SNDL Inc

F:VY4

Earnings Call Transcript 2022-Q1

[Operator]

Good morning, and welcome to Sundial Growers First Quarter 2020 Financial Results Conference Call. Yesterday, Sundial issued a press release announcing their financial results for the first quarter ended on March 31, 2022. This press release is available on the company's website at sndlgroup.com and filed on EDGAR and SEDAR as well. The webcast replay of the conference call will also be available on the sndlgroup.com website.

Sundial has also posted a supplemental investor presentation found on the sndlgroup.com website. 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.

Before we start, I would like to remind investors that certain matters discussed in today's conference call or answers that may be given to questions 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. We will now make prepared remarks, and then we'll move on to analyst questions.

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

[Zach George, Chief Executive Officer]

Good morning, everyone, and thank you for joining us on our first quarter 2022 earnings call. The first quarter of 2022 was both transformational and transitional for Sundial. Through our acquisition of Alcanna, Sundial is now Canada's largest private sector distributor of both liquor and cannabis with an industry-leading balance sheet and access to capital.

In terms of results, our net revenue was $17.6 million, including 1 day of revenue from the acquisition of Alcanna on March 31, which represents an increase of over 78% over the first quarter of 2021. Had the acquisition of Alcanna occurred on January 1, 2022, and revenue would have increased by approximately $162 million, a single day of contribution from Alcanna and Nova in Q1 amounted to approximately $2 million in revenue.

One of the most powerful highlights of this quarter is the material improvement in gross margins in our cannabis operations. While we have a significant amount of work yet to do, we have reduced costs and created a more balanced and diverse product mix that focuses on higher margin, higher-quality cannabis. Our cultivation techniques and processes continue to be refined, and we achieved our all-time highest average THC potency results of approximately 24% in Q1.

I am proud of our team at our facility in Olds, Alberta and I would now put the quality of our flower up against any of our competitors. The cannabis retail experience and infrastructure acquired through Spiritleaf in 2021 have now been bolstered with the Alcanna Nova acquisition. The transaction has materially improved our talent entity, and these combined banners represent the largest cannabis retail network in Canada, with average daily transactions north of 21,000 during Q1 and more than $900,000 in average daily revenue.

The insights gained from this critical distribution infrastructure will be key to owning the customer relationship. Across a broader retail value chain in cannabis and liquor Sundial now has access to unique insights into tens of thousands of daily shopper transactions at over 350 retail stores. This will enable us to optimize offerings, pricing and promotions in both liquor and cannabis locations to better serve customers.

The company's access to a larger customer base also provides us with a strong foundation for e-commerce and direct-to-consumer strategies that will improve Sundial's competitiveness. Additionally, we will continue to assess private label opportunities and develop targeted merchandising strategies for our entire retail portfolio.

We remain committed to the development and support of the Spiritleaf and Value Bud banners. Following a 2-year break due to COVID, we are thrilled to welcome our role franchise partners to Calgary in June for our Circle event, which will facilitate strategic discussions, education and engagement with Canada's top LPs. Nova's Value Bud banner has been highly disruptive in the Canadian industry has become an absolute velocity machine in Alberta, with a current average annual run rate of around $3 million per store, which is more than twice as much as the average retail door in the province.

In less than 2 months, we have been able to increase branded product distribution by shipping products to Value Bud stores and have started to realize synergies against an integration plan that will be a focus for the balance of the year. By the end of the first quarter of 2022, Sundial has deployed capital on several cannabis-related investments, resulting in a total of $650.2 million, including about $453 million to the SunStream Bancorp joint venture.

For the first quarter of 2022, the investment portfolio generated interest and fee revenue of $3.9 million, equity pickup of $4.1 million from SunStream and an investment loss of $17.7 million on marketable securities, which includes unrealized losses on previously publicly disclosed strategic investments in Village Farms International and The Valens Company.

