for over 15% of our overall product offering, but a much larger percentage of our overall revenue and with our offerings of Bliss and Twist, pre-roll is making up two of our top 20 selling products in Delta 9 retail stores.
In Q1 this year, we released a new 0.25-gram pre-roll, offering Canadian consumers a convenient personal use setting in the pre-roll category. In Q2 of last year, we launched a new infused pre-roll, which we have now relaunched into 2023.
The company has increased its presence in the pre-roll category and expanded its SKU lineup to include new potencies, strain-specific pre-rolls and multi-pack settings, now making up approximately 40% of pre-roll products sold in Delta 9 branded stores across the country.
As noted, the company has now completed our pre-roll automation project and plans to introduce multiple new pre-roll products and settings in the balance of 2023 and 2024 to increase our sales in this important category.
On oils, extracts, and derivative products, in 2022, the product — the company launched our 2.0 product lineup, including three formulations of ingestible cannabis oils, three formulations of 510 vape carts, cannabis kief and pressed hash in the concentrate formats category. It’s our belief that these categories will continue to become an increasingly important component of the recreational use cannabis market into the future.
Over the next 12 months, we plan to launch several new vape products, an expanded line of infused pre-rolls and a new infused cannabis milled product with the goal of seeing similar segment penetration as we have seen in 2023 with our pre-roll segment.
In our retail stores, we carry a full complement of new 2.0 cannabis derivative products from the industry’s leading manufacturers. We believe that through our retail unit, we are extracting valuable intel on which of these new product formats are having a positive impact with the consumer and investing in those categories as we pivot to capitalize.
From a distribution standpoint, we 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 the company’s overall business.
The company has undertaken a strategy to add new distribution markets incrementally as our increased supply capacity has come online in order to reach our ultimate goal of becoming a nationwide distributor of recreational use cannabis products.
As at the end of Q3, Delta 9 was licensed for distribution in Manitoba, Saskatchewan, Alberta, British Columbia, Ontario, the Yukon, Newfoundland, and Labrador, as well as the Northwest Territories, with these nine provincial markets representing well over 50% of the Canadian population. Subsequent to the end of the period, Delta 9 was notified of a successful listing of our products in New Brunswick.
Delta 9 has also made strides in this year in our first international shipments, announcing in February this year that we completed our first Wholesale shipment of cannabis to a customer in Australia. We also received seven additional export permits from Health Canada for shipments to the Australian market. The company has completed multiple shipments into the Aussie market in 2023 and expects to continue to develop international market opportunities into the future.
We expect near-term announcements regarding Good Agricultural and Collection Practices or GACP certification for our Winnipeg-based operations, which will expand our international market opportunities for higher margin export sales.
On vertical integration and retail cannabis sales, over the past three years, Delta 9 has made significant progress in expanding its retail footprint. Delta 9 started the year 2020 with only four operating retail stores in Manitoba.
Fast forward to 2022, the company announced a transformative retail acquisition to acquire all of the assets of Uncle Sam’s Cannabis Limited in connection with their 17 operating stores in the province of Alberta, operating under the Uncle Sam’s Cannabis and Discounted Cannabis brands. The combination of Uncle Sam and Delta 9 into our existing store network has made Delta 9 a leading multi-banner retailer of cannabis products in Canada.
In September last year, Delta 9 announced the closing of our next acquisition of three Garden Variety branded cannabis stores in Manitoba. The all-stock transaction added approximately $8 million in annualized topline revenues and the deal was immediately accretive to our EBITDA.
Delta 9 opened our 39th cannabis store in December 2022 in Dauphin, followed by our 40th cannabis retail store in January of this year and we opened our 41st cannabis retail store in February of 2023.
In this calendar year, we’ve begun to hone our pricing strategies across all geographies to enhance gross margins in our Retail business, addressing KPIs such as average transaction value, units sold per transaction, revenue per square foot and implementing cross-selling opportunities into non-cannabis products, which will allow our Retail segment to maximize profitability.
The company has and will continue to employ an aggressive growth strategy to actively acquire cannabis retail stores that will provide meaningful revenue growth and positive adjusted EBITDA. We are actively pursuing retail expansion opportunities in all Canadian provinces, which allow for privatized retail cannabis sales and will continue to expand on this successful vertical integration strategy.
On business-to-business opportunities, the company derives a portion of our overall sales — from sales of our proprietary grow pod system and from licensing and consulting activities provided to other licensed and pre-licensed cannabis companies.
