Delta 9 Cannabis Inc. (OTCQX:DLTNF) Q4 2021 Results Conference Call March 31, 2022 9:00 AM ET
Company Participants
Alexa Goertzen – Senior Executive Assistant
John Arbuthnot – CEO
Operator
Good morning, ladies and gentlemen, and welcome to the Delta 9 Q4 2021 Financial Results Conference Call. [Operator Instructions] This call is being recorded on March 31, 2022.
I would now like to turn the conference call over to Ms. Alexa Goertzen. Please go ahead.
Alexa Goertzen
Good morning, everyone, and welcome to the Delta 9 Cannabis Q4 and year-end 2021 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’d 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 Q4 and year-end 2021 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, year-end 2021 financial statements, management discussion and analysis and annual information filing documents have now been made available on SEDAR and our Company’s website.
We also note that this morning the Company announced closing of a material refinancing of the Company’s balance sheet through our previously announced $32 million debt financing with Connect First Credit Union. We announced a $10 million strategic financing from Sundial Growers, which positions the Company for further growth and aligns us with Canada’s, — or one of Canada’s leading large cap cannabis companies. And we announced a transformative retail transaction to acquire 17 operating retail stores in the province of Alberta, which positions the Company as one of Canada’s leading vertically integrated LP retailers.
Press releases detailing the above transactions have been posted on SEDAR, distributed through the Company’s website and newswire. We will provide additional commentary on each of these transactions during today’s call and can answer any questions on these transactions specifically at the balance of the call. And with that let’s begin.
Throughout 2021, Canadian cannabis industry sales have continued to expand, posting retail cannabis sales of $382 million in December 2021, based on figures from Statistics Canada and up 28.5% over the previous year. Annualized cannabis sales in Canada are now approximately $4.58 billion. And with the market plan to increase at a compound annual growth rate of approximately 10% per year over the next five years, the industry is expected to double in terms of retail cannabis revenues by the end of this decade.
The industry continues to deal with challenges relating to an oversupply of cannabis products, generally compressed wholesale and retail margins, growing pains of provincial crown distributors and market volatility. 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 significant value for shareholders.
I’m pleased today to be presenting you with Delta 9’s Q4 and year end 2021 financial and operating results. These results show a continued upward trend in year-over-year revenues, gross profits and consistency in the Company’s positive adjusted EBITDA profile. 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 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 the business, we’ll begin with an update of activities for our Delta 9 facilities in Winnipeg. The primary purpose of these facilities of course is to cultivate, process, and manufacture high-quality cannabis products.
In Q4 this year, the Company maintained 297 of our proprietary Grow Pods licensed by Health Canada and in operation within our Delta 9 facilities. We are now operating these assets at or above the original designed capacity of our facilities and are beginning to assess efficiencies in terms of number of harvest rotations per year, average grams per harvest, and overall potency in order to maximize returns from these assets. The Company’s purpose-built processing center, which was licensed in April 2020 and allows for fully-automated bottling, packaging, capping and labeling functions is now fully operational. We anticipate that once this processing center is at capacity, it will allow for up to 25,000 kilos per year of processed, dried cannabis flower material.
The Company received approval in Q3 2021 this past year to expand our Health Canada license perimeter to 95,000 square feet from 80,000 square feet, including a new purpose-built 7,500 square foot vault area and distribution center, which allows for more efficient distribution of Delta 9 branded new products to provincial markets across Canada. We will continue to update the market on expansion progress, as the Company further develops its forward-looking expansion plans through this coming year and as licensing approvals are obtained from Health Canada.
In terms of our portfolio of cannabis products, there has been a significant amount of excitement in the cannabis space over the rollout of cannabis 2.0 products. However, dried flower and pre-rolls continue to demand approximately 70% market share by category through our stores in the Canadian marketplace, with much of the consumer demand in the high-potency segment. We currently produce approximately 30 different genetic strains of cannabis, each with its own unique chemical cannabinoid content terpene and flavonoid profiles and with another 100 or more strains being stored in an onsite seed bank to provide options into the future. We are continuing with our production pivot towards higher potency cannabis strains, which are the highest demand segment with the retail cannabis consumer.
Over the past 12 months, the Company has increased its average THC in its harvested cannabis flower products to over 18% from less than 15% at the beginning of 2020. The Company continues to improve processes for drying, curing and processing of dry cannabis flower material and will continue to strive to produce the highest quality cannabis products at scale.
Cannabis pre-rolls have become an increasingly important category over the past two years as consumers have moved to smaller packaging sizes and saw 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 selling — excuse me, two of our top 20 selling products in Delta 9 retail stores in the past year.
