SNDL Inc.
Q3 2020 Earnings Call Transcript

Published: 12 Nov 2020

[Operator:]

Good morning, and welcome to Sundial Growers' Third quarter 2020 Financial Results Conference Call. Yesterday afternoon, Sundial issued a press release announcing their financial results for the third quarter ended September 30, 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. 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. I'd also like to note that we are conducting the call today from our respective remote locations. As such, there may be brief delays, crosstalk or minor technical issues during this call. We thank you in advance for your patience and understanding.

[Zach George:]

Thank you everyone for joining us on our third quarter 2020 earnings call. As the COVID-19 pandemic continues to affect global markets and people around the world, we hope that everyone is staying safe during this unprecedented time. Health and safety continues to be of priority at Sundial. We remain committed to stringent procedures to ensure the protection of our employees and consumers while minimising disruption to our operations. To-date, Sundial has not experienced any material disruptions related to COVID-19. As we enter the last month of 2020 and plan for the future, some context and perspective may be helpful. The Canadian cannabis industry is complex and still in its infancy. We're just two years into legalization and Sundial is about 22 months into commercial operations. Much of our competition is at a multiyear head start on Sundial. In a short time frame, we've been able to connect with consumers, capture meaningful market share and quickly become competitive in a rapidly evolving marketplace. Following the change in our management team and subsequent financial restructuring, we have drastically improved our operating practices targeting a sustainable cost structure and a simplified, more focused business model. We entered 2020 with optimistic projections and a severely challenged capital structure. We have since taken aggressive steps to de-risk our balance sheet through a combination of cash repayments, asset sales, and debt for equity swaps. A total of $100 million in total debt has been eliminated on a year-to-date basis. We have also reduced annualized cash debt service obligations by approximately $31 million. In addition, we currently have approximately $60 million in cash on hand and access to capital if required. Our restructuring has required significant dilution, but we are well-funded through 2021. We expect the current rate of dilution to decline into Q1 2021 as the last of our convertible debt is extinguished. Under current operating conditions, we do not require additional capital in the near-term unless we engage in a material strategic transaction. While we will not comment on the process itself, our previously announced strategic review is active and continues to be a focus. Turning to our third quarter results, we experienced a decline in revenue partially due to our transition away from wholesale transactions. However, we are pleased with the progress we've made in terms of operating discipline and cost initiatives. We have also adjusted our inventory levels to better align our supply with expected demand and have taken related impairment charges. In doing so, Sundial has repositioned itself to better capitalize on the current market environment. These initiatives will be discussed in more detail by Jim momentarily.

[Jim Keough:]

Thank you, Zach. And good morning to those listening in. I would like to remind everyone that all amounts that I mentioned this morning are denominated in Canadian dollars unless otherwise stated and that the comparative period is a sequential quarter Q2 of 2020 unless I indicate otherwise. Let's start with a review of our improved liquidity and capital structure. During the third quarter, we closed a brokered registered offering for gross proceeds of $26.4 million and we entered into US$50 million aftermarket equity program. Subsequent to quarter end from October 1 to November 9, the company issued 121.9 million common shares for net proceeds of $45.4 million under this program. For the year-to-date, through a combination of cash repayments, asset dispositions, equity and equity linked issuances and debt for equity conversions, Sundial has greatly improved its over-leveraging cash position. We eliminated $100 million of debt in 2020 up to November 9, with a net debt reduction of $72 million. We reduced our annualized debt service costs by $31 million through the June 5 restructuring. We raised gross cash proceeds of $93 million since June 5. We received benefits under the Canada Emergency Wage Subsidy, the CEWS program, of $4.1 million. We amended and restated our syndicated credit agreement and converted our term debt facility to senior second-lien convertible notes. At November 9, Sundial had $127 million of indebtedness outstanding, down from $199 million at the beginning of the year. That includes $55 million of aggregate principal amount of senior secured convertible notes and $72 million of syndicated bank debt. We had $439 million common shares outstanding and we had an unrestricted cash balance of $60 million. While the share issuances and the process of converting debt into equity has resulted in dilution and pressure on the trading price of Sundial's common shares it significantly improved the company's balance sheet and financial flexibility. Sundial's shareholders have authorized the Board of Directors subject to required regulatory and stock exchange approvals to consolidate its outstanding common shares to ensure compliance with the NASDAQ's continued listing standards, which provides access to a broad universe of investors, access to equity capital and access to trading liquidity. Further details will be announced at a later date, should the company will have to proceed with the share consolidation.

