Question And Answer
Operator [1]
[Operator Instructions] And our first question will come from Bobby Burleson with Canaccord.
Robert Joseph Burleson, Canaccord Genuity Corp., Research Division - MD & Analyst [2]
Sorry for any background noise. I guess the first one would be just trying to understand some of the research you've done on the 35's -- the LF 35's launch. It sounds like you see some nice prospects there and it's fitting into -- looks like a hole in the market. So just maybe a little bit more detail on what your assessment of its prospects?
George Allen, Lowell Farms Inc. - Chairman of the Board [3]
Well, Bobby, I would tell you we could go hard on this topic for a long time. We've done a lot of work on this. Really, I would generally say where we think the need comes from is really an understanding of who drives the cannabis market. And when you look at the data, of who buys cannabis today, 90% of the cannabis that's consumed inclusive of the illicit market. 90% of the cannabis consumed, we estimate is bought by the consumer, who smokes every single day. So we really wanted to understand what the use case for that consumer is, right?
So we spend a lot of time trying to find that consumer because I think we talk a lot in cannabis, and it's really fun to explore the novelties of cannabis discovery for people, who haven't smoked a lot of weed or aren't smoking a lot of weed. But when you really look at the market and the big dollars out there, it -- the sort of the fat pitch coming down the middle are is this -- is this daily cannabis consumer. But a lot of these consumers, who are relatively heavy users, in a lot of cases, they buy from the illicit market, in a lot of cases, they buy weed at volume because they're price-sensitive, right?
If you use something like cannabis every single day and some consumers smoke up to an 8 a day, some of those consumers, they're super sensitive about price point. And so a lot of what was happening in the market was sort of failing from how to talk to that consumer, how to go find that consumer. And frankly, we've got some leadership on our board from the tobacco industry, and so we spend a lot of time looking at the tobacco industry and the history of tobacco industry and how the tobacco industry went from loose tobacco into cigarettes. And really, a lot of it -- a lot of it came down to sort of the price point of when you can achieve price parity with flower.
And if you take our flower today, our flower today [indiscernible] flower that we sell could be on the market for anywhere from $28 to $35. Our pre-rolls, the sort of the legacy pre-roll pack that Lowell is so well known for, that pre-roll is on the market for anywhere from $40 to $50 in California and higher in other markets. And so you really are -- that product and that brand, even though it represents sort of a high -- sort of a high watermark in terms of brand legacy, is sort of out -- is priced out that, that cannabis consumer.
In addition to that, we also -- we really started with the fact that like during COVID, what happened during COVID was the consumers started smoking more cannabis, and we -- this is pretty well documented, but you're smoking a lot -- a lot more often you're smoking sort of alone. And even when you were smoking with other people, you weren't sharing cannabis. So one of the journeys that we had to go on was how to get the pre-roll smaller. And when you try to get form -- when you try to get the form factor down in terms of dosage size, what happens is [ your ] costs start to skyrocket. So the only way to really unlock the single-use serving size or sessionability of a pre-roll for this sort of daily smoker in cannabis is to try to get your cost down. And the only -- really the only path to doing that was in automation.
So we -- then we started exploring sort of automation, and it sounds easy, but it has been an incredibly long journey for us to sort of crack the code on automation. And we think we -- we think we have, and I think that the product that we're coming out with at the beginning and next month or potentially the end of this month is truly game changing. And so we're super excited about it. We think it does present that sort of daily cannabis consumer, an alternative to have fresh, really high-quality, good cannabis experience in their pocket at all times in the form of flower. So we're very excited about it.
Robert Joseph Burleson, Canaccord Genuity Corp., Research Division - MD & Analyst [4]
And then just on the CPG revenue, how tightly correlated is your kind of year-over-year decline there and some of the weakness you're seeing for that business to just overall same-store sales comps in the retail channel in California.
