Rubicon Organics Inc. (OTCQX:ROMJF) Q2 2022 Earnings Conference Call August 15, 2022 10:30 AM ET
Company Participants
Jesse McConnell – Chief Executive Officer
Margaret Brodie – Chief Financial Officer
Conference Call Participants
Neal Gilmer – Haywood Securities
Rahul Sarugaser – Raymond James
Operator
Good morning. Welcome to Rubicon Organics Second Quarter 2022 Financial Results Conference Call. As a reminder, this conference call is being recorded on August 15, 2022.
At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session and instructions will be provided at that time for research analysts to queue up for questions.
Before we begin, I will refer you to Slide 2 of our presentation, which contains Rubicon’s caution regarding forward-looking statements and non-GAAP measures. Today’s presenters will be Jesse McConnell, Chief Executive Officer; and Margaret Brodie, Chief Financial Officer.
I will now turn the call over to Jesse McConnell. Please go ahead.
Jesse McConnell
Thank you, operator, and good morning, everyone. The Rubicon investment thesis has been the same since we began. Firstly, cultivate the highest quality organic cannabis possible in the right-size facility to generate strong operating leverage; secondly, focus on the premium segment and design premium brands and products to deliver against targeted consumer insights, rightsize, right segments, right strategy. Today, I am proud to announce that we have delivered on our first quarter of adjusted EBITDA profitability and that we are currently on our trajectory to grow our revenue, gross profit and adjusted EBITDA in the upcoming quarters.
In quarter two, we refined our focus by reducing our overall portfolio breadth and introduced new streams and formats to drive our portfolio deeper into provincial markets and onto store shelves. We began quarter two as a top 12 license producer. And in June, we became a top 10 licensed producer. In quarter two, we increased our market share to 2.3% of the total market, and in the month of June, it grew even further to 2.6%, making us one of the fastest-growing licensed producers in Canada.
In our key segments, premium flower and pre-rolls, we were the number two license producer with an 8.6% market share and are the most premium-focused license producer with a 64% ratio of premium sales to total sales. Our net revenue grew 68% for the 12 months ended quarter 2022 compared to 2021 and 92% net revenue growth for the three months ended quarter 2022 compared to quarter two 2021. We continue to believe that innovative and novel genetics cultivated organically to the highest standard of quality is foundational to developing long-term equity and premium brands that consumers love and are loyal to.
In quarter two, Simply Bare Organic remains the number one premium brand in Canada in flower and pre-rolls for the fifth quarter in a row with a 5.1% market share for the 3 months ended June 30 and retained the number one premium brand position across flower and pre-rolls in our home province of British Columbia with a 10.5% market share for the 3 months ended June 30. Competing at the very top of the mainstream pricing segment, 1964 Supply Co has become the number one mainstream brand in BC in the 3.5 gram format category, which is the highest sales volume category. 1964 Supply Co has been a major contributor to our revenue growth.
As we look toward future growth areas, we anticipate that our business will accelerate in both Ontario and Quebec because of innovative new genetics and product listings that we have recently secured for both quarter three and quarter four. Moreover, and perhaps more importantly, since the beginning of this year, we have seen the foundation of our investment thesis proven out, namely that the premium segment will outpace the growth of the total market as consumer taste preferences evolve and mature, resulting in the corresponding development of real brand equity. As the pace of the overall market growth decelerates, the premium segment has, in fact, accelerated from a 28% growth rate in December 2021, which was equivalent to the overall market growth rate to a 51% growth rate, doubling the growth rate of the current total market. The two risks that I would flag here are the macro environment risk of a Canadian recession, while Rubicon is not opining on the likelihood of it occurring, we are nonetheless risk adjusting our behavior given the possibility and are being especially prudent in our allocation of capital. And secondly, the recent OCS distributor cyber-attack, which presents a short-term risk impacting the availability of OCS warehouse inventory for retail stores.
We have not yet noticed any change in the cadence of ordering. However, it may have a minor impact on our Q3 revenues if it is not resolved in the near term.
I will now pass the call over to Margaret, who will share some specifics about our financials, after which I will provide Rubicon’s key deliverables of our three-pillar strategy.