[Andrew Stordeur:]

Thank you, Jim. As mentioned, our top line declined this past quarter versus the Q2 2020 while we continue to make significant progress on our cost structure. Let me update you now on some of the progress Sundial is making. We continue to be consistent on our sales mix strategy, as we focus on driving better market penetration, with our brand new product offering versus relying on the wholesale channel. Our Q3 branded net sales increased to 77% versus 69%, in Q2 2020. This keeps us on track to our target toward 80% branded and 20% wholesale business mix by year-end. To deliver our craft-at-scale promise, we need to continue to develop capability and competency in cultivation. Over the past 22 months, we have completed hundreds of harvests enabling our team to leverage this robust set of cultivation statistics, and implement action plans to improve our cultivation consistency. Since implementing these actions, we have achieved the highest average potency results in our company's short history. To further support our cultivation expertise, Sundial has acquired an expanded library of genetics that will better serve evolving consumer preferences with a specific focus on higher potency products. We are excited to bring these unique cultivars to market in 2021. The company's decision to prioritize larger pack formats in flower during the early stages of COVID-19, resulted in a slower than expected ramp in pre-roll production. Demand for Sundial's pre-roll products remained strong. And as such, we've made significant investment in our operations to remove capacity constraints. The pre-roll segment is critical to our inhalables focus, and we will be doubling down in 2021 to accelerate our pre-roll offerings to meet market demand. Our national market share increased from just 0.6% in Q3 2019 to 3.3% in Q3 2020. We have lost market share in the latest 13 weeks, as the value segment accelerates nationally aggressively across all formats. We've recently expanded our Palmetto brand coast-to-coast. Palmetto's dried flower format recently launched in Quebec and was sold out within two weeks indicating early resonance with consumers in a rapidly expanding and competitive market.

[Zach George:]

Thank you, Andrew. In conclusion, our team has moved aggressively to focus our operations and product portfolio to get the very best from our high quality people and assets. I'm proud of the entire team's ability to take decisive action to improve our business while navigating this unprecedented time. I will now turn the call back to the operator for the question period.

[Operator:]

Thank you. We will now begin the question and answer session. . Our first question comes from Tamy Chen of BMO Capital Markets. Please go ahead.

[Tamy Chen:]

Hi, thanks for the question. First, just wondering if you could quantify, you mentioned that this October was sort of the highest average THC that you've achieved. Could you quantify what that range was?

[Andrew Stordeur:]

Good morning, Tammy. It's Andrew here. Yeah, so we've obviously -- the market dynamics have changed as Zach mentioned pretty aggressively over the last 12 months. But we're seeing products consistently now punch above, kind of, the 19.5% to 20% range on all of our cultivars. And obviously, as we get into the market, we're seeing a significant rate of sale change on strains that are above that 20% potency mark that's kind of where we're going, So that's the range and that's moved over the last 12 months from when we started to 15%, 16%, all the way punching about 20% out. So we're feeling pretty good progress.

[Tammy Chen:]

Got it, okay. And I also wanted to understand a bit better, you called out one of the factors to be sequential sales decline of provinces, sort of, adjusting their inventory management and ordering. I think, we've heard others mention that though it sounded like this adjustment in how they ordered becoming more smaller orders but more frequently, so it sort of happened a while ago. So, I guess, I'm still not fully understanding what -- how that sort of impacted your Q3, especially when we look and the industry as a whole revenues in the third quarter were really increasing, which I assume is from the Ontario store thing. So can you just elaborate on that a bit more? Thank you.

[Zach George:]

Yeah. It's -- so I think a couple things there. I think when you look at the timing of, kind of, when we ramped up some par levels or weeks on hand inventory to particular provincial boards in June, I think we went pretty heavy on the inventory. And I think that was specific to Western Canada. So, I think, some of that is timing. So we saw board going a little bit heavier in that June timeframe. We since adjusted, kind of, our demand planning cadence to really understand, kind of, how we can manage those par levels better. I think the provincial boards have done that as well. So it's a work in progress but I think some of that Q2 number late June impacted us getting off the ground to Q3, which accelerated some of that smaller orders more frequent as you move through that inventory in that weeks of coverage at select boards. That was particularly Western Canada, Tammy.