George Allen, Lowell Farms Inc. - Chairman of the Board [5]
Yes. I mean I don't have the exact data. I do know that during the quarter, we lost share. We decidedly lost share during the quarter largely in flower. And flower historically is almost an impossible brand product to really hold on to brand. But it's very hard for you to get consumers because consumers have so much more data when they buy flower, right? They have potency levels that are printed on the jar. They have the how the flower looks and the jar appeal, the bag appeal. So the -- so the brand sort of ends up being sort of far less important for the consumer. So the consumer goes into a dispensary and price tends to be a factor and look and peel and smell tend to come in place as well. But way down the list is sort of like brand.
And so what that means is that as other flower producers drop price and pretty aggressively dropped price during the quarter, we sort of refrain from doing it, and that means we lost share. And the reality is we couldn't afford [ for it ] to chase, and it doesn't make sense to brand. What you don't want to do is, you don't want to chase because pricing is a one-way street in cannabis. We've learned this too many times. If we drop our flower price, it denigrates our brand, especially on the eve of a new product launch, which we want to have an elevated brand. But then in addition to that, we know that we can never really raise prices again. And so we just made a conscious decision, and I don't know how to play out the alternative set of facts and what it would have looked like had we not -- had we not held price or been so convicted on holding price. But I suspect that top line would have been healthier in CPG, but we probably would have suffered on margin.
Operator [6]
Our next question will come from Jason Zandberg with PI Financial.
Jason Zandberg, PI Financial Corp., Research Division - Special Situations Analyst [7]
I just wanted to get your thoughts on the elimination of the cultivation taxi California. So specifically, what would -- what would it look like if it was in effect at the beginning of Q2, sort of what would the cost savings? And just generally, your high-level view on what you think this will do in terms of -- obviously, it's going to be lower cost, so competition with the illicit market will be easier. But do you think that -- and so what sort of impact do you expect this to have?
George Allen, Lowell Farms Inc. - Chairman of the Board [8]
Yes. I mean -- so if we held on to all of it, right, if we held on to all the cultivation tax for CPG products, for anything that's flower based, it would be sort of greater than 10 point of margin shift, 10 points to 15 points of margin shift. The reality is that I think that is an ephemeral way to look at it because I don't see that margin -- I don't see how that's possible to hold on to it. In fact, we've -- some of our products, we've given the savings, not all of that, we've given a great portion of the savings back to retailers, just because the fundamental issue is that you've got more supply than there is demand in the market.
And so when it comes to like a big step function change, where everybody gets $1.40 off on an [ 8 ], you kind of have no choice, but to pass that along because it's a prisoner's dilemma, the first person that does it is going to get the share. So when it came to like that change in the market, we looked at all our products and we said, how many of them are commoditized, which ones are the most commoditized. And if they're most commoditized, can we expect the prisoner's dilemma, we expect somebody else to be the first prisoner, but then -- then we're going to get in front of it.
In some of our other products like our Lowell pre-rolls, which tend to be very sort of stable and price agnostic for consumers within a relative pricing band, we didn't see the need or the feel need so much to compromise in terms of price. So there, we should see margin expansion, but it's going to -- to a lesser extent because they're higher priced, our legacy pre-rolls are higher priced. So it's not quite 10 points. But -- but I will say that we have probably been more firm on holding price there. A lot of the stuff, it will remain to be seen like how fast the market adjusts.
In general, I think the case for the cultivation tax, and I think this even went to the policy decision that they made in Sacramento, the case for the cultivation tax reduction is really about trying to compete with the illicit market. And if the price -- the tax cut gets to the consumer into the dispensary and the effective price drops in the dispensary, then I think -- and this is a positive, then I think that there's a chance that some, some incremental wave of consumers that was making the -- that were making the decision to go to illicit market could potentially be lured into the legal dispensary market and so growing the pie.
And I think that's where probably the affirmative case is for the cultivation tax relief, probably more so on a longer-term basis than just a margin boost for all cultivators. And I think any cultivator that thinks that they're just going to pocket their cultivation tax relief and not see pricing degradation on the backs of it, I think that's kind of [ foolish to do ] especially when it comes to anybody, who's predominantly selling flower.
