Fire & Flower Holdings Corporation (OTCQX:FFLWF) Q2 2020 Results Conference Call September 15, 2020 8:30 AM ET

Company Participants

Trevor Fencott – CEO

Nadia Vattovaz – EVP of Operations and CFO

Chris Bolivar – VP, Strategic Growth

Conference Call Participants

Justin Keywood – Stifel GMP

David Kideckel – ATB Capital Markets

Brian Lee – Eight Capital

Andrew Semple – Echelon Wealth partners

Stephen Kwai – National Bank Financial

Operator

Good morning. My name is Juliana and I will be your conference operator today. At this time, I would like to welcome everyone to the Fire & Flower’s Second Quarter 2020 Financial and Operational Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session with research analysts.

I will now turn the call over to Trevor Fencott, Chief Executive Officer. Please go ahead.

Trevor Fencott

Thank you and welcome everyone to our second quarter 2020 fiscal operational and financial results for Fire & Flower. On the call today will be myself, Chief Executive Officer, and Nadia Vattovaz, our Executive Vice President of Operations and our Chief Financial Officer. Earlier today, the Company published its operational financial results for the second quarter 2020 ended August 1, 2020 and the results are available on the Company’s website and on SEDAR.

Just the reminder of the format of today’s call, members of our senior team, myself, and Nadia will be providing commentary on the Q2, 2020 financial and operational results, and then, we will conclude with a moderated question-and-answer period from equity research analysts that cover us.

Before beginning, I’m required to direct listeners to the cautionary statement regarding forward-looking information that’s included on the MD&A provided on our website and SEDAR filings. The key themes for this morning are; first, continued meaningful revenue growth; second, meaningful strides towards positive adjusted operating EBITDA through the optimization of our retail platform; and three, normalization of operations in response to the COVID-19 pandemic.

So with that in mind, we’ll begin with our operational highlights. During the second quarter, we continue to see significant growth for Fire & Flower year-over-year with revenue of 158% to $28.6 million for the quarter as a business began to emerge from the COVID-19 pandemic. A very meaningful metric here was that we’ve referenced in our earnings, our adjusted EBITDA loss was reduced to $0.3 million.

We see this as a very positive indication that the Company is making progress towards its positive operating EBITDA goal. What contributed to this meaningful change is the optimization of the Company’s retail network, with a focus on delivering positive margin contribution from a greater number of stores in the Company’s portfolio, and Nadia will talk a bit more about that in her presentation.

During the quarter, we achieved a major milestone in the province of British Columbia by completing the final steps required for licensing to cannabis retail store locations in the major urban market of Vancouver, British Columbia. We’ve been waiting on this entry to our market for well over a year and are pleased to see the progress. We anticipate also receiving the final steps in the licensing progress for other locations in the province as well.

Fire & Flower’s balance sheet was further strengthened during the quarter with the retirement of more than $28 million of debt including the principal amount of 8% unsecured convertible debentures can be accrued and unpaid interest. Combined with this, prior to beginning the quarter, Fire & Flower was the first cannabis retail company to obtain senior secured debt financing with a major financial institution ATB Financial.

Through the post-amendment agreement with Alimentation Couche-Tard, this amending agreement with C-Tard committing $19 million of cash in 2020 and a potential premium to market re-pricing of the series B and series warrants, which if fully exercised would result in 50.1% ownership by Couche-Tard in a controlling position in the Company.

As part of providing increased operational flexibility, both Couche-Tard unsecured convertible debentures and the private placements led by Green Acre capital LP have agreed to extend the maturity date to provide Fire & Flower with increased operational flexibility. By combining our activities to strengthen our balance sheet, the amendment of the strategic investment by Couche-Tard and the extension of the maturity of the convertible debentures, Fire & Flower now has a clear path to deliver upon its growth strategy at a sufficient run rate till the Company achieves positive EBITDA.

Some additional highlights that I’d like to cover and the operational update as well. In August, we launched Revity CBD, our private label wellness focused brand in the province of Saskatchewan. In launching this brand, we look to the Hifyre digital retail analytics platform to deliver consumer insights that led us to the conclusion that there’s an underserved CBD market within valuable customer segments of ours. The private distribution model in the province of Saskatchewan has enabled this product strategy and we believe the private distribution model would have benefits in other jurisdictions across Canada. So, we will stay tuned on that.

On August 27th, Fire & Flower entered the largest Canadian urban market of Toronto through the acquisition of a cannabis retail store at 378 Yonge Street, on the high traffic corner of Yonge and Girard in close proximity to the Yonge Dundas Square. We’re very pleased to introduce Fire & Flower brands to the Toronto market, and we’ll be announcing our grand reopening of this store under the Fire & Flower brand in the coming weeks.

Our Ontario real estate strategies continued to see meaningful progress with a number of retail stores having completed construction and are awaiting the final stages of licensing from the province of Ontario. The impact of COVID-19 on our operations has now been normalized within our new business as we continually adapt to these changing realities.

During the quarter, we saw the province of Ontario suspend the emergency order that permitted home delivery. We minimized the impact on our business. Digital customer engagement through Spark Perks Member program continues to deliver higher overall customer lifetime value, higher basket sizes and a greater frequency of purchase continually providing improving the value proposition of a digitally enabled retail company.