The current rising interest rate environment has caused us to make noncash accounting adjustments to our largely fixed rate SunStream portfolio, resulting in muted adjusted EBITDA contribution for the quarter. SunStream remains the largest Canadian funded credit portfolio in the industry. Given rising interest rates and geopolitical turmoil as well as the cannabis industry being right with challenges such as oversupply, price compression and saturation in the retail market. Cannabis equity valuations have been under extreme pressure.

As our investors are well aware, Sundial has not been immune to these market challenges. While our shares have outperformed global and Canadian cannabis indices on a 1 year and year-to-date basis through May 13, we believe that we are undervalued and are committed to the relentless pursuit of shareholder value creation.

Sundial's debt-free balance sheet and ample cash reserves place us in an enviable position as we witness a violent and swift reckoning taking hold in the Canadian cannabis market. Continued aggressive cash consumption by our peers, reduced access to capital and waning investor risk appetite are likely to accelerate sector rationalization as the industry slowly moves towards the formation of an oligopoly.

While the Canadian sector is difficult and may be entering its starkest hours, the industry's rate of change is showing no signs of slowing down and will likely look vastly different over the next 12 to 24 months. We are keenly focused on the future state of our business and the industry as we focus on delighting consumers.

Before I close, I'd like to provide an update on the previously announced share repurchase program. In light of Sundial's management views on the company's liquidity, assets, operations and the recent trading price of our equity, we view the repurchase of shares as an accretive use of capital. In addition, the company recently sought approval from the Alberta and Ontario Securities Commissions to enable Sundial to sell put options to enhance this program. In summation, we remain optimistic about the future of regulated products in Canada.

Sundial remains focused on building long-term shareholder value through vertical integration, including the expansion of our retail network, the further streamlining of the company's operating structure and an enhanced offering of high-quality brands to consumers. Thank you, and I'll pass the call to Jim for comments on our financial results.

[Jim Keough, Chief Financial Officer]

Thank you, Zach, and good morning, everyone. I'd like to remind you that all amounts that I discuss today are denominated in Canadian dollars, unless otherwise stated. Certain amounts that I will refer to on this call are non-IFRS GAAP measures. Please refer to Sundial's management discussion and analysis for the definitions of these measures.

On the last day of March 2022, Sundial acquired Alcanna Inc. and its 63% owned subsidiary, Nova Cannabis Inc., and we are now reflecting a fourth operating segment, Liquor Retail. With the acquisition, Sundial is Canada's leading private regulated products retail platform.

Please note that the Alcanna and Nova inclusions are comprised of just 1 day of operations following the acquisition on March 31, 2022. However, I will also discuss the estimated full first quarter 2022 results for these entities. I'll begin with our consolidated results. Net revenue for the first quarter of 2022 was $17.6 million, including the 1 day of revenue on the acquisition of Alcanna, an increase of 78% over the first quarter of 2021.

Had the acquisition of Alcanna occurred on January 1, 2022, revenue would have been approximately $164 million and gross margin would have been approximately $36 million. Our gross margin improved to $3.4 million for the first quarter of 2022 compared to a loss of $3.5 million in the first quarter of 2021, a 200% improvement. We reported a reduced net loss of $38 million for the first quarter of 2022 compared to a $134 million loss in the first quarter of 2021. The $96 million improvement in net loss is primarily due to a net revenue increase of $7.7 million, share of profit from SunStream of $4.1 million in 2022 and a noncash change in fair value of derivative warrant liabilities of $122 million. This is partially offset by a downward change in investment revenue of $31 million and higher general and administrative expenses of $3.6 million.

We had an adjusted EBITDA loss of $0.7 million for the first quarter of 2022 compared to adjusted EBITDA of $3.3 million in the first quarter of 2021. The decrease was largely driven by fair value adjustments and central bank interest rate changes related to the SunStream joint venture in 2022 as well as realized gains on disposition of marketable securities in 2021.

General and administrative expenses for the 3 months ended March 31, 2022, were $10.7 million compared to $7.1 million for the 3 months ended March 31, 2021. The increase of $3.6 million was mainly due to increases in salaries and wages, office and general, and professional fees due to the acquisition of Inner Spirit Holdings in July 2021, and to a lesser extent, to 1 day of Alcanna following the acquisition. The increase in professional fees was largely due to the completion of our year-end audit.