Jason Zandberg, PI Financial Corp., Research Division - Special Situations Analyst [9]
Just can we -- can you just give some color on just your out-of-state revenues that fell during the quarter. Obviously, you're going to get some, some help with addition of Colorado, New Mexico. Just wondering if you could address both the decline and then sort of the -- what your expectations are for adding those 2 new states?
George Allen, Lowell Farms Inc. - Chairman of the Board [10]
Yes. So the royalty decline is obviously [ that's ] more challenging [ or the ] more concerning, right? So in our revenues, we have a combination of royalties, which are high margin, almost all margin. And then we have -- we have packaging sales, which are -- I think we make 5 points of margin on the packaging sales. So a large -- and to a great extent, and Brian showed the exact numbers, but to a great extent, the decline was accounted for by a decline in packaging sales, which is timing of packaging sales and timing of inventory.
But there was also a pretty material decline in royalties, and the royalty decline is something that we're really focused on. And that's [ where] I would say, the health of that business, I think we've suffered a little bit from some quality issues that we've seen in the market and probably a little bit of footfalls on our side in terms of brand support and to reaffirming those brand, as our competitors are sort of getting a little bit more savvy. We've added some resources locally to start to improve the brand support that we're gaining. We are seeing some traction on that so far this quarter.
So I think that we have -- I think that we have a good plan of action there. The quality issues that we're struggling with a little bit are just partnership issues. I think Ascend has been a great partner to us. At the same time, I think the focus that they've given the brand at times has been ebbs and flows. And so we're just trying to make sure that we get our fair share of attention from them.
The brand is still the #3 pre-roll brand in Illinois and sort of somewhere close to that in Massachusetts. We have a lot of potential. And really, that licensing is about getting consumers familiar with the brand and using that opportunities to sow the seeds for future product development, as well as complementing our margin profile. So I think I think we've learned some lessons from it. I think we've also -- we're trying to be a better partner to Ascend and maybe being a little closer on a daily basis, as to how things are being managed over there and greatest on our report card from here?
Jason Zandberg, PI Financial Corp., Research Division - Special Situations Analyst [11]
And then just a look ahead to Colorado and New Mexico?
George Allen, Lowell Farms Inc. - Chairman of the Board [12]
Yes. So Colorado, New Mexico, I think they're probably going to launch -- I think they're -- we're trying to get it in this quarter. It's going to be at the end of the quarter. If it is -- if it lands this quarter, I'm super excited about it. I think Colorado is just an awesome market to be in, and I see a lot of blue sky. Despite Colorado is really sort of crafty market, it's very craft, like brands are very crafty and localized. And I think there's a blue sky opportunity there to be sort of -- to sort of be like a little bit bigger of a brand. And I think so that Colorado is just a market we have to be in, if you want to have [ street cred ] in cannabis.
New Mexico, I think this is a good market. Schwazze has a great footprint there. I would say it probably wouldn't have been a market that we rush into, but for what's the partnership in Colorado and grateful for it, and we can't wait to be there as well. But as I said, I think the impact is likely to be much more Q4 and we'll give you guidance, as to how things are headed there. But I think it's very likely to hit towards the end of the quarter.
Operator [13]
[Operator Instructions] Our next question will come from Doug Cooper with Beacon Securities.
Doug Cooper, Beacon Securities Limited, Research Division - MD & Head of Research [14]
Good evening, George. Just on the 35's launching towards the end of this month or early in September. Can you talk a little bit about your distribution strategy and given that this is a new product for the consumer and the dispensary, the bud tenders, have you run focus groups or like what is your strategy for roll out there? And how quickly do you think you can gain share in shelf space?
