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48North Cannabis Corp. (OTCPK:NCNNF) Q3 2020 Earnings Conference Call May 26, 2020 8:30 AM ET
Company Representatives
Charles Vennat – Chief Executive Officer
David Hackett – Chief Financial Officer
Conference Call Participants
Jenny Wang – Eight Capital
Operator
Welcome to 48North Cannabis Corp, Q3 2020 Fiscal Results Conference Call. At this time all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session for analysts. Instructions will be provided at that time for you to queue up for questions. [Operator Instructions].
I would like to remind everyone that this conference call is being recorded today May 26, 2020 at 8:30 a.m. Eastern Time.
I will now turn the call over to David Hackett, Chief Financial Officer. Please go ahead Mr. Hackett
David Hackett
Good morning! I would like to welcome all call participants to the 48North Cannabis Corp’s, Third Quarter 2020 Conference Call.
48North’s intentions, hopes, beliefs, expectations or predictions of the future are forward-looking statements. It is important to note that 48North’s actual results could differ materially from those projected in such forward-looking statements. While these statements reflect the company’s beliefs regarding its plans, estimates and projections, they are subject to some uncertainties and risks that could cause actual results to differ materially.
More detailed information about the company and factors that may affect its operations can be obtained from 48North’s filings with SEDAR at sedar.com. 48North is under no obligation to update any forward-looking statements discussed today and investors are cautioned not to place undue reliance on these statements.
48North, DelShen Therapeutics, Good & Green and Latitude are trade names of 48North Cannabis Corp. All other companies and products mentioned herein may be trademarks or registered trademarks of their respective holders.
Joining me on today’s call is Charles Vennat, Chief Executive Officer of 48North. First Charles will highlight the company’s achievements this quarter and events subsequent to the end of the quarter and then I will provide a brief review of the company’s financial results. After the presentations are complete, we will be happy to open up the call to analysts for questions. Over to you Charles.
Charles Vennat
Thank you, David. Good morning everyone. Third quarter of 2020 was foundational for 48North Cannabis Corp. Notwithstanding the onset of COVID-19, I am very proud of the accomplishments made by our team this quarter and the position the company finds itself in looking ahead.
This morning I will provide an update on 48North’s response to COVID-19, review our third quarter accomplishments and results and highlight some of the milestones we hit subsequent to the end of the quarter. In addition, I will be providing an update on the progress of our second season at the Good:Farm, 48North’s outdoor cultivation facility in Brant County, Ontario.
The company acted swiftly to the sudden onset of COVID-19 and to the best of its ability mitigated risk posed by the global pandemic. While the situation is constantly evolving, 48North has managed to keep its three production facilities operating at full capacity without jeopardizing the health and safety of its workforce.
From a corporate perspective, the company has managed to continue building relationships with retailers across the country, sign contract manufacturing partnerships with best-in-class brands and launch products into new markets.
In response to the pandemic, the company sent all non-essential production employees able to work from the private residences home. Effectively this minimizes the number of potential exposures on a daily-basis. At the facility, the company also staggered start-times, implemented a staggered shift program, prohibited social gatherings and implemented increased sanitation programs, as well as mandatory health checks for all employees entering the workplace.
While at work, physical distancing measures were enacted to the best of the company’s ability; PPE was made mandatory both inside and outside the production area including office spaces, and a third party disaster relief cleaner was retained to institute a deep clean on a weekly basis.
As the company monitors the evolving situation and closely observes best practices put forth by local health authorities, all of the above measures remain in place and will remain until otherwise deemed appropriate. At this time no 48North employee has tested positive for COVID-19.
The federal government has announced a number of measures to support workers and businesses; however, to-date we have not been eligible for additional support. That said, the company continues to investigate and monitor the activities of the federal and provincial governments and will apply for support wherever possible.
Since COVID-19, sales have continued to grow and demand for the product has increased. I am very proud of our team’s ability to grow and flourish under these difficult circumstances. Our response to the pandemic is indeed a true testament to the efforts we have made as an organization in improving our operational capacity and in strengthening our team.
When appointed as the company’s CEO, I inherited a strong brand with significant consumer demand. However, the organization required operational and structural improvements to satisfy this demand. We have now laid the groundwork for sustained accelerated and future growth, and done so while increasing quarterly revenue by 55%.
