TerrAscend Corp. (TSND) Earnings Call Transcript & Summary

Good morning, everyone. Welcome to TerrAscend's Third Quarter 2020 Conference Call for the 3-month period ending September 30, 2020. Listeners are reminded that certain matters discussed in today's conference call or answers that may be given to questions asked could constitute forward-looking statements that are subject to risks and uncertainties relating to TerrAscend's future financial or business performance. Actual results could differ materially from those anticipated in these forward-looking statements. The risk factors that may affect results are detailed in TerrAscend's annual information form and other periodic filings and registration statements. These documents may be accessed via the SEDAR database. I would like to remind everyone that this call is being recorded today, Thursday, November 19, 2020. I would now like to introduce Mr. Jason Ackerman, Chief Executive Officer of TerrAscend. Please go ahead, Mr. Ackerman.

Hi. Good morning, everyone, and thanks for joining us on our call today. With us, as usual, we have our Chairman, Jason Wild; and Keith Stauffer, our Chief Financial Officer. We will take a few minutes this morning to review some of our progress and priorities on our recent success, and Keith will discuss our results. And afterwards, we will take some questions. So we had another very productive quarter as we continue to demonstrate great progress on executing our goals. We've added depth and scale to our business, and have continued to be responsible in managing our costs with great discipline. The positive results of this focus have really been seen in our reported EBITDA margins of 35% this quarter, which is up a full 10-point from last quarter. This was driven by strong improvements in both our gross profit margin as well as continuing to leverage our SG&A costs. And I want to acknowledge that these results are really driven by our people, and I'm so impressed with what our team has been able to achieve. And I'm really loving the strong base of talent that we're building as a team. Taking a look at our current footprint, I'm also excited to have announced that we have entered the state of Maryland with an acquisition of HMS, which is a cultivator and processor of medical cannabis products. We've entered the market with an attractive EBITDA multiple and plan to expand our depth and capacity in Maryland over time. This acquisition establishes another strong foundation for us in an East Coast state, which is contiguous. It's really a great strategic fit as we'll be able to leverage both our existing talent, which oversees our neighboring operations in New Jersey and Pennsylvania as well as our playbook of -- our strong portfolio of branded products. We'll now have 3 states with a common playbook. We also remain very committed in these high-growth limited license markets to continue to look at opportunities to go deep and build scale. Moving over to Pennsylvania. Our best-in-class branded manufacturing business continues to perform very, very well. We've recently completed our cultivation expansion, which increased our capacity by another 25%. That expansion happened during the third quarter and has begun to hit the market in early November, and we're very pleased to say that all of our new capacity is fully selling through. In addition, the team is making great progress on improving new records on yields and grams per square foot, while costs continue to go down in that market inside our facility. We continue to demonstrate our ability to ramp up and meet customer demand and are extremely proud of the fact that all of our products are available in every dispensary in the state. This wide success is really a focus on the team on great product quality and product innovation and a strong focus on delivering great levels of customer service to our retail partners. Looking at our retail presence in Pennsylvania. All 3 of our dispensaries are performing well. The Plymouth location continues to break weekly and monthly records, even though it's been open for more than 2 years. Our Lancaster store, which has opened for only 6 months, has quickly ramped up to the level of Plymouth, which is really fantastic. And our most recent store in Thorndale is also moving up quickly. So we've seen some really, really strong continued demand at the retail level. Turning to New Jersey. We are extremely pleased that voters have approved