Margaret Brodie
Thank you, Jesse, and good morning, everyone. I am pleased to report that in the 3 months ended June 30, ’22, Rubicon Organics reported record net revenue of $8.8 million and achieved positive adjusted EBITDA for the first time. Firstly, in terms of revenue, we earned $8.8 million in revenue in Q2 ’22, a 92% or $4.2 million increase over Q2 ’21. On a trailing 12-month basis, net revenue was $27.8 million, a 68% or $11.3 million increase as compared to the same period in ’21. This increase in net revenue was 72% growth compared to Q1 ’22, driven by the launch of several new strains and product formats in both Simply Bare Organic and 1964 Supply Co.
As typical in the cannabis industry, Q1 ’22 was impacted by the seasonality of dry January and the provincial distributor year-end to March 31. We believe that the largest contributor to our revenue growth is a step-up in our product quality. The company has also achieved adjusted EBITDA of $300,000. This adjusted EBITDA is driven by a large increase in our revenue, increased throughput of our facility, meaning our costs are spread over a larger base, delivering better gross margin, excluding gross profit and continued prudence on our spending and operating expenses. I would note that taking out the termination accrual for our current covenant of $0.5 million, net of the reduction of other C-suite compensation and adding back onetime inventory write-downs, the adjusted EBITDA figure would be over $800,000 in Q2 ’22.
The company has maintained a strong balance sheet with $6.8 million in cash and $19.4 million in working capital at June 30. We currently have $5.6 million in cash with $6.2 million in receivables, of which, $3.9 million is imminently receivable in the next two weeks due by the end of August. In June ’22, we have arranged an extension to our existing secured debt due on to December 2024, giving Rubicon’s a strong position with its current trajectory to repay or seek competitive longer-term mortgage financing in the coming years.
Rubicon’s cash position and working capital meaning that we are confident in our ability to fund the growth in the second half of ’22 and beyond. Rubicon Organics has only one large capital project budgeted for ’22 and it’s in its final stage of completion. This project is the BC hydro grid connection, which is funded by our existing capital. This project was due to be completed by June ’22, but with global supply chain delays and labor shortages with hydro get drifted into the third quarter, and we are waiting BC hydro took us up into the system in just the next coming days. We’ve been pushing this project forward as quickly as possible as the cost savings of being on the hydro grid are significant to our business and are expected to be well over $1 million in operating cost savings annually.
In terms of cost in general, given the high inflationary environment in which the company is operating in 2022, management continues to monitor its cost closely and is actively seeking cost saving initiatives. And that can be seen in the prudence in which we are incurring our operating expenses.
As I said earlier, Rubicon experienced a 72% growth in net revenue for the 3 months ended June 30, 2022, as compared to Q1 2022, driven by the launch of several new strains and product formats in both Simply Bare Organic and 1964 Supply Co. We have seen a tremendous increase in our rate of sale of Simply Bare and 1964 as well as a large increase in the number of distribution points in store, that being the number of our SKUs carried by the individual store, which we believe is attributable to the continued improvement in our product quality and higher THC results and the strength of our sales and marketing team. The revenue growth has been experienced relatively evenly across all our key markets of Alberta, our home province of BC, Ontario and Quebec, which together make up 97% of our sales in both the 3 and 6 months ended June 30, ’22.
As you may know, selling to Crown Corporations means that credit risk around our receivables is very low. After our revenue, our gross profit before fair value adjustments is impacted by two things: firstly, our production costs; and secondly, the inventory expense to cost of sales or the costs incurred in drying, processing and packaging our products. In terms of our production costs, we have seen a slight increase in our cost in the second quarter of ’22, that’s related to an increase in plant density, our improved plant handling techniques and the number of plants we have in situ meaning additional labor is required during the cultivation cycle and harvest.
In addition, there have been a notable increase in the cost of fertilizer and other input materials due to inflation as well as the need for additional inputs due to larger crop sizes and the increased number of plants on hand. This cost increase is expected and having a direct impact on our increased quality and yield from the Delta facility. But we do expect this cost increase will be offset in the second part of ’22 once the hydro project comes online.
