Flower One Holdings Inc. (OTCQX:FLOOF) Q2 2020 Earnings Conference Call September 9, 2020 8:30 AM ET

Company Participants

Ken Villazor – President & Chief Executive Officer

David Kane – Chief Financial Officer

Kellen O’Keefe – Chief Strategy Officer

Conference Call Participants

Scott Fortune – Roth Capital Partners

Graeme Kreindler – Eight Capital

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Flower One Holdings Inc. Second Quarter 2020 Results Call. At this time, all participants are in a listen-only. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions]

I would now like to hand the conference over to your speaker today Ken Villazor. You may begin.

Ken Villazor

Thank you, operator, and good morning, everyone. We appreciate all of you taking the time to join us for today’s second quarter 2020 earnings call. The second quarter was an unanticipated and unprecedented time for Flower One, as it was for virtually all companies. The COVID-19 global pandemic set the tone for challenging second quarter market conditions, including in Nevada.

The pandemic realities and its timing certainly tested the resiliency and full operational capabilities of the entire Flower One team when you consider that we ended March with continued strong momentum to our business with a record-setting monthly revenue of $3.9 million to cap what was our — only our second full quarter of revenue.

As previously disclosed, our sales relative to the first quarter expectedly declined due to COVID-19. Sales for April and May were approximately $1.9 million in aggregate. But more importantly, subsequent to those two challenging months, the company experienced a doubling of sales relative to the previous month, with June sales reaching $2 million.

Even more positively, as we previously reported, this notable and strong progression in revenue continued into July with sales increasing month-over-month by another 64% to $3.2 million. Based on our initial review, our August sales appear to have trended in a similar manner to July. Our CFO, David Kane, will speak further to this strong month-over-month revenue trend in the context of the company’s Q3 guidance.

To achieve such a strong piece of revenue recovery since the emergence of COVID-19 is a testament to our Flower One team. I’d like to commend and thank our entire operations team for working cohesively and swiftly to respond to the evolving market conditions as cannabis consumer demand reemerges in Nevada.

Leveraging their deep and unique cannabis experience and knowledge, our operations team were quick to adopt as needed to ensure a seamless process was maintained, for everything from initial screen selection, plant propagation, cultivation, post-harvest drying and curing, quality control, lab testing, inventory assignment, sales fulfillment and lastly distribution to the retail channel.

We have certainly come a long way since our first sale of product out of the greenhouse just a little over a year ago on August 9, 2019. That was a momentous day for the Flower One team, as it represented the culmination of more than 16 months of painstakingly detailed commercial scale of greenhouse design, engineering, construction and cultivation expertise to successfully complete the conversion of 400,000 square feet that comprises the greenhouse portion of our flagship cultivation and production facility in North Las Vegas.

More importantly, this first sale of inaugural inventory from our greenhouse signals our company’s emergence into its active operational phase of working closely with our portfolio of leading cannabis brands, who were looking for the most accelerated and capital-efficient way to enter Las Vegas, one of the most important target markets for all cannabis brands striving for long-term success and the ability to establish an industry-leading position in the highly competitive U.S. cannabis brand space.

First sale of our inaugural inventory was assigned to our California-based brand partner Old Pal. Over the past 13 months, the Flower One team has worked collaboratively and consistently with the Old Pal team to transform the brand from a new entrant in the Las Vegas and Nevada market, to the state’s number one flower brand, based on total units sold.

The rapid and sustained market share success of Old Pal validates the overall value proposition of our unique and focused model of being a large scale full-service brand fulfilment and wholesale manufacturing. And the benefits that brings to both our brand partners and the 70 cannabis retailers across the state. Kellen, our Chief Strategy Officer will speak in greater detail on this later in our call.

As we witnessed firsthand in Nevada over the past six months, it is quite evident how rapidly the business environment can change. And how critical it is for a company to be able to adopt, pivot and seize new market opportunities as they emerge. I would like to speak further about this but before doing so I will pass the call on to David Kane, who recently joined us, to speak directly to our Q2 2020 financial results, followed by Kellen to provide an update on our brands and their performance in the Nevada market. David?

