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

Hi, everyone. Welcome to Rubicon Organics Fourth Quarter 2020 Financial Results Conference Call. As a reminder, this conference call is being recorded on April 6, 2021. [Operator Instructions] I will now turn the call over to Marc Charbin, Head of Investor Relations. Please go ahead, Marc.

Thanks, operator. Good morning, everyone, and thank you for joining us today. Rubicon Organics fourth quarter and year ended 2020 financial results were released this morning. The press release, financial statements and MD&A are available on SEDAR as well as the Rubicon Organics website at rubiconorganics.com. Before we begin, I'll refer you to Slide 2 of our presentation, which contains Rubicon's caution regarding forward-looking statements. I'm joined on the call today by Jesse McConnell, Chief Executive Officer; and Margaret Brodie, Chief Financial Officer. I'll now pass the call over to Jesse.

Thank you, Marc, and thank you, everyone, for attending our quarter 4 2020 conference call. Rubicon Organics remains laser-focused on cultivating the best cannabis on earth and for the earth and on building a global premium cannabis brand. We are focused on the premium segment because this is where the greatest margin opportunity exists. We believe that given our unique intellectual property, our team of world-class branders and consumer packaged good professionals and our rightsized facility, we have created a competitive advantage in the cultivation and marketing of premium cannabis. In 2020, we saw evidence of the premium market growing steadily in Canada from 11% in quarter 1 to 16% market share in quarter 4, as Rubicon and our peers have increased the output of high quality cannabis. In the medium term, we believe the share of the premium segment will continue to grow. If you look to mature cannabis markets in the U.S. and observe the market share of the premium product segment and consider analogous consumer industries such as alcohol, we can estimate that the premium market in Canadian cannabis has a potential to comprise between 25% and 30% of the market. And this market share is not driven by volume, it is through dollar value. From a volume perspective, we anticipate the market share of the premium market will be approximately half of the dollar share value, demonstrating how higher margins can be commanded for a premium experience. While we have global ambitions over the long term, for 2021, our growth will be driven in Canada. Canada is the ideal place to hone our skills, given the elevated regulatory requirement of this market relative to other markets, and it is also well suited to attracting global talent. In order to structure the base for global brand leadership, we made several key hires throughout 2020 in supply chain, innovation and operations and sales. We have been very strategic in our personnel selection. All of our new team members have significant experience in consumer packaged goods, with organizations selling premium products to global consumers. Turning to our recent milestones, we had a truly stellar quarter 4 2020 in market share gains. Our first full quarter of Simply Bare Organic being available in each of British Columbia, Alberta and Ontario, our products held the #1 or #2 position in the premium or super premium categories in each product, in each province and in different product formats. This is a remarkable performance from our team. While we cannot expect to always maintain the coveted #1 position quarter-over-quarter, going forward, we do expect to grow our market share in the premium segment and to consistently have Simply Bare rank amongst the top premium brands in Canada. In late quarter 4 2020, we also received our first purchase order in the province of Québec. And in conjunction with our product rollout in Québec, we launched our 1964 brand. We also signed an agreement with PAX LABS to fill organic cannabis oil pods for the PAX ERA and PAX ERA Pro vaporizers, which we expect to be available in quarter 2 under the Simply Bare brand. Looking forward to 2021, we will remain undeterred in our focus on the premium segment. It's where Rubicon has the right to win and is currently winning. We continue to be committed to driving industry-leading profitability and this will be through continued product excellence, driving innovation and rigorous cost control. We recently announced purchase orders in 4 provinces for the Wildflower branded CBD sticks, and our PAX oil pods are expected to hit shelves in 2021, and we are regularly adding new products and product formats under our existing brands. We expect that the first half of 2021 top line growth will be impacted by restriction placed on retailers, particularly in Ontario. Store closures and curbside pickup have significantly reduced the expectation for total sales volume in Canada's largest province, and this has had a disproportionately higher impact on premium cannabis which tends to require interaction between consumers and budtenders to drive sell-through. Moreover, Ontario recently conducted a product rationalization, reducing the number of provincial SKUs from approximately 2,000 down to 200. While in the short term, this inventory drawdown impacted the rate of reorders, we are happy to report that Ontario retained all of Simply Bare's product line and is also committed to increasing our portfolio by 5 SKUs. We expect Ontario will be a big contributor to our growth as retailers are permitted to