the legalization of recreational marijuana and the state on election night. As we wait the passage of the necessary legislation, we will continue to execute on our growth strategy here as we're very well positioned to support the new market. We have already completed several harvest from our new 40,000 square foot greenhouse and our 80,000 square foot indoor manufacturing facility will be completed at the end of this month and ready for planting. So we anticipate sales in the market from these facilities to begin in the coming weeks. And I'm excited to announce the soft opening of our Phillipsburg location in New Jersey on November 23 with a full grand opening on November 30. That will be our ninth Apothecarium location nationwide and our first one in New Jersey. We really look forward to bringing our full suite of branded products in New Jersey marketplace. And additionally, we've signed leases for a second and third dispensary in New Jersey, and we're targeting opening these in the first half of next year. With our recent entry into Maryland and the footprint we've established in key states such as New Jersey and Pennsylvania, we think we're very uniquely positioned to capitalize on the anticipated growth trend of legalized recreational adult on the East Coast. And we're developing a very strong presence here, which we believe will be well positioned for the future. Turning to the West Coast. We announced last week that we have opened an additional dispensary located in Capitola, our first one outside of the urban Bay Area that was contiguous, further expanding our retail presence to 5 locations in Northern California. Our West Coast team has been highly successful identifying lease-up license opportunities and opening new dispensaries in some pretty strategic locations within the state. We've also recently commenced sale of our newly expanded State Flower cultivation facility in San Francisco. It was expanded from 5,000 feet to 20,000 feet, including some great progress and some amazingly hard work from our team. We've increased throughput by 500%. And the product coming out of State Flower is incredibly high-quality premium market, which we're selling both through our own dispensaries and through the wholesale market. Our first launch of State Flower into our Apothecarium stores represented close to 45% of all flower sales, which really supports our goal of becoming more and more of our own products on our own shelves in California. Looking at Canada, we've made some great progress implementing our strategy here, and I'm pleased to report that we begin to see some really great signs of success. We have fully revamped our product offering with significant improvements in our commercial focus. For example, in the province of Ontario, we had the #1 selling item out of 2,000 products over the last 2 weeks in a row, which I can't tell you how great that feels to see the team have some really wonderful wins. As we've driven this greater commercial focus and have introduced a lot of new items in the market, we've also rightsized the operation to match more of the current market sizing. And with this streamlined approach and target approach or portfolio, I'm proud to say that we have finally achieved, I'll call it, slightly positive EBITDA in the quarter, in Canada, which is a huge achievement, and I'm really proud of the team and the dedication that they have put into this. And I'm proud to say I'm very optimistic about the future in Canada. Throughout the year, we've also made several additions to ensure our team is well supported for growth. This has continued with the appointment of a new Board member, Ed Schutter. Ed brings a wealth of experience in business acumen from this time spent in the U.S. global pharmaceutical industries and will further strengthen our Board as we accelerate our growth strategy. Despite the challenges of this environment in 2020 due to the pandemic, our team has been very successful in serving customers safely while maintaining a high level of satisfaction. And I'm really, really proud of for frontline workers who have shown up every single day and have done an amazing job growing the business and serving customers. And I'm really confident that we will continue to finish out the year on a very high note. I'd like to turn the call over now to Keith, who will discuss the financial highlights of the quarter as well as provide some updates of our guidance for next year. Keith?