David Kane

Thank you, Ken. Its part — it’s great to be part of the Flower One team. And I look forward to reviewing the second quarter 2020 results with everyone today. As a reminder, all figures discussed on today’s call are in U.S. dollars unless otherwise noted.

As Ken noted, after a very strong first quarter that ended with record monthly sales in March, sales in April and May were significantly impacted, by COVID-19. In response to lower market demand, we’ve downsized our cultivation and production capacities, dedicated our resources in the second quarter to our newer and premium products.

Following, the reopening of in-store sales dispensaries here in Nevada, we began to see a notable improvement in our revenues, with June monthly sales increasing as Ken noted 144% over May to bring second quarter revenues to a total of $3.9 million, in line with our previously announced expectations.

This strength in June continued into quarter three 2020 with July sales, representing our second highest company monthly sales to-date. I’ll discuss more about this, in our third quarter shortly. Cost of sales for the second quarter was $2.1 million. This resulted in a gross margin of 46% for Q2 2020, compared to a gross margin of 28% that we reported in Q1 2020.

The sequential improvement in gross margin was due to the sale of flower and extracted products with a lower cost basis, than we had in prior quarters. While margin did improve we are now — I’m sorry. While margins did improve and we’re now more in line with our prior levels, cash cost per harvested gram in quarter two rose from our 49% in quarter one to $1 — I’m sorry, $0.49 in quarter one to $1.04, in quarter 2.

This increase in cost per harvested gram is the result of greater reduction in our output than our corresponding reduction that we made in non durable production cost over the same time period. Keep in mind that most of our inventory harvested and produced in quarter two, remains in inventory as of June 30, and is therefore expected to have a negative impact on margins, when the product is sold through in future periods.

However as sales of branded product with higher revenue, per gram for flower and extractions expand, through the remainder of the third and fourth quarter and beyond, we expect to realize increased margins that will offset the greater cost per harvested gram that we had in prior quarters. Now that we see market demand rebounding we are ramping up production. We expect these increased productions will result in harvested cost per gram returning to our historical cost program levels. Keep in mind, excluding the recent increase that we had in quarter 2 our cost per gram has historically ranged between $0.40 and $0.49 per quarter.

Moving on to general and administrative expenses for quarter two, quarter two G&A totaled $5.5 million, a decrease from $6.2 million in quarter one as a result of lower cannabis, taxes, selling costs and wages partially offset by increased accounting and legal fees during the quarter.

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Net loss for the quarter was $21.3 million partially driven by a onetime non-cash write-down of intangible assets and goodwill totaling $9.3 million. In the second quarter, we conducted an in-depth review of our business operations and concluded that due to the impacts of COVID-19 the value of certain assets intangible assets and goodwill at June 30 exceeded the fair market valuations.

As a result we took a onetime non-cash charge which included $8.5 million in non-cash provision against intangible licenses and a $0.8 million non-cash provision against goodwill. In addition to the onetime impairment charge, net loss for the quarter included $0.2 million in fair value losses on biological assets, $0.6 million in fair value losses on derivatives, $1.1 million in four — in exchange losses mainly related to our Canadian-based convertible debentures, $0.1 billion in the income tax expenses mainly related to inventory write-down in the first quarter, $6.5 million in finance expenses and $1 million in realized fair value of inventory sold.

Operating cash flows for the quarter totaled $6.5 million. During the same period, we invested a net of $1.6 million in property, plant and equipment, primarily related to our flagship greenhouse facility. At the end of June, we had a working capital deficit of $3.3 million. The decrease in working capital was driven by a reclassification of a term note of $21 — $28.1 million to current from non-current liabilities now that it is due within 12 months of the balance sheet. This term note, it should be noted has an option to extend the term for six months.

In the second quarter we continued to raise funds to support our general working and corporate capital needs. In May, we closed a $7.8 million private placement, then in June we raised another $6.2 million in non-broker private placement. Funds from each of these capital raises have gone to support our general working capital requirements, as well as to retire a $7.2 million note. Subsequent to quarter end, we raised another $3.1 million including a $1.1 million in a short-term loan and another $2 million in debt from other sources.