Our strategy is built around a commitment to manufacturing high quality cannabis products for our own brand and other leading brands, as well as our commitment to low cost cultivation practices that result in consistent biomass. I can now report that the company has completed the groundwork for sustained accelerated and future growth. Previously lacking a clear direction, the company is now steadfast in its commitment to manufacturing high quality cannabis products for its own brand and other leading brands in the maturing Canadian marketplace.
Our low cost cultivation practices that result in consistent biomass are a critical ingredient in the development of accessible next generation cannabis products. This quarter, the company recorded – reported revenues of $2.8 million representing a 55% quarter-over-quarter increase over the second quarter 2020 revenues and a 307% increase over third quarter 2019 revenues of $689,000. At the tail end of the quarter, the company booked its first revenues from the sale of next generation cannabis products using biomass from the company’s Good:Farm.
Looking ahead to subsequent quarters, with the launch of an expected 26 additional skews before October 2020, alongside the company’s planned expansion into four additional markets, the company expects that top-line revenue will increase. Further, it is anticipated that 48North’s quarterly expenses will see a decrease alongside an increase in revenue driven by the sale of additional cannabis product. Moreover, the company expects to see additional revenue driven by contract manufacturing relationships with cannabis brands, retail brands and other licensed producers and pharmaceutical brands such as PAX and Medical Cannabis by Shoppers Drug Mart.
While this quarter the company accelerated revenue growth, it’s most notable accomplishment for future viability was the completion of its manufacturing and commercialization hub at the Good:House and its state-of-the-art improvements at the Good:Farm.
Of course these improvements did come at a cost. At the end of the quarter, the company had $17.8 million of cash and cash equivalents on hand. This use of capital was required to position the company for future growth. The company has now nearly completed all of the capital intensive projects required to execute on its current business plan. To that end, the company now has the foundation to build upon organically scale.
Without significant capital expenditures, we are poised for future growth. This quarter 48North completed the build out of the Good:House. This includes a state-of-the-art extraction facility expected to process 30,000 kilograms of cannabis biomass annually. In addition to its current capacity for dried flower and next generation product, the company is currently commissioning automated packaging lines for dried flower, increasing pre-roll and topical manufacturing capacity, and adding additional secured storage space.
To that end, 48North announced the launch of the company’s strategic partnership with Humble & Fume, Fume Labs. Fume Labs will manufacture 48North’s and humble+fume’s vaporizer products, contract manufacture cannabis products for cannabis brands, licensed producers and retail brands, and leverage humble+fume’s extensive nationwide sales and distribution network, and act as the sales agency for products produced at the facility.
In addition, the company completed the build-out of the purpose-built drying facility at the Good:Farm, with the capacity to hang dry the entirety of 48North’s outdoor cannabis harvest. The license amendment application was submitted on May 8, 2020, and the company expects to receive the necessary approvals before the fall harvest. I can say with confidence that these capital improvements were absolutely necessary to the company’s future success.
In house, the company can now manufacture next generation cannabis products with complete control of the supply chain. From cultivation to distribution, the company has invested in industry leading machinery, processes and people. This capital intensive process has laid a strong foundation for accelerated future growth.
Most importantly, these improvements give 48North the ability to launch high quality, consistent and diversified products at good margins across the country. In addition, these improvements allow the company to contract manufactured products for other brands who lack the operational capacity to commercialize and launch products.
In subsequent quarters, the company expects that its contract manufacturing capacity for a variety of cannabis product forms, including pre-roll, dried flower and extract based products will be significant driver of revenue and ultimately a critical component of the company’s eventual pathway to profitability.
In addition to focusing on the company’s renewed commitment to improving our operational capacity, this quarter we launched our initial suite of next generation cannabis products. This included 48North’s first vape pen and topical cream. The company also launched sun-grown flower in Alberta and its first accessible dried flower brand in Quebec.
Since the end of the third quarter, the company continued to make significant progress in launching new products in new markets. This includes vape-products, topical products, and additional SKUs of outdoor flower, indoor flower, accessibly priced flower and pre-rolls. Moreover, 48North launched its set of products into British Columbia and Saskatchewan. Looking ahead, the company has immediate plans to expand into Manitoba and New Brunswick.
