SNDL Inc

F:VY4

Earnings Call Transcript 2020-Q1

[Operator]

Good morning and welcome to Sundial Growers First Quarter 2020 Financial Results Conference Call. This morning Sundial issued a press release announcing our financial results for the first quarter ended March 31, 2020. This press release is available on the company's website at sndlgroup.com and filed on EDGAR and SEDAR as well.

Presenting on this morning's call we have Zach George, Chief Executive Officer, Jim Keough, Chief Financial Officer and Andrew Stordeur, President and Chief Operating Officer. Please note there will not be a question-and-answer session on today's call. Before we start, I would like to remind investors that certain matters discussed in today's conference call could constitute forward-looking statements actual results could differ materially from those anticipated.

Risk factors that could affect results are detailed in the company's financial reports and other public filings that are made available on SEDAR and EDGAR. Additionally, all financial figures mentioned are in Canadian dollars unless otherwise indicated.

I would now like to turn the call over to Zach George.

[Zach George, CEO]

Thank you, operator and thanks to everyone for joining us on our first quarter earnings call. I joined Sundial on January 30 and a lot has happened in the last three and half months. We've made solid progress on advancing our core objectives including improving our financial flexibility narrowing our operating focus and lowering our cost structure all the while operating in a very challenging macro-environment.

The legal cannabis market continues to mature, more slowly than originally expected, with ongoing regulatory delays and strong competition from the illicit market. And most recently COVID-19 has added a new set of challenges that has impacted us all in different ways.

Before we discuss our operations in our first quarter results, I want to take a moment to thank our staff whose outstanding dedication and courage have never wavered over the past few months. They have adapted to new processes and procedures, often involving more work for them, while also remaining focused on producing Sundial's high quality products.

While the totality of risk facing Sundial due to COVID-19 are currently unclear other than an increase in employee absenteeism, our operations have not been materially impacted to-date. The health and safety of our people is our top priority and we remain fully committed to ensuring their protection along with achieving minimal disruption to our operations and cash flow.

The improvements we have made over the past few months have helped position Sundial for long-term profitability. Sundial strategy is centered around three key initiatives delivering industry-leading best-in-class products with a focus on inhalables, optimizing asset utilization and reducing costs and improving working capital and our overall liquidity. As part of our focus on long-term profitability, we completed a detailed evaluation of our assets, product lines and potential opportunities.

This review clarified and confirmed our core focus on the inhalable segment of the recreational cannabis market. We have achieved some strong results in this segment over the past few months and Andrew will provide more detail on those in a moment. Our work on optimizing asset utilization and cost reduction has progressed well with the conditional sale of Bridge Farm and other non-core assets, allowing us to focus on our core business operations in Canada.

We've also made significant changes in our operations, including a focus on selling current inventory on hand and a temporary curtailment of cultivation and harvesting activities while maintaining current processing levels to meet anticipated demand. In addition, we made the difficult decision to reduce our workforce to better align with current market conditions. These changes are expected to result in annualized net cost reductions of approximately CAD 28 million.

These asset optimization and cost reduction efforts also assist Sundial in improving working capital and overall liquidity by improving cash flow and reducing debt. While we have made significant progress, we know there is still more to do. I am confident in our team and our ability to achieve our goals. We have best-in-class facilities in Canada that produce high quality product and established and growing brand presence and engaged and talented employees that are also shareholders. We remain focused on customer delight and sustainable profitability.

I would now like to turn the call over to Jim Keough, Sundial’s CFO to provide our financial update.

[Jim Keough, CFO]

Thank you, Zach and good morning everyone.

I'd like to remind everyone that all amounts that I use this morning are expressed in Canadian dollars unless otherwise stated and the comparative quarter is Q4, 2019 unless I indicate otherwise.

I'd like to start off by addressing the transaction we announced earlier today. I'm very pleased to advise that earlier today we entered into a binding purchase and sale agreement subject to buyer financing and our lenders approvals to sell Bridge Farm and all related assets for CAD 90 million. The transaction will be consummated with a company affiliated with the former management sellers that we're parties to the original acquisition.

This is a non-cash transaction as the proceeds of the sale will be used to reduce indebtedness under our term debt facility by CAD 45 million. This debt being assumed by the purchaser with the balance of proceeds used to extinguish the remaining earn-out and make whole provisions under the terms of the original Bridge Farm acquisition, which took place on July 2, 2019.