As we continue into the second half of 2020, we continue to look forward to ways to improve our operations, refine our cultivation methods to reflect the increase in market demand for cannabis and in order to support these enhanced processes and to reinitiate our growth strategy, we are currently considering ways to support our general working capital needs including raising additional equity and debt.

Before I turn the call over to Kellen, I’d like to provide some preliminary guidance on our third quarter 2020 revenue on sales and gross margin figures.

As Ken noted following strong July sales continued in August. As a result, we are now anticipating third quarter 2020 revenue in the range of $9.8 million to $10.8 million, which represents a sequential improvement of roughly 154% to 180%. As it compared to the first quarter, third quarter revenues are anticipated to improve approximately 11% to 23%.

We are also anticipating gross margins in the range of 30% to 35% for the quarter, as compared to 46% in Q2 and 28% in Q1. Remember we still have much of our harvested inventory with the higher cost basis from Q2 held in inventory and this product will drive down margins in the near future.

Thank you for your time. With that, I’d like to turn the call over to Kellen O’Keefe, our Chief Strategy Officer to discuss our brands and sell-through approach in the second quarter. Mr. O’Keefe?

Kellen O’Keefe

Thanks David. It’s great to have you as part of the Flower One team. While it’s only been a few weeks since we last spoke, there’s been several exciting developments that I’d like to share today. This summer we officially launched Cookies and 22Red. Both brands essentially pre-sold all of their launch inventory, and we have started signing supply agreements with preferred retail partners to ensure we are able to meet market demand for both brands and best forecast our business going forward.

Speaking of Cookies, we would like to congratulate them on the announcement of their first Cookies retail store in Nevada scheduled to launch on the Las Vegas strip in January of 2021 in partnership with GTI. We are very excited for the opportunity to continue to evolve our partnerships with two industry leaders GTI and Cookies.

We will be supplying the Cookies store with a variety of products from Flower One’s portfolio of brands and white label offerings in addition to Cookies full line of products. Cookies retail stores in Los Angeles are among the top performing retail dispensaries in the country and Essence and GTI are established leaders in Las Vegas cannabis and more specifically retail. So we are very excited to continue to work with both companies to support their growth in Nevada and beyond.

In a matter of just a few quarters, we have built an industry-leading portfolio of brands that have themselves generated dedicated and loyal customer bases who seek out their products wherever they are sold. This brand recognition drives traffic count and market share for cannabis retailers and is evident by the numerous retail partnerships many of our brand partners have established in Nevada. Cookies, Kiva, Old Pal, Heavy Hitters, Lift Tickets and the Clear all have their own retail partnerships further strengthening their ability to penetrate the market and gain market share.

Our brand partners are all among the leaders in their respective categories and bring significant IP and manufacturing expertise to Flower One. A great example of this is one of our newest partners Lift Tickets Laboratories. In June, we announced an exclusive brand partnership with Lift Tickets Laboratories, an industry leader in pre-roll innovation and manufacturing. We are currently implementing several of Lift Tickets’ proprietary pre-roll production methods at our facility. We look forward to launching their infused pre-rolls and signature glass tipped joints featuring Cookies and other premium Flower One genetics later in the third quarter.

Ultimately, after a challenging start to Q2, our team made the most out of the difficult operating conditions and worked diligently to improve our efficiencies and enhance our processes, so that we could continue to bring some of the world’s leading cannabis brands to life with minimal delays. The quality of the product, coming out of both our greenhouse and production lab improves every day, further demonstrating our team’s capabilities and commitment to delivering the highest quality products in the state of Nevada.

In closing, I’d like to add to Ken’s comments and commend our cultivation and production teams for their hard work and dedication during these very challenging times. Both teams continue to execute and as a result, the value and power of working with Flower One has never been stronger. I look forward to continuing to share our progress over the coming quarters.

With that, I’ll turn the call back over to Ken for his closing remarks. Thank you.