Thanks, Jason. Good morning, everyone. Just as a reminder, the results that I'll be going over this morning can be found in our financial statements and MD&A and are all in Canadian dollars. I'll first spend some time talking through our third quarter results, and then I'll outline our updated guidance for the current year and also talk through our first time guidance for 2021. For the third quarter, net sales increased 90% to $51 million compared to Q3 2019 and increased 8% sequentially. This sequential growth was largely driven by growth in our retail stores in Pennsylvania, which continue to ramp extremely well, along with stronger sales from our new and streamlined portfolio in Canada. Gross margin before gain on fair value of biological assets for Q3 2020 was 59% compared to 18% a year ago, and 56% in the previous quarter. Improvements in gross margin are a result of higher mix and lower cost from our increased cultivation yields per pound in Pennsylvania as well as improvements within our TerrAscend Canada operations, which achieved slightly above breakeven adjusted EBITDA for the quarter -- for the first quarter in its history. Q3 2020 G&A -- SG&A was $13.7 million compared to $15.9 million for the previous quarter. This sequential reduction was primarily driven by onetime expenses in the previous quarter related to professional and other fees. Excluding onetime expenses, we've maintained costs relatively flat, generating significant leverage overall. As a percentage of revenue, SG&A continued to improve, reducing to 27% this quarter compared to 33% in Q2 due to our continued focus on controlling costs. Looking at EBITDA, excluding a $22 million net increase in fair value of warrant and derivative liabilities related to our preferred share issuance in June, we continued to improve sequentially to $10 million in Q3 from $3.8 million in Q2. Our Q3 2020 adjusted EBITDA was $17.8 million compared to minus $8.7 million last year, same quarter. And on a sequential basis, increased by 56% from $11.4 million in the previous quarter. We saw improvement in our adjusted EBITDA margin to 35% in Q3 from 24% in Q2 and 14% in Q1. These improvements are a clear indication that our focus on going deep and gaining scale, while controlling costs is enabling us to deliver industry-leading profitability levels. We will continue this focus through our recent addition -- pending addition of Maryland and our imminently ramping business in New Jersey. Adjusted net income for the quarter was a positive $12.7 million. This is the first time in company history reporting positive adjusted net income. This is a non-IFRS measure and excludes 2 nonrecurring and noncash items. The first item I noted a minute ago relating to the $22 million net increase in the fair value of warrant and derivative liability associated with the issuance of the preferred shares in June. Given the increase in our stock price during the quarter, IFRS requires a noncash charge to the P&L based on a fair value assessment of the instrument. The second excluded item in the -- the second excluded item is the accretion or revaluation of the contingent consideration, mainly relating to the final earn-out payment to the sellers of Ilera. I want to again emphasize that these 2 items are both noncash and nonrecurring in nature. We, therefore, are very proud to report this positive adjusted net income for the quarter. Turning to the balance sheet. We ended the quarter with $45 million in cash and cash equivalents, including restricted cash, which will provide us with ample liquidity to fund existing operations through Q1 of next year, when we expect to turn free cash flow positive. CapEx spending during the quarter was approximately USD 13 million and was similar to Q2. This investment was focused on the completion of our build-out in New Jersey, which is now largely completed with some final payments coming due during the fourth quarter. As a result of our extremely high-performing Ilera, Pennsylvania business, we will have a final earn-out payment for this acquisition of USD 155 million coming due in Q1 2021. Due to the extremely strong cash generation from this business, we already prepaid $15 million in the past few months towards this final earn out payment. Thereby reducing the final payment to USD 140 million. We expect to continue to use funds generated from the operation to prepay up to an agreed-upon total of $30 million. Consequently, and as per recently signed agreement with the sellers, TerrAscend will have the option to defer up to an equal $30 million from March to June of 2021. Leaving TerrAscend with $95 million of remaining balance due in March of 2021. It is important to note that most of this potentially deferred $30 million could be funded directly through free cash flow generation from the Ilera business during the 3-month period. With regards to the remaining $95 million balance, we believe that we will have a clear line of sight to multiple financing options for making this final payment. Lastly, before turning the call over to questions, I want to take a few minutes to discuss our guidance. As a result of our strong performance in Q3, particularly on profitability, we are increasing our 2020 annual guidance from the previous guidance of $192 million to updated guidance of at least $196 million of revenue, and from previous guidance of $45 million to updated guidance of at least $54 million of adjusted EBITDA. Q4 growth will primarily be driven by the cultivation expansions in Pennsylvania and California, continued ramp-up at dispensaries in Pennsylvania and California, the opening of our first New Jersey dispensary in Phillipsburg, initial sales from our Booton, New Jersey cultivation facility and our gummies launch in Canada. As we look to 2021, we anticipate an exciting year with continued rapid growth and expansion. We expect our Pennsylvania business will continue to grow in Q1 2021 being the full first quarter following the completion of our 25% cultivation expansion. New Jersey will be a leading growth driver for us as we realize the full capacity of both the 40,000 square foot greenhouse and the 80,000 square foot indoor space beginning in Q1 2021 and ramping throughout the remainder of the year. For retail, sales from our Phillipsburg, New Jersey and the openings of our second and third dispensaries in New Jersey in the first half of 2021 will drive growth. In California, we will fully annualize the late Q3 2020 expansion of State Flower and continue ramping up our retail footprint with our fourth and fifth stores in Berkeley and Capitola. In Canada, with our business right-sized and our commercial strategy clarified, we expect to see positive contributions to sales and profit growth in 2021. Lastly, our recent acquisition of HMS, Maryland will begin contributing to our sales once we have acquired regulatory approvals and the final closing of the transaction expected in early Q1 2021. With all of these growth drivers, we expect annual revenue for 2021 to be in the range of $360 million to $380 million, representing 85% to 95% of growth versus 2020, and adjusted EBITDA to be in the range of $140 million to $160 million, representing 155% to 190% growth versus 2020. Adjusted EBITDA margin as a result, is expected to surpass 40% in 2021. In closing, we're very pleased with the quarter, and we anticipate to be a strong finish to an amazing and transformational year for TerrAscend. We even more excited for what is yet to come in 2021. I'd now like to turn the call back over to the operator to open up for questions.