With respect to inventory against the cost of sales, we have seen the ratio of this relative to net revenue decreased due to more throughput of our facility, meaning that the overheads are spread on a larger number of units. And given the increase in production and sales, this has positively impacted the ratio. Our product mix also has a large impact on the ratio of inventory, expense to cost of sales relative to revenue. And in the period, the company’s ratio has been most impacted by two factors. Firstly, the growth in larger format products such as 28 grams, which in some provinces gives the customers lower per gram price; and secondly, the increase in sales in 1964 Supply Co, which sells at a more competitive price point than Simply Bare.
Overall, our gross profit in Q2 ’22 is $2.8 million, meaning that we are an annualized run rate of around $11.2 million in gross profit. Reviewing our performance on a trailing 12-month basis. Net revenue is $27.9 million, a 68% or $11.2 million increase as compared to the same period in ’21. We have enjoyed growing positive gross profit trend over the last four quarters and expect this trend to continue through ’22. With our current revenue trajectory, full portfolio of brands in key markets in Canada and current business structure, we remain on track to deliver on our guidance of positive operating cash flow in each of Q3 and Q4 of ’22 and positive adjusted EBITDA in the full year ’22.
I would now like to turn the meeting back to Jesse to share more on our year ’22 outlook.
Jesse you are on mute, I believe.
Jesse McConnell
Thank you, Margaret. Our three-pillar strategy is composed of clear business priorities with the goal of delivering sustainable profitability. Firstly, optimizing yield and increasing quality from our production facility to improve the potential possible gross profit pool for every gram produced. Secondly, improving product mix to maximize the Canadian domestic market opportunity. And thirdly, obtaining the requisite certifications to enable us to build an international route to market to take advantage of the international price premium and establish our brands in emerging markets.
Each pillar is expected to have a positive impact on our long-term profitability and cash flow. We continue to meet our quarterly yield targets due to our continuous improvement process and genetic portfolio optimization. In quarter two, we achieved a yield run rate of approximately 10,000 kilograms per annum. We also continue to see an increase in our average THC that have exceeded our internal quarterly targets with some genetics testing as high as 29% THC. Not surprisingly, these ultra-high THC results have corresponded to a significant increase in the rate of sale of those genetics. We are well on our way to achieving our yield goal of 11,000 kilograms, and we expect to achieve it by the end of quarter three versus our previous expectation of quarter four.
With the development of 1964 towards a mainstream brand leader, along with the continued success of Simply Bare as a leading premium brand in Canada, Rubicon now has access to a wider pool of consumers at different price points. The process of managing margin mix is always ongoing. And while we anticipate that large format will be a key value driver of our brands in the medium term as the premium market grows, we will become supply constrained in large format and expect to allocate flower away from large format toward higher-margin categories like 3.5 gram.
Our production costs have historically remained quite flat but increased in quarter two slightly due to the increased labor, soil and fertilizer required to deliver the increased yield and quality and in large part due to inflationary pressures of the production input materials.
Last quarter, we announced that Rubicon received IMC-GAP certification, which is a key milestone that allows us to sell cannabis into certain international markets, including Israel and the EU GMP processing facilities for access into Europe and Australia. We expect to ship our first product internationally in quarter four of 2022 or early in 2023. The company is also working toward the receipt of its EU GMP certification and having undergone a preliminary audit subsequent to quarter two, we now expect to receive our EU GMP certification in quarter one of 2023.
Rubicon has built the leading premium brand portfolio in Canada, and we continue to experience significant domestic growth. Our vision is to be the global brand leader in premium organic cannabis, and we see the opportunity to maximize our gross profit for the international markets over the next two to five years as medical cannabis markets grow and recreational markets are established. Having realized our goal of becoming EBITDA positive in quarter two, Rubicon has set new financial goals for 2022. The company’s current expectation is to continue to achieve positive operating cash flow in the second half of 2022, and we now update our guidance to adjusted EBITDA profitability for the full year 2022.