Additionally, all shares held by and obligations owed to the former management sellers will be canceled. This includes approximately 2.7 million shares. Our lenders require the sale to be closed on or before June 1, 2020. A further condition of our lenders, requires that the remaining CAD 70 million in outstanding principal under the term debt facility will be exchanged for non-interest bearing convertible notes secured by a second lien on our assets.

We've been working collaboratively with our lenders to resolve breaches of covenants under our credit agreements. Under the terms of amended and restated waivers and agreements that we received yesterday, the lenders have agreed to waive all defaults and cross defaults until June 1, 2020. On or before that date Sundial is required to provide the following to our lenders.

First a duly executed amendment and restatement of the credit agreement with our syndicated lender. Second, a refinancing of our term debt facility; third, a duly executed amendment and restatement of our inter-creditor agreement and fourth, closing the sale of the Bridge Farm asset.

We are in advanced stages of completion of all of these required milestones and are working diligently toward the June 1 2020 timeframe. The net effect of these transactions would be a significant deleveraging of our balance sheet, reduction of our debt service requirements and an improved ability to seek additional capital.

Turning to our Q1, 2020 results on a consolidated basis, net revenue amounted to CAD 23 million, while adjusted EBITDA was negative CAD 13.9 million. On a comparative basis, net revenues were CAD 21.6 million and our adjusted EBITDA loss was CAD 19.7 million in Q4 2019. Overall for the first quarter 2020, we reported a net loss of CAD 44 million or CAD 0.41 per share

Included in that net loss are non-recurring charges for the following an asset impairment of CAD 5.7 million relating to our Merritt BC facility inventory impairment and obsolescence provisions of CAD 14.4 million and restructuring charges of CAD 2.7 million.

I'll now turn to our cannabis segment results in the first quarter we harvested approximately 10,300 kilograms and sold approximately 4,400, kilograms of cannabis. This compares to last quarter, where we harvested approximately 11,000 kilograms and sold nearly 4,300 kilograms. As we indicated previously, we are driving the composition of our sales mix towards a higher proportion of sales under Sundial brands to provincial boards with the decreasing proportion to other licensed producers.

This was the case this quarter, the sales to provincial boards were approximately 54% of net cannabis revenues compared to last quarter where sales to provincial boards represented approximately 33% of total net cannabis revenues. During the quarter, we shipped our products to 8 different provinces. Average selling prices during the first quarter were CAD 4.76 per gram for branded flower and CAD 2.74 per gram for unbranded flower.

This compares to 6.15 per gram and 3.15 per gram for branded and unbranded flower respectively in Q4, 2019. The sequential decline can be attributed to brand and product mix variation, as well as the industry pricing pressure. These prices were also impacted by increased provisions for future returns. Net cannabis revenues amounted to CAD 14 million in Q1, 2020 compared to CAD 14.7 million in Q4, 2019.

Gross margin before fair value adjustments for Q1, 2020 was negative CAD 7.2 million, compared to negative CAD 0.5 million in the fourth quarter of 2019. Our gross margin this quarter was impacted by a CAD 14.4 million inventory obsolescence provision that was recorded primarily against bulk shake and bulk winterized oil inventory. Excluding this provision our gross margin before fair value adjustments would have been positive CAD 0.5 million. We reported an adjusted EBITDA loss from cannabis operations of CAD 11.3 million in the quarter and this compares to the adjusted EBITDA loss of CAD 17.9 million in Q4, 2019. I'd also like to provide an update on our efficiency and cost savings initiatives.

We expect the initiatives we are undertaking to result in more than CAD 28 million in annualized cost savings. As of yesterday, we made the difficult decision to further reduce headcount in response to prevailing market conditions. We've now adjusted headcount by just over 50% in 2020.

Moving to our balance sheet as at March 31, 2020 we had cash and cash equivalents, including restricted cash of CAD 26.5 million, while total debt stood at CAD 189 million. Subsequent to closing the Bridge Farm transaction and term debt facility restructuring on a pro-forma basis, we will have CAD 70 million under our syndicated credit agreement and CAD 70 million in non-interest bearing secured convertible notes.

These changes to our capital structure will substantially reduce our cash interest payments to approximately CAD 900,000 per quarter and reduce our principal repayments to approximately CAD 2.1 million per quarter. This will also allow us to pursue opportunities to raise new capital including other sources of subordinated debt or equity, inventory liquidations, long-term supply agreements with other LPs while continuing to monetize non-core assets.