To that end, 48North begin commercializing its cannabis biomass from the Good:Farm. To-date, the sell-through of these products has been strong and the company expects this trend will continue.
In addition, 48North signed a key supply agreement with Medical Cannabis by Shoppers Drug Mart Inc., a subsidiary of Shoppers Drug Mart Inc. Under the terms of this agreement, 48North will become a supplier of cannabis and cannabis products through the Shoppers online sales platform. As a result, 48North-branded products and licensed brands will now be available to Medical Cannabis by Shoppers™ patients across Canada.
Keeping in the spirit of signing partnerships with best-in-class players, 48North signed a supply agreement with Pax Labs Canada Inc. At launch, Fume Labs will manufacture two cannabis oil pods for the PAX Era and PAX Era Pro. The company expects to continue to announce similar partnerships with other brands in the coming months.
Since last year’s harvest at the Good:Farm, 48North has been focused on preparing for its second season of planting at the company’s outdoor cultivation site. To-date the company is using its three licensed hoop-houses on the farm to propagate its clones, adding the necessary amendments to the soil, and removed all single-use plastic from the farm.
In addition, the company has completed the build-out of the state-of-the-art drying facility at the farm and submitted the applicable license amendment on May 8, 2020. The company expects to receive the necessary approval from Health Canada in time for the fall harvest. Finally, the company expects to begin planting its clones and seeds at the Good:Farm in the beginning of June, a full month ahead of the 2019 season.
Finally, the company launched its second edition of Latitude, 48North’s onmi-channel customer acquisition tool focused on building brand, targeting new customers and engaging existing 48North customers.
As part of the company’s ongoing commitment to becoming a beloved cannabis brand for Canadian consumers, the company will continue to invest in building brand and other marketing activities. As the industry matures and consumers begin to make more educated choices with their wallets, 48North remains committed to reinvesting in its brand and product.
I will now pass it on to David Hackett, our Chief Financial Officer, for his analysis of our financial performance.
David Hackett
Thanks Charles. Revenues for the three months ending March 31, 2020 were $2.8 million, up 55% from Q2 revenues of $1.8 million. The revenue mix for the quarter included sales to both other licensed producers and sales to provincial regulators in Alberta, Quebec and Ontario.
Sales to the AGLC, SQDC and OCS were up 270%, 96% and 51% respectively over the last quarter as our ability to manufacture more pre-rolls and edible flower increased by 23% and 298% respectively.
We expect the provincial sales will continue to become a larger percentage of our cannabis sales and this is consistent with our transition plans to focus on branded product sales in the adult cannabis marketplace.
For Q3, 85% of our cannabis sales were through provincial channels compared to 56% in Q2 of 2020. We believe that by increasing manufacturing capacity, we will be able to increase the volume of pre-roll and edible flower to the market place.
This quarter also saw the introduction of Cannabis 2.0 products with Avitas, our vape cartridges and apothecanna, our topical cream products into the marketplace. As we move from an LP to LP sale – provincial sales, the excise duties as a percent of revenue increases caused our excise duties to be 24% of our net revenues up from 12% in Q2. During Q3 our gross margins declined to 20% down from 32% in Q2. As we move up the learning curve on manufacturing and automate several of our processes, we expect our gross margins to improve.
The company capitalizes production costs related to biological assets and expenses these costs to cost of sales before fair market adjustments as the inventory is sold. For the three months ending March 31, 2020 inventory expense to cost of sales before fair market adjustments were $1.7 million compared to $1 million in Q2. For the nine months ending March 31, 2020 inventory expense to cost of sale before fair market adjustments was $3.4 million.
During the third quarter, the company reviewed the underlying assumptions for the inventory valuation. And based on current market trends regarding expected selling price per gram, has reduced the expected selling price per gram for outdoor cannabis from $1 to $0.50 per gram. As such, during Q3 of 2020 the company has increased the fair market adjustments on inventory on the statement of loss by $5.4 million.
During the quarter the company reviewed its assumptions regarding the license, goodwill and intangible amounts, specifically whether there was any impediment to the balance sheet values. As such, the company determined that the goodwill and intangible assets relating to the Rare and Sackville acquisitions were impaired and had been written off at quarter end. This has resulted in an impairment of goodwill and intangible charges of $4.1 million during the quarter and a loss on change in fair value of contingent consideration of $2.2 million for a total non-cash charge of $6.3 million.