Quarter two is a watershed moment for the Rubicon Organics as we inflect into profitability and carry that momentum through the rest of the year. We believe that despite any market volatility in 2022, our relentless focus on our three key priority areas will deliver sustainable profitability and position Rubicon to grow its leadership position in the premium cannabis market.
We would now like to open the line for analyst questions. Operator, please open the line.
Question-and-Answer Session
Operator
[Operator Instructions] And your first question will be from Neal Gilmer at Haywood Securities.
Neal Gilmer
And congrats on a strong quarter. Jesse in your prepared remarks, you talked about your sort of current mix is about 64% premium, I believe, is what you referenced. And then I know that your focus is on the premium segment. How do you see that evolving over time? Do you expect it to sort of still that two-thirds to one-thirds ballpark area?
Or would you be moving more into premium or a little bit more on the mainstream side of things?
Jesse McConnell
That’s a great question, Neal. When we look at our current mix between Homestead, our value brand, 1964 our mainstream and Simply Bare our premium brand, a number of our products in 1964 fall in the premium segment when we look at it from a pricing perspective, particularly at the high fire data. Our expectation is in the upcoming quarters, the amount of product that we’ll be able to allocate the Homestead that will become much, much smaller, and the majority of our products will go between Simply Bare, which we anticipate growing slightly and 1964, which we anticipate growing rapidly. So this data, of course, is coming out of high fire, Neal, as you know. So the adaptation of that ratio will continue to grow.
Neal Gilmer
Second question is on the international side of things. Obviously, you provided an update on your timeline and expectations for at least your first shipment. Just wondering if you can provide any color on some — like until you get the final certification, are you still able to have those sort of ongoing conversations and sort of build a pipeline that sort of helps fill out 2023 as far as customers that will be — you’ll be looking to ship to?
Jesse McConnell
Another great question. There’s two different certifications required, the — as I mentioned, the IMC-GAP, which currently enables us to ship to Israel, those conversations are in late-stage negotiations. We do not require any additional certifications in order to ship to countries like Israel or others that only require a GACP.
As for the EU, we are contacted quite regularly. We had many conversations regarding shipping to the German marketplace, which, as you know, is anticipated to open up in late 2023, early 2024 for the recreational market. So I would anticipate that we have that certification sometime in early 2023, and then we’ll be shipping subsequent to that.
Neal Gilmer
And my last sort of a small one, maybe for you, Margaret. On BC hydro, when you get that $1 million plus in annual savings once you’re connected. Is that all flow through the production costs, and that’s where we should see a slight benefit from that being hooked up?
Margaret Brodie
Yes. Similar to our ratio of depreciation, it ticks into our overhead cost. So think like because we do it on a use perspective, obviously, the majority of our facility is the greenhouse. So about 80% of it will go there. I do anticipate that we’re going to be closer to $1.5 million in annualized savings, but I’m making sure, I deliver saying $1 million.
And it is truly in the coming days. We’re just waiting on hydro to come in and connect it, connection it should be on the outside by the 26th of August.
Operator
[Operator Instructions] Our next question will be from Rahul Sarugaser at Raymond James.
Rahul Sarugaser
Congratulations from us on the very, very strong quarter. So Jesse, you alluded to or guided to providing positive EBITDA for the remainder of the year. And so clearly, you see durability in your EBITDA trajectory. Given the operating leverage on the company, could you perhaps give us a little bit more color in terms of how we factor [Technical Difficulty] as proportion of revenue dropping to the bottom line now that you essentially have covering essentially most of the costs of the company going forward?
Jesse McConnell
Okay. I’m going to give that — turn that question over to Margaret.
Margaret Brodie
Best way to think about it is our production costs are fixed. So I’m going to talk about gross profit. If you were to conservatively keep the ratio of inventory expense to cost of sales over revenue, I’m imagining it’s around 32%, 34%, any increase in dollar you just add to that line and our operating expenses are expected to remain fixed.
So if I were you and mapping it out on a quarterly basis, I would look at the high fire data on how we’re progressing in terms of what we’ve achieved so far and the indicator we’ve given with our receivables and just seeing the growth multiplied out by our inventory expense to cost of sales, keep the OpEx the same and there you go.
