Rubicon Organics Inc. (ROMJ) Earnings Call Transcript & Summary

Hi, everyone, and welcome to Rubicon Organics' Third Quarter 2020 Financial Results Conference Call. As a reminder, this conference call is being recorded on November 25, 2020. [Operator Instructions] I will now turn the call over to Marc Charbin, Head of Investor Relations. Please go ahead, Marc.

Thanks, Amy. Good morning, everyone, and thank you for joining us today. Rubicon Organics' third quarter 2020 financial results were released this morning. The press release, financial statements and MD&A are available on SEDAR as well as on the Rubicon Organics' website at rubiconorganics.com. We'd like to remind listeners that portions of today's call include forward-looking statements. There could be no assurance that these statements will prove to be accurate or that management's expectations or estimates for future developments, circumstances and results will materialize. As a result of these risks and uncertainties, the results or events predicted in these forward-looking statements may differ materially from actual results or events. Risk factors that could affect results are detailed in the company's annual information form and other public filings that are made available on SEDAR, and we encourage listeners to read those statements in conjunction with today's call. Forward-looking statements made during the conference call are made as of the date of this call. Rubicon Organics disclaims any intention or obligation to update or revise such information, except as required by applicable law, and Rubicon Organics does not assume any liability for disclosure relating to any company mentioned during this call. Rubicon Organics' financial statements are presented in the Canadian dollars, and the results discussed during this call are in Canadian dollars. I'm joined today by Jesse McConnell, Chief Executive Officer; and Margaret Brodie, Chief Financial Officer. I will now pass the call over to Jesse.

Thank you, Marc, and good morning, everyone. A sincere thank you to everyone for joining our very first quarterly conference call. This is a very exciting period for Rubicon Organics' evolution as a company. In 2018, we set out with the vision to create the global brand leader in organic cannabis. In order to realize this vision, we knew we needed to focus on the right product segments, in the right marketplaces, with the right-sized facility, and we needed to go about executing our strategy with the right team. We also understand that to deliver on our long-term vision of industry brand leadership, we need to demonstrate short-term results. Showing a clear path to profitability sets us apart from the noise in the cannabis sector. I'm going to take you through why our strategy of focusing on the premium segment will bring near-term profitability, which, in turn, gives us the confidence to invest behind product innovation in order to drive long-term value. A global brand starts as a national one. And as of this morning, I'm thrilled to announce that we have delivered on one of our major 2020 commitments with the signing of the direct supply agreement with Quebec. This makes us one of only 18 LPs to have access to the Quebec market. Through our new supply agreement, we'll be introducing Simply Bare products as well as additional brands and products that we'll be announcing in the very near future. With the Quebec market in hand, Rubicon's products are now available to over 90% of the Canadian population. We also have direct supply agreements with BC, Alberta, Ontario and third-party distribution agreements in place where no provincial distributor mandate exists. Now that we have a national distribution platform to grow our brands, the importance of focusing on the premium segment will become more evident. There are plenty of LPs with value-priced products, but very few who are able to deliver in the premium segment. Earlier this year, we launched our super-premium flagship brand, Simply Bare, to overwhelmingly positive reviews. Whether from budtenders, store owners or from consumers in online discussion forums like Reddit or Twitter, it is abundantly clear that Simply Bare has been a great success. While we have limited overall market data available, we all are able to ascertain some key learnings from the data that we do have in the Ontario marketplace. Firstly, Simply Bare is the market share leader in the organic category by a significant margin, outselling our nearest organic competitor by 2.6x in Ontario. Secondly, Simply Bare is the #4 selling pre-roll across the entire Ontario market, including value and mainstream offerings. This is a remarkable achievement when you consider our premium price point. What this demonstrates to us is that although we currently have a limited range of products available, our brand is generating a strong rate of sale. The success of Simply Bare is an important part of the strategy to realize our vision of becoming the global brand leader in organic cannabis products for 3 reasons. Number one, a premium segment generates higher margins in the rest of the sector. So having a super-premium segment as our core product offering is great for our profitability. Number two, premium products with high sell-through rates are preferred by retailers as they are better for their own margins. By hitting a home run with our first brand launch, we have built a reputation that makes it materially easier for our sales and marketing teams to introduce new products into our existing channels, generating significant operating leverage. Thirdly, [indiscernible] brand loyalty as consumers repeat their purchases. This proof of concept that we have [ the right ] team that understands how to align brand value propositions with consumer insights and successfully launch them into markets. We have invested significantly in our innovation team and processes as we view innovation as critical to our long-term strategy being a high margin, highly profitable business. Our brand and innovation team has been busy developing a robust pipeline of new products and platform brands that we will begin to bring to market as early as next week and throughout 2021. We have prioritized the launch of our innovation pipeline, so the products that will generate over 50% gross margin as a percentage of net sales on a unit economic basis. This will further drive operating leverage from our rightsized facility. Our near-term innovation pipeline includes new flower screens, our own 2.0 branded products, such as live resin, diamonds and caviar; vape products in partnership with PAX LABS as well as partner brands, such as our previously announced agreement with Wildflower CBD and THC Topicals. We, of course, will still drive quality yields upward in 2021 and beyond, but we've reached a point where we can depend on our supply operations to consistently generate high-quality flower, and we have successfully entered the premium segment with a category-leading brand. With Simply Bare positioned as a core premium offering that retailers need to have in their inventory, we expect to generate significant operating leverage and drive profitability through the launch of our new products and brands. Thank you again for joining today's call. And I will now pass the call over to our CFO, Margaret Brodie.

