SNDL Inc

F:VY4

Earnings Call Transcript 2021-Q3

[Operator]

Good morning, and welcome to Sundial Growers Third Quarter 2021 Financial Results Conference Call. Yesterday, Sundial issued a press release announcing their financial results for Q3 ended on September 30, 2021. 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 snglgroup.com website. Presenting on this morning's call, we 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 maybe given to questions, could constitute forward-looking statements. Actual results could differ materially from those anticipated.

Risks 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 a question-and-answer session. 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 Third Quarter 2021 Earnings Call. We are excited to update investors on our progress and we'll answer many of the questions we have received, which are anchored around a few common recurring themes. We're pleased to announce Sundial's first ever quarter with positive results for both Adjusted EBITDA and net earnings. These results reflect the initial impact of the business transformation, led by Sundial's team over the last 10 months, as we focused on the continued improvement of our cultivation practices, and the accretive edition of the SpiritLeaf retail network. Despite the sustained challenges facing Canadian industry participants, our financial position has never been stronger. As mentioned on our last earnings call, Sundial has structured its operations into two segments: cannabis and investments.

The acquisition of Inner Spirit Holdings, which we referred to as SpiritLeaf, has expanded the Company's cannabis operations to include a retail component. The October announcement of a definitive agreement to acquire Alcanna is another important step in the development of our integrated business model. We believe that we have hit a point of maximum retrenchment in our cultivation and production activities during the Third Quarter. Our relentless focus on improvement in our cultivation activities, including the refinement of our processes, as well as numerous cost reduction initiatives has resulted in exciting improvements in product quality, potency, cost structure, and gross margin. Since the beginning of the year, we have seen our results and potency yield in terpene improved month after month, hitting all-time best results for cultivation in the Third Quarter.

We still have significant work to do but acknowledging the material progress our teams have made is important. Sundial was the first Canadian-licensed producer to launch Caviar Cones. A high potency premium infused pre-roll product, under our award-winning Top Leaf brand. We're seeing increases in our average selling prices and have improved our market share in the premium flower segment in important markets like Alberta and Ontario. We remain focused on sustainable profitability and continued improvement in all aspects of our operations. And we believe the premium segment will drive that profitability as the market matures. The terms of our retail operations, the SpiritLeaf acquisition, demonstrates our commitment to owning the relationship with the consumer. SpiritLeaf has proven its ability to grow its brand from coast-to-coast, and we plan to support this growth trajectory while also enhancing operational efficiencies and supporting our franchise partners.

As we further develop and optimize our store network in Canada, we launched a multi-store pilot program to improve the consumer experience through assortment, price, and engagement, to meet the diverse needs of Canadian cannabis consumers. We also kicked off our SpiritLeaf Franchisee Advisory Council to further engage and support SpiritLeaf franchisee partners, while also obtaining feedback and collaboration on strategic initiatives, which will drive the continued growth and success of the SpiritLeaf brand banner. We are encouraged by our investment operation results as we continue to use our financial strength and liquidity position to invest strategically, providing our investors with broadened exposure to the rapidly growing global cannabis industry. Since the beginning of 2021, Sundial's investments in cannabis-related credit facilities and the SunStream Joint Venture, a total CAD489 million.

These investments generated realized interest and fee income of CAD19.2 million for the quarter, and is tracking an annualized rate of return of close to 13%. Our balance sheet remains strong, and we remain debt-free. Sundial is uniquely positioned, relative to its peers, as we seek to delight consumers and become a trusted industry partner. Through our two-pillared strategy, we're looking to build a consistently profitable and scalable business, delivering free cash flow within the 2022 calendar year. As mentioned earlier, I will also be answering investor questions. And will do so after Jim and Andrew's comments. Thank you all, and I will now turn the call to Jim for commentary on our financial results.

[Jim Keough, Chief Financial Officer]

Thanks, Zach. And good morning, everyone. I would 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. As we mentioned in our last conference call, Sundial determined the beginning in Q1 2021, we had two operating segments, being cannabis and investments. The acquisition of Inner Spirit Holdings Limited, has expanded Sundial's operations to include a third retail segment. For the three and nine months ended September 30th, 2020, there was only one reportable segment and therefore, no comparative segment information.