Subsequent to quarter end, on Friday in an effort to sharpen our focus on the Canadian market place we announced to divestitures, specifically 48North returned Rare and Sackville, two U.S. base cannabis companies to their previous ownership groups.
During Q3 our inventory decreased from $17.8 million at December 31 to $15.5 million at March 31, 2020. This decrease is largely due to the non-cash inventory adjustment of the outdoor inventory of the Good:Farm. We continue to believe that the outdoor cannabis will largely be used for extraction purposes.
During the third quarter we started to process our outdoor cannabis into extraction oils to be used in to produce vape and Cannabis 2.0 products, and as such we have seen an increase in inventory related to packaging materials for our cannabis products.
As mentioned earlier, we are bringing additional manufacturing capacity online at the Good:House, and believe that additional quality cannabis will be processed, packaged and sold in the coming quarters.
Investing activities during the nine months ending March 31, 2020 grew $11.5 million and largely reflect the addition of plant, property and equipment. We continue to invest in the Good:House facility increasing our extraction expertise and by expanding our manufacturing automation capacity through a build out of the facility.
We are expecting to continue to invest in the Good:House in the current quarter, although we expect a reduction in overall size of capital expenditures. We recorded a net loss of $17.8 million compared to a net loss of $6.2 million in the last quarter.
This quarter’s net loss equates to a basic and fully diluted earnings per share of $0.10. Included in the net income were non-cash items; goodwill write down of $4.1 million, contingent consideration of $2.2 million, revaluation of outdoor inventory of $5.4 million, depreciation of 677 and an additional $104,000 included in depreciation and the cost of sales, and $288,000 [ph] in stock based compensation, totaling approximately $12.8 million.
During Q3, 2020, our cash usage was approximately $14.8 million. This can be broken down into three component parts; cash used in ongoing operations was approximately $6 million, cash used in working capital balances was $4.7 million and cash used in investing activities was $4.1 million. We expect to have reduced property, plant and equipment investments during the current quarter as we optimize the Good:House facilities to allow for increased production activity.
We continue to monitor our capital resources to assess and manage the liquidity to fund our operations and at the end of Q3, 2020 we had $17.8 million in cash and cash equivalents on hand. 48North remains in the development stage and while we do generate revenue from our sale of our dried cannabis and related products, we are focusing on reducing the execution risk that comes with growing cannabis and manufacturing products at scale.
And on a personal note, I would like to take this opportunity to wish my father a Happy 83rd Birthday. And with that, I’ll now turn the call over to Charles for his closing remarks.
Charles Vennat
Thank you, David, and Happy Birthday to your father. 48North knows that high quality and consistent products create trust and brand loyalty with customers, and we’re seeing that our brand is cutting through. We launched Canada’s first topical in Ontario and Alberta and have a number of the top selling pre-rolls across the country, but we need to build on this with more products and dependable supply in the Canadian adult use market.
I believe the report that I made today highlights that we are making significant progress in this regard. Getting high quality, well-branded and accessible products to market, and maintaining adequate supply requires hard work. We learned important lessons from last year’s Good:Farm harvest and are working diligently on our 2020 licensing application for additional Good:Farm drying space.
Combined with our state-of-the-art manufacturing capabilities at the Good:House, we believe we are one of the most advanced cannabis companies in our combination of low cost, high quality inputs and scalable operational capacity. For Q4 you will see our first revenues from our extraction facility that uses outdoor grown cannabis from the Good:Farm. Future growth stemming up from advancements at Fume Labs and the Good:House will result in both increased supply for consumers and revenues for the company.
We know that it’s a challenging time for our industry with many players and limited capital, but we believe we have the fundamentals right and we have our priorities straight. Buoyed by the result of our indefatigable team, I look forward to showing you that we are putting actions behind our words. We are confident that the results will follow. I look forward to providing continued updates on the next era of 48North.
Thank you for your time, and operator, if you would so kindly open it up to questions. Thank you.
Question-and-Answer Session
Operator
Thank you. [Operator Instructions] Your first question is from the line of Jenny Wang with Eight Capital. Please go ahead, your line is open.
