Sundial Growers Inc

NASDAQ:SNDL

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Good morning, and welcome to SNDL's Second Quarter 2024 Financial Results Conference Call. This morning, SNDL issued a press release announcing their financial results for the 2024, second quarter ended on June 30, 2024. This press release is available on the company's website at sndl.com. And filed on EDGAR and SEDAR as well.

The webcast replay of the conference call will also be available on the sndl.com website. SNDL has also posted a supplemental investor presentation. In addition to the conference call presentation, we will be reviewing today on its sndl.com website.

Presenting on this morning's call, we have Zach George, Chief Executive Officer; and Alberto Paredero, Chief Financial 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 cause -- 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. Please go ahead.

[Zachary George, executive]

Welcome to SNDL's Q2 2024 Financial and Operational Results Conference Call. We are pleased to see that the second quarter confirms the increased profitability we reported in the first quarter and material progress on our path of continuous improvement. We maintained strong momentum in our cannabis segments, reporting consistent revenue improvement in Cannabis over the last 10 quarters. While we noticed a slowdown in revenue from our liquor segment, we still posted greater margins and greater gross profit dollars on a year-over-year basis, and we have additional tools at our disposal to battle through this volatility.

We are pleased to report an all-time record gross margin of 25.5%, with all segments contributing to gross profit and gross margin growth compared to the same quarter of 2023. Our Cannabis operations segment achieved positive gross profit for the second quarter in a row. Operating income also showcased a significant improvement, not only on a consolidated basis but also supported by growth in all segments, driven by gross margin improvements and strong cost discipline in SG&A management.

Importantly, none of these results include the benefit of the recently announced plan to reduce corporate overhead by more than $20 million, which we expect to begin to impact results in Q3. SNDL remains steadfast in its commitment to driving long-term profitable growth. We continue to grow our substantial retail platform are making significant strides towards manufacturing excellence and are involved in 4 different restructuring processes 2 on each side of the border, that may result in accretive M&A or some other type of liquidity event.

Our unique approach to the deployment of credit capital is also likely to result in the significant repatriation of cash. We currently expect approximately $130 million in principal repayments to occur in the second half of this year with about $90 million of that having been received in the last 2 weeks from both Ascend and Jushi. It is also worth noting that this quarter, we have provided transparency and an update on our material credit exposures in Canada and the U.S. This information can be found in the investor presentation available on our website. I also want to provide some context for the delay in closing our U.S. restructuring efforts under Sunstream. It is clear from our dealings with local regulators across Canada and the U.S. that the industry continues to face many regulatory obstacles, bureaucracy and inefficiency.

From the selective and inconsistent enforcement of excise taxes in Canada, which effectively penalizes participants who pay all of their excise obligations to provincial regulatory officials leaking confidential information to competitors, or Florida state regulators recently delaying the parallel reorganization being unable to locate parts of our documentation that were submitted months ago. There are multiple examples of the need for more efficient professional regulatory bodies. At SNDL we have the skill, resources and determination to overcome all of these challenges. We will persevere in our efforts, partnering with regulatory authorities to continue advancing this agenda and improving the regulatory framework. We expect to provide further updates on our U.S. restructuring in the next 90 days or sooner if and when we have clarity.

I will now pass the call to Alberto for a deeper dive into our Q2 financial results.

[Alberto Paredero-Quiros, executive]

Thank you, Zach. I'd also remind you all that amount discussed today are denominated in Canadian dollars, unless otherwise stated.

Certain amounts referred to on this call are non-GAAP and non-IFRS measures. For definitions of these measures, please refer to SNDL's management discussion and analysis documents.

Looking at our Q2 2024 financial highlights. We continue to see significant improvements in operating income and free cash flow, as in the first quarter. Despite the revenue headwinds impacting our liter segment. Net revenue in the second quarter of 2024 reached $228.1 million, a $3.8 million or 1.6% decline year-on-year. This decline was driven by our Liquor Retail segment. As our combined Cannabis business posted a healthy 9.2% growth.