Sundial had just over $1 billion of cash, marketable securities and long-term investments and no outstanding debt at March 31, 2022, and we had $361 million of unrestricted cash at May 13.

Now let's turn to cannabis cultivation and production. Gross margin for the first quarter of 2022 was negative $0.2 million compared to negative $3.5 million for the 3 months ended March 31, 2021. The improvement demonstrates Sundial's progress in supply chain and cost optimization despite price compression and lower revenue. Andrew will provide more details on the improvements we have achieved to date.

Gross revenue for the cultivation and production of cannabis was $11.3 million for the first quarter of 2022 a small decrease of 3% compared to the first quarter of 2021. This reflects a further shift to branded product sales compared to the first quarter of the prior year.

Sundial has terminated the service and sale agreement between Sundial and Sun 8 Holdings Inc. for consideration of approximately $3.1 million in cash and $2.9 million of Sundial shares. Sundial has decontracted the royalty and eliminated the annual royalty fee that Sundial was paying to Sun 8, which was $2.6 million in 2021.

Our cannabis retail results, including 1 day of Nova, are as follows. Gross revenue for the 3 months ended March 31, 2022, was $7.5 million, including $0.7 million, representing 1 day of sales for Nova. Gross margin for the first quarter of 2022 was $3.3 million. And system-wide retail sales were $34.6 million for the first quarter of 2022, including that 1 day of Nova revenue.

The Nova retail store results for 1 day were gross revenue of $0.7 million and gross margin of $0.2 million. And while Sundial does not account for the results of the Nova retail stores prior to the acquisition date, the NOVA results for the full quarter were gross revenue of $49.8 million and gross margin of $9.4 million or 18.8% of sales.

As for our 1 day of Liquor Retail results, gross revenue was $1.3 million and gross margin was $0.3 million. Again, while Sundial does not account for the results of the liquor retail segment prior to the acquisition date, the results of Alcanna's retail locations for Q1 were as follows. Gross Revenue for the Ace Liquor, Wine & Beyond and Liquor Depot banners was $115 million and gross margin was $27 million or 24.1% of sales.

And finally, I'd like to review our investment operations. By the end of the first quarter of 2022, the company had deployed capital on cannabis-related investments totaling $650 million, including $453 million to the SunStream Bancorp, Inc. joint venture. Revenue from investments and loans in the first quarter of 2022 was a negative $9.8 million.

This is comprised of $3.9 million of interest on credits held directly by Sundial, $4.1 million on share of profit from the SunStream joint venture and unrealized losses of $17.8 million from investments in marketable securities, which are mark-to-market. Downward performance of share prices from our strategic equity portfolio of Canadian cannabis-related investments resulted in these unrealized losses.

I would now like to invite Andrew to provide further remarks related to cannabis operations.

[Andrew Stordeur, President and Chief Operating Officer]

Thank you, Jim. I'm pleased with our team's continued execution and commitment to cultivation excellence this past quarter. Our cannabis operations are continuing to build momentum as we remain focused on driving to a sustainable, profitable business. The Canadian cannabis market remains volatile with too much low-quality product and geographical pockets of high retail saturation. These headwinds pose challenges but they've also forced our business to be opportunistic by differentiating through product, pricing and a better understanding of the consumer and customer needs.

Our average net selling price in the first quarter of 2022 increased by 5% versus the first quarter of 2021 and showed an 11% increase compared to the fourth quarter 2021. This pricing and mix focus supported material improvements in our gross margin on a year-over-year basis with the first quarter of 2022 at negative $0.2 million compared to negative $3.5 million in the first quarter of 2021. We are making progress with our gross margins in cannabis operations with more work required.

While our overall revenue increased, our cannabis cultivation and production revenue decreased slightly by 3% compared to last year, mainly due to industry declines, most notably in the province of Quebec as January and February industry sales in that province declined by about 3% as measured by Stats Canada.