Jenny Wang
Good morning David and Charles. Just first question on timing of gross margins this quarter. It’s still a bit lower than last quarter. I was just wondering is that a function of kind of pricing coming down or – I mean, we’ve just seen pricing of I guess whole-dry cannabis and the vape product kind of coming down in the industry overall. If you could give a little bit more color on that please.
A – Charles Vennat
Thanks Jenny and I appreciate you spending the time with us this morning and I’ll answer your question.
With regards to the gross margins, I think the large part of that is we have some contract manufacturing occurring at the Good:House and that deals with you know getting people to come-in and bag and ship it and all that sort of good manufacturing process. That component is really based on both a fixed cost and a variable cost component to it, and as we have just started rolling that up and getting it sort of off the ground, the fixed cost component of it has been you know a larger percent per dollar earned than it would normally be once we get up and running and up that curve as far as capacity goes.
So I don’t think it’s necessarily reflective of decreases in the prices that we’re receiving. We’re still receiving reasonably good margins on those. It’s really just largely due to getting the mortar facility up to scale and having it run efficiently.
Jenny Wang
Okay, got it. And then maybe moving on to the shoppers agreement, are there any minimums with that agreement or kind of maybe you know what kind of products are associated with it and when are you expecting kind of first shipment there?
Charles Vennat
We’re please report that we’ve initiated our first shipments and it’s been received at Shoppers Drug Mart for our apothecanna line of topicals. We’re going to continue to work in partnership with this important partner to launch a suite of products that is accessible and available to patients across the country, based on the demand in those channels and we’re having some very positive conversations to that effect.
Jenny Wang
Okay, thanks. And maybe just on the extraction facility, are you planning to use that for your own products or you maybe for third party kind of tool extraction or a mix of both?
Charles Vennat
That’s an excellent question. So the company has made significant investments in our operational capacity, both in our extraction facility Fume Labs in partnership with humble+fume and in our automated packaging facility at the Good:House. In both cases, including Fume Labs, we will be using that to manufacture 48North’s branded products, as well as bringing to market leading brands for other consumers and partners. So it’ll be a combination of contract manufacturing, tooling and of course, 48North’s own branded products.
Jenny Wang
Okay, and maybe just one on the SG&A. I guess, is this the level that we should be expecting going forward or I know you mentioned in your press release that your
expecting costs to come down. I guess, is this quarter kind of a normally quarter in terms of just higher costs than what you were expecting?
David Hackett
Jenny, its David. So it is higher than normal. The third quarter costs do include severance accruals for some of the team that’s left 48North and so that’s largely why you’re seeing a higher than normal SG&A cost.
Jenny Wang
Okay, and just one last one from me. In terms of the inventory on hand, $15 million, is that mostly outdoor cannabis from the outdoor farm or is there a potential mix of both?
David Hackett
Jenny, it’s a combination of both. The outdoor cannabis really at this point in time, given that we’ve taken a write down of it, represents about $5 million in our inventory. We then also have both, cannabis that we have from DelShen and what we purchased from other suppliers, as well as we have increased packaging now. So if you recall, if you went back a couple of quarters, we were selling a lot of LP to LP kind of sales and that really required us to put it in large kilogram you know plastic bags, pack and sealed, etcetera.
Now that we run it through from the boxes into the pre-rolls, into the packaging, etcetera, we need to have some inventory of packaging materials on-hand and as we get more products, we obviously need more of that. So that’s probably also a couple of million dollars now as well.
Jenny Wang
Thank you. That’s good for me.
Operator
[Operator Instructions]
There are no further questions at this time. I would now wish to turn the call back over to Mr. Charles Vennat for closing remarks.
Charles Vennat
Thank you very much. On behalf of 48North’s employees, management and Board of Directors, thank you for taking the time to dial into our conference call this morning. Last week the company filmed a brief corporate update highlighting our Good:House and Good:Farm facilities. Please take a moment to watch the video. It can be found on 48North’s YouTube channel. The link can also be found hyperlinked in our earnings press release.
If there are any questions we have not answered, please don’t hesitate to be in touch. Our investor relations contact information is available on our website.
Thanks again, and have a great morning!
Operator
This concludes today’s conference call. You may now disconnect.