To date, Delta 9 has licensed more than 15 third-party facilities, representing over 250 of our modular grow pods, for various cultivation partners across North America. In 2023, to-date, we have announced grow pod projects, which we anticipate will lead to sales of over 20 of our grow pods, north of $2 million in a sales pipeline and have a pipeline of projects developing domestically and internationally.
We will continue to pursue and expand these business-to-business revenue opportunities over the coming year. We are also continuing our pivot to expand sales and marketing efforts for our B2B business in the United States. We anticipate to see larger growth from our U.S. B2B sales in the balance of 2023 and beyond as this pivot begins to take effect.
Now on to the financial results. We’ll begin with an assessment of the balance sheet. The company ended Q3 this year with $2.4 million in cash, up from a low point this year of $1.7 million, as at the end of Q1.
As at the end of Q3, Delta 9 showed a working capital deficiency of $22.7 million, although we note that as at the end of the reporting period, the company was showing a breach of its debt service coverage ratio covenant for our credit facility with Connect First Credit Union, which required the classification of this debt as current on our balance sheet.
The company continues to make all required interest and principal payments across all of our existing credit obligations and we do not anticipate any deterioration of our credit condition. The company intends to secure additional or expanded waivers as necessary from CFCU, as the company works to improve its adjusted EBITDA results and bring its covenants back into compliance.
We note that the company has begun a more aggressive deleveraging strategy of our balance sheet, repaying almost $2 million in borrowings for the first nine months of 2023 and producing annualized interest savings north of $100,000.
We continue to address overall debt levels and expedite prepayments of certain tranches of our debt through the balance of 2023 and into 2024. This deleveraging will assist in supporting free cash flow improvements into future quarters.
On the company’s at-the-market equity facility, the company has raised approximately $2.05 million in gross proceeds as of the end of the reporting period to support our liquidity position and continued expansion. We believe the company is currently well capitalized to continue to execute on our expansion plans and we will 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 Q3 this year, the company produced approximately 1.5 million grams of cannabis versus 1.6 million grams in Q2 this year. This decreased in harvest quantities is anticipated in the wake of our cost-cutting measures and decreased capacity announced in January of this year.
Production cost per gram decreased to $0.58 per gram versus $0.77 in Q2 this year. We would highlight that even with the production and output capacity, the company continues to find efficiencies in its cultivation business reflected in these metrics.
Total grams produced in Wholesale reached 2 million grams in Q3 and exceeded grams produced for the second consecutive quarter, allowing the company to draw down inventory levels and improve our turnover ratios in our Wholesale business. 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 remained relatively flat at $1.30 per gram versus $1.35 in the previous quarter. While this marks a measured decline from previous years, the company would note that one-time sales of aging cannabis material resulted in the decline. These types of sales are not expected to recur.
We will continue to push to maximize production efficiencies to ensure the company can be competitive in the current market environment and continuing to address the company’s Wholesale business, improving overall grams sold and average selling price will continue to be a focus for us moving forward.
In our Retail segment, the company recorded a record 419,000 retail transactions in Q3, surpassing our previous record of 402,000 transactions in Q2 this year. Average transaction value is stable at $37.80 per transaction. Overall transaction size, units sold per transaction are key growth drivers for — focus for our Retail division through the balance of 2023 and into 2024.
On revenue and revenue segmentation, total net revenues for the three-month and nine-month period ending September 30th were a record $18.4 million and $53.6 million, reflecting an increase of 18% and 17%, respectively, versus the same period last year. Sequential net revenue increased 1% versus Q2 this year.
From a segmentation standpoint, Retail revenues were $15.9 million versus $13.8 million in the same period last year. Wholesale cannabis revenues were $2.6 million versus $2.8 million in the same period last year. And B2B revenues were $409,000 versus $345,000 for the same period last year.
The company saw relative strength in its Retail segment in Q3 this year as new store openings early in 2023 have begun to contribute to topline growth, price compression continues to affect cannabis Wholesale revenues due to excess competition in the Canadian market and our B2B segment has begun to see an uptick in revenues relating to the announced projects announced earlier this year against a backdrop of an uncertain overall business environment, which we see impacting business sentiment and capital investment.
In the upcoming quarters, we will focus on four main growth initiatives to drive revenue growth. First will be a focus on same-store sales and KPIs aimed at driving revenue growth from our existing retail store chain.
We’ve spoken about key improvements and investments the company has planned in its cultivation and processing business, which we feel will help us drive momentum, increased revenue and improve margins in our cannabis Wholesale segment with a focus on expanding product distribution in our existing provincial markets, as well as adding new provincial markets.
We will focus on expanded international market wholesale sales leading on the back of the success of our current year sales in the Australian market and we will continue to expand B2B revenues through a focus on creating relationships in the Canadian micro-cultivation industry and expanding into emerging markets such as the United States.