Our focus will be working towards delivering positive operating EBITDA, which is largely dependent upon when we see meaningful recovery from COVID-19 that will allow us to resume the normal course growth of our retail channel. Overall, the quarter was one of significant operational progress in the business. And because of Fire & Flower’s technology enabled approach, we believe the Company is well positioned in its relationships with customers as consumer behavior continues to evolve in a post COVID-19 landscape.

We will now get into our financial highlights, and I’d like to introduce Nadia Vattovaz, our Executive Vice President of Operations and Chief Financial Officer.

Nadia Vattovaz

Thank you, Trevor. Good morning, everyone. I’m pleased to provide a financial overview of Fire & Flower and our operations as released to the markets earlier this morning.

To begin, I’ll remind everyone that Fire & Flower follows a retail calendar with every quarter consisting of 13 weeks. Today, I’ll be speaking to the quarter ending August 1, 2020. For this quarter, Fire & Flower recorded total revenue of $28.6 million at a gross profit of 34.8% of revenue. Compared to the same period for fiscal 2019, revenue was $11.1 million at a gross profit of 36.5% that represents a substantial increase in total revenues of 146%, demonstrating strong year-over-year sales growth. Between Q1 of fiscal 2020 and Q2 of fiscal 2020, we saw sequential revenue growth of $5.5 million or 23.7%.

Revenue sources for Fire & Flower come from three primary channels, the retail channel which is our network of stores across Alberta, Saskatchewan, Manitoba, Ontario and the Yukon Territory; the distribution channel through Open Fields distribution, which is the cannabis and accessories wholesaler that sells its product to both Fire & Flower and third party retailers in the province of Saskatchewan. And third, the Hifyre digital retail and analytics platform, which produces revenue from clients of the HifyreIQ and data analytics platform as well as external consulting accounts.

Of the $28.6 million in total revenue, the retail channel generated the bulk of the revenue at $23.4 million. $4.3 million came from Open Fields distribution and $0.9 million from Hifyre Digital. Fire & Flower recorded a total gross profit of $10 million or 34.8% of revenue in the quarter. In comparison, total gross profit was $4 million or 36.5% of revenue during the comparative quarter of the previous fiscal year, ending August 3rd, 2019.

In the retail channel, revenue growth was primarily the result of the larger network of retail shops as well as sales of cannabis 2.0 products. The Company had 51 stores at the end of Q2, as compared to 20 stores at the end of the comparative period in the previous fiscal year. From a product perspective, highlights include traditional formats, such as flower and pre-rolls continue to see top-line growth, particularly in large format value options. These categories continue to make up the largest share of sales.

We have continued to see growth in cannabis 2.0 products format with most of the growth in the vape category. Notably, cannabis 2.0 products have increased 83% sequentially over the first quarter of fiscal 2020. We have largely seen edibles and beverages as trip passengers or basket builders that are attached to the purchase of flower pre-roll and vapes. Fire & Flower has been over-indexing the market in cannabis 2.0 products compared to the rest of the cannabis retail categories.

Also driving revenue is our Spark Perks Membership Program. With a decrease in foot traffic as a result of COVID-19, the Company quickly pivoted to encouraging customers to transact online. This included the 10% Spark Perks sign up incentive in the early days, which was clearly successful given the rapid increase in Spark Perks membership. We are now in excess of 145,000 members and are able to generate higher customer lifetime value through the member program.

With this large pool of information on customer behaviors, we have been able to evolve our merchandise planning and in-store service models, which has translated into stronger sales, lower costs and improved working capital. I will note that, in response to the COVID-19 public health crisis, we made the decision to temporarily close 9 stores to redeploy retail staff, to support higher volume shops that serve the most customers, although one of these locations have since reopened. I’m pleased that despite these temporary store closures, our revenue performance has been strong.

Within the Open Fields distribution channel, we saw a significant increase in revenue from $3.9 million in Q1 2020 to $4.3 million in Q2 2020, representing an 11.2% increase quarter-over-quarter. This increase is attributable to Open Fields growth in the Saskatchewan market, where we service both Fire & Flower retail network as well as external accounts. It is also important to note that, although the distribution carries are lower margin in and itself, certainly the ability to directly procure product and distribute through our own retail stores assisted in protecting total retail margins.

Hifyre revenue increased revenues sequentially from $0.8 million in Q1 2020 to $0.9 million in Q2 2020, as the Company increased commercial digital platform subscription and recurring monthly services to external clients, which had slowed in Q1 2020 during the onset of the pandemic. With the Hifyre digital platform, the Company was able to rapidly deploy services, such as sapling click and collect, curbside pickup and home delivery, and provinces that permitted these services under temporary special government orders.

A special note, we continue to see a materially higher basket for our Spark Perks members as well as the higher number of repeat purchases. Members who reserve products online through Fastlane down 32% more than non-members in store and purchased more products per transaction. We saw 11% larger baskets and Fastlane purchases compared to the prior quarter and this outpaced growth compared to non-member purchases by nearly 15%.

With respect to total gross margin, while we saw margin dollars increased, we did have a decrease in margin as a percentage of sales quarter-over-quarter and several factors were at play. Better margins from 2.0 products help drive the retail margin up. Offsetting this, however, was a slightly lower margin for traditional product offerings being primarily flowers. What’s very interesting is that compared to Q2, 2019, the average selling price per gram has decreased approximately 32% and this demonstrates meaningful progress to black market pricing. Also offsetting the gross margin is a higher sales mix of the lower margin wholesale business.