Gross profit of $58.2 million represents a $6.2 million increase or 12% growth year-on-year. And a material 310 basis points of gross margin improvement with positive contributions from all segments. This translates into another quarter of record gross margin reaching 25.5%.

As in the first quarter, the second quarter gross margin increased, income contributions from our investment segment and disciplined management of corporate overhead led to significant year-on-year improvements in adjusted operating income and free cash flow. Of 82% and 70%, respectively. These 2 metrics were yet again close to breakeven in the quarter. As mentioned last quarter, we only adjust operating income for restructuring-related write-offs and intangible asset impairments. Specifically, in the second quarter of 2024, we adjusted operating income by removing [ $0.2 million ] expenses related to restructuring charges.

While in the same quarter of 2023, there was an adjustment to remove a $4 million restructuring expense. We're looking at the quarterly historical traction of main financial KPIs, we noticed the quarter-on-quarter improvement in net revenue. A [ 15% ] growth between the second and the first quarter of 2024 to be precise, although still declining compared to the same quarter of 2023. Where we're seeing significant improvements both quarter-on-quarter and compared to the previous years is in gross profit, where the second quarter represents a 15% quarter-on-quarter increase and a 12% growth compared to the same quarter of 2023.

Both adjusted operating income and free cash flow are very close to breakeven. At very similar levels when compared to the first quarter of 2024. Clearly, the first half of 2024 represents a significant improvement compared to the same half in previous years. And the second quarter is the confirmation of the profitability improvement we posted in the previous quarter. As we look at the contributions from each segment, we can see how the net revenue decline in Liquor is impacting the overall consolidated results despite a good performance from Cannabis. When we had the $4.2 million net revenue growth from Cannabis retail, the $4 million from Cannabis operations and the small negative of $0.9 million in the corporate segment related to the revenue elimination the Cannabis operation sales into our own retail, we come to a total of $7.3 million or 9.2% growth in Canada.

In terms of gross profit, all segments are contributing to growth. Even Liquor Retail shows positive gross profit in the quarter despite the softness in revenue and the Cannabis operations segment is showing a strong $4.4 million improvement. As a result of our productivity initiatives. Altogether adding up to $6.3 million or 12% growth in gross profit.

On the next page, we're seeing a material improvement in adjusted operating income driven by Cannabis operations as well as our Investment segment. The $10 million contribution from our investment segment is a combination of $3.2 million in investment income and a $5.2 million improvement in asset valuation from our SunStream portfolio in the second quarter of 2024, compared to $1.5 million of losses in the same period of 2023. Free cash flow also saw a significant improvement in Q2 2024 versus the same period of 2023.

As a result of our improvement in profitability, but also a more disciplined approach to working capital management, partly offset by lapping onetime cash proceeds in the second quarter of 2023 related to asset divestments. As we did last quarter, we would like to share some insights into the drivers of free cash flow in the second quarter. Both quarters were similar in terms of actual reported free cash flow with a small improvement from negative $6.4 million in Q1 to negative $5.6 million in Q2. There are, however, some differences in the composition of these numbers. Net income, noncash add-backs and CapEx and these payments are very similar in both quarters. The differences are in the working capital components.

In the first quarter of 2024, we reported an inventory increase of [ $5.8 million ]. While in the second quarter we recorded a reduction of [ $2.3 million ]. This is in contrast with material historical increases in inventory during the first semester of previous years as illustrated in the right-hand side graph of Page 7. Clear evidence of the progress made by our operational teams in optimizing inventory levels. At the same time, we're seeing the opposite dynamic in the other working capital changes.

That were impacted in the second quarter of 2024 by the annual payments of our management incentive and insurance presents. These 2 annual elements account for cash outflow of $10 million in the second quarter. We're encouraged by these results in the second quarter as it keeps us on track to demonstrate our ability to deliver positive free cash flow for the full year 2024. Turning into each 1 of the 3 operating segments, let's start with Liquor Retail.