During Q1, we sold one non-core real estate asset for CAD 2.1 million. As we continue to evaluate and rationalize our entire portfolio capital expenditures have been limited to essential expenditures. This will include extraction and processing equipment and maintenance CapEx. Capital expenditures are expected to fall somewhere in the CAD 6 million to CAD 8 million range for the remaining three quarters of this year.

While we've made significant process on our initiatives to improve our liquidity and capital positions, we will remain steadfast and further strengthening our balance sheet to put Sundial on more stable footing. As we drive toward sustainable run rate profitability in 2020. I would like to mention that we received a noncompliance letter from NASDAQ this week as the closing bid on Sundial stock price did not meet the minimum $1 per share threshold for 30 consecutive business days.

As a result, we have until December 28, 2020 to regain compliance through either share price improvement or share consolidation. At our AGM on May 20, 2020, the Board will be authorized to consolidate the company's shares if required.

Now, Andrew Stordeur, Sundial’s President and Chief Operating Officer, will review some of the key operational milestones that Sundial has achieved to-date.

[Andrew Stordeur, President and COO]

Thank you, Jim and good morning everyone.

Look, Q1 was a challenging quarter for Sundial. However, despite the significant headwinds and industry uncertainty, we continue to focus on delivering high quality cannabis products to our consumers and customers. Now realize there is a tremendous amount of heavy lifting required and that's why we announced our plan focused on achieving sustainable profitability last quarter.

The plan was designed to streamline our operations, focus on best-in-class inhalable products, optimize our assets while reducing costs and improved working capital along with overall liquidity for the business. So now let me update you on some of the operational progress the team is making.

Since the beginning of the year, we made the difficult decision to reduce our labor force by about 50%. This decision, coupled with our temporary reduction in cultivation and harvesting activities are solid evidence that management is committed to turning the corner in achieving sustainable profitability. Despite this temporary reduction, we expect the current capacity level supplemented with inventories on hand will be sufficient to meet anticipated demand in the short-term.

We are taking complexity out of our supply chain. This will be accomplished by focusing on larger format in the short-term, a revised simplified product portfolio for the balance of the year and optimizing throughput with a focus on label and excise. Our team has done a great job at overcoming some significant processing headwinds during the first quarter as evidenced by our recent on time and full metrics that have now surpassed 90%.

We've been consistent on our sales mix strategy over the past two quarters as we focus on driving better market penetration with branded cannabis sales versus supplying the wholesale channel. Our Q1 branded net sales increased to 54% versus 33% in Q4, 2019. And we remain on track to achieve 80% branded sales mix by year-end.

We believe our brands Top Leaf Sundial Palmetto and Grasslands are well positioned to meet the diverse needs of cannabis consumers and we continue to see improved market share nationally. We're very pleased with our brand performance to-date and Top Leaf continues to perform well amongst the highest pricing tiers across Canadian retail.

Since Q1, 2020 we successfully launched additional SKUs nationally under our brand portfolio consisting of flower, vape and oil offerings. Our Quebec launch has been significant and well executed with first shipment starting in April and replenishment orders continuing weekly. Continued growth in Quebec will be a key part of our commercial strategy moving forward.

Our vape offerings have been well received by consumers and customers as we push for a leadership position in this high-growth segment. Recently, we've seen double-digit share within the vape segment for Sundial and Top Leaf, vape pens in key markets across the country. As you can see we are moving with pace to quickly implement our plan and are starting to see glimpses of sustainable progress.

While I'm confident in our team and the plan we are beginning to execute against, it will not happen overnight. The decisions we have made these past few months are the right decisions for the success of the company, but we're not easy and not taken lightly. We know this is the right path to ensure Sundial is fit for purpose in today's marketplace.

And with that, I would like to turn the call back to Zach for closing remarks.

[Zach George, CEO]

Thank you, Andrew. In conclusion, we remain focused on our strategic plan and are continuing to make progress in an uncertain environment. Transparency is a core value with Sundial and we will continue to update you as we work to deliver for all of our stakeholders. Thanks everyone for joining the call. Take care of yourselves and stay safe. I'll now turn the call back over to the operator.

[Operator]

Thank you. This concludes today's conference call. You may disconnect your lines. Thank you for participating and have a pleasant day.