resume normal operations and the overall number of products available to consumers is reduced. In response to the unexpected setbacks to revenue in the first half of 2021, we have pushed out certain discretionary expenditures and have been vigorous in implementing efficiencies across our production processes. Gross margins and cash costs remain in line with our expectations. Notwithstanding near-term challenges relating to COVID, Rubicon remains a very high-growth company. Through our new brand and product launches and increased penetrations in the provinces we operate in, our true potential remains many multiples higher. We firmly believe that our long-term revenue trajectory is intact and are confident this will be demonstrated as provinces resume expected enough buying patterns. Thanks to the support of existing shareholders through an accelerated warrant exercise in December 2020, we raised gross proceeds of $7.2 million and then a $23 million equity finance that completed in February of this year. Our balance sheet is rock solid, and we have the capital we need to execute our growth plans and accelerate strategic initiatives to drive shareholder value. 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. In the fourth quarter of 2020, Rubicon Organics reported net revenue of $4.8 million, a 51% sequential increase over the third quarter of 2020. The increase in net revenue is due to expanded distribution of our flagship Simply Bare Organic brand across Canada and more SKUs available to the consumers. For 2020, as we ramped up our first year of sales, we earned $9.4 million in net revenue. We believe we have only just begun to show our revenue-generating ability. Rubicon Organics products are now available in 6 provinces, and our products were only launched into the Québec market on December 29, 2020, right at the end of the year. With more SKUs of each brand available in more provinces in 2021, we continue to expect significant revenue growth in the coming year. This growth is expected to be weighted towards the second half of 2021 as it has been impacted by recent store closures, and we expect our revenue trajectory to be back on track once Ontario retailers return to normal operations. We reported an EBITDA loss of $3 million in Q4 2020. The quarter-over-quarter decrease in EBITDA was impacted by an increase in our net revenue and release of accrued bonuses, offset by the impact of inventory write-downs. Rubicon Organics remains uncompromising in the quality of product we bring to market. And from time-to-time, this means the write-off of inventory that, that does not live to our quality standard. Looking forward, we expect the compensation expenses and administrative and -- general and administrative expenses will stay relatively in line with inflationary increases. Sales and marketing expenses, a relatively smaller line item, will tick higher with the launch of new product SKUs and brands. In 2020, we also had additional costs for COVID-19, such as additional space and PPE, and we hope in the latter half of 2021, these costs will be reduced. We still expect to generate operating leverage once our net revenue accelerates as production costs and operating expenses increase at a slower rate and its inventory expense to cost of sales decreases on a per unit basis. We also have certain capital expenditures planned in 2021, which should decrease our operating costs as they get put into place. We ended 2020 with $12.1 million in cash and in February, we successfully completed an equity financing for gross proceeds of $23 million, which strengthens our balance sheet and has resulted in a cash balance over $20 million as of April 1, 2021, and that includes the impact of the repayment of the $5 million first mortgage on the Delta Facility, which was completed on April 1. Turning to our financial objectives. We have pushed out our financial objectives for monthly EBITDA profitability to Q2 2021 and cash flow to H2 2021. Simply put, store closures in Ontario have had a material impact on our forecast for that market, by far, the largest in Canada. As soon as Ontario returns to sustainable buying patterns, we are very confident this will be reflected in our financial results. But after last week's uptick in COVID-19 cases across Canada and messaging from provincial governments, if further lockdowns occur, we expect it will have an impact on our ability to deliver profitability in the short term. Pending the impact of further COVID-19 lockdowns, which we do believe will be relatively short-term in nature, we remain confident in meeting our financial milestones for several reasons. Our product pricing has remained unchanged as consumers recognize the value of our premium brand. We have built the right-sized facility to operate very efficiently. We have remained rigorous in our control of cash costs. Our senior management team is in place, and our innovation pipeline is expected to meaningfully contribute to profitability. So now we would like to open the line for questions. Operator, please open the line.

[Operator Instructions] Your first question comes from Neal Gilmer, Haywood Securities.

Congrats on the Q4 numbers. Maybe I just wanted to see if you had any further commentary with respect to the Québec market. You commented about your first purchase order on December 29 for shipment. How have you seen that sort of trend for Q1? Have you seen some reorders? Any sort of feedback that you've gotten on entering in that new market?