[Operator Instructions] First question comes from Matt McGinley at Needham.

On the 2020 guidance, into the fourth quarter, the implied revenue growth shows that you have a nice sequential increase in revenue, but the EBITDA will grow slower. And I think that implies some degradation in the EBITDA rate into the fourth quarter. What would drive the decline in the fourth quarter? Is that start-up costs? Or is there something else going on that's in the business that would be a drag on margin rate?

I'll let Keith answer, but I don't believe our margins are dragging. I think it's the opposite. Keith, would you take that, please?

Sure. So we still have a little bit of start-up costs from New Jersey, and also with some of the mix coming in from the retail stores. But we should see it continuing to improve. So the guidance shows -- might be a little bit on the conservative side, but we should really see the cultivation expansion from Pennsylvania kicking in and the mix improvements there. So there's a little bit of drag from New Jersey and retail, but overall, we should see positive momentum.

And then up into the right into 2021, which is good. And then, Keith, I want to make sure I heard the comment you made in your prepared remarks, I think you said that the free -- the Ilera payment, the $30 million will be pushed from March, I think, until June. You said that you would be free cash flow positive in the first quarter, and you would be able to fund the $30 million delayed payment with free cash flow generation. Did I hear that correctly? Am I correct in assuming that you'll generate at least $30 million in free cash flow in the second quarter?

Yes. That's correct. That's what that implies.

The next question comes from Kenric Tyghe at ATB Capital Markets.

Jason, you've previously provided some really good color on just the evolution of Pennsylvania market, New Jersey rec, some of your thoughts around timing. And how we get from here to there, from medical to rec? Could you provide some sort of just high-level update sort of post the election and you're reading of the tea leaves, just so we get a feel on those 2 markets and how you're thinking has evolved?

Yes. So in New Jersey, it's definitely going to be a pressure catalyst. We expect 6 or 7 months from now in New Jersey, we'll have its recs up and running, and we'll be able to operate under the rec rules as a -- it's kind of the indication we've been given. And then as you can imagine, the chatter that we've heard in the other states in Pennsylvania, there's a lot of talk about rec. I can't speculate. As you know, the legislative processes can be quite tricky, more politics than customer support. But just like New Jersey, the population is very supportive of recreational. So we'll see. But as you know, with Pennsylvania growing as fast as it can, now well over 400,000 cardholders, we would characterize the record -- the market in Pennsylvania is really already turning rec when you look at the population that's there, and we see that strength just continuing.

That's great, Jason. And then just a follow-up on Pennsylvania. Can you just speak to competitive dynamics, competitive intensity with the recent change in control of another fairly material wholesaler and retailer in the state? Do you look at this as being additive? Do you look at this as being a threat in terms of that change of control? Or is that just your point that much to go around that it's needed here and all there, at least not through 2021?

Yes, sure. No, look, the market is very robust. And while there's some capacity continuing to come online, the 50% growth -- patient growth is really absorbing everything that's in. As we said, we just added 25% capacity, that is -- was immediately sold and absorbed into the marketplace. And from a competition perspective, I want to say I don't worry about it, but of course, we worry about every day satisfying customers. If we weren't -- the fact that we're in all dispensaries in the state does show that we have been very successful at working very hard to compete and have great success with that. And so we don't -- we've been competing in the state with all of the regular players. And so we have a very high degree of confidence that we will continue that level of success. And remember, there's still under 100 dispensaries out of a license to 180. So the market has a lot of room to grow. So as others bring on capacity, we still see that being absorbed for quite some time. And again it's -- and it's not even rec. So we think there's some real long runway here for us to compete successfully.

That's great. And then just a quick final question from me. On the guide, the adjusted EBITDA margin of the 40%-plus through 2021 on a 35% exit here. You've certainly given some indication on the drivers. But could you provide some color on what could possibly go right or go wrong around that 40% margin? Any sensitivity or insight you can around that, Keith, would be really useful just to understand how you've I guess, thought about it and determined that midpoint 40% type margin? I mean, clearly, you have a range there for a reason. So any insight you can provide around that would be great.

Sure. Keith, would you take this.

Yes, sure. So first of all, our forecasting internally is very much a bottoms-up build. So we have pretty good line of sight and visibility. There's -- the 1 variable, of course, is we haven't sold our first product in New Jersey. So there are just a lot of variables around getting out of the gates. Of course, we're optimistic, as Jason describes, and it's going to be a supermarket. But just getting out of the gates and ramping that is really the variable. But you look at Pennsylvania and you look at New Jersey and the scale that's going to be as a percent of our total business. And you look at the margins that are generated there and assuming demand outstrips supply, which we all continue to believe pricing will hold, our costs continue to go down, and that's kind of the formula.