Net revenue in the second quarter of 2024 for this segment was $114.6 million, a decline of $11 million or 7% compared to the prior year. The decline was driven by a [indiscernible] timing between March and April when compared to 2023, but mostly due to market slowdown as you are probably seeing being reported by most Liquor manufacturers in North America. We believe this is not indicative of the structural challenges in the industry, but due to short-term consumption dynamics. Despite the macro headwinds, we continue to expand gross margin, reaching 25.4% in the second quarter, an improvement of 210 basis points compared to last year.

This was achieved through multiple initiatives, including a 10% growth of our margin-accretive private label, procurement productivity and data sales monetization. As a result of this margin expansion, the segment's gross profit and operating income delivered low single-digit growth versus the same quarter of 2023.

Moving to Cannabis Retail. We saw net revenue in Q2 2024 of $76.1 million, which is a 6% increase versus Q2 2023. Mainly driven by same-store sales growth of 2.4%, supported by double-digit propane of title as well as the expansion of our data sales program and new store openings. Data sales are the main factor contributed to the 60 basis points of gross margin improvement for the segment, enabling an 8.5% gross profit growth compared to Q2 2023. Adjusted operating income increased by $1.6 million or 67% growth compared to the prior year, driven by the gross profit improvement.

Finally, looking at our Cannabis operations segment. This is where we see once more of the largest improvements both in terms of growth and profitability. In the second quarter of 2024, the segment delivered net revenue of $25 million, a 19% increase year-over-year. All of this growth is organic. And driven by provision Board and business-to-business distribution increases. As already reported in the first quarter, the biggest improvement from this segment is in profitability, driven by a holistic productivity program. In the second quarter of 2024, the segment posted positive gross profit of $3.2 million, an improvement of $4.4 million compared to Q2 2023.

As a result, the gross margin of the segment improved from a negative 5.8% in Q2 2023 to a positive 12.7% in Q2 2024. Adjusted operating income was negative by $1.9 million compared to a loss of $11 million in the prior year. The slightly negative number is mainly driven by a $1.3 million fixed asset impairment related to Cannabis legacy facility.

In summary, a solid quarter with record gross margin and a significant improvement in profitability and free cash flow compared to the previous year. And broadly in line with the improvements reported in the first quarter. Let's also keep in mind that at June 30, 2024, the company had $183 million of unrestricted cash, an additional $601 million in marketable securities and investments and no outstanding debt. By thanking all our team members at SNDL for their pattern contributions to these results.

I would like to pass the call back to Zach to share a few more operational highlights for the quarter.

[Zachary George, executive]

Thanks, Alberto. Beyond our financial performance, I would also like to share a few highlights of our progress towards our strategic priorities: growth, profitability and people as each of these pillars is fundamental to our long-term success. Starting with growth, it is great to see our Cannabis segment not only continue to deliver net revenue growth as highlighted in the financials, but also gain market share. In fact, our latest reading shows an impressive 0.5 percentage point gain in retail share through quality execution, the ramp-up of 2023 store openings and the recent expansion into British Columbia. This last point is actually another highlight as during the second quarter, we launched the Value Buds banner into Bruce Columbia with the rebranding of 3 stores acquired in the Dutch Love transaction.

Not only is our Cannabis retail segment making strong progress, but our Cannabis operations segment is rapidly gaining strength, confirming our focus on manufacturing excellence and the elimination of exposure to noncompetitive cultivation. Our continuous focus on quality and innovation enabled the expansion of approximately 40 new SKUs available for provincial boards, enabling 19% organic revenue growth from this segment in the second quarter. I have never been as excited as I am today about our branded product line, much of which will hit the market this fall. Anecdotally, in June, SNDL became the first LP to exceed $1 million in 1 month through the OCS flow-through program.

Additionally, in Ontario, SNDL is the only top 20 LP to have reduced the number of SKUs in Q2 on a year-over-year basis and still outpace OCS category dollar growth in the same period. The team also recently launched a 3-in-1 disposable base that quickly became a top seller for us.

Finally, despite the market contraction that impacted our liquor segment during the second quarter, our focus on offering quality products at affordable prices to our customers enabled us to increase liquor private label sales by 10% at accretive margins. Moving on to profitability. We continue exploring options to improve margin, operating income and ultimately, free cash flow. To this point, during the second quarter, we delivered productivity improvements of $7 million in our cannabis operations segment through procurement and cultivation efficiencies.