[Operator:]

Our next question comes from Vivien Azer of Cowen and Company. Please go ahead.

[Vivien Azer:]

Hi, good morning, thanks for the questions. The first one has to do with your shelf space and your outlook for being able to preserve that. It strikes me that with inability to fulfil even if they are just small orders at the provincial level plus some cultivation that wasn't coming in due to your standards, from a potency perspective, it seems like perhaps the dialogue that you're having with the provinces is probably not all that constructive, if you have to continue to apologize for misses there. So where does your shelf space stand today? And then what is your outlook for your shelf space? Thanks,

[Andrew Stordeur:]

It's Andrew, thanks for the question, Vivien. I think it's a good one. Look, the shelf is obviously a battle and we're conscious of that. We've had good market share growth over the latest 52 weeks. And as I mentioned, in the opening, we've seen that erode a little bit over in the last 13 weeks. So look, what are we doing about it? Look, I think that the key thing is, as you mentioned, start to cultivation. So we've addressed a lot of those areas, specifically to ensure we have more consistent kind of high potency quality product get out in our brand formats. But I think another one for us is we kind of slowed down our investment really in our portfolio. I think, in Q3, we saw two times increase on our sales and marketing spend for our brands, that's going to help. You don't get the benefit in the first month. So when we start to attack the shelf and we start to look away to sale with our retailers and the provincial boards, they're asking what is the integrated holistic program you've got on your brands, and I think as of Q3, we really started to ratchet that up accordingly. So I anticipate we'll see better awareness and better rate of sale coming through that as we improve our cultivation. And I think the only thing that we're doing that I think Zach mentioned is really good skew optimizations, Vivien. And I think as we think about the retail shelf and we think about having so many offerings in certain formats and particularly in our case, vape, we've launched a significant portfolio of eight products across all provinces. Some of that cannibalizing our own shelf space to be quite honest. So we're working very collaboratively with the retailers in the board to simplify the SKU mix. We're expecting a lot of that volume that we have in those products right now, even though we're going to take down some of those few offerings to move into our -- or stay in that brand. And I think that's usually what you see in the skew optimization exercise. So it continues to be a big focus for us. We've increased our distribution so the anticipation is the cultivation comes back online, the investment in sales and marketing our brands and anticipate that we're going see that continue to be strong. But there's some short-term work that we need to be doing for sure.

[Zach George:]

Vivian, just add to that. I wouldn't say that our relationship or conversations with our provincial board partners are not constructive. They're absolutely constructive. We've certainly gone through growing pains earlier this year. When we were encountering issues with the renewal extension of our credit facility, we had a significant drop in sales and marketing expense. And we're just coming out of that now. So you can see that having ramped in the quarter, and we expect to see benefits in the coming quarters. And I would also say that whether its Sundial or other LPs, you're seeing -- you have seen quarter-to-quarter quite a bit of volatility, both in terms of market share products that have worked or not, where there have been some misses and some recoveries to the upside as well. So we think we understand the factors, some are self inflicted, but we've moved beyond them and found solutions. So we're pretty excited about the coming quarters.

[Vivien Azer:]

Got it. That's helpful. Thanks. And then next my follow up, dove-tailing off of that. So it sounds like the calculus you guys are making is spend now, hopefully, the market share recovers, the revenue shows up. And we hope that is the driver of operating leverage. Is that kind of the right way to think about it? And so, then, if sales and marketing benefits don't in immediately, is it fair to assume that the magnitude of your adjusted EBITDA loss and in the fourth quarter probably doesn't improve and perhaps gets a little bit worse?

[Andrew Stordeur:]

Look, I would say, just speaking very plainly about the current run rate, we need to be running at about twice the current size to get to profitability. We have a path to get there. There's really two means of arriving at profitability, one through organic growth, the other is through M&A activity. And I think, as you're aware, we're really focused on both paths. So I wouldn't draw the conclusion that we're going to see EDITDA necessarily fall out of bed. We think that these investments in sales and marketing are going to benefit our brands and business for many quarters to come. And we're looking at this on a slightly longer term basis than just Q4.