In Q3 2021, Delta 9 launched a new 14 pre-roll multipack of our best selling Bliss and Twist pre-rolls in the Manitoba and Saskatchewan markets, and the Company plans launches of these multi packs across additional markets in the coming quarters. The Company also plans to release several other pre-roll and infused pre-roll products in the coming quarters to increase our overall market share in this important category.
In the last week and subsequent to the end of the reporting period, Delta 9 released our new 0.25 gram pre-roll, offering Canadian consumers a convenient personal use setting, again in this important pre-roll category. We plan to further invest in automation of our pre-rolls manufacturing in the next year, which will increase the Company’s capacity to produce and distribute pre-rolled products in all of our markets.
On oils, extracts and derivative products, over the past year and a half, we’ve seen a successful initial sell-through in the market for our cannabis 2.0 products, including ingestible cannabis oils, vape cartridges and cannabis concentrates. In 2022 Delta 9 will relaunch 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 includes three formulations of ingestible cannabis oils, three formulations of vape — 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 market into the future.
In our retail stores, we are carrying the full complement of new cannabis 2.0 products from the industry’s leading manufacturers. We believe that through our retail unit, we will be able to extract valuable entail 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 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 on line in order to reach our ultimate goal of becoming a national and international distributor of recreational use cannabis products.
Throughout the year, Delta 9 added two new — excuse me, throughout the year 2020, Delta 9 added two new provincial markets Newfoundland and Labrador in Ontario. And we’ve expanded our SKU selection through 2021 across virtually all provincial markets that we participate in. At the end of the year, Delta 9 was licensed for distribution in Manitoba, Saskatchewan, Alberta, British Columbia, Ontario and Newfoundland, with these six provincial markets representing over 50% of the Canadian population.
The Company is currently undertaking license applications in additional Canadian markets and we highlight the Quebec market as our next key plan market entry, as well as exploring international distribution opportunities in markets like Australia, Israel and Latin America to expand our distribution potential into 2022.
On vertical integration and retail cannabis sales, we continue to believe that there are a number of benefits to pursuing a vertical integration strategy into retail, including control over direct-to-consumer sales force and products distribution, control over direct-to-consumer branding and marketing initiatives, capturing additional revenue and gross margin from retail sales, and receiving direct feedback from consumers regarding product trends, marketing strategies, et cetera.
Over the past 24 months, Delta 9 has made significant progress in expanding our retail footprint. We started the year 2020 with only 4 operating stores within the province of Manitoba. Prior to today’s date, Delta 9 operated 17 cannabis retail stores having opened during 2021, our first express store in the Portage Avenue West area of Winnipeg and another Superstore in the Bunns Creek Shopping Center in Northeast Winnipeg in Q1 2021.
In Q2, Delta 9 opened its 12th operating store in the Northgate Shopping Center in Winnipeg. In Q3, we continued our aggressive expansion strategy, opening stores in Selkirk, Manitoba, acquiring two stores in Edmonton, Alberta, and opening another store on Pembina Highway in Winnipeg, Manitoba. In early 2022, we opened our 17th retail store on Portage Avenue in Winnipeg co-located in the St. James Hotel.
Today, 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 cannabis stores based in the province of Alberta. The purchase price paid by Delta 9 Cannabis Store relating to the Uncle Sam’s transaction was $12.5 million, subject to customary adjustments. Uncle Sam’s Cannabis Limited also received 6.66 million common shares of the Company, at a deemed price of $0.27 per common share. The Uncle Sam’s retail cannabis stores have demonstrated significant revenue, EBITDA and earnings growth over 2020 and 2021. We do expect that this transaction will be accretive to the Company in 2022 and 2023 before synergies, while the acquisition represents an attractive revenue multiple of approximately 0.68 times annualized revenue. The combination of Uncle Sam’s Cannabis stores and Delta 9’s existing store network will make Delta 9 a leading retailer of cannabis products in Canada.
As of today’s date, Delta 9 operates 34 cannabis retail stores across Canada, and is positioning as one of the country’s largest vertically integrated cannabis retailers. The Company has an aggressive growth strategy to actively acquire cannabis retail stores that will provide meaningful revenue growth and positive adjusted EBITDA.