From a quarter-over-quarter standpoint, we had some onetime factors through our previously announced licensing service agreement that positively impacted Q4 2021 revenue that was not repeated in Q1 2022. Accounting for this onetime factor, our net revenue for cannabis operations is stable on a sequential basis and reflects the early progress and commitment to executing our retail vertical integration strategy across Western Canada and Ontario.

We have a strong plan that our team continues to execute against, underpinned by the 5 key initiatives announced at our year-end update.

Now let me walk you through these initiatives and provide some additional context against each. We continue to make progress with our cultivation excellence focus. This has contributed to an improvement in our cultivation consistency with Sundial's highest average weighted potency results achieved in the first quarter of 2022, coming in at 23.9% THC. This represents a 1.5% increase from the previous quarter.

Further, Sundial's average weighted yield per square foot broke a new record for Sundial in March 2022 with a weighted average yield of 64 grams per square foot. As we continue to focus on cost, we have made significant progress in optimizing costs on pre-roll packaging and processes. From an operational standpoint, we continue to identify significant cost savings beyond our synergy initiatives.

The company has made material improvements in its cultivation and innovation pipeline, which is contributing to an enhanced product portfolio nationally. In Q1 2022, priority SKU distribution increased nationally by 1,389 points of distribution as measured by internal CRM reporting. Further, we continue to partner effectively with provincial board securing 159 new inhalable product listings nationally year-to-date.

This innovation success rate represents a 92% strike rate versus the company's plan in an industry where provinces and retailers continue to scrutinize and rationalize SKUs. Western Canada represents the largest gain on new listings year-to-date with 104 SKUs followed by OCS with 20 SKUs, SQDC with 8 SKUs and Atlantic Canada with 27 SKUs.

Our vertical integration strategy is proving fruitful, and we expect to see better results in the coming quarters. Some now continue to see brand share increases for its health brands sold in Spiritleaf locations through the first quarter, and we continue to see product penetration momentum in the second quarter of 2022.

Finally, our fifth initiative is analytics and insights. With over 350 retail locations and thousands of daily shopper transactions, we have a unique advantage as one of the largest vertically integrated players in Canadian cannabis. The shopper insights are now being deployed with our franchise partners, other license producers and our retail customers nationally as we like to take accountability for a healthier industry dynamic for all of our stakeholders.

We look forward to sharing some of these important capability building initiatives through advanced analytics and insights at our upcoming Circle event next month. In summary, we remain focused and consistent in our approach with our cannabis operations division. While the industry continues to evolve, we believe our differentiated strategy is on target and beginning to show proof points of sustainable progress moving forward.

I will now turn the call back to Zach for closing remarks.

[Zach George, Chief Executive Officer]

Thank you, Andrew. Our goal is to deliver sustainable profits and returns to shareholders through 2022 and beyond. By focusing on fundamentals and executing a contrarian strategy relative to our peers, we believe that we are in the process of setting Sundial up for success. We have significant work ahead to reach our goals, and the path forward is unlikely to be a straight line. Through a vertically integrated model and an unapologetic focus on the Canadian market Sundial is on a differentiated path towards consumer delight and the creation of shareholder value.

I'll now pass the call to the operator for analysts' questions. .

[Operator]

[Operator Instructions] The first question is from Frederico Gomes with ATB Capital Markets.

[Frederico Gomes, ATB Capital Markets]

I guess my first one is on your buyback program and the plan of selling puts against your own stock. Is there a metric or matches that you're looking at to buy back stock? Is it going to be based on book value per share or net tangible book value? Or some other metrics like that, that we should be looking at?

[Zach George, Chief Executive Officer]

Thanks, Frederico. It's Zach. Yes, we're not going to give out specific metrics on the back. We will have significant transparency as any purchases or transactions require filing, in line with securities regulations. So there will be -- the market will be well aware of the transactions and where they are. But don't want to get into trading strategies on a public call at this time.