In the second quarter, we achieved over $4 million in data licensing revenue from our Cannabis and liquor retail segments. Compared to the second quarter of 2023, our SG&A expenses were reduced by $4 million. As stated, we recently announced a restructuring program that will allow us to deliver over $20 million in annualized savings going forward, some of which will start being realized immediately in the third quarter of 2024. Zooming in on the restructuring announcement, this project focuses on corporate overhead spending as we look for ways to materially improve efficiency and reduce costs. In this regard, several opportunities were identified impacting both people and non-people costs.

Starting with people, we identified opportunities to improve organizational alignment by combining the cannabis retail and cannabis operations segments under Tyler's leadership. Through the strategic plan review we initiated a few months ago, we also identified the opportunity to increase focus on our must-win initiatives and markets, better leverage technology and process automation as well as streamline and delayer the organization. While approximately 60% of the over $20 million in savings will be delivered through people-related cost reductions, 40% will be achieved by optimizing nonpeople expenses, such as rationalizing our office footprint adjusting insurance coverage and rates or implementing efficient zero-based budgeting policies to reduce discretionary spending.

We have started immediately with the implementation of several of these initiatives which will allow us to deliver $5 million in absolute savings in 2024 between July and December, ramping up to $18 million in the 12 months of 2025. And achieving ongoing annualized savings of over $20 million by the second half of next year.

Last, but not least, is our people priority. We are convinced that to be the best company in our industry, we need to attract and retain the best talent, creating engagement and alignment through a performance culture and developing each team member to their full potential. To this point, during the second quarter, we kicked off what we call the strategic talent review process. This is not a one-off exercise but a structured way to focus on talent development, capability building and succession planning. We have also launched several community engagement initiatives, offering all of our team members the possibility to participate in sessions around mental and physical well-being or psychological safety, to name a few. We also started the development of a recognition framework that will allow us to recognize and display a lot of the great work done by our teams across the entire organization.

Finally, we've also approved a review of our compensation philosophy focusing on ensuring competitive, fair, equitable, aligned and transparent compensation strategies and policies. I would like to take this opportunity to thank our entire organization for their hard work and the passion they demonstrate every day. and our shareholders for their trust.

I will now pass the call back to the operator for Q&A.

[Operator]

[Operator Instructions] Our first question comes from Yewon Kang with Canaccord Genuity.

[Yewon Kang, analyst]

Thank you for the question. So my first one here is regarding the Cannabis operations segment. Just noticed that the adjusted operating income dip back into negative territory for the quarter after generating a positive income last quarter. So could you just provide some color on any of the puts and takes that happened throughout the quarter that led to that?

[Alberto Paredero-Quiros, executive]

Two factors, one of them impacting Q1. There was a onetime benefit of some bad debt collections north of $3 million. And in the second quarter, specifically, we have about a $1.1 million impairment charges related to our fixed assets that came with the Cannabis acquisition a couple of years ago. That has been held for sale, but we didn't find as good placement for the assets. Therefore, we decided to take an impairment in the second quarter, $1.3 million specifically.

[Yewon Kang, analyst]

Got it. And just on the second question here. It's regarding the liquor retail segment. Obviously, so there's some softness in the revenues on a year-over-year basis. Can you comment on any trends that you're seeing from the consumer spending environment that is leading to softer revenues recorded in this segment? And any of the initiatives that you guys have in place within the retail segment to kind of address the softening of the consumer environment here?

[Alberto Paredero-Quiros, executive]

Absolutely. So starting the answer was this is a global phenomenon. It's not something that is happening specifically in Canada or our businesses, as you read probably input from different manufacturers or different data sources, everything is pointing. But across North America specifically, there are single-digit declines. In most markets. Obviously, there are certain segments like beers that are declining even more and some other like wine, that may be a little bit more resilient -- but overall, we're seeing the market in the first few months of this year really having this slowdown.