Gross profit before accounting for changes in the fair value biological assets for the three-month and nine-month period was $4.9 million, a 27% gross margin and $14.4 million, also a 27% gross margin. This compares with $1.9 million or a 12% gross margin and $9.5 million, a 25% gross margin for the same period last year.
Overall gross profitability has trended higher by 15% and 6% for the three-month and nine-month period respectively versus the previous year. We have begun, excuse me, Delta 9’s management has been undertaking a thorough assessment of our pricing and margin across our various business segments and we will 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.
Operating expenses, excluding share-based compensation for the three-month period ending September 30, was $7.2 million versus $8.5 million, a decrease of $1.25 million or 15% versus the previous year.
The most notable changes that we are experiencing in expense categories versus the previous year are amortization. This was an increase of $173,000. The following cost categories reflect material decreases in insurance, legal, professional and public company costs, personnel expenditures, which reflected a decrease of $435,000, utilities costs and supplies and materials costs.
These decreases in overall operating expenses are largely due to the cost-cutting measures implemented by our management in January 2023. We note that cash operating expenses have decreased by $850,000 from the same period the previous year, placing the company on pace to achieve our target operating expense reductions of $3 million to $4 million annualized.
The company’s loss from operations for the three-month and nine-month period ending September 30 improved to $4.5 million and $9.2 million versus a loss of $6.2 million and $12.6 million for the same period last year. We are confident that our continued focus on revenue growth, gross profitability improvements and prudent cost controls will return the company to profitability from operations over the coming quarters.
The company’s adjusted EBITDA for the three-month and nine-month period ending September 30 was $1 million and $1.9 million versus a loss of $1.6 million and $3.8 million for the same period last year. This also compares with adjusted EBITDA of $1.4 million for the sequential quarter ending June 30.
We attribute the overall improvement in adjusted EBITDA in the period to higher overall net revenues and gross margins, as noted from our Material Business segments, as well as savings from our cost-cutting plan.
We are confident that the company’s recent acquisitions, cost-cutting initiatives and renewed focus on revenue growth will continue to improve and strengthen the company’s adjusted EBITDA position in coming quarters.
We note that this marks the company’s second consecutive quarter of positive adjusted EBITDA, which is our main barometer of profitability for the company. We see this result as materially positive as a milestone for Delta 9.
We note that operating cash flows have also improved materially versus the previous year. Cash generated from operations for the first nine months of 2023 was $2.7 million versus cash burned in operations of $6.3 million for the same period last year.
As we look forward to the balance of the 2023 operating year, we feel that the company is well positioned to continue to execute on our vertical integration and growth strategies. In our Production and Wholesale segment, the company will continue to push forward to maximize the utility and efficiency of our existing assets, pushing to operating cash flow positive on the back of our recently announced cost-cutting initiatives and increasing our ability to supply volumes of cannabis both domestically and internationally.
In our Retail segment, we will add to our retail and distribution capacity by adding new stores to our existing chain and maximizing the efficiency and outcomes of our existing retail store network.
In our B2B segment, we will continue to cultivate long-term and value-added relationships with our B2B customers as we deliver on grow pod projects across North America, while deploying our resources into international markets to position our non-plant-touching businesses to realize growth in the ever-growing cannabis opportunity globally.
We 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 may have.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] First question comes from Lev Zentner from National Bank. Please go ahead.
Lev Zentner
Congratulations on the good quarter. I have a question pertaining to the adjustment of the mark-to-market on biological assets. Do you know what the earnings per share would have been without the biological mark-to-market adjustment? Thank you.
John Arbuthnot
Yeah. Good question, Lev. In terms of the biological asset adjustments, we are showing a loss of on those fair value changes of $2.2 million for the quarter. Subtracting that from the operating loss would place the operating loss at approximately $2.2 million and would decrease the loss per share by approximately $0.015 on an initiative and outstanding basis. So it was certainly material in terms of the impact.
In terms of that decrease and what is resulting in that decrease, we are continuing to see the impacts of the decrease in output capacity from our facility. Although the core underlying metrics that go into those calculations, things like average yield and average selling price per plant continue to remain stable. So we would anticipate that that unrealized loss will stabilize over time, but certainly negatively impacting EPS in the quarter.
Operator
Thank you. There are no further questions. You may proceed.
John Arbuthnot
If there are no further questions, I want to thank everyone for taking the time for the call this morning and we’ll turn the call back over to the Operator to wind up.
Operator
Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and we ask that you please disconnect your lines.