Thank you, Jesse, and good morning, everyone. Rainy morning here in Vancouver. In the third quarter of 2020, Rubicon Organics reported net revenue of $3.2 million, a 219% sequential increase over the second quarter of 2020. For the year-to-date, we have now earned $4.6 million in net revenue. In the second quarter of 2020, our delta BC greenhouse reached full operating capacity, and thereafter, our revenues have increased as new product becomes ready for sale to both the recreational and medical channels. Our gross profit before fair value adjustments was nearly breakeven in the quarter, excluding the impact of write-offs of inventory that weren't quite to spec. It's important to note that different than the largest LP, our cannabis production costs until the point of harvest are expensed as incurred rather than capitalized to inventory. Expensing our production cost as incurred means that in Q3, we expensed the cost of full capacity production, whereas we're still building to our full sales volume potential. In the coming quarters, you can expect to see that production cost line stabilize while net revenue continues to increase. And the same goes for inventory expense to cost of sales. As the pace of our sales increases, the per-unit cost of inventory expense to cost of sales is expected to decline. In the third quarter of 2020, we reported a $2.6 million adjusted EBITDA loss as compared to $2.5 million in the second quarter. While our revenues have increased significantly, we continue to expect further revenue growth and significant operating leverage. We are very cost-conscious at Rubicon Organics, and we are very pleased with the cost control we've been able to demonstrate very early on as our revenues continue to ramp. In the last quarter, we've invested ahead on certain critical roles in senior management across the organization and to build our business with the goal of functioning at the sophistication of a world-class CPG company. In addition, we recognized accrued bonuses and catch-ups to salaries in the quarter that were not incurred consistently over the 9 months to September 30. We continue to be in a position of financial strength with $8.1 million in cash at quarter end and $2.4 million in receivables, primarily from government and provincial sources. In the 9 months ended September 30, 2020, we invested $4.4 million in cash in our delta facility, including having installed additional high-performance LED lighting in the final 3 of 5 flower compartment. This will increase the quality and yield throughout the year. The company is currently performing an assessment of areas for additional capital expenditure, which will increase throughput and efficiency in 2021. And renovations are underway to the processing area to facilitate compliance with EU-GMP requirements to export our flower to our German partners. Last week, we announced the acceleration of the expiry of $3.1 million warrants from our August 2019 financing. If fully exercised, this would add incremental $10.9 million of cash to both -- to further bolster our balance sheet. We also expect to be refinancing our debt maturing in the first half of next year and throughout 2021 to have a long-term mortgage financing in place at considerably lower rates. Our cash position, warrant funds available and debt refinancing plan, together with the growth of the revenue line of the business, means we expect our balance sheet to provide ample cushion as we reach profitability milestones. As previously disclosed, our key financial milestones are: One, positive adjusted -- monthly adjusted EBITDA before the year-end 2020; operating cash flow in the first half of 2021; and gross profit as a percentage of net sales greater than 50%, excluding the impact of fair value changes on biological assets. We remain very confident we can deliver on these milestones given the trajectory of our revenue growth, maintain our premium pricing and our disciplined cost control. We would now like to open up the line for questions. So operator, would you please open up the line?

[Operator Instructions] Your first question today comes from the line of Neal Gilmer with Haywood.

Congrats on the quarter. Maybe just sort of 2 questions from my perspective at this time. You talked in your prepared remarks about moving towards that 50 -- towards that 50% gross margin level. As you look forward towards over the next couple of quarters, how do you see your progress from where you were at in Q3 to getting towards that 50% level? I understand your comments with respect to how you're not capitalizing on some of those costs. So just trying to get a feel for where you are in that ramp-up phase and whether we should see that gradual progression sort of into the middle of 2021? Or any sort of further color you might be able to provide on that?