On business-to-business opportunities, the Company derives a portion of our overall sales from sales of our proprietary Grow Pods, from licensing and consulting activities provided to other licensed and pre-licensed cannabis operators. We do believe that these opportunities provide us with a number of benefits, including a complementary business vertical, which produces diversified and high-margin revenue, a third-party validation of the Company’s proprietary Grow Pod platform, valuable partnerships with other pre-licensed and licensed cannabis companies, and the proven opportunity for international expansion through non-cannabis revenue streams.
To-date, we have licensed over 15 third-party facilities, representing over 150 Grow Pods for micro cultivation partners across Canada. We will continue to pursue and expand on these B2B revenue opportunities over the coming year. We are also continuing our pivot to expand our sales and marketing efforts for this B2B segment in the United States, and we anticipate to see larger growth from our U.S. B2B sales in 2022, and beyond as this pivot starts to take effect.
Now onto our financial results. We will begin with an assessment of the balance sheet. The Company ended the year with approximately $3.7 million in cash inclusive of the Company’s draw on its CWB operating line of credit and showed negative working capital of approximately $4.2 million, a decrease from $8 million in working capital as at the end of Q3, due in large part to two main factors: the transfer of $11.8 million in face value to debentures to a current liability from a long-term liability in Q2 2021; and the transfer of $10.7 million in borrowings under the Company’s CWB facilities to current due to a potential breach of the Company’s debt service covenant as at December 31, 2021. The Company obtained a waiver from CWB on its potential covenant breach and has now repaid all of these facilities with CWB.
During our Q3 2021 earnings call, we highlighted balance sheet strengthening as a major near-term focus for management. And as of today, we are pleased to announce two material financing and refinancing transactions. The first is the Company’s closing of $32 million in credit facilities from Connect First Credit Union. These facilities include a $23 million commercial mortgage facility, a $5 million acquisition facility, used for the Uncle Sam’s transaction and a $4 million authorized overdraft. The facility matures after five years, and amortizes over a 12-year term. The first portion of this facility, the $23 million mortgage facility is anticipated to be established in multiple tranches, advancing at various times and for purposes again including $11.2 million for the repayment of our existing long-term debt with CWB, and $11.8 million for the repayment of the Company’s existing 8.5% convertible debentures. The interest rate under these credit facilities is 4.55% per year.
The Company has already used a portion of these facilities to repay its credit facilities with Canadian Western Bank, and we expect to repay our convertible debentures on the maturity date of July 17, 2022. As noted in our press release dated February 1st of this year, these facilities provide an attractive and industry leading interest rate, annualized interest and principal repayment savings versus the Company’s previous debt profile and expansion and operating capital through the acquisition and working capital facilities.
Second, the Company’s closing of a $10 million strategic financing from Sundial Growers in the form of a three-year $10 million principal amount of 10% senior secured convertible debentures, this financing will provide acquisition capital for our previously noted retail acquisition, as well as capital for further expansion and for general corporate working capital purposes. The result of these two transactions is a balance sheet, which provides a significantly improved working capital position, alleviating concerns around the current maturity of the CWB and unsecured convertible debenture facilities and positioning Delta 9 with two new strategic partners in connectFirst and Sundial Growers to help facilitate the next stage of the Company’s growth.
Total assets on the balance sheet as at year end totaled $74.7 million. This was down modestly from $76.4 million the year prior. We believe the Company is currently well capitalized to continue to execute on our 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, we do provide quarterly updates on progress of our KPIs for our businesses. In Q4, the Company produced approximately 2.65 million grams, up from 2.4 million grams in Q3 last year. As the Company continues to improve its production efficiencies, we expect that these production numbers will continue to increase over the coming quarters. Production costs and total cost per gram increased modestly to $0.61 and $0.76, respectively versus $0.58 and $0.73 per gram in Q3 last year.
We do continue to highlight that these production cost figures are quite competitive, even comparing to our largest competitors in the context of the current cannabis flower market in Canada. As the Company continues to refine its production techniques, we anticipate that our economical cost base will be essential to improving gross profitability in upcoming quarters.
Total grams sold in our wholesale segment in the quarter reached a record 2.2 million grams, up from 1.2 million grams in the last quarter. We note that overall grams sold in the past four quarters represent a significant improvement over the previous four quarters. The Company is continuing to expand its number of SKUs listed in its — in our provincial markets, and we’ll begin to report on number of SKUs listed, cases sold and order fulfillment rates, as well as other KPIs in the coming quarters as these KPIs are formalized. We believe these new KPIs will continue to demonstrate that there’s positive momentum in Delta 9 Cannabis wholesale business.