[Operator:]

Our next question comes from David Kideckel of ATB Capital Markets. Please go ahead.

[David Kideckel:]

Hi, good morning. Thanks for taking my question. So my first, I just want to dig a little bit deeper into your previous answer with regarding skew optimization. So I'm just trying to understand now as you guys exit wholesale and look to improve product mix 80

[Andrew Stordeur:]

Hey, David, it's Andrew. Just on the -- if you can just, sorry, just repeat the first one real quick on the skew optimizations. I just want to make sure I understand the question a little bit.

[David Kideckel:]

Sure. I'm just trying to understand on skew optimization how you're trying to improve that especially in a market with vapes where that's a key differentiator for you and it's already a very crowded market.

[Andrew Stordeur:]

Got it. Yeah, a couple things on that. I think, we have to simplify our supply chain and I think our retailers and customers are asking for, but they don't have limited, our unlimited shelf space, kind of, house 55 different vape offerings. So, I think, what we're really trying to do is obviously the early days, we were attempting to monetize as much of the inventory that we had inclusive as some of the oil, and put that into our vape portfolio. But I think what we've seen in the data is we have great repeat purchase on our vape products, but we've got a lot of them, and we're seeing, kind of, that Pareto principle play outs with regard to the 80

[David Kideckel:]

Okay. Thank you, that's very --

[Zach George:]

Just to add there, David, on the wholesale side, in terms of, as you phrased it moving away from wholesale, just to level set there, it's always been Sundial's strategy to connect directly with consumers with branded retail products. But what's happened in the wholesale market is not a function of Sundial's decision-making or choices, per se. So you've got a market today, if you look at our history, as you know, we've sold tens of millions of dollars of product to top LPs in Canada over time. That market is in a very different place today than it was 12 months ago, full stop. So Canada is very long cultivation, Canada is very long supply. We believe that this is going to be somewhat cyclical, and you're going to see that wholesale market evolve over time. But it's in a pretty unique spot today. We've seen demand for wholesale transactions at the margin a bit reduced in the near term quite dramatically. While we've also seen other LPs come in and want to engage in longer term supply agreements, and as you will know from covering the space, the history of, sort of, the sanctity of these contracts is extremely poor. So I think the industry is still evolving and maturing in terms of how to deal with these long-term supply agreements. Many LPs have had issues where they signed the wholesale deal, it gets broken, it gets re-traded, and our experience hasn't necessarily been any different. So it's not to say that we'll -- we won't be engaged in wholesale in the future. But it's much less than opportunity today as well.

[David Kideckel:]

Okay. That's really great color, both of you. Thanks so much. My last question here is just going to your MD&A with your debt covenants and potential violation by December 2020, which I think is listed in there. So just a couple points on that, I mean, by all calculations, your cash burn for the last quarter is just -- is about $21 million. And then to satisfy the principal payments that you're going to need for these -- for the principal repayments of your debt, it's going to be about $6 million a quarter. So please do correct me if I'm wrong on these calculations. But assuming not, how confident and comfortable are you guys moving into the next, I guess, ones and two quarters that you're going to be able to satisfy whether it's these conditions or just being able to finance even the principal repayments of your debt. Thanks.

[Andrew Stordeur:]

David, we don't want to make any forward looking comments here. I'll let Jim speak to this. But what I can tell you is that we have a very close and productive working relationship with the banks. Instead of making aggressive projections about what's going to happen in the coming months, I would point to our track record with regards to these matters. I think we've raised and gotten access to more capital than many thought we would be able to, and also have aggressively started to repair our balance sheet at a pace that has also surprised many to the positive. So we're very constructive on the process, we're laser focused on it. It's not something that we're going to wake up to in late December and start to work on. So I would just point to our track record this year in terms of dealing with these matters. And that's what gives us confidence that we're going to navigate this successfully.

[Operator:]

Our next question comes from John Zamparo of CIBC. Please go ahead.

[John Zamparo:]

Thanks. Good morning. I just want to reconcile the top line performance and dive a little bit deeper there. I mean, the industry is growing quarter over quarter well into the 20% range but you saw branded sales down, I think, nearly 30%. But it's clearly not pricing, your pricing is well above most of your peers, so I mean, the impact of that would be volume. I'm wondering if you could take a shot at quantifying how much of that decline was from not being in stock at retailers versus the cultivation challenges you referenced versus consumers switching to value and they do away from your premium or mainstream products, if any commentary there would be helpful?