As is the case for all normal course retail operations, we will continue to evaluate performance at the shop level to ensure the portfolio of stores delivers a balance of being full participation in key geographic markets and positive four wall contribution to the overall business. For Q2 2020, the Company reported a net comprehensive loss of $29.1 million or net loss per share of $0.18 on a basic and fully diluted basis. For the same period last year, net comprehensive loss was $6.5 million or 6% per share — or $0.06 per share. And for Q1 2020, net comprehensive loss was $12.7 million or $0.08 per share, both basic and fully diluted.

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Of this loss, $18.3 million was due to the revaluation of the conversion options and warrants recognized as derivate liabilities. These are non-cash non-operating, resulting from higher estimated volatility and an increased share price at the quarter end. For comparison, in Q1 2020, the revaluation was a gain of $3.6 million. Also included in that net comprehensive loss are finance costs of $8.2 million in Q2, 2020 as compared to $6.7 million in Q1, 2020. The increase in finance costs quarter over quarter is the result of $1.8 million of higher interest and accretion expense on the debentures.

Notably, of the $8.2 million in finance costs for the quarter,$6.7 million are non-cash. While we continue to build a company of scale and invest in all lines of our business, we are focused on achieving positive adjusted EBITDA. As you may recall from our 2019 year-end and the previous quarter’s call, we put into motion a restructuring plan. The positive impacts of the plant can continue to be demonstrated by our results. For example, general and administrative expenses have decreased from Q1, 2020 by $300,000.

And it’s important to note though, that this quarter includes the additional cost of operation of two more stores than last quarter, as well as the full quarter operation of two stores, which opened late in Q1. We have seen payroll cost decrease as a result of optimizing our store operating model while improving sales. All without sacrificing our service model, which we believe is a key differentiator for Fire & Flower. When we look at adjusted EBITDA, the loss for Q2 2020 was $300,000, an improvement to both the comparative Q2 last year’s loss of $4.8 million and a loss of $2.7 million for Q1 2020.

As a reminder, adjusted EBITDA is defined as the income or loss for the period removing the share-based compensation expense, depreciation and amortization, gains and losses relative to a derivative liability revaluations and debt extinguishment, professional fees associated with financing, acquisition and business development activities, impairment charges restructuring costs, and includes lease payments that would have been excluded from profit and loss due to the application of IFRS 16 accounting standards.

It is important to understand that adjusted EBITDA is not a defined term under IFRS and may not be comparable to similarly titled measures reported by other companies. I would like to highlight that lease payments are deducted to more reasonably approximate the operating performance of the business on a cash basis before the impact of taxes, financing and capital expenditures. Returning very positively against last quarter, adjusted EBITDA was in a $300,000 loss position, primarily due to general and administrative costs across our business lines.

We have seen an improvement quarter over quarter from Q1 2020 toQ2 2020 of $2.4 million in adjusted EBITDA, which is primarily due to higher gross profit and a lower general and administrative costs previously addressed. We continue on our path towards a positive adjusted EBITDA and during our second quarter of fiscal 2020, we have made meaningful progress towards this critical goal.

The Company maintains a strong cash position and access to capital to satisfy debt obligations relative to maturing convertible debentures, especially amongst capital challenges in the cannabis sector. As of August 1, 2020, cash and cash equivalents was $20 million. During the quarter the Company repaid $28.2 million in debentures and accrued and unpaid interest and received the proceeds of $28 million from the new debenture issuance at the end of Q1 2020.

In the first quarter, the Company finalized a borrowing arrangement with ATB Financial for up to $10 million with an additional option of $5 million for a non-dilutive credit facility. And doing so, Fire & Flower became the first publicly traded cannabis — Canadian cannabis retailer to secure senior debt financing with a major financial institution. $2.5 million was drawn on the facility during Q2.

To summarize, the second quarter of fiscal 2020 was a period of meaningful revenue and margin growth as well as demonstrable progress on adjusted EBITDA. The Company continues to farewell during the pandemic. As we continue to optimize our business, we will focus on retail fundamentals on the store by store basis with the objective of delivering positive EBITDA.

Thank you. And I’ll turn it back to Trevor and look forward to questions from the participants on the call.

Trevor Fencott

So, I’d like to provide a short update on the Hifyre platform separately here because I think it is a very key part of our strategy. So for people who haven’t heard of this before, Hifyre is our digital retail and analytics platform that both producers an independent external revenue source us as well as it enables Fire & Flower’s advanced retail operations.

So Hifyre is essentially made up of three core products within the platform, Spark Perks, which is our consumer facing member program that offers benefits such as Fastlane pickup, member-only events at exclusive discounts; HifyreONE, which is the digital infrastructure that enables advanced retail operations, which includes inventory management, clienteling, menu boards, digital signage, retail ad network; And HifyreIQ, which is the industry leading data and analytics platform that we offer.

As the COVID-19 pandemic covers the Company diverted resources away from Hifyre to focus on maintaining continuity of business. Towards the latter half of the quarter, we began to refocus efforts back on the Hifyre platform, and in particular HifyreIQ, which is currently the primary generator of revenue within the Hifyre business.