Neal, good to hear from you. Jesse here. As you know, we did enter the Québec market very late in last year, in the last couple of days. We are now 1 of only 4 LP -- or 20 LP, sorry, in the Québec marketplace, and 1 of only 4 premium producers. So we're quite bullish on the Québec market. We have 4 SKUs in the market right now, 2 from Simply Bare and 2 from 1964. And we're anticipating rolling out significantly more SKUs than that over quarter 2 and quarter 3. So we expect that to be a pretty significant contributor to the overall revenue mix for Rubicon.

All right. And then maybe you recently announced an agreement with Valens for the production of some sort of 2.0 products. What sort of the time line that you're expecting that those products could come to market? You commented in some of your prepared remarks that within Ontario, you have another 5 SKUs that they've committed to bringing on board. Are those some of the 2.0 products? Or is there some of the Wildflower products? Any sort of comments on when you can see those in the marketplace?

Yes. Well, some of those 5 SKUs have already been committed, although we anticipate further as the quarters go on here. So those are for our Simply Bare products, in particular, and the Wildflower SKUs. We -- with Valens, it's been really important for us to really dig into the value chain here. I think for a number of LPs, you've seen too many touch points across the value chain, resulting in diminished margins. So we want to work very closely with a single LP who can drive some of our 2.0 products, and that's the reason for the relationship that we're building with Valens. So you can expect to see the first phases of that rolling off as early as the end of this quarter, potentially in early quarter 3 for Simply Bare pack products. And you'll see some other extraction products coming out of there as well.

Great. And maybe I'll squeeze one last one in there. Margaret, you commented that you have some CapEx plans for this year that will help produce some of your operational costs. Any sort of range that you can give on what those CapEx dollars would be for 2021? And any comments on what some of those investments might be?

Absolutely. Great question. We're only looking at CapEx that focuses on quality, increasing efficiency or decreasing our cost. We're not overall expanding. Our overall spend is expected to be in the range of $5 million in the year. A lot of it is we've got the climate where we want it. So we've been renting dehumidification equipment. We're actually now -- so that has an increased OpEx cost. We're actually planning on purchasing that equipment, which will be positive on cash costs in our production. And also, we've been waiting for a BC Hydro uplink for grid power and using natural gas generators in the interim. We are now expecting in H2 2021 for those to be put in place. But there's some costs that we will bear to do that. It will mean our costs go down, but we're also using sustainable hydro-generated grid powder. So we're very pleased with that.

Your next question comes from Rahul Sarugaser with Raymond James.

Congrats on the strong revenue this quarter. So just starting with the one keeps -- that may be a concern, but I just wanted to kind of put this context with you guys. There have been some write-downs, Margaret, you made reference to the fact that this is not going to be something that we should see in the long term, given your focus on quality. So maybe can you give us a little bit more color on what caused the write-down? And how should we be thinking about potential write-downs in the future?

Absolutely. We do not expect to see significant write-downs, and I think relative to the sector, we're actually quite low. We -- it was our first full year of operations. And one of the things I just mentioned in talking about capital expenditures was getting the facility in the first full year where it was fully planted, right? We ended up having -- we improved throughout the year on our production. And as we refined the climate in the greenhouse, and that was part of the capital that we raised in May last year, in particular, putting in new lights. That's when we also put in the dehumidification equipment. That improved the product that we had. And as we improve on quality and we get better quality, we want to make sure we're putting the best quality out there to our customers. So those write-downs were really, I would say, more of a learning piece throughout the year as we improved. And Jesse, I don't know if you want to add to that, but I think inevitably, there's going to be small amounts, but we don't expect to see the level we have now, really our first full year of planting.

Yes. Just to put a little additional color on that, one of the KPIs that we measure internally is the percentage of our products that we're able to grade into Simply Bare quality on any given crop. And so we've seen that percentage trend higher throughout the course of the year. Rahul, as you'd expect, our first crop wasn't 100% Simply Bare quality, but we still recapitalized all those production costs. And a certain point at the end of the year, we make a determination that we're not going to reuse old product. So that's where you're seeing that write-off come from. But now that our percentage of Simply Bare quality product coming out of the greenhouse is literally double what it was at the beginning of the year, you're going to see that write-down be significantly smaller in the future.