George Allen, Lowell Farms Inc. - Chairman of the Board [15]
Yes. It's really the million-dollar question, as to how fast the ramp goes. I mean what I generally tell you is like our conviction level from top to bottom in the Company, about the quality of the product, the price points and the differentiation of the product, the uniqueness of the product, I don't think that there's any disagreement whatsoever about all those testimonies. And so I think we get -- we have a -- we have almost unanimous consent about where we go eventually. The path to getting there is a little bit more challenging in California, in terms of predicting it. You've got a lot of retail end points that we're trying to get distribution through. We're trying to focus our efforts to a very limited number of end points, I mean retailers initially at launch because we want to make sure that consumers have a really good experience with the product. We also want to point consumers to a store that's going to have adequate inventory and volume to support the roll out.
What I'll generally say is like we are pushing everything we have on a limited budget, but we're pushing everything we have behind this product launch. We think we've got all the key ingredients behind it. The big factor -- the big swing factor here is going to be what's the adoption ramp look like. But from just a consumer and what the consumer is looking for, I think we've got a product that is really well tailored for this advanced California market. And I think there's also a strong belief that this product will get dragged or pulled into other markets, which we're looking forward to.
Doug Cooper, Beacon Securities Limited, Research Division - MD & Head of Research [16]
So can you give us an idea, are you going to launch in the Los Angeles area? Or is there a specific region you want to...
George Allen, Lowell Farms Inc. - Chairman of the Board [17]
Yes. I mean when you really think about California, there's islands of cannabis. So we're picking somewhere between 5 and 7 stores to initially launch and we're giving all those stores virtually bottom less inventory, basically refilling them every night as much as we can. And then we're doing a big social media push to drive consumers to those stores. And that way, we can make sure that the experience in those stores, the education level, the bud tenders in those stores, the engagement level, the social media push, the homepage takeovers, all of that stuff we can manage when it comes to a smaller footprint release and we can cover almost the entire state.
So that those stores are relatively geographically diverse within the state. We haven't picked all our partners just yet, but we're in the process right now. And what we're targeting for is a store that is an 80% probability that's within a 10-minute drive of 80%, as I said, 80% of the consumer. So trying to get as much as we can, San Diego, L.A., Bay Area Cities, San Francisco and Sacramento, all of those sort of big sort of islands are going to be covered.
Doug Cooper, Beacon Securities Limited, Research Division - MD & Head of Research [18]
So can you just walk through how many machines do you have -- pre-roll machines you have? What's the capacity? What's the throughput on those, do you think? And when you talk bottomless inventory, like this is inventory come from LFS or coming from -- I mean, where is the actual product coming from?
George Allen, Lowell Farms Inc. - Chairman of the Board [19]
Yes. So right now, we're putting -- I want to be a little careful about the -- Doug, I have to think a little bit about machine count and giving -- and giving -- I don't think that we're going to be supply constrained. Let's put it this way. I don't think that we're going to be supply constrained at this launch. I think it's about generating as much demand as we can.
I want to be a little bit careful about talking about the sort of general unit economics of the engineering product because I just don't want -- we have a moat and I need that moat, as deep and wide, as I can make it. So -- and recognizing that a lot of our competitors listen to the call. So what I will say is that we think we have a lot of capacity that -- where demand is going to be the primary driver. I would say we are extremely excited about the launch, but we -- the one thing that we're, I think, trying to be tepid about is the pace of adoption.
And by the way, we're also willing and excited to hear customer feedback and iterate alongside customer feedback. We've done a tremendous amount of work on our side, getting the product right, but that doesn't mean we're blind or immune to or deaf to feedback from consumers.
Doug Cooper, Beacon Securities Limited, Research Division - MD & Head of Research [20]
And just I guess, [ from my indication ], when you say single, [ this is ] single dose, is this like [ 0.3 of a gram ] or [ 0.25 or 0.2 ] or something like that?
George Allen, Lowell Farms Inc. - Chairman of the Board [21]
Yes. So the product -- the reason why the product is called the 35's [ is just ] 350 milligrams. It basically 10 sticks to a pack, making up an 8. We are -- we are engineering and preserving the ability to go up and down in size. So the way we think about it is the consumer, who likes cannabis sort of dials in on exactly what they think the right kind of amount of cannabis is that they want to have in each [ stick ], right? And the price point is commensurate to that.