We’re seeing additional traction in the HifyreIQ platform category, where customers now include the majority of Canadian licensed producers, equity research analysts, consulting firms and investment banks. So, we’re moving outside of the direct cannabis industry into larger marketplaces outside that.

Additional functionality in the platform is being achieved during the quarter and the Hifyre continues to build out additional market research products, including qualitative products, addressing brand loyalty and consumer preferences that will be rolled out in the coming weeks. Annual recurring revenue will provide a consistent and growth-focused high margin revenue stream within the digital retail and analytics platform.

Within the HifyreONE platform, we’ve continued to develop the white label retail technology to be licensed through our strategic agreement with Cova Software Solutions, one of the leading point of sale providers in Canada and the United states. This presents an international growth opportunity for the HifyreONE platform.

Within the Spark Perks program, which is our member engagement program, we’ve continued to see a significant growth in the platform. So today, actually we reached a significant milestone of 150,000 members in the program and are continuing to acquire customers at a very rapid rate. As other retailers in the market begin to build similar programs, Fire & Flower is already underway on the evolution of the Spark Perks program to its next iteration that has a significant first mover advantage of cannabis member engagement.

Sharing some insights on consumer behavior from the Spark Perks program, overall, 25% of all Fire & Flower transactions happen through the Hifyre powered digital channels, which include Fastlane click and collect and e-commerce has been a traditional delivery. On average, Spark Perks members who transact in-store spent 15% more than non-members. That number rises to 33% more by members transact through Fastlane or other sort of digitally-enabled mediums and 60% more when those members actually use a delivery service.

So again, coming back to my love of Saskatchewan where we are allowed to do delivery and access to all mediums, you can start to see that this is a significant advantage. On a unit per transaction basis, Spark Perks members purchase 9% more units in-store and that number rises to 30% more units or 2.7 units per transaction through the Fastlane service and that Fastlane by the way is available in all provinces.

That now rides for 3.5 units per transaction, or a 47% increase compared to non members in-store. We see the Hifyre digital retail and analytics platform is a key differentiator to the Company and value proposition for both advanced retail operations as well as consumer behaviors, adapting to them as the COVID-19 public health crisis evolves and eventually ends. Hifyre is a first mover advantage here this space and we will continue to deliver as an innovative leader.

So to conclude our management presentation today, I’d like to focus back on the three key themes we’ve mentioned; the first, meaningful and consistent continued revenue growth; second is a focus on forward retail economics driving towards positive operating EBITDA; and the third is, our response to COVID-19 and how this evolves into a post-COVID environment.

This quarter despite headwinds from COVID-19 and continued direct competition from provincial governments in Ontario and Alberta, we have continued to grow our business and show them both year-over-year and quarter-over-quarter revenue growth while ensuring healthy margins.

As a technologically-enabled retailer, we’re able to adapt more rapidly and make data-based decisions within our business, and we view this as a key competitive advantage. Fire & Flower remains laser-focused on the optimization of our retail network as a key driver towards positive EBITDA.

This concludes our presentation for management, and we’ll now move on to the moderated question-and-answer period.

Question-and-Answer Session

A – Chris Bolivar

Good morning. Thank you, Trevor. This is Chris Bolivar, Vice President of Strategic Growth with Fire & Flower. Thanks to all for participating in our call this morning. I’ll be moderating our analyst question-and-answer period.

With that, we’ll begin by welcoming Justin Keywood, Director Healthcare and Special Situations with Stiefel GMP. Justin. Go ahead, please.

Justin Keywood

Good morning and thank you for taking my call. Just on the improved EBITDA, that was good to see in the opening remarks. There is mentioned of optimizing the store model. I’m wondering, if you can just provide some additional details on what those initiatives are? And if there’s further improvements still to be had going ahead. Thank you.

Trevor Fencott

So, Nadia, I think you’re probably the best one to answer that.

Nadia Vattovaz

Sure. So thanks, Justin for the question. So through the information that we glean from our Spark Perks program as well as our data and analytics platform, we’re able to see specifically what our customers purchase in particular provinces as well as particular locales. And accordingly, we started a program in the first quarter of the year really focused on refining our merchandise planning and buying strategy, and I think that that’s really showing nice results Justin. And so far, as buying the right inventory for the right location, and what it also does is it frees up working capital. So, you will have seen our average inventory per store go down.

Also what it does is it tells us when our — it tells us essentially how to plan for our payroll and sales function in the in the stores, and how to optimize those according to what that particular store does in terms of when it’s busy selling periods or et cetera. So with that we’re able to really hone in on our payroll costs. The project is not over. We continue to refine our models as we learn more and more. And certainly the higher number of Spark Perks members help us refine that model on a go forward basis.

Justin Keywood

Thank you. That’s a helpful color. And I assume as there’s additional stores added to the network, there will be further improvements in the operating profits? Or is there improvement to be had just with greater efficiencies just in the current store networks?

Nadia Vattovaz

So, I think that there’s a couple things to note. You’ll notice that in our general and administrative expenses that, from a year ago, compared to a year ago that it is growing at a much slower rate than it did before. And that really is because, we earn now incremental costs that are associated with direct store, labor and other expenses to open a store and operate a store. And as we continue to gather more information, Justin will be able to refine the model further.

Justin Keywood

Okay, thank you. And then I was wondering if you have an update on the expected store count for this year and going into next year?