The Company’s average selling price decreased to $2.07 per gram in Q4 from $3.42 per gram in Q3 this year, due to larger than average bulk wholesale sales to other LPs during the quarter. We’ve seen average wholesale selling prices stabilize over the last several quarters and feel that Delta 9 can reach sustainable profitability from our wholesale cannabis business at these current levels.
Continuing to address the Company’s wholesale business and improving overall grams sold and average selling price and product quality will continue to be a focus for us moving forward. We continue to see positive trending in our overall number of retail transactions processed and have seen retail activity in store and online increase over 2021. Our average cart size appears to be stabilizing around the $42 to $43 per transaction level. Including our investor webpage retail store and medical clinic, Delta 9 now sees well over 1 million unique webpage visitors to our websites each year.
Turning to the income statement on revenue and revenue segmentation, total net revenues for the three months and year ending last year were $17.1 million and $62.3 million. This compares with $14.1 million and $52 million, an increase of 21% and 20%, respectively over the previous year. Sequential net revenues increased 13% from $15.2 million for the period ending September last year.
From a revenue segmentation standpoint for the full year last year, retail revenues increased 25% year-over-year to $40.2 million, wholesale revenues increased 57% year-over-year to $18.5 million, and business to business revenue decreased 42% year-over-year to $5 million.
We would point to the year-over-year increases in net revenue as a positive indication that the Company’s diversified revenue and growth strategy has been able to contribute to overall revenue growth. We attribute the increase in year-over-year revenue to relatively stronger performance in our wholesale and retail segments. And in the upcoming quarters, we will focus on three main initiatives to drive revenue growth: firstly, a continued expansion of the Company’s retail store chain, while continuing to market our price-leading strategy to generate customer acquisition at new and existing company stores; second, building continued momentum in the cannabis wholesale segment with a focus on expanding product distribution in our 6 provincial markets, as well as adding new markets and expanding in the bulk wholesale market as well; and expanding B2B revenues through a focus on creating relationships in the Canadian micro cultivation industry and expansion into emerging markets, such as the United States.
Gross profit before accounting for changes in the fair value of biological assets for the three months and year end period was $4.9 million and $18.3 million. This compares with $6.3 million and $17.8 million for the same period the previous year. This also compares with $4.8 million for the sequential period ending September last year.
We would note the increase in overall gross profit for the full year before changes in the value of biological assets, as a positive indication of the Company’s ability to maintain and increase gross profit in a challenging market environment. For the year ending last year, the Company’s gross profitability by business segment was 34% in our wholesale cannabis segment, 27% in our retail cannabis segment, and 35% in our B2B segment, for a weighted average gross profitability of 29% last year.
Operating expenses for the year ending December 31 last year were $23.5 million. This is up from $19.1 million for the year end December 31, 2020. The most notable increases in operating expenses year-over-year were: amortization, an increase of $1.2 million; insurance, an increase of $118,000; and personnel expenditures, $1.9 million. Overall increases in personnel expenses, the largest cash increase in SG&A year-over-year, mostly relate to the increase in overall operating stores from 6 stores in Q3 2020 to 16 operating stores at the end of last year.
The Company’s loss from operations for the three months and year end December 31 last year was $3.5 million and $7.6 million. This compares with a loss from operations of $69,000 and $2.7 million for the same period the previous year. This also compares with a loss of operations of $55,000 for the period ending September.
We are confident that our renewed focus on revenue growth through our recent acquisition and other growth drivers and prudent cost controls will return the Company to operating profitability over the coming quarters.
The Company’s adjusted EBITDA for the three months and year end last year was $613,000 and $2 million. This compares with $1.9 million and $3.8 million for the same period the previous year. We would note that three months period ending December last year marks the Company’s ninth consecutive quarter of positive adjusted EBITDA, putting us in an industry-leading category in terms of maintaining a positive adjusted EBITDA profile against the backdrop of a very challenging market environment in Canada, and a meaningful indication of the relative strength of the Company’s overall operating results.
As we look forward to the balance of the 2022 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, increase production output, and increase our ability to supply volumes of cannabis across all of our markets.
From here, there is opportunity to grow, either through further capital spending and expansion or through acquisition of assets, brands or complementary products. 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 for our suppliers, seeking the best locations and positioning as the most competitive LP-owned retailer in the Canadian cannabis space.
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 and deploying our resources into international markets to position our non-plant touching businesses to realize growth in the ever-changing and ever-growing cannabis opportunity globally.
Thank you 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 questions.
Question-and-Answer Session
Operator
John Arbuthnot
If there are no questions, folks, we will turn the call back over to the operator to wrap up.
Operator
Thank you. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a great day.
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