Ken Villazor

Thanks a lot Kellen. As I said earlier on the call, August revenue has trended strongly bringing our pace of sales back to pre-COVID levels. As we mentioned on our last earnings call, in early Q2, during the most challenging market conditions brought on by the pandemic, we focused on preserving and successfully harvesting our existing live plant inventory. We quickly recalibrated and revised our crop management plan to reflect market changes.

As we move through April, Nevada Governor, Sisolak progressively eased restrictions on cannabis retailers. And by May 9, in-store sales were allowed to resume, followed by the reopening of casinos and hotels in Las Vegas and across the state beginning on June — beginning on June 4.

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With these positive developments in June, we responded quickly and began propagating select genetics to ramp up cultivation. This effort continued through the remainder of Q2 and into Q3. We anticipate that by the end of September, all of our flower zones will be fully planted. And while lower tourism levels continue to impact the state’s economy, the Nevada market has observed notable strength from its resident population as well as the welcome return of the transient tourist market.

According to the Las Vegas convention and visitors authorities, most recent tourism report, occupancy levels in Las Vegas in July were 42.5% relative to I guess about a year ago where it was about 90% and vehicular or land traffic into Las Vegas is now backed up almost 90% compared to the same period last year.

Furthermore, the state of Nevada reported retail cannabis revenue for the month ending June 30, 2020 of $61.4 million, up from $57.9 million for the same period last year. With this improving market context, we have also seen Flower One gain a stronger foothold in the market. We are excited to carry our recent revenue momentum through the back half of 2020, as we continue to expand our brand and SKU offerings to Nevada’s cannabis retailers where we expect a notable portion of our revenue to shift to higher-margin, high demand premium brands like Cookies and 22Red.

And we will continue to focus on consistently reinforcing our value proposition to our primary customer which is the 70 cannabis retailers across Nevada. That value proposition is foundationally built upon the following. First, our ability to leverage our significant scale in the market. We can consistently deliver high-quality just-in-time cannabis week in week out to our retail customers.

This ability to be consistent — sorry this ability to be a consistent reliable source of finished cannabis products is not easy to achieve and requires an established track record of supply chain performance to gain the trust and confidence of retailers. The fact that our current retail market penetration sits at over 95% is a testament to how far we have come in just one year of selling into the market to secure the trust and confidence of our retail accounts.

Second, we understand the rapid pace, at which the cannabis sector is maturing, which includes an enhanced knowledge base of the cannabis consumer and the ever evolving expectations they have for the optimal cannabis experience each time they make a purchase. That progression of the cannabis consumer has created a tangible shift in their buying habits were established brands that deliver a consistent high quality experience are driving buying habits.

We are observing this across Nevada, whereby, more and more brands do indeed matter to the cannabis consumer. We have always believed in the same power of leading cannabis brands. And as Kellen has highlighted, our portfolio of brands is amongst the most extensive offering to Nevada retailers.

By anchoring our retail channel filling strategy around leading cannabis brands like Old Pal, Kiva, Cookies and 22Red to name just a few. We offer an efficient single source of supply of the widest range of brand offerings and price points.

Furthermore within that offering, our cultivation and production team have demonstrated their proficiencies to steadily deliver new offerings to the market. We believe this extensive brand and SKU offering will continue to be an important attribute to our overall value proposition as we strengthen our strategic supply relationships with our retail accounts. It provides opportunities to establish volume discounts and thereby support the preservation of our retail accounts margins. And as importantly it offers an expedited and efficient path to immediately strengthen the brand power of their shelf space to remain competitive in an increasingly competitive market to win the long-term — to win that longer term consumer loyalty.

And last but not least, our value proposition is rooted in our in-depth knowledge of our retail accounts. We will continue to leverage our unique across the board connectivity with virtually all 70 cannabis retailers in Nevada to quickly but strategically respond to shifting market and consumer preferences. And beyond our retail accounts we recognize that in the near-term there remain bulk wholesale opportunities that are important not only from a revenue perspective, but also in building strategic relationships with other non-retail accounts in the market.

So despite the challenging start to Q2 as a result of the exceptional collaboration and resilience of our operations team, we were not only able to weather through the worst of COVID-19 but also benefit from the improved workflow and system efficiencies identified by the team. That effort along with our disciplined approach to stay true and consistent to delivering on being the market leading highest quality lowest cost brand fulfillment partner in cannabis has positioned us very well as the Nevada market continues to reemerge and gain strength.