Trevor Fencott

So, I’ll handle that one. I think that we’re moving away from that modality of looking at store count and we’re moving into, as I think you’ve sort of seen with this presentation into efficiency per store four wall economics per store. Nadia, I don’t know, if you want to add some color to that, but that’s how we’re looking at it internally.

Nadia Vattovaz

Yes, I think just as important to note that, given the regulatory environments and COVID in particular as well. The pace of growth is, obviously we’re going to continue on our growth plans. Those haven’t changed. The timing thereof though is somewhat unknown. So, we’ve decided to not really communicate that going forward in our future looking information. However, that has not stopped us from continuing our growth trajectory and I’ll continue to optimizing the stores and the operations.

Justin Keywood

Okay understood in how many licenses are in progress right now in Ontario?

Nadia Vattovaz

So, we continue to work towards the 10 maximum and then of course, the 20, maximum, we will also target.

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Chris Bolivar

No problem. Thank you, Justin. With that, we’ll walk next to the call David Kideckel, Managing Director, Senior Equity Research Analyst with ATB Capital Markets. David, go ahead please.

David Kideckel

Hi, good morning. Thanks for taking my question and congrats on the quarter. A couple for me here. So, the first is given with the — during COVID, you’ve implemented your next day delivery into the greater Toronto area from your Kingston site. So, a couple questions on that front. The first is. Are you able to comment what type of percentage of revenue that contributed to overall retail revenue specifically for during COVID? And number two, along the same lines, we’re seeing an uptick in COVID cases and then Ontario, in particular. I’m wondering, should the government look to shut down certain parts of the economy as this can back on the table within the province of Ontario for next day delivery, if it was successful for you? Thanks.

Trevor Fencott

So maybe I’ll start with that one. And Nad, you can add some color to that as well. So, I mean, obviously, we reacted very quickly and got our delivery system up as you mentioned. So, we could absolutely do that. Again, it’s part of our DNA. We built the tech, invested in the infrastructure. So, we could pivot back. We obviously are disappointed that, that was taken away from us as a particular retailer. Every other retailer seems to be able to do online delivery, including alcohol in Ontario, but we did focus on optimizing the store and re-engaging our customers digitally.

So even though we can’t do delivery, I think as Nadia alluded to and perhaps provide some more color, we really went after our digital engagement, and things like that, click and collect, sort of things like Fastlane are still available, we’ve seen an uptick in that. So whereas I think we lost a bit on the delivery because that was in demand for a while. We’ve made up a lot of that ground using our digital platform. The reality is people still do want to go to stores and people really sort of resist government platforms and that. So that’s one of the reasons, prohibition didn’t work and we feel that we’re part of the solution there.

So, we’re hopeful that the government will look at this again we hit another wave. In fact we’re hopeful that the government will look at this as at taxpayer effective way to combat the illegal market because we’re already in Ontario and we have multiple touch points. From you imagine the blanket of retail stores across the province to be able to do deliberately delivery safely, which we did. You’d have a much more efficient delivery network, and I think reduce the illegal market. So, that’s my soapbox on policy, but I’ll leave it to Nadia to provide some color on the actual economics.

Nadia Vattovaz

Yes, and this was a little tough David because even though we did see a good portion of our Ontario sales come from delivery and curbside pickup in Q2 when the government allowed us to be able to do both. We did repatriate a fair bit of both sales to in-store. So, customers like curbside, customers do like to engage and they’re really interested in newness. So, they do like to come to the store, speak to the canister and try new product. But again, to be able to service the customer in a way they want to be served, be it, e-commerce, pickup, in-store. I mean, that is a really the way that we would like to see obviously our retail operations move forward.

David Kideckel

Okay. Thank you both for that. Moving along here as well just back to Couche-Tard for a second, I’m wondering if you can provide any color with respect to your pilot of the co-location. How are those locations doing? Will you be moving forward with additional opportunities? And I guess the context is on my question as well now relates to the recent of acquisition of Meta Growth by High Tide in Canada. So just wondering, how you view that transaction coupled with your obviously groundbreaking partnership with Couche-Tard?

Nadia Vattovaz

So again, I’ll probably start this and then maybe Nadia, if you want to add some color to this as well because it has two pieces. The first is a strategic piece. So, we are firmly of the view that to monetize and displace the legal market, you have to have a distribution system that is what people want. And we think that, that evolves hub and spoke kind of modality with a third ring around that, which is the last three kilometers to consumer, which is delivery. So, you have to have flagship stores where people engage with the brand. People are on-boarded digitally and they become sort of brand loyal. And then you have to be able to service that demand through smaller sort of spoke locations around that in a concentric circle almost.

And then the final piece of that is the last three kilometers to consumer, which is hopefully in an efficient market service by delivery, such as Saskatchewan or other international markets like California. So, that’s how we see distribution, and a big part of the co-location experiment for us is looking at these very small, footprint stores that are very efficient in the sense that they use our digital infrastructure to predict what will be needed in that kind of small footprint store, because they’re only about 300 to 500 square feet, which is great from a lease perspective and a staffing perspective. So, that’s kind of how we look at it.