Terrific. That's really great color. And then my next question, sort of following on from Neal's question about Québec. One thing that we do understand about Québec is that it's a bit of an animal unto itself. Buying habits, it's a bit of an opaque market. It's hard for us to see what the provincial buyers be buying relative to other provinces. Consumers there have slightly different buying habits. So given that you've been in the market for about a quarter now, what is it that you're seeing? And then how are you -- is there any way -- anything you can give us that will help us understand the trajectory of Québec-based revenue?

Yes. Well, I'd start with -- you're right, there is some unique features and characteristics of the Québec market. But what is universal there is the premium consumer enjoys high quality cannabis. And that's where we intend to win and are winning. So they've been very receptive to our products in that marketplace. I think one of the biggest differences in Québec versus some of the other markets is the importance of working very, very closely with the regulator there, given the verticality of the supply chain, owning all of the old stores, as you know, are SQDC-owned and they warehouse the product there with the SQDC. So we work more closely with the regulator there or the distributor than we might in other provinces. And I think that's important for a variety of reasons. But the one that I would highlight is Québec's intention to have no more than, I believe the last number I heard was 22 LPs in the marketplace and then rounding out the difference would be Québec-based craft LPs, so -- and micro producers. So that marketplace continues to grow. They continue to do store openings, and they are keeping the number of LPs in that market to a very, very small number. So very, very bullish in the Québec marketplace and taking a slightly different strategy there than in some of the other markets.

Great. Great. That's very helpful. And then one last question, if you don't mind. Sort of extending that line of thought to Ontario, Alberta, BC, where you've been able to maintain #1, #2 spot, which is terrific. Given that we're still in the early days of the industry and there's not a lot of brand loyalty broadly. We see, of course, that there's going to be more brand loyalty in the premium end of the market, which is, of course, one of your competitive advantages. How do you see being -- how do you see keeping up without being able to defend your position going forward, particularly as the market sort of matures and gravitate towards?

Consumer package good in creating brand loyalty, we like to think that it's magic, but it's really sort of the ABCs of creating loyalty. It's just consistency, right? And so, so long as we maintain the consumers' heart through creating consistent product, delivering that in a timely fashion, that's how you see brand loyalty develop. And what we see right now in the marketplace is the consumer bouncing around a little bit. To your point, there really isn't much brand loyalty because there's just so little consistency in the market. It's batch by batch. And what we're looking to do is generate that consistency. So the consumer, once they develop that trust, they come back and they try our new product launches. So as I said, it's a time-tested method, but creating high-quality consistent cannabis is where the big challenge lies. And of course, you've seen the whole industry struggle to do that. And that's something that we pride ourselves on. So that also, I think, speaks to the write-down that we did this quarter. Other LPs may have decided to release some of that product for us. It was so important to maintain that consistency in the marketplace.

Your next question comes from John Chu with Desjardins Capital.

Can you hear me?

Yes, we can, John. Go ahead.

Okay. So maybe my first question is just what sense are you getting regarding the provincial wholesalers looking to start to restock? I mean are we at the point where they're doing that now? Is it giving you any sense that, especially with some of the senior management changes at the OCS and even in Alberta, any color on that would be helpful.

Yes. I can give you some color on that. It's interesting because the COVID closures are certainly a part of impacting sales industry-wide. Arguably as large an impact, if potentially larger, was the provincial distributors going through that SKU rationalization. So they are working through a lot of products, and we're beginning to see those reorders happen just in the last 2 weeks. Specific -- I'm specifically referring to Ontario at this point, John. So as an example of that, some of our SKUs, they run down to 2 weeks' worth of inventory in stock, which to give color on that, 2 weeks means that we'll have an out-of-stock event when you see inventory run down that low by time that PO gets processed and delivered. So they've been very aggressive in running down that inventory. And just recently, as I said, the last 2 weeks, we've begun to see that those orders start to uptick. And then we'll have to fill their coffers up to make up for the inventory rundown.

And do you expect that the gradual upticks on the reordering? Or do you -- or can this be a pretty significant spike in the coming weeks? How do you see that potentially playing out?