So in the future, we'll be going smaller and we'll be going larger to give consumers, a serving size choice because one thing that we decided in the beginning of COVID, we were all relighting way too many joints, right? Like the kind of prospect of relighting weed is like one of the most [ disgusting ] phenomenon. But when you're sitting there with a 1 gram joint and there's nobody around to share with during COVID, it sits there in an ashtray and you either throw it out and waste a lot of weed or you relight it, and you just taste disgusting.
So what we're trying to do is make sure that we're trying to create weed and sort of sessionability and that -- look, it's changing the way consumers behave can take some time. But when we really look at the way our hardcore smokers perform and what they look for this product really does seem to fit them all. So we'll see. I mean, look -- we're looking forward to seeing how it hit.
Doug Cooper, Beacon Securities Limited, Research Division - MD & Head of Research [22]
And just on the pricing, when you said pricing is a one-way street, so you want to make sure I guess, the launch price, you want to get it low enough to attract people, but then maybe you can't raise. So when you said [indiscernible] [ 28% to 35% ], I think that's yours, but the Street sort of lowered and the competition lowered [indiscernible] by 30% is already said in the quarter. So what is the pricing strategy out-the-gate.
George Allen, Lowell Farms Inc. - Chairman of the Board [23]
Yes. We're trying to get it out the door at pre excise tax than $20. And so I think a lot of that -- a lot of the reasons why we're launching with a limited set of retailers right away is we're trying to encourage the retailers to launch with sort of a more consumer-friendly keystone. And so part of the narrative for us is to approaching retailers, who are willing and working with retailers, who are willing to be a little bit more aggressive on keystone with the consumer.
So we're going to cut price, and we're going to be pretty aggressive in terms of how we price it to those retailers because we -- I mean, we have a lot of savings here, right? We've engineered the system here to create a lot of savings. And so we want to make sure that our consumers get the benefit of that. And remember, what you're trying to talk to, you're trying to talk to the consumer, who usually buys weed by the ounce or by the half ounce, right? That consumer is super price-sensitive and you're not going to get their attention with a [ $30 8 ] pre-roll. It just won't happen. So we're trying to get their attention and we have the margin to do it. Obviously, margin is something that we're working very closely on right now to refine, but we do have the margin with our systems and infrastructure.
Doug Cooper, Beacon Securities Limited, Research Division - MD & Head of Research [24]
So on the back of the envelope, if yours -- if there's -- if the retailer is selling to me, the consumer $20 plus excise s tax, what are you selling to the retailer at? And then what is your cost? Can you just give us an idea, ballpark what the margin growth well, might look like compared to your CPG product today exactly?
George Allen, Lowell Farms Inc. - Chairman of the Board [25]
Yes. So I'll give you some guidance on this. What I'll say is -- it is work in progress.. We do have some flexibility built into the system on pricing. We're somewhere in the [ $10 to $11.50 ] range in terms of price out the door. And I'm [ going to do everything ] I can to get us close to $10. And yes, at $10, we're operating at a [ 6-plus ] margin.
Doug Cooper, Beacon Securities Limited, Research Division - MD & Head of Research [26]
Sorry, you missed that George, part, operating at what.
George Allen, Lowell Farms Inc. - Chairman of the Board [27]
A 16%-plus material margin.
Doug Cooper, Beacon Securities Limited, Research Division - MD & Head of Research [28]
And then, I guess, moving to the balance sheet, $2.2 million cash at the end of June. What was the -- what's the CapEx that you expect in Q3, including buying the machines, I think or was that for stock? I don't have the net, I only have the press release right in front of me, but -- and then [indiscernible], yes, go ahead
George Allen, Lowell Farms Inc. - Chairman of the Board [29]
No, if you remember -- do you remember that originally, yeah go ahead.
Doug Cooper, Beacon Securities Limited, Research Division - MD & Head of Research [30]
And then maybe just walk through the $2.2 million regarding -- was that IRS rebate or something else? Sorry, I didn't quite get that?