I will start with our consolidated results and Adjusted EBITDA. We are pleased that for the Third Quarter of 2021, Adjusted EBITDA from continuing operations was CAD10.5 million, compared to a loss of CAD4.4 million for the Third Quarter of 2020. The increase in Adjusted EBITDA was due primarily to the following factors: Sundial's investment operations yielded an Adjusted EBITDA contribution of CAD19.2 million. And we have included the results of SpiritLeaf from the date of acquisition on July 20th, 2021. Net earnings for the three months ended September 30th, 2021, was CAD11.3 million compared to a net loss of CAD71.4 million in the previous year. General and administrative

expenses were about 33% higher at CAD9.6 million, compared to CAD7.2 million in the previous year. The increase was mainly due to the inclusion of SpiritLeaf results, subsequent to acquisition. In Q3, 2021, sales and marketing expenses, including SpiritLeaf, subsequent to the date of acquisition, increased slightly compared to the previous year from CAD1.1 million to CAD1.3 million. Sundial continues to focus on cost discipline, specifically when it comes to brand development and promotional expenses, targeting sales and marketing investments on priority strains and formats in select markets. Now let's turn to cannabis cultivation and production. Gross margin before fair value adjustments from cannabis cultivation and production operations, for the three months ended September 30, 2021, was negative CAD4.9 million compared to negative CAD17.3 million for the three months ended September 30, 2020. The increase of CAD12.4 million was a result of our ongoing focus on cost optimization, reduction of harvest inventory subject to potential impairment, and offering the most competitive and profitable strains and brands to our customers.

Net revenue from cultivation and production operations in the Third Quarter of 2021 was CAD8.2 million compared to CAD12.9 million in the Third Quarter of 2020. Reflecting consumer demand shifting to value segments, continuing industry-wide price compression, and the Company's focus on margin accretive branded sales over unprofitable share acquisitions and wholesale revenue. As for our retail operations results, Sundial's retail gross revenue from the SpiritLeaf network for the period from July 20, 2021 to September 30 was CAD6.1 million. Retail revenue was comprised of CAD3.9 million of revenue on sales to consumers from corporate owned stores and CAD2.2 million of royalty revenue and franchise fees from franchise partner stores. System-wide retail sales were CAD33.5 million from July 20 to September 30, 2021 and CAD41.7 million for the full Third Quarter, setting new records for the SpiritLeaf retail network. Gross margin for retail operations subsequent to acquisition, was CAD3.7 million.

Now let's turn our focus to investment operations. As mentioned earlier, Sundial's investment income is reported as income from operations. As Sundial intends to continue to invest a significant share of our available capital, targeting a portfolio of attractive risk return opportunities in the cannabis industry, in debt, equity and hybrid instruments. To summarize the deployment of capital in our investment segment to date, during the nine months ended September 30th, 2021, the Company invested CAD489 million, including CAD323 million through the SunStream Bancorp, Inc. joint venture. In the Third Quarter, CAD181 million was directed to these investments, including CAD135 million through SunStream.

Investment operations generated CAD19.2 million in investment income in the Third Quarter, including interest fees and realized gains on marketable securities, but excluding unrealized gains and losses. Including unrealized gains and losses on marketable securities, revenue from investment operations in the Third Quarter of 2021, was negative 4.8 million, due primarily to fluctuations in marketable securities closing prices, which are mark-to-market. In the Third Quarter, Sundial's portfolio of credit related investments generated an annualized rate of return of 13%. And November 9th, 2021, we had an unrestricted cash balance of CAD 571 million and remained debt-free. Now, I would like to invite Andrew Stordeur, President and COO of Sundial to provide further remarks related to cannabis operations.