The experiment is still in its early stages. But as far as, when we look at the High Tide Meta merger, I do think that they’re sort of different things. So, while we absolutely know that, the industry is in its consolidation stage, I think there’s been number of early entrants and I think that we should expect to see more consolidation in this space, it’s very normal. We see it as a very different type of offering. So, when we look at, as I said, those three rings, those three concentric rings and a data-driven infrastructure informing, how those three rings interact.

I think that’s a fairly uniquely Fire & Flower offering because we started from the ground up. So, it’s of sort of a famous slide that we have in our deck, which is sort of that we sit in the middle because we weren’t pivoting from a legacy business and we weren’t vertically integrated. So, we sort of started from the ground up to be retail 2.0, and I think that that’s going to continue to be a differentiator for us in this space. So, Nadia, I mean, maybe if some more operational color on the co-located stores?

Nadia Vattovaz

Yes. I mean, I think Trevor said it well. We are in the experimental phases. We’re quite excited now to see how the customer behaviors in those locations are. I’m always trying to look for opportunities for hub and spoke model and our development in in our real estate development plan, so certainly that continues to be on my agenda.

David Kideckel

Okay, thanks for that. And my last question here is one on Spark Perks. So obviously, this program has been a huge success for you. Trevor, you announced 150,000 members to-date. So my question is. What’s the target number you’re looking for? And at what point do you look to monetize all the efforts you put behind this program? Thank you.

Trevor Fencott

Sure, I mean, obviously, the sky’s the limit. So, we would like to grow it to as big as the market is, which presumably, is a significant part of the Canadian adult population. But typically, with things like members of engagement programs, you need to have at least sort of a $0.25 million before you start to kind of look actively to be able to monetize it independently. So, we’re not at that stage yet. We are very much dedicated to understanding our consumer and I think that that’s probably the biggest value driver.

I mean, it would be exciting to be able to have enough size to monetize it independently and obviously that’s the long-term goal. But for the immediate term, it’s delivering probably its highest value, which is making our customers more valuable. So hopefully that provides some sort of some thoughts on it. So, we do expect that at some point, we’re not there, but I don’t think we need to be there now BECAUSE the goal right now is to make our customers the most valuable possible.

Chris Bolivar

Thank you, David. Next, we’ll welcome to the call, Brian Lee, Associate Consumer and Healthcare Research with Eight Capital. Brian, go ahead, please.

Brian Lee

Hi, good morning and thank you for taking my question. The majority of questions have been answered, but I was just kind of wondering if there’s any sort of progress with respect to the RFP in New Brunswick? Do you expect the process to move fairly quickly at this point? Any sort of color will be helpful?

Trevor Fencott

Yes. So as far as we were made aware in the process, they had to get through the election because of course, as you may recall, one side had sort of one of their campaign promises was to not sell the licenses in the province. So now that we have a definitive answer from the electorate there, we expect in the coming weeks, the process will be notified about the next steps in the process. The necessary part of the processes happen now, the election has happened and this was the government that was for privatization in the province. So, we expect to see some movement in the coming weeks.

Chris Bolivar

Thank you, Brian. Next we’ll welcome to the call Andrew Semple, Equity Research Analyst, with Echelon Wealth partners. Andrew, go ahead, please.

Andrew Semple

Good morning everyone and congrats on the quarter. My first question here, just wanted to ask on cannabis 2.0 products. I know it’s still early days, but I’m wondering, if you could provide any color on where those products stand as a portion of your overall sales mix? And perhaps, given the idea where do you see that shaping out over the coming quarters?

Trevor Fencott

Nadia, I think that’s right up your alley.

Nadia Vattovaz

Thanks, Trevor. Hi, Andrew. So cannabis 2.0 and I think I mentioned in my commentary that quarter over quarter, cannabis 2.0 sales have increased 83%. So, obviously, it’s a great growth category for us, particularly because they tend to be higher margin products. By far, vapes are the most popular Andrew, and they have become a meaningful part of our product mix. I will say that things such as chocolates and beverages are really more basket builders.

So, people come in or they order online either flower pre-rolls or vapes or combination of thereof, and kind of add the other categories as basket builders. So, they’re less than 5% of the overall product mix, and I think the offerings especially in the beverage category have been a little bit slow to come. So, I think the other notable mention is really large format value options. Those are going like gangbusters and we anticipate that to continue.

Andrew Semple

Understood. Thanks for the color there. Just want to go back to the co-located stores with Couche-Tard. I assume there’s lower CapEx associated with those locations. Are you also experiencing, I guess, somewhat lower sales given your store within store model there than you’re seeing in your standalone locations? And secondly, I’m wondering if it would make sense to take that model into the Manitoba market and to be able to leverage the Couche-Tard footprint there perhaps you could comment on that?

Trevor Fencott

So maybe I’ll start with again as sort of a strategic overview and Nadia can provide some additional color. So when we talk about sort of this concentric ring model like the bullseye of one ring out, that really, I mean, the co-location model is a good way to test that because it’s an obvious. We’ve got a willing landlord partner and we can start to experiment to see what the cross promotional opportunities are in crossover of traffic and consumer groups are.

So it’s a great way to start, but it doesn’t have to just be a co-location with circle.

I think that what people should expect is capital efficient distribution nodes from us, like that’s how we view it, which is flagship stores and smaller types of stores that are more lightweight that service the markets that they’re in very efficiently because we know what the consumers want in those markets. So, they’re only carrying because they’re small stores. They can’t carry every possible skew.