It's important to highlight that despite the revenue softness, that we see in the market that obviously is impacting ourselves as well as retailers. We are managing to expand gross profit by 1% absolute dollars. So we believe that the strategy that we have deployed to deal with this type of macroeconomic context is working for us as the absolute bottom line is still growing. And we still believe that there is long-term growth potential in this segment and in the category.

Immediately, what we're seeing is the short-term impact is driven by the consumer sentiment and the impact of inflation over the last few years post-COVID starting to have the bigger impact on disposable income with our consumers. There is as well a certain dynamic that if you analyze the information over the last 3, 4 years, Obviously, there was a significant market expansion in 2020 when -- in home consumption driven by COVID pandemic increase significantly. Actually, the stores that we're operating today, where we're seeing that at that point in time, they had an 11% growth in revenue in 2020.

In 2021, they were virtually flat or just growing about 1%. So maintaining that trend. And in 2022, we saw already the first correction with a decline of 6%, '23 was flat, and then in '24 were seeing this additional 4%, 5% correction. That is still taking the market to similar levels, slightly higher still than the pre-COVID consumption levels. So that's what we're saying that there is an element as well of correction. Based on COVID dynamics, but we're not concerned about long-term performance of the categories. We believe that the long-term outlook is still remains around 1% to 2% underlying growth.

We believe we continue exploring all options to increase traffic. Which is the main driver of the slowdown. We are uniquely positioned in our opinion to compete in this type of environment. We do have a very attractive private label with a very broad offering across multiple categories. And our private label, it's not enough quality products at affordable prices that really resonates with consumers at this point in time. That's why, as you heard back saying before, we're seeing double-digit growth of our private label revenue in the period despite market softness Obviously, we're getting as well promotional activities, tactics and leveraging our attractive real estate and breadth of portfolio to continue driving that traffic. More to come on that basis, but I said we're not concerned for the long run.

[Operator]

Our next question comes from Frederico Gomes with ATB Capital Markets.

[Frederico Yokota Gomes, analyst]

First question is on capital allocation. Just curious to talk about your capital allocation plans, just given the principle repayments that you're expecting in the second half of this year, as you mentioned, $130 million, quite substantial. So -- any plans in terms of investing that money either in the U.S. with additional credit investments or growth investments in Canada. Maybe just any color there?

[Zachary George, executive]

Federico, thank you for the question. We are working on those priorities. And as discussed, we're still looking at meaningfully growing our cannabis retail network in Canada and are also eyeing a number of accretive investments in the U.S. as well. while also acknowledging that our valuation is undemanding right now. And so there are other opportunities to return capital to shareholders as well. So really trying to balance our growth objectives with maximizing the accretive use of capital.

[Frederico Yokota Gomes, analyst]

And then on the Cannabis operations, just a couple of questions here. First, in terms of the EU GMP certification that you are pursuing, I'm just curious if there's any time line there for that? And second, with the in vivo process ongoing? I noticed that you have 5 facilities in Canada right now. Can you anticipate with that closing, is there any additional consolidation in terms of your footprint of facilities that you expect to pursue?

[Zachary George, executive]

Yes, I'll take the second question first, Frederico, and maybe pass the mic to Alberto, but you're absolutely right. Regardless, we don't have a certain outcome with Endiva at this point, so we're not going to speculate. But even with our existing footprint, we do have some excess real estate, and we'll be looking to monetize that and make use of that capital with much better returns than we would have in their current form. And so whether we plan to drop additional liabilities through excess office leases, into 2025 or monetize some of the excess noncore real estate we have. That will be another story for us in terms of our path on capital efficiencies.

[Alberto Paredero-Quiros, executive]

Yes, we're still track multiple synergies that could come as a result of that potential transaction. So yes, would anticipate some [ retaliation ]. It's a little bit too early to say, but there's still a few more months to go through this process. And as soon as we -- if the transaction gets completed, obviously, we will then come with some additional updates on where we're seeing those opportunities. And in terms of certification, to answer your question, we are working actively through it, and we're expecting it in the next few months before the end of this year.

[Operator]

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

[Zachary George, executive]

Thank you, operator. Thanks to all for joining our call today. We look forward to updating you on our progress in the near future. Thank you.

[Operator]

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