[Andrew Stordeur, President and Chief Operating Officer]

Thank you, Jim. We continue to make progress on our old facility transformation, focusing on cultivation consistency, and operational improvements. As Canadian consumer preferences continue to evolve, we remained steadfast in our view, that growing high-quality cannabis consistently with appropriate COGS, is a sustainable advantage. I am proud of our team's progress on material average potency increases with corresponding quality improvements, good crop yield, and a higher percentage of sellable product over the past year. We are reducing operational costs, and have several initiatives implemented to support our efforts on accelerating sustainable profitability with our cannabis operations.

Continuous improvement of all aspects of cultivation and processing production together with a strong focused innovation pipeline will enable our national owned sales force and retail footprint to better meet customer and consumer needs. We are encouraged by the results achieved in Third Quarter, but further opportunities being realized as we doubled down on improvements across all facets of our business. Let me walk you through the highlights of cannabis operations for the Third Quarter 2021. Our average weighted potency achieved on flower lots, fully tested in Olds, set a record in Q3 at 21.7%. This represents the highest potency average since Sundial's inception and an increase of over 200 basis points versus the Third Quarter last year.

Our cultivation team has increased our percentage of harvest with greater than 24% THC potency in three consecutive quarters now, and over 40% of total harvest tested in Q3, came in greater than 22% on potency. Sundial's ongoing investments in innovation and cultivation practices generated continued crop yields stability in the Third Quarter, which result at 51 grams per square foot versus 49 grams per square foot in Q3 2020. We also launched our Caviar Cones under the Top Leaf brand. This launch, the first of its kind in Canada, reinforces Sundial's focused innovation pipeline around premium inhalables in the Canadian cannabis market. In the first four weeks after launch, the Top Leaf forbidden lemon Caviar Cone was the top-selling SKU in all SpiritLeaf stores in Alberta, Saskatchewan, and Manitoba. Sundial's premium portfolio remains well-positioned to focus on the higher-margin inhalable segment. In Q3, 2021, Sundial's Top Leaf brand increased its market share within the premium flower segment in several key markets, including Alberta, where market share increased by 1.7% in the quarter.

We successfully completed a significant R&D initiative, inside our Olds facility, by harvesting 12 new genetics in the Third Quarter, many of which are exclusive to Sundial. Several genetics have achieved the THC and quality specs required for our brand portfolio. And we remain on track to release in select provinces by year-end, with full commercialization commencing in the first half of 2022. I'm excited to announce that we will be on-boarding a new head of supply chain this month. This new leadership role will be tasked with the continued optimization of our sieve to sale supply chain transformation. Ensuring Sundial branded products are readily available and at the appropriate inventory levels across the country will be a key part of this critical leadership for all. Further to our supply chain transformation initiatives, the recent announcements by the AGLC to allow ecommerce in our home province for retailers in the first half of 2022, is encouraging.

Given our significant retail footprint in the province, Sundial has begun work to build a strong capability and a differentiated consumer experience through this important and growing BTC channel. And finally, I'd like to provide a brief update on the progress our team has made on our retail integration efforts subsequent to the close of SpiritLeaf acquisition. We have recently completed several pilots within our SpiritLeaf Store Network, which further improve our understanding of, and experimentation with, products and services that best work at the retail level to benefit consumers, customers, and other retailers. We're excited to begin sharing and implementing these category growth drivers with our partner stores across the country, as we look to optimize all aspects of retail operations.

We have made substantial progress with the availability of our Sundial portfolio brands at store level. Market share for our proprietary brands at SpiritLeaf stores across the country continue to build momentum. As of the end of September, our Sundial -branded share has grown in both corporate and franchise part locations, with corporate stores leading the growth at 13.63% market share for Sundial products versus 5.8% at the end of June 2021. With that, I'd like to turn the call back to Zach, for closing remarks.

[Zach George, Chief Executive Officer]

Thanks again for joining us today. This is an exciting time for Sundial and we're looking forward to the year ahead of us. We remain focused on our plan as we continue to make progress in a rapidly evolving cannabis environment. As transparency as a core value at Sundial, we thought it was important to invite investors to directly send their questions to answer -- for us to answer on this call. We received close to a 100 different emails from investors. We have read each and every one, and we thank our investors for their support and engagement. We are inspired by the level of diligence, strategic thinking, and creativity expressed, by many of our investors.