But as Nadia mentioned before there, we’re getting very, very good at knowing what our customers want and be able to predict that so we can stock what is, so we’re not missing out on sales by not having things stocked. So, I guess so that’s the first distinction. It doesn’t have to be a sort of okay co-location. But obviously, we will look at that in every jurisdiction. And the reason we want to hone this model because we believe this is going to be the certainly one of the successful models is we know that the world is larger than Canada.

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And as I’ve said many times before, Saskatchewan is the testing ground for Canada whether or not other provinces listen it is the flagship hub spoke and distribution model that would work there. And so that’s kind of why we’re trying to do this, but back to your question, maybe Nad, if you want to provide some color on Manitoba and the other things like CapEx.

Nadia Vattovaz

Sure. So, Andrew, I think you asked how that, how foster location compares to a standalone Fire & Flower location. So, I think it’s a little too soon to tell. We tend to like to give our stores four to five months to see how they’ve really ramped up and moved on. And certainly, we’ve opened these locations during the time of COVID. So, we still need to be able to do that. But all indication is that they contribute and can contribute like a smaller standalone Fire & Flower location, Andrew.

With respect to CapEx, our initial foray into foster was, yes, it was definitely cheaper on the CapEx side than a standalone earlier location of Fire & Flower. So, we anticipate that to be the case. With Manitoba, I think that’s a great idea, Andrew, and we continue to look at Circle K has co-locations and some non co-locations across Canada, and they service smaller markets as well, and so co-location in areas where maybe a standalone Fire & Flower location might not make sense. There’s a great opportunity with Circle K to be able to find options to service our customers in those markets as well. So, they are definitely part of our real estate development plan.

Andrew Semple

That’s awesome. Those were very helpful comments. Thank you for that. Just a final point and just quickly on this. Could you perhaps expand on when we might see additional private labels product launches in the near future and what’s kind of the types of formats you would target initially?

Trevor Fencott

Also I think it’s in front of you, Nadia.

Nadia Vattovaz

So with the launch of Revity, we are — I think that was, I want to say about five weeks ago, four or five weeks ago, and of course we’re seeing, what the experiences with Revity in the Saskatchewan market. We are working on potentially other formats in other categories, maybe not just focused on CBD, but its early days. We are able to do this in Saskatchewan, Andrew. But, right now, the government regulatory authorities are a little bit slow to adopt private label programs at this time now. They’re open to it, but I think it’s just a matter of refocusing the attention on that. So, we will definitely be there when we’re able to be there.

Chris Bolivar

Thank you. Thank you for your questions, Andrew. Next, we’ll move on to Stephen Kwai, Equity Research Associate Analyst at National Bank Financial. Stephen, go ahead and please.

Stephen Kwai

Hey, guys. Thanks for taking my questions. I’m just calling in for Andrew and I apologize, if you answered some of these already. But just my first one is. What happened with the guidance for these store openings as well as a positive EBITDA? I think you guys originally said, you were aiming for H1 fiscal 2021. And particularly on the ladder, EBITDA was pretty close to breakeven this quarter with just a handful of store opening. So, I’m wondering if this is what the Company looks like in a steady state?

Trevor Fencott

I think Nadia is probably be best to handle that one.

Nadia Vattovaz

Sure. So, within the last quarter, sort of towards the end of the first quarter and really during Q2, Stephen, we found that, given the delays as a result — delays in opening stores as a result of COVID-19 and the uncertainty that the pandemic has caused, as well as the delays in licensing and Ontario. And I think we’re all familiar with that particular issue. Putting out store numbers by quarter didn’t feel fair for me to the investor, so I have removed that commentary from the MD&A simply because we are not big on not setting deliverables and not meeting them.

So, I felt that at this time, it would be more appropriate to indicate to folks that we haven’t changed our growth trajectory. We are looking to achieve the same type of growth that we’ve communicated in the past. It’s just a matter of when, Stephen. So to me, and I think that it’s clear to investors as well given the results this quarter that are focused and we are maniacally focused on positive operating EBITDA. So, I would expect, I think it’s fair to expect that we will continue to have focus on those areas and deliver to the best that we can.

Stephen Kwai

Okay, great. And I have a few on some of the stores. So, as you just mentioned like there’s been reports of a licensing backlog, particularly in Ontario and it could potentially take up to two years. So what are you guys seeing? And just also on the Ontario stores would be similar CapEx to those versus Alberta?

Trevor Fencott

So, a couple yes, it will impact in a couple of different ways. So in terms of the backlog, there certainly is a licensing backlog. We have received assurances that course the government has gone from 20 a month of five a week to we were told that it was going to double to 10 a week. So, we’re hopeful that that’s going to increase.

The way we look at it in general though is less from a policy perspective and much more from economic perspective. So we go back to our experience in Alberta where the government as you’ll recall, put a moratorium on any licensing for a certain period ostensibly to allow supply to catch up whereas now, there is no supply. There’s no dearth of supply. In fact, if you cover the space, you’ll know that we are producing as a country probably five times our entire gross like our entire market at this point.

So, there’s no supply issue, but there may in fact be sort of a bandwidth issue kind of granting these licenses. But looking at Alberta, they went from zero licenses to sort of 20 a month for a few months and then it opened up. And then eventually, within the year, it was sort of opened. They’ve moved through the backlog quite efficiently. And the numbers there of licenses that were in the queue are very similar to the ones that are currently in the in the Ontario queue.