The second half of 2020 we’ll see our revenue momentum continue. And as David pointed out with our third quarter revenue guidance expected to be in the range of $9.8 million to $10.8 million, which would represent the highest reported quarterly revenue for the company.

On behalf of the Board of Directors, our senior leadership team, and all our employees, I thank you for your continued support of Flower One. We hope you are staying safe and healthy and we look forward to speaking again on our third quarter call.

And with that, I will turn the call back over to the operator for your questions. Operator?

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Scott Fortune. Your line is open.

Scott Fortune

Good morning and thank you. Congratulations on the call. First, I’d like to look at how long can your inventory side? And how long is the expectation that the product with the average cost is going to last in inventory? And how much flower do they produce? Did you guys produce at the $1.04 gram level? Just kind of so we have a sense of when margins will return to normalcy going forward here?

David Kane

Of course, Scott, our inventory increased, I believe $6 million, which represents about one quarter worth of sales. This is David Kane by the way. About one quarter’s worth of sales. So, we have roughly three or four quarter’s worth of sales in inventory right now. So, we expected that to definitely roll through over the next two or three quarters.

Scott Fortune

Okay. That’s helpful. I appreciate the color. And then, I just want to touch base on the retail level. You guys mentioned you’re 95% penetrated into retail accounts. What is the level from a penetration in those 70 stores? I’m trying to get a level or a room here you continue to gain market share in these stores from that standpoint kind of where you’re at with your products in the retail side of things from the store level?

Ken Villazor

Yeah. Yes, Scott, I’ll start and maybe have Kellen also add to that. But I think it’s a good question, because I think even though we highlighted our retail penetration, which is important, I think the more important aspect to how we’re managing our retail accounts with our sales force is recognizing that there are key retail accounts.

In other words, there are retail accounts that really do sort of comprise a significant portion of the overall retail market in Nevada. And so, obviously, we’re focusing a lot on those accounts. Many of those accounts are multi-store accounts as you can appreciate. And I think really that’s the bulk of our focus is, is to kind of increase the order size and if you will the basket size or SKU count of those key more dominant retail accounts.

And when you look at that, maybe just to be a bit more specific, I would say, earlier in the year when you looked at the frequency of those accounts ordering, we didn’t have many standing orders. I think today if you looked on a store basis, our weekly standing orders have really grown significantly. We’re at about 20 standing orders.

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So, that really helps. We know we’re getting very consistent orders week-in week-out from those larger retail accounts. So, I think again that’s most important for us. It’s nice to have connectivity with all the retailers. But we understand the main accounts that are driving most of the market share today.

And then, specifically if you’re looking at our market share in Nevada, we’ve been asked this question before, and it is challenging to quantify because we’re a wholesaler. But I think if you were to take even this year from January to June and you looked at the wholesale tax that’s being collected by the stat, and then you looked at our portion or our contribution of wholesale tax during the same period, it puts us at about just under 16% market share.

And that’s one methodology to sort of come up with an estimate on our market share. I think there are other means, but that’s one example. So I would say that that’s a good, I would say, benchmark to where we sit today in the market. And of course, as we move more Cookies into the market and 22Red and we launch some brands like Lift Tickets and Heavy Hitters, we do expect that market share to increase through Q4 and – sorry, through Q3 and Q4. Kellen, I don’t know if you want to add anything to that in terms of…

Kellen O’Keefe

I think that was very well said Ken. So I think that you answered the question comprehensively. Scott, if you have anything else.

Scott Fortune

Thank you. Appreciate the color. No, that’s – appreciate the color. I’ll jump back in the queue.

Ken Villazor

And Scott maybe just before you go on – I think one of your questions was just related to seeing, what do we think will happen with our harvested cash cost per gram. As David pointed out, I think that our reported figure for Q2 is an anomaly, largely driven by COVID.