Eighty-five percent of the questions we received centered around four main themes. So we decided to address these topics head-on. Once we are done answering the questions, we will turn the call over to the Operator for analysts to provide their questions. I first want to address NASDAQ compliance and the possibility of a reverse share split, or share consolidation. We are acutely aware that some of our investors are spending an enormous amount of time and energy obsessing over our NASDAQ compliance in the potential for reverse split.

We are compelled to address this head-on to stop the spread of misinformation and hope the use of flawed logic. First Sundial's management and board are unanimously committed to retaining our NASDAQ listing. And we'll proactively take all necessary steps to remain compliant with NASDAQ rules, period. Also, the NASDAQ has discretion to provide an additional extension beyond the February 7th deadline. Therefore, it is not a foregone conclusion that Sundial we'll need to reverse, split its shares prior to February 7, even if our shares continue to trade below a dollar. Given the nature of the questions we have received, I think it's important to level set, and make sure we all understand exactly what a reverse split is.

I'm going to do this once, and I plan to never address it again. A simple example of a reverse split would be to think of it in terms of another currency besides shares. In the context of US dollars, a reverse split is comparable to you giving me four quarters, and me giving you back a $1 bill. The result is that you will still have a dollar of value to spend. This is the same outcome when a Company reverse splits it's shares. The implied market cap, or total equity value, of the Company does not change, but the share count declines and the implied book or other value per share increases in the same proportion. Second, flawed logic is being used to spread fear among our investors. This flawed logic is related to the causal relationship between all manner of share split, and the price action of securities following such an event.

The logic go something like this, when a reverse split occurs, the shares almost always then trade down following the split. This somehow suggest that the reverse split is the cause of the share price decline, which is a false premise. The reality is that many companies whose shares fall to a level that require reverse split, have deteriorating fundamentals and financial performance. If this trend continues, it makes perfect sense if the share prices and equity values would continue to also decline. But please note that in those cases, it is usually the fundamentals of the business that drive the poor performance of shares.

Not the reverse split event itself. I can make a strong case for Sundial's improved performance, but I would prefer to point to our unique attributes and track record, and let investors make up their own mind. A small percentage of firms who default on their debt and get managed by the special loans groups within the banks ever make it out alive. But Sundial did exactly that in 2020. Over the last 10 months, Sundial's business model has been materially re-positioned, and we have one of the best balance sheets in the industry. We have built a growing cash flow stream that has helped us to deliver record Adjusted EBITDA in Q3, and have more than CAD0.5 billion in unrestricted cash to deploy in a disciplined manner.

In fact, the Third Quarter EBITDA reported yesterday, is greater than what the analysts, according to Bloomberg, have projected us generating in the entire 2022 calendar year. I want to say that one more time. The third-quarter EBITDA reported yesterday, is greater than what the analysts, according to Bloomberg, have projected us to generate in the entire 2022 calendar year. If Sundial can continue to deliver improvement in its results, and create equity value in a demonstrable way, we believe that the long-term share price performance will take care of itself.

I urge our investors to focus on the business and industry fundamentals in making investment decisions. By all means, stay focused and stay concerned. But let's please stop obsessing over a reverse split for the wrong reasons. The second theme I want to discuss, is that of a repurchase of shares. This is a theme that came through in many investor questions. And there was a strong suggestion that Sundial repurchase a portion of its shares. Given the recent downturn in our share price and the fact that we last raise capital approximately five months ago, in June, at above a dollar a share, our Board of Directors is supportive of earmarking CAD100 million to repurchase shares at levels that will be accreted to net asset value per share. Given the Company's view of the trading price of Sundial shares, may not fully reflect the value of our assets going forward.