[Frederico Gomes, ATB Capital Markets]

Okay. Understood. The second question is, just looking at your investments here in Canada, your stake in Village Farms and Valens, how are you looking at those investments right now, just given the decline in the stock prices? If you look at Valens, for example, stocks down 90% of the last year. So the amount that you pay for your stake could now potentially -- is the market price of the company right now? So I'm just curious on how you're looking at those investments right now. It seems like the market is offering some great prices there. So just your strategy going forward?

[Zach George, Chief Executive Officer]

Sure. So certainly, the mark-to-market impact across the space, but with those 2 securities specifically, has been painful as of late. But it also creates an opportunity, especially if you're thinking about potential industry consolidation or M&A. All else being equal, if you were looking at these companies as potential acquisition targets, you would welcome the decline in prices. So specifically, we see some very interesting capabilities with both Village and Valens. Valens is a very unique -- has unique manufacturing and processing capabilities in terms of 2.0 products. And Village Farms is a very well-run upstream cultivator, with extremely attractive cash cost of cultivation in their British Columbia-based operation. So again, we do expect a further consolidation in the industry. The timing is sometimes difficult to plan and there's many reasons why otherwise good transactions can stumble or not get done. But we think that you're going to see further M&A in the space and don't think that the Alcanna transaction is necessarily the last acquisition that Sundial engages in.

[Frederico Gomes, ATB Capital Markets]

That's really helpful. And maybe just I could squeeze one more question here. On your SunStream portfolio, you mentioned that it's mostly fixed rates. Can you give us a sense on the weighted average fixed rate of that portfolio? And could you comment on the potential risk to your real rate of return there, just given inflation and rising interest rates?

[Zach George, Chief Executive Officer]

Sure. Jim, do you want to comment on average yields in the investment portfolio?

[Jim Keough, Chief Financial Officer]

Sure. Thanks, Zach. Yes, our weighted average return on the portfolio is around 13%. And I think we disclosed in the press release that the impact of the fixed rate changes was a little over $6 million in Q1.

[Operator]

[Operator Instructions] The next question is from Pablo Zuanic with Cantor Fitzgerald.

[Matthew Baker, Cantor Fitzgerald]

Hi. This is Matthew Baker on for Pablo. Thank you for taking our questions. Can you describe how the competitive environment has changed for SunStream Bancorp? We think there's more supply and capital yields have also come down. And also related to that, can you remind us of the growth plans for SunStream? Thank you.

[Zach George, Chief Executive Officer]

Sure. So in terms of the competitive environment, there has been a bit of a cottage industry that's popped up in the U.S. various formats. You actually have publicly listed entities that have taken the form of BDC or mortgage or property REIT models that I think you're well aware of.

I would say that many individual states are starting to go through their own cycles. And as some degree of oversupply and saturation impact of these markets, there are pricing and margin pressures out there.

That being said, we're quite pleased to, be for the most part at the senior point in the capital structure for these companies and are a strong partner to help them work through consolidation and other business improvement efforts that they have on the go. And we've previously announced the commitment that our Board has made to the SunStream Limited Partnership fund and strategy, and there's no intention to update or increase that at this time, still working on the existing portfolio and building out the previous allocation.

[Matthew Baker, Cantor Fitzgerald]

And then for a follow-up question. We realized that the company now has 4 verticals, but would you consider entering the cannabis-tech and/or fintech space in a large way?

[Zach George, Chief Executive Officer]

Our sole focus right now is really the integration of this transformational Alcanna transaction. So we do see a number of potential business opportunities in other lines. But really trying to stay focused on our knitting right now in terms of proper integration and getting our feet underneath us and really showing the market and our investors the benefits of this vertically integrated model. And thereafter, as we get to a more stabilized rate of profitability, we'll be able to lift our heads up and think about other opportunities, but we're really not looking to get outside of the 4 segments we're working on currently.

[Operator]

[Operator Instructions] This concludes the question-and-answer session. I would like to turn the conference back over to Zach George for any closing remarks.

[Zach George, Chief Executive Officer]

Thank you, and thanks to all for your support in joining our call. We look forward to updating you on our progress in the near future. Have a great day.

[Operator]

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