I'll take that, Neal. Good to hear from you. I think your assessment is accurate. We'll start -- you'll start seeing that impact in the financial statements come middle of 2021. As we're ramping up those revenues, the production costs should remain linear, and you'll start seeing that operating leverage kick in, which will be reflected in the gross margin. But until we reach more steady stage production and we get the balance between our revenues and our production line as you're aware, the fair value adjustment, the IFRS reporting results in a gross margin that isn't as accurately reflected as to what is actually happening in the business.

Okay. Yes. Okay. That's helpful. And then, I guess, sort of a 2-part question is my second one. Obviously, it sounds like we're going to get some news flow, or next week, on the new brands and stuff like that, which is we're sort of I lead into -- as you look at your balance sheet, you've got a good cash position now, and then that's obviously going to be bolstered between now and the end of -- or December 16 with that warrant acceleration. What sort of -- what are your thoughts with respect to capital plans going into 2021 to either accelerate other new brands coming into market? Or are you looking to do other CapEx into the facility of delta versus sales and marketing initiatives to help brand awareness? So maybe sort of just give us a thought on some of your capital allocation considerations.

Well, we've spent the latter half of this year, focused on getting our innovation pipeline ready to launch throughout 2021. So a lot of the investments in sales and marketing and people overheads have occurred in the most recent quarter as we're investing ahead to get ready to put these products and brands into the marketplace. So you're not going to see significant expenditures, specifically on our innovation pipeline. In terms of CapEx projects, we are considering some moderate capital expenditures at our existing facility, which would be specifically on the processing side in order to accommodate the ramp-up of that innovation pipeline. To date, we haven't allocated that capital in our business plan as we look to see how our innovation pipeline scales. As we had mentioned previously, Neal, we have substantially completed all of the material CapEx at the cultivation facility with the installation of the new lighting and HVAC.

I would add to that, Neal. We are -- we believe we're in a strong capital position at this stage, in particular, relative to our peers. And we would like to make sure that we continue to be in that position. So we will -- as we look at those capital allocation decisions, the innovation is critical for revenue growth. But looking at where we spend, we would like it to be very specific on increasing our throughput and efficiency.

That's great. Thanks very much, guys. Appreciate the answers.

Your next question comes from the line of Greg McLeish with MRCC.

Just a couple of questions. I'm trying to figure out is what your cash position is as of today just because I know you're accelerating some warrants, and you also got a payment from the California operations of USD 390,000 on November 18. So what is your cash position as of today?

Well, Greg, I'm going to tell you we're comfortable but not rich. So we know where our next meal is coming from, which is a very cheesy way of saying that we actually aren't disclosing that actual number today. But I can tell you that in terms of the plans we have and where we're going, we're confident with where we're at with cash.

Okay. Because those warrants are going to bring in about just under $11 million.

They will, and we haven't seen what the impact of -- the total impact of that. That acceleration only just started. So we don't have a good view of what will happen over the next 3 weeks. There's been a lot of bouncing around in the market. So we'll wear base on that.

Okay. And just what is the sales ramp-up going to be like for the -- for Q4 itself? I know that you've got the Quebec deal now, and there'll be a big order -- or should be a reasonably sized order to stock. How are you sort of thinking of sales going into Q4?

I think the critical takeaway here is what we have now in place is the right foundation. We have the national distribution platform, we have the right team in place, we substantially onboarded all of our senior leadership and our supply leadership team over the last 2 quarters. So we're really in a good position to drive that revenue growth. Big unknown, Greg, frankly speaking, is unknown that we -- that none of us know, the impact of COVID and what that would look like in Ontario and Quebec with some of the recently announced COVID closures in place. Frankly speaking, I don't know if that could be a net positive. I mean that not flippantly, but as we saw some of the runs on inventory in March and April when we first had those COVID impacts, certainly, there's going to be a knock-on impact at the rate of licensing of retail stores in Ontario due to some of these delays. So while we're bullish on where we are as a team and where the reception that our brands are getting in marketplace, the quarter 4 impact of COVID as of today is an unknown.

And I would add to that, Greg. We started off very strong in October and continued from there. With recent events, we are watching very carefully what happens in Ontario. What happened back in March was, while consumers and shoppers increased their sales, stores did not order. So actually, the OTX reduced their ordering at that moment. And that's what's very difficult to predict as to what's going to happen here right now. It's also the holiday season. So there's quite a few impacts. Perfect storm of trying to forecast, I would say.