Well, my COVID crystal ball here isn't working perfectly, but that really is the question. If we didn't have COVID closures, I would confidently say that what we're expecting was a double down in quarter 1 with the rundown of inventory and then a double up on the other side. Because as they move through that product inventory, the consumers aren't going away. It's not like there's -- they've decided to leave. And that's -- the demand segment is still growing. The real question then is how does the inventory reordering correlate with store -- potential store closures in Ontario. I know on the aggregate, we're going to see a significant increase in those orders. How that is impacted by what is happening today in Ontario in the coming weeks, I wish I could answer that question, but I just don't know that answer.

Sure. Fair enough. And then just a follow-up on the inventory write-downs, you mentioned that some of the inventory were destroyed, some of that's going to be used for 2.0. Can you give me a sense of what percentage was destroyed? I mean could have not been used for 2.0 or concentrates or anything like that?

Yes, to a certain extent, it was quite a small amount that was actually destroyed, and it comes to aged inventory. What we ended up having was we've done quite a bit of [ RNG ] in the summer, and it was individually small lots. So when you have individually small lots, we have to be clear on what we're putting in every product, so that makes it a little more challenging. We've seen that across the country as craft growers have grown very small lots and tried to sell them is difficult. We also -- our pre-rolls are whole flower pre-rolls. They're not all the other junk that gets in there. And the hash that we've done, a lot of it has been whole flower. So whilst understanding the point, from time to time, you end up with these small lots where economically, it's actually smarter to just move it out.

Okay. And then just last question for me then is in areas in the press release, you highlighted Alberta and Ontario as being likely the biggest drag for the upcoming quarter. And so I'm just curious, I mean, on Ontario, we've had here store lockdowns, closures and curbside. I think Alberta has been a little bit more open than that. So maybe just some color on why Alberta was being a drag?

Well, Alberta was being a drag because they were going through inventory rationalization. Those 2 marketplaces went through that. I think in fairness, it's a little more difficult to operate in the premium segment in Alberta given the overall economic environment there. But I think we really see the difficulties more so in Ontario and largely related to -- as you've seen in the last week, there's massive spike in COVID cases and are we going to see a -- we're just being extra cautious, I guess, the best way to say it, John, when you have the kind of COVID cases that they have in Ontario today and the anticipation that you may see store closures happen here within the week, with those kind of case numbers. So we're just -- this is just us trying to be prudent in expectations, while hoping like the rest of the country is opening that you'll see that curve flatten out.

Sorry. And then sorry, one more question, if I can. So you said Ontario was rationalizing a lot of SKUs. Were there a decent number of premium or super premium brands that were being rationalized and because presumably, that would be good for Rubicon and seeing that you haven't lost any SKUs? So I'm just trying to understand that dynamic.

Well, I mean, in the short term, as I said, the SKU rationalization has impacted sales but I'm actually quite happy to see that happen. I think you had a situation in Ontario where the consumer wasn't -- it was beyond spoiled for choice. They got to the point where there was just too much choice, right? It was the sort of the toothpaste problem where there's 1,000 different types of toothpaste on the shelf and the consumer can't make a choice. So we were quite happy to see that reduction. I mean it's a tenfold reduction in products that are available to the consumer. I could get you that information to understand specifically what that reduction looked like in Ontario. I don't have that data in front of us right now, but I would certainly say that at a minimum, we face decreased competition in Ontario to what we did previously as a percentage of SKUs available in the premium segment. And then I'm just -- I'm very happy to report that we not only kept everything that we wanted them to keep, but increased that number.

Okay. Actually, that's a good color right there that you think you've got less competition. That's more than enough for me.

Thank you, John.

There are no further questions at this time. I will now turn the call back to Jesse, CEO, for closing remarks.

Thank you very much. Well, I think the key takeaways for this are that despite some short-term challenges associated with COVID and with the temporary store closures and inventory rationalizations, the long-term growth trajectory for both the cannabis industry and Rubicon, in particular, is quite strong. We've proven that we have a right to win in the premium segment, and we've proven that we are in the process of winning that segment. This is the most profitable segment. It continues to grow its market share on a relative basis. We anticipate that growth being 60% to 100% over the coming year on a relative basis. And so where are we today is that Rubicon is in a very strong financial position to weather any of these short-term COVID challenges and to invest behind revenue growth and the launch of our developed innovation pipeline, which you'll see over the coming quarters. So we're very excited, very bullish on 2021, even in light of some of these COVID issues. I'd like to thank everybody for joining the call today and for your continued support. Thank you very much.

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