I think a lot of that inventory around that higher harvested cash cost per gram we will move through the bulk of that in Q3. So I would say subsequent to Q3 you’ll see our harvested cash cost per gram likely come closer down to that $0.40 to $0.49 range that we’ve historically reported.

Scott Fortune

Thanks. That’s helpful.

Operator

[Operator Instructions] Your next question comes from the line of Graeme Kreindler. Your line is open.

Graeme Kreindler

Yes. Hi, good morning and thank you for taking my question. I guess just as a follow-up to the previous question there. You alluded a bit about your calculations on market share. I’m just wondering, given the circumstances we’ve seen at the beginning of the year with COVID, the dynamics in the Nevada market, do you have any sense of whether from a wholesale perspective that market has begun to consolidate, or have there been any other players that have dropped out that market? And I’m wondering if any of that has helped to drive the acceleration of revenue moving into the next period here? Thank you.

Ken Villazor

Yes. I think it’s a lot of what we’ve observed and heard – I shouldn’t say observed but a lot of what we’ve heard is obviously anecdotal. We have a sense that there are challenges with sort of the early part of the supply chain around cultivation and production, largely due to COVID, where some operators have really been forced to kind of scale back their operations. And then subsequent to them really have had difficulty ramping back up.

Some factors include just the availability of the labor pool – limited labor pool to support that ramp up but I would say, it’s difficult for us to know really whether there’s any consolidation. I think, again because of our bulk – the bulk side of our business Graeme, we do have a pulse on where – what producers are asking for and there is a sense, certainly we’re getting lots of inbound calls on bulk flower and bulk distillate, which leads us to believe that supply is not strong in the market today and that it will likely remain somewhat challenged. So for us we see that as an opportunity. Kellen, do you want to add to that just in terms of what you’re observing on the ground?

Kellen O’Keefe

Yes. I think those are great points. As Ken mentioned, it’s very difficult for us to confirm when a cultivation facility has effectively gone dark or a portion of their facility has been taken out of production. But based on, as Ken mentioned, a number of our license producer clients that are purchasing wholesale or both distillate or bulk flower from us, we are under the impression that there is a limited number of options in the market.

And in particular at — what we like to continually drive home at the value part of the market where there is a good quality or high-quality at a reasonable cost. And that is where I think we continue to excel. And a number of those licensed producers I would say really all of them at the top of the market have turned to Flower One for something as far as their ingredients go whether it be again bulk distillate biomass or trim or flower to produce those products or in many cases we’re actually now moving even past that to begin white labeling and doing some additional services for some of those clients.

So for all those reasons, I think, it’s a valid question and I think that we do expect to just looking at the rest of the cannabis industry as a whole we do expect to see more consolidation on the cultivation and manufacturing side of the business. But of course we believe that will favor Flower One.

Graeme Kreindler

Okay. Understood. I appreciate the color there. Just — and as a follow-up question for David here. I was wondering could you — you discussed some of the initiatives on the capital side in the prepared remarks, but just for some further clarity. Can you walk through the sources and uses of capital I guess for now till the end of the year here just to get some more clarity there? Thank you.

David Kane

So yes, uses of capital we will definitely be building out inventory and working capital needs for the greenhouse. We are expanding as Ken said our greenhouse. When we entered into COVID we reduced our production and operations level significantly and have started since July to rebound and reboot our cultivation and inventory needs. So a good use of our capital will be to rebuild the greenhouse.

A source of our working capital will be our inventory. As I mentioned we had about $32 million at June 30 in capitalized inventory costs and we plan to reduce that significantly as we enter Q3 and Q4. That’s mostly it. We do not have any anticipated needs for capital for property plant and equipment.

Graeme Kreindler

Okay. Thank you very much.

Operator

There are no further questions at this time. I’ll turn the call back over to the presenters.

Ken Villazor

Thank you, operator. To close I’d like to again thank and recognize the entire Flower One team from our Board of Directors to all of our Nevada based employees who work collectively and collaboratively to manage through the challenges of COVID-19 and prepare us for a strong second half to 2020. Thank you again to everyone on the call for joining us this morning and we hope everyone continues to stay safe.

Operator

This concludes today’s conference call. You may now disconnect.



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