Great. And just you mentioned that October sales were very strong. How did that compare to the monthly sales in like September? How much were they up?

Well, I can't give you a specific on that because our quarter 4 isn't out, but we were very happy with the October sales growth relative to what we saw in quarter 3. Looking to maintain that trend. We are, as I said, still bullish on December given Christmas. And I really will have to point you back to the big unknown closures in Ontario as of yesterday, what does that mean for cannabis. That genuinely is big unknown. Going forward in the long term, we see that simply as a hiccup along the pathway. We have the right things in place. We're going to generate real operating leverage going forward, and we're very bullish on 2021.

Great. But does this change -- does this change your EBITDA? You're looking to achieve positive monthly EBITDA by year-end 2020. Does this impact that potential?

At this point, I'm going to -- we're still holding that we anticipate getting monthly EBITDA -- sorry, EBITDA positive on a monthly basis in quarter 4. If Ontario decides next week that they're not going to be putting orders in for the Christmas season as a result of closures, that's going to have an impact on us. Again, as of right now, we're just going to hold the line.

And I would say the great news yesterday on Quebec for us hopefully will offset quite a bit of that. So we are very excited to be answering for that.

Yes. That's massive for us to be in the Quebec marketplace.

Our next question comes from the line of John Chu with Desjardins Capital Markets.

Maybe just following up on the gross margin target that you have, 50%. So there's a lot of pulls and pushes as we move along for the next several quarters. So maybe give us a bit more of an idea about the margin profile for some of the current initiatives that you have and some of the upcoming ones. So for example, pre-roll seem to be selling very well. Give us a sense on how that margin profile for pre-rolls looks relative to that 50% number. Is that a dray? Or is that [indiscernible] towards that 50%? We know Germany is coming into play. [indiscernible] the margins are better there, you said previously. And then with the launch of some of these 2.0 products, are these margin -- are these going to be margin drivers towards that 50%? Or is there actually potentially a bit of a drag as you're ramping up for that?

Thanks, John. I'm just going to repeat the question. You're a little crackly on the line there for everyone else's purposes. The question is are some of the new innovation initiatives going to be accretive to gross margin or detrimental to gross margin. John, I know it's difficult in the numbers as we are required to report them with fair value adjustments to determine what gross margin is for us. Internally, our target is all dry flower equivalent is $5 of gross margin per gram. We have an average sale price of over $7 right now across various marketplaces. Any innovation, we prioritize over 50% gross margins on a unit economic basis. And until we get to a more material revenue line, it is difficult to see that gross margin the way that we're required to report that under IFRS. So I would say that things like pre-rolls are very -- give us very strong gross margins. And the innovation that you're going to initially see rolling out will be on or around similar gross margins to what we receive with pre-rolls.

Okay. That's very helpful. And then maybe just talk a little bit more of Quebec. Has pricing been determined in terms of what your flower will be selling at? And maybe just talk about the margin profile for Quebec, given that the product you're producing are going to be more or less [indiscernible] other than the [ flower ] are probably going to be more exclusive strictly for Quebec? And does that actually become a bit of a margin drag as well?

Okay. Again, you're -- I'm going to repeat that for everyone else's purposes. What does the competitive Quebec marketplace affect both our top line and our margin profiles and just a little color on our view on the Quebec marketplace. I start by saying we're really excited to be in Quebec. It is a fantastic market if you can get into it. They pay timely. They work very closely with you to drive value for you. There's only 18 licensed producers in that marketplace. As a comparison, I believe Ontario is currently just under 100 but I believe there's 96 LPs in the marketplace. So there's a smaller competitive set. The Quebec market will look a little different than the rest of the marketplaces. We're expecting to see strong margins on our Simply Bare product there, with additional innovation that we're going to launch in Quebec. You're right, John. That won't be as lucrative on a margin basis, specifically because some of our higher-margin products such as the solventless products or live resin is not able to be sold in Quebec at this time. So we are looking to launch things like lower potency hashes and other more mainstream offerings there. The flip side of that is, while there may be some drag on the margin in that aspect, we would anticipate that by working closely with Quebec, we'll be able to drive significant volume through that marketplace. So there is a little give on margin, I would anticipate, across the blended portfolio in Quebec. But we're anticipating strong volume in Quebec in quarter 1 and beyond.

And then just on the pricing you're seeing right now for your Simply Bare products, has that been holding pretty firm through the quarter? We've been seeing a lot of price compression in [indiscernible] for flower products. So just curious on that.