This may be done through the use of derivatives and the cash purchase of shares. Investors should temper any expectations that we will recklessly chase shares higher to benefit short-term investors, as this will not happen. As Fiduciaries, we are tasked with managing Sundial for the benefit of all shareholders, not just those focused on short-term trading strategies. The third theme that was addressed by investors focused on entry into the US I want to be very clear on this point. We have no interest in making large-scale CBD or other US acquisitions for the sake of a press release. As a Canadian Company listed on NASDAQ, we're prohibited from engaging in any plant touching activities south of the border. Yes, the US represents a large, important addressable market, it also represents the fragmented and competitive market that is seeing the emergence of cyclical downturns in select regions driven by oversupply and price compression.

Our SunStream joint venture with SAF has deployed more than CAD300 million into US credit opportunities, and expects to be active into the end of the year. Our limited partnership commitment to SunStream Joint Venture, provide Sundial with attractive exposure to US markets, and cash returns without the use of options on equity, which can materially delay the enjoyment of synergies and profits. The last topic to cover, is dilution. As we have explained, in 2020, we brought Sundial back from the brink of death. More than a few pundits have spent time drafting our obituary prematurely. The out-of-court restructuring, and subsequent raise of more than CAD1 billion drove material dilution, represented a hard reset to the business. We have sufficient capital to weather the storm in the Canadian cannabis industry for years, but our goals go well beyond survival.

We are focused on the accretive deployment of cash in a disciplined manner, and have not raised any cash via our ATM, or other equity issuance in almost five months, and have no imminent need to do so. We view the issuance of shares for the Alcanna transaction as both accretive and strategic, and look forward to sharing the results of our capital deployments in 2022. Again, we want to thank everyone for sending in their questions. We view our investor base as a critical driver for our future success. Without your support, we would not have the luxury of contemplating the rich opportunity set that lies in front of us. I will now turn the call back over to the Operator for analyst questions.

[Operator]

Thank you. We will now begin the analyst question-and-answer session [Operator Instructions]. If you're using a speakerphone, please pick up your handset before pressing any keys. To withdraw your question, [ Operator instructions]. We'll pause for a moment as callers join the queue. The first question is from Pablo Zuanic, from Cantor Fitzgerald. Please go ahead.

[Pablo Zuanic, Cantor Fitzgerald]

Thank you. I want to ask two questions first. One on the retail side, if you can talk about how you're going to integrate the two very different chains, right? I understand one is SpiritLeaf Franchisee model, the other one is more of a discount model. What are they doing to remain separate, but just talk about that, particularly in the light of other retailers. So they're talking about price compression and competition and moving more into a discount model. So if you can touch on that. And then two, in terms of capital deployment, yes, you've deployed more than CAD300 million at SunStream Bancorp.

But just remind us as you look forward, you have SunStream Bancorp, more money going there, more money going into a Canadian operations, or more money go into share buybacks, how do you handicap that? Thank you.

[Zach George, Chief Executive Officer]

Thanks Pablo. It's Zach. On the first question, we're going to have to delay our response. As you know, we've announced a definitive agreement to acquire Alcanna. We expect the circular to be filed and available for review shortly. We're not going to talk about integration on a transaction we have not closed yet. We're excited to share more of the strategic path with you come the new year. In terms of pace of deployment, it's quite possible that we could end up deploying another $100 million to $200 million, US that is, into select secured and structured earn opportunities into the end of the year.

[Pablo Zuanic, Cantor Fitzgerald]

All right. Thank you.

[Operator]

The next question is from Shaan Mir from Canaccord Genuity. Please go ahead.

[Shaan Mir, Canaccord Genuity]

Hi, good morning and congrats on the quarter. My first question is touching on Pablo's first question, but focusing more on the SpiritLeaf chain. So we stare at really strong margins from SpiritLeaf in the quarter at around 60%. But given the prominence of value buds and a lot of the retail offerings going towards discount models, I just wanted to see if you've seen any headwinds to the SpiritLeaf margins in recent weeks, or if there's any thoughts around adjusting pricing at all, given the premium focus there?

[Zach George, Chief Executive Officer]

Sure. Thanks for the question. Appreciate it. There's no question that the entire cannabis retail space in Canada is under significant pressure. We've been talking publicly about peak retail in Canada for almost six months now. We think we're very well-positioned with staying power and capital to whether what we think will be a pretty violent storm and a reckoning that's going to occur in 2022. And so we're certainly not immune from pricing pressures, and from consumers who are highly sensitive to price. We are continuing to maintain price above some of the deep discounted rates that you're seeing in the space. And we're working on. merchandising and pricing strategies, to address that in-store SpiritLeaf going forward.