George Allen, Lowell Farms Inc. - Chairman of the Board [31]
Yes. So once again, there is still -- the original All Good transaction was a stock transaction and cash transaction, the cash fees was $1.5 million. So that commitment we've funded with the cash that we had. And we also were able to bring in to factor this IRS receivable related to the CARES Act and the CARES Act basically had a provision for recovery of payroll taxes associated with the COVID burdens.
So we had an IRS receivable that our company filed in, I believe in April and May of this year. And we chose to factor that receivable to an interested party in order to get some additional cash in the door to fund some of those CapEx. So the $1.5 million is through the machines, but there's also CapEx associated with our facility improvements and preparedness. And we'll give more clarity around that -- but the $1.5 million is by far the biggest chunk of it.
Doug Cooper, Beacon Securities Limited, Research Division - MD & Head of Research [32]
And sorry, just my last one, I guess, would be we're halfway through the third quarter essentially. If you take a conservative launch on the 35's given what you see in the market now on the CPG market and the bulk and so forth, do you expect to be cash flow neutral in the quarter. [indiscernible] maybe give us some sort of guidance?
George Allen, Lowell Farms Inc. - Chairman of the Board [33]
I mean I think we're definitely going to consume cash during the third quarter inclusive of the CapEX...
Doug Cooper, Beacon Securities Limited, Research Division - MD & Head of Research [34]
Just from operations, I am talking about. I am -- yes, just talking about the operations, excluding CapEx.
George Allen, Lowell Farms Inc. - Chairman of the Board [35]
The -- what I would generally say is, I would say, third quarter, the bar will be high for us to be cash flow neutral from an operational perspective given some of the operating investments we're making around the 35's launch and launched the product out there accelerating, but and some of that will be reflective of working capital going into inventory.
The market conditions for us, like what I'll generally say is our business, where bulk prices are for flower right now, the only answer for us is to gain CPG revenue dollars. I mean that's where the margin future is for our Company. So we need to gain traction in terms of more CPG and margin dollars and doing that outside of the low-margin category of flower. So that's our primary focus right now. That's really what the 35 launch is all about. I think we'll have a lot more to say about our trajectory and success in doing that this time next quarter. But I think we'll also be updating as time moves on in terms of the traction of launching them and how things are going.
Doug Cooper, Beacon Securities Limited, Research Division - MD & Head of Research [36]
Sorry. And just my last one. I think you have access to 8 machines. Is that right? And you brought in 3? Is that where you stand right now?
George Allen, Lowell Farms Inc. - Chairman of the Board [37]
So yes, I want to be a little bit careful about that -- the answer. Right now, the machines that we have under contract -- well, right now, we have 2 machines, 2 machines, we've got another machine coming either towards the end of this year or early next year, and then we've secured an order for more, more next year. I want to be a little bit careful about how many -- how many exactly.
Doug Cooper, Beacon Securities Limited, Research Division - MD & Head of Research [38]
And if Ascend or Schwazze says you're shooting the lights out with [indiscernible] brand now has basically switched from the new style pre-roll. Would you give them access to machine? Or are we getting ahead of our association?
George Allen, Lowell Farms Inc. - Chairman of the Board [39]
It's a really tough question for us. It is a really tough question. I think the world is changing so quickly right now in terms of cannabis. Regardless of where we are from like a policy standpoint, cannabis is moving more freely around this country. And I don't know whether or not we want this product to be -- we don't know yet, whether we want this product to be some -- something that other people control.
I think it's -- I think we need to learn a little bit more about our capabilities and margin profile. It's a complicated -- this is a really complicated product to make, and it represents a tremendous amount of IP, a lot of which we acquired in the All Good transaction. So I'm really reluctant right now to [ use the future], where we just say, here are the keys, you guys can make this. And by the way, sure, go ahead and make whatever else you want. That feels a little dangerous. So then you're left with other options. Do you basically tell the consumer, the only way you're getting this product is come to California and get it? Or do you tell the consumer we're going to make the capital investments in your home state to try to replicate the experience? I don't know. I think it's too early to say.
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