Yes. No, we're religious zealots when it comes to quality on our Simply Bare product. And because of that, that obsession with quality is flowing through in our maintenance of the margin. We haven't seen issues with margin in any of our current marketplaces with Simply Bare products. And I'd even point you to the small write-down that we took this year that I believe other LPs might not have taken that we did just because while it was good, it is a good product...

It's not great.

It's not great. And only great is what is accessible for us in the Simply Bare product lineup.

And your next question comes from the line of Rahul Sarugaser with Raymond James.

So congrats on the -- and yes, congrats on the Quebec -- entry into Quebec. And so you already answered a couple of my questions there, but just sort of wanted to drill down a little bit. Have you been able to understand in terms of maybe a little bit of voice of the customer, what the anticipation is for Simply Bare and Rubicon's products in general? And then I'll maybe ask my second question as well, which is as the provincial buyer comes online, how are you looking at that inventory buildup in Q4 relative to future quarters?

Well, I'd start with -- so 2 parts of that question. And thanks, Rahul, for pointing out how early it is for us. Having a young child at home, getting up at 5:00 a.m. is becoming more commonplace. The -- as I stated before, we are very bullish on Quebec. And while we haven't forecasted all of our sales through 2021 with Quebec at this point, because we're really still in the early stages of developing our supplier relationship with them, although we've been in conversations with them for over a year. I had a tech sent to me last night from somebody who's active in the Quebec market from a private group that has over 12,000 members. And I'll read you the translated version here is -- which is 2020 isn't so bad. We've been waiting a long time to see quality product in Quebec, and we're honored to finally announce that Simply Bare is coming into the Quebec marketplace. So that comes from a consumer -- it was a bartender actually in a private chat group. So we're actually, I said, quite bullish in Quebec. I think Quebec has been neglected by some LPs who have focused on the Ontario marketplace and not given as much attention to Quebec, I think, as they deserve. So to see real premium product flowing into that marketplace, I think, is going to be very well received by Quebec consumers.

Great. And then how do you anticipate -- that's really helpful color. Thank you very much for that, Jesse. And so particularly, as now, they start to build their inventory, are you looking at them sort of kind of tiptoeing in, in Q4? Or do you anticipate sort of a large bolus order that then should hopefully be followed by further bolus orders based on strong demand?

That's an excellent question, and I think we'll know the answer to that question within the week when their first order comes in. And let me break that into 2 parts. As we sell Simply Bare product into Quebec, we'll see what that uptick looks like in the premium segment in Quebec. The other element of that relationship we're looking to build with Quebec, which is about more than just our focus in the premium segment but it's about how we do business. It's about the Rubicon way. Now servicing the SQDC and working with them as partners to help build out their portfolio in the super-premium segment and beyond is how we're looking to target our business relationship in Quebec. So it's going to be one, not simply as supplier to a marketplace but one where we are working with them to achieve the mandate that they have to their marketplaces. And we anticipate that having that kind of relationship, building and the partner there is going to give us -- it's not technically be a preferred supplier but will give us access to the market that maybe is different than some others.

Terrific. And if you could bear with me and just allow me to shoehorn one last question and just as a follow-up to that. We do recognize that Quebec is quite a sequester to almost sort of protectionist market relative to all of the provinces are somewhat, but Quebec seems to be more so. And you referred to sort of the building of relationships and that sort of pseudo preferred supplier relationship. Maybe could you elaborate a little bit on that in terms of what Rubicon is doing differently, obviously without giving away your secret sauce, that should be able to drive that material revenue and maybe overcome some of that protectionism that we do see in Quebec? And then I'll stop after that question.

I would like to tell you that, Rahul, but I'm going to demur on that one. Well, I would leave it at Quebec has a mandate that [ leads ] the black market there. And Quebec also has a mandate to encourage business inside of Quebec and generate employment there. And so there are some specific things that we're looking to do that would help them achieve that mandate. And I think for now, I'd leave it there, and I'll follow -- on our next year-end call, I'll speak more to that because it'll become more evident in what we're doing.

Terrific. And excellent use of the word demur.

And there are no further questions in queue at this time. I turn the call back to the presenters for any closing remarks.

Well, thank you, everybody, for joining us on our very first quarterly conference call. Thank you for the analyst for some excellent questions. And we're very excited about 2021 and what's to come. We've laid an incredible foundation here. We're looking at generating real operating leverage as we enter into the new year. So again, thank you all for joining us on this conference call, and I'll let you go about your days.

And this concludes today's conference call. Thank you for your participation. You may now disconnect.