Rahul Sarugaser
So the follow-on is then you also guided to being cash flow positive this year. So what are some of the additional levers that we should be looking at as you then sort of make that transition from EBITDA positive side through the cash flow positive?
Jesse McConnell
Do you want to expand on what additional levers that we will be looking for? I mean we’re expecting to be cash flow positive as we go through the end of the year. Of course, there’s decisions that we can make around CapEx. As right now, we have no material CapEx plan for the rest of the year. Given the growth trajectory that we are currently on and the demand that we are seeing, there is a conversation ongoing to — on whether or not we should put in incremental tables.
They’re not currently budgeted in our forecast right now. It would be a CapEx spend of around $900,000 to $1 million, giving us more real estate, and then, therefore, more yield approximately 10% to 15% more than we currently have as an expectation. But that’s the only significant budgeted CapEx right now — or sorry, yes, considered CapEx.
Rahul Sarugaser
And then just finally, given that you’ve driven such strong revenue and market share growth over the last quarter and assuming that, that does persist, could you maybe give us a little bit more color in terms of the interplay between the three brands, Simply Bare and 1964 and Homestead? And how those respective channels, how you’re optimizing and filling up those respective channels to what optimize your margin profile?
Jesse McConnell
Yes. It’s really about a portfolio strategy that aligns a good, better, best than inside each one of those portfolios, having the right genetics at the right price points to match the consumer insights that we see again at those brands. Homestead is largely a brand that we use to move product that doesn’t meet our quality standard for some reason or that we are phasing out. We expect in this — in quarter three, in fact, we’ve become supply constrained on that because the quality is just too high for that brand. And we’d expect to see that contributing less and less as to our overall revenues and becoming fairly insubstantial by 2023.
The 1964 brand will — we expect to continue to grow quite significantly. It’s priced at the top of the mainstream segment as we define mainstream. I expect under high fire that you’ll see that begin to show up under premium as to how they define pricing for premium and that brand has experienced significant growth.
As we go forward and become supply constrained inside of our brands, you’re going to see us shift product formats moving from things like large-format bags, which are definitely delighting to consumer and into even higher margin products like 3.5 gram and pre-rolls. As demand grows in those categories, we’ll be allocating supply more to that and that will help us drive more margin in line with what we see in the premium segment, which is the growth outpacing the total market.
Rahul Sarugaser
I know I said that was my last question, but I will ask 1 more, if you don’t mind. So given success in Alberta, B.C., Ontario, and we’re also able to somewhat track that, of course, through the high fire data. Quebec is the one region, of course, where we have limited visibility as analysts.
So could you give us a little more color in terms of how Quebec is playing out? How — because that could be particularly to get a big lever for revenue as you drive forward?
Jesse McConnell
Yes. Quebec is a difficult market to enter. When we first entered Quebec, there was 11 other LPs. And I believe, currently, there’s 24. We’ve been very focused on Quebec because we have under-indexed and comeback relative to the rest of the country.
We anticipate that changing in quarter three, quarter four for a couple of reasons. One, we’ve seen the inflection point on our own sales growth recently in quarter three, where we are now selling more than we were on a year-over-year basis in Quebec. And secondly, the largest value driver for us will be the new SKUs and product formats that we have listed in Quebec. Our current listing is five different SKUs in Quebec, and we’ll be going to 15 SKUs in Quebec in the fall through September and October. And a large portion of those are going to be in-store while currently, we only have three products in store and the rate of sale difference between the in-store product and an online product is quite significant.
So we’re expecting to see a lot of growth coming out of Quebec in quarter three and quarter four.
Operator
And at this time, Mr. McConnell, we have no further questions. Please proceed with closing remarks.
Jesse McConnell
Thank you. Well, I’d like to thank everybody for joining our quarter two earnings call today. And a special thank you to the team at Rubicon Organics who have been so passionate and focused on our vision to become the global brand leader in premium organic cannabis. They should be very proud of what they’ve accomplished as we inflect into profitability and drive that profitability going forward. Thank you, everyone.
Operator
Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.
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