So, it’s not good to sort of try to predict what the government will or will not do and how fast they will or will not move. But I do think that it’s, the two years seems like a very long time to me for to move through the Q, based on our experience in Alberta. So I don’t see that as the big, the two year issue.

Now, having said that on the store construction front, I will pass that part to Nadia because we’ve made a lot of improvements there obviously being in the industry since legalization, we’ve had a lot of learning, some very positive, some little negative, but nevertheless learnings, and we’re incorporated that into our bills. So, Nadia, do you want to speak to that a bit?

Nadia Vattovaz

Yes, I mean, I think Trevor, you covered it very well. We’re always looking to find ways to optimize our cost profile for our build outs and I think that the next wave of Ontario stores will be indicative of that — of those efforts.

Stephen Kwai

Okay, great. That’s, that’s really helpful. And I saw your press release about your BC licenses recently. I’m just wondering, if there’s more of a timeline for those new stores?

Trevor Fencott

Well, that comes back to the government point, so we’re excited because now we are provincially licensed. So, that’s kind of a background or each province that has regulated cannabis, you have to perceive provincial license, which effectively means you are — you’ve been vetted for good character and the Company meets the right criteria, like not operating the illegal market. So then you’re capable of having a retail store like a store level license.

So, we’ve got that and that’s the necessary, but not sufficient condition to open a store. And now we’ve got licensing in process for the two in Vancouver and some other ones as well. But we don’t really have visibility. That’s the first news we’ve gotten from the BC government in, I believe its 18 months with this.

And so, we’re very cautiously optimistic about how fastest process is going to move. So, it really wouldn’t be prudent to kind of put a timeline on that. Other than to say, we have seen increased movement. So, we went from sort of zero movement from the BC government for almost two years to seemingly expedited movement over the coming the past few weeks and months. So hopefully that continues, but again we wouldn’t want to speculate as to precise timelines on that.

Stephen Kwai

Okay, yes, fair enough. And so you also mentioned the store optimization plans that have been going through. And I’m just wondering like as you ramp up opening stores, how will that — how that develop there’s any differences between, the optimization that you guys are currently doing your stores? Or will there be any headwinds? Or will it take longer than expected as you ramp up the new stores?

Trevor Fencott

It’s probably your Nadia, yes.

Nadia Vattovaz

Yes. Yes. So no, I don’t anticipate any headwinds or challenges from a store optimization plan perspective. Really, that optimization plan really speaks to how we staff the stores and how we merchandise and put product into those stores. So if anything, I think that that will help us move faster and provide sort of a better product offering and service to our customers from the get go.

Stephen Kwai

Okay, perfect. Yes, that makes sense. And I’m sorry, just a couple more for me. And so, on the marketing and promotions, it was down significantly year-over-year. Could you maybe just provide further commentary on how that will develop as well as G&A over the next few quarters?

Nadia Vattovaz

Sure, I think that one’s for me, Trevor, as well.

Trevor Fencott

Absolutely.

Nadia Vattovaz

So with respect to marketing, marketing slowed down given a COVID-19. And certainly, we like other retailers, we’re finding our way through how to communicate and engage our customers. I think we’ve worked through a fair bit of that. We have ramped up the marketing spend. Of course, it’s critical to do that to support revenue and bottom line. So, I would expect that to ramp up a little bit to more normal levels.

On G&A, I get a lot of questions about G&A. And I think if you look at last year versus this year, there’s a couple telling lines. And it really speaks to the fact that the growth in G&A is really about payroll at the store level and cost directly attributable to new stores offset by savings in the existing stores that I talked to earlier in the conference call.

So, we have our essential infrastructure in place. I think there’s always optimization to have there, but the structures in place for further growth. So, I would anticipate that and certainly the way I look at it is as we add more stores are really talking about adding the direct store costs only.

Stephen Kwai

Okay, perfect. And, just at the product level, on margins. How are those margins on the larger format versus for example the pre-roll products and the other products? I know the 2.0 products you said are larger or are more significant margins, but what about the value larger format and the pre-rolls?

Nadia Vattovaz

So, they’re, I mean, they’re relatively consistent with the flower category in general.

Stephen Kwai

Okay, great. And sorry, my last one here, you mentioned a bunch of stats on your Spark members and I think I missed some of them, but correct me, if I’m wrong. Did you say these Spark members basket side versus non-members is approximately 11% higher? Or can you just run through some of those numbers again, please? Thanks.

Nadia Vattovaz

Sure. So, Trevor, I’m happy to, I have that.

Trevor Fencott

That’s fine.

Nadia Vattovaz

Yes. So, members to reserve products online through Fastlane spend 33% more than nonmembers in store, and they purchase about a third more products per transaction, and we saw that 11% larger baskets in Fastlane purchases compared to the prior quarter, and that outpaced growth compared to non-member purchases by nearly 15%.

Chris Bolivar

Thank you to all the analysts for participating in our call this morning. That concludes our question-and-answer, and I’ll turn it back over to Trevor to conclude the call.

Trevor Fencott

Thank you so much for your attendance and for your good questions. That’s it for today and this quarter and we hope to hear from everyone again next quarter.

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 at this time.



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