[Shaan Mir, Canaccord Genuity]

Thank you. And then just staying on the SpiritLeaf transaction, with that now closed. I just wanted to touch on the integration efforts a bit and maybe some takeaways you're seeing this far. In the press release, I think you noted that the Caviar Cones are the top-selling pre-rolls in the SpiritLeaf chain today. But maybe you could help detail some of the broader integration activities that the Company has implemented or is in the process of implementing particularly the branded Sundial products through the SpiritLeaf chain? And I'll leave it there. Thanks.

[Zach George, Chief Executive Officer]

Sure. So great question. Obviously, we don't have the full quarter of performance given the July close of the transaction. But we have in the months following our close seen greater pull-through of Sundial products. And we've had some great success with recent SKU launches. And we're starting to finally hit our stride on cultivation to live up to the brand promises we've laid out with consumers. So certainly a work in progress and believe that will be a more steady-state in terms of that pull-through and integration in the first half of 2022.

[Shaan Mir, Canaccord Genuity]

Perfect. Thank you for taking my questions. I'll pass it on.

[Operator]

[Operator Instructions] The next question is from Frederico Gomes from ATB Capital Markets. Please go ahead.

[Frederico Gomes, ATB Capital Markets]

Hi, and good morning, guys. Thanks for taking my questions and congrats to the quarter. I just want to touch in your Credit Investment portfolio. You guys said a 13% return, they're pretty good. But can you comment on how you see the credit market evolving in Canada? There's some talk about gulf of capital are gradually declining in the state and also the superficial up leasing of US and the souls that need your access to capital. So how should we think about the impact that could have in your opportunity set there and your ability to generate [Indiscernible]? Thanks.

[Zach George, Chief Executive Officer]

Yes, thanks. It's great question. One we spend a lot of time thinking about, I would say, that we do believe that over time, as the industry matures, you are going to see the cost of equity and debt come down across the space. You have some significant issues in Canada right now, and the cost of debt and equity is extremely high. In the US, you have a real lack of institutional and banking support, which is really the driver for the elevated cost of capital across the space. You're starting to see a bit of a cottage industry emerge of different groups using various structures to supply the industry with capital.

And we have seen in certain markets, like Florida and California, quite a bit of volatility and the emergence of cycles where you are seeing price competition and oversupply really start to bite in terms of Company -- individual Company results. So we -- look, we believe that this window of opportunity is going to remain open over the intermediate term, perhaps several years. And we will continue to evolve the model to adapt to any roll down in rates going forward. So we continue to take advantage of that, but don't really see anything in the near term that will derail the type of transaction and profile of returns we're seeing in the pipeline today.

[Frederico Gomes, ATB Capital Markets]

Okay. Thanks. That's helpful. And then on your share buyback program, I know that you mentioned that NAV per share would be among natural to look further to drive our decision to exercise that. But just thinking about the value of the business itself outside of NAV and maybe just on the free cash flow that you expect to generate in the business. Any metric that we can look for that will indicate a good opportunity for that to start buying back shares? Thanks.

[Zach George, Chief Executive Officer]

Yeah, another great question and respect the ask. We're not going to give guidance in terms of the parameters that have been approved by our Board for the repurchase of shares. We spent a lot of time focused on net asset value, focused on the potential future cash flow generation that our aggregate business is capable of. And we're really excited for a time when investors and analysts start to move away from this robotic and revenue based analysis, which we think is completely inappropriate when assessing companies in space.

[Frederico Gomes, ATB Capital Markets]

Thanks, I'll hop back in the queue. Thanks.

[Operator]

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

[Zach George, Chief Executive Officer]

Thank you, Operator. And thanks to everyone for joining us. Really appreciate the engagement and the questions. Look forward to updating you on our progress in the future. Thank you.

[Operator]

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