[Zach George:]

Hey, John. I don't have the quantifiable, kind of, idle stocks. And I think we can follow up on that. But I think, again, coming back to what we saw, we're seeing a significant rate of sale increase. Some of the data that we're looking at, John, is if you had a Top Leaf brand and it's above 20% potency we're seeing rate of sale increased 60, 70% versus something that's lower potency. So, as we put that product in the market, higher potency being the deciding factor, it's selling out very, very quickly. So, it's kind of tied into, can we produce that high potency regularly and in every harvest and I think that's what we mentioned in the opening was there was an inconsistency there, that led to kind of some of that lower ability to fill the pipeline on that higher potency. But I don't have the quantification on what that stock looks like right now.

[John Zamparo:]

Okay. And then the comment in the press release about underestimating the inventory count of certain retailers, just want to get a better understanding what visibility the company has on that matter. Is there a way you can get data on this either real time or close to it? How often are you talking with these retailers? It just seems like we're two years into legalization, you think some of these issues would be ironed out by now, so this came as a bit of a surprise. But just understanding that relationship better would be useful. Thanks.

[Andrew Stordeur:]

Yeah, look, I think it's not just the retailers and it's certainly on us too with regards to making sure we have better demand planning to coincide with what consumers are looking for. So I think, to say that it was feeding on the retailers and we're not looking at that regularly, I think it's not accurate. I think a lot of what we saw from the provincial boards, and what we continue to see from the provincial boards, which is pretty consistent language that we've had, and I think some of our peers have had is they're also figuring out how to manage their weeks at hand on certain SKUs. So it's still -- it's two years but I think, honestly, it's two years of learning on multiple ends, whether that you're a retailer, whether that you're a licensed producer, or whether you're a provincial board running the distribution. So, as far as data goes, this is part of the issue that we have in cannabis right now, there's limited data at a provincial level. Some of the provincial boards are working aggressively to provide that so we can make better decisions, and they can make better decisions on inventory. And you know there's data programs right now with some of the retailers that we're diving into on a regular basis, we're looking on all that and trying to get a better read on what demand should be and how do we forecast better so that we can manage inventory and obviously help our retailers make some money.

[John Zamparo:]

Okay. That's helpful. Thanks. And then the last question I have is on the value segments. You mentioned Palmetto in your remarks. About how aggressively does Sundial want to compete in the value category? And how do you expect your sales in value will compare to the overall industries in the medium or longer-term? Thanks.

[Andrew Stordeur:]

Yes. Good question. Look, I think, compete is the keyword you mentioned there. I think we want to compete, we have to compete. There's obviously a huge amount of consumers playing in that price range and we're obviously seeing, you know, that less than $6 per gram kind of price partition aggressively grow. So our year-to-date number on Grasslands, I should put it in context, John, for us is, we're sitting at about 13.5% of our total mix, is sitting in Grasslands, that's about right. In Q3, we're about 12.5%, so right in that range. We'll see that kind of move as we get into Q4. And obviously, I think pricing is going to continue to be a key driver, obviously. So if we can keep that mix, kind of, in that 15% to 20% range, John, I think we're in a -- exactly where we want to be. And when it comes to pricing, our strategy has been in -- and you mentioned that we've kept our average sale price on a branded, we have one of the strongest pricing structures in Canada, as you mentioned, we're really proud of that. So -- but we're also mindful of the fact that we have to compete. So we've made some decisions on pricing. And that's inclusive of kind of all formats and all brands and we will compete, but we're certainly not going to lead price down. I think that's a really slippery slope. And we're seeing some others play that game. I think from the long-term, in our view, that's not healthy for the category, it's certainly not healthy for our business model. And I think that's really why we're focused on that core, core plus premium segment. And we're seeing good things in that as well, but certainly the acceleration of value has contributed aggressively. 15% to 20% is where we want to be and that's where we are right now.

[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:]

We would like to thank everyone for attending and for the great questions by our analysts. Look forward to updating you soon. Stay safe. Thanks.

[Operator:]

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