I would add -- the thing I would add, as you recall, we put in place all of the SG&A outside of the stores to build New Jersey without any revenue. So there's a very high level of confidence that as we ramp in New Jersey without taking on much more G&A, we'll see that leverage come through.

The next question comes from Glenn Mattson at Ladenburg Thalmann.

So with Pennsylvania being such a large part of the business now, I guess, I would -- and you've done multiple rounds of capacity expansion. That's going to be a key driver, obviously, for next year's growth. So can you just kind of go into how much more -- how much harder you can push the assets now? And how much room there is to increase production from these assets? And do you have any further ability to expand that capacity in Pennsylvania?

Yes. Glenn, sure. We do. There are some -- there are 2 core drivers for Pennsylvania, well, 3 core drivers. One is retail does continue to grow. It's just amazing how strong it is. Second is the yields in the facility, the team just continues to dial in and the productivity levels per square foot have continued to rise. So we think that, that will continue to add and benefit to -- and that's very much dropping down to the bottom line. And then from a space perspective, we do believe that we have additional square footage that we can build and we do intend to increase the capacity. So we do believe that even after this recent increase, that there is lots of runway for Pennsylvania to grow.

Great. Jason, I missed what you said about when you thought New Jersey would go to rec. So if you don't mind repeating that, but then can you just let us know like is that factored into the guidance for next year? Or is there a rec upside at this point? Or just how you -- it's difficult to time it exactly. So how you've played that into the guidance.

Yes, sure. Well, as you -- look, this is regulation. So this is speculation, but the indication we've been giving is that the state has a goal of getting the commission up and running within 30 days of the ballot initiative and hopefully within 6 months having the recs written to allow people to operate under the -- under that new bill. So we're hoping that June, July of next year, we'll be able to operate. And at that point, we will already have our dispensaries, all 3 of our dispensaries, hopefully open. So that will give us an advantage. So we have not budgeted rec at all in our numbers. Our numbers under the medical market are what we forecasted in the budget today.

Great. That's helpful. And then lastly, just the outlook for California. I imagine it continues to be a little bit depressed given the -- there was the wildfires and then there was some shutdowns and things. And so just kind of your outlook for next year on how you're thinking about California?

Yes. California, it's -- we're very concentrated up in the north. Our goal is to add -- do some very tactful adds to our retail presence to go deeper with our on shelf. We've had some good success. The gummies are the #1 selling. Our flower is now the #1 selling in half. So we -- that will continue to help with our margin structure in California. But given the dynamics in that marketplace, we continue to remain relatively cautious on our investments relative to the East Coast. So I'm very pleased with the progress that we've made. But our investments in that area are more limited than we do, where we think the returns are higher in the East Coast.

Congrats, again on the quarter.

Our next question comes from Russell Stanley at Beacon Securities.

I guess, first, with respect to New Jersey, your Phillipsburg location, I think is poised to have pretty limited nearby competition. I'm just wondering, given New Jersey's population density with respect to your second and third locations, do you have a sense as to how much of a buffer you'll have from potential competition? And whether sites may be going up?

Yes. So as you know, the state is divided into 3 north, central and south. So there is a limited number of competition. There's only -- there's 12 licenses in each region. So there'll be 12 stores for the north, where we are, and the north has the largest percentage of the population. So yes, there will be competition. I think we're in great locations. We're on within a 30-minute drive of our locations is well over 2.5 million people from each one of our locations, which are more towards the New York City side. So now, we feel really, really good about the locations. And we haven't seen another dispensary in that area where we're opening.

Great. And maybe a more general question with respect to adding additional states in the east, our valuation expectations climbing? Or are there still reasonably priced assets to be had, I guess, given the green wave with the election results?

That's a very situational thing. Maryland was a divestiture from the merger because of the 2 licenses. So I do think that we have seen quite a range in opportunities. But I think you expect us to maintain some pretty strong disciplines on -- we're not just trying to get somewhere to be somewhere. We've got to make sure it makes a ton of financial sense. So we do see opportunities out there, for sure, but we'd be cautious.

Understood on that. And just my final question around Pennsylvania. You've mentioned product mix being one of the drivers behind gross margin improvement, I guess, can you elaborate a bit on that? And comment as to how sustainable that aspect is?

Yes. Well, most of the Pennsylvania margin has been actually fairly steady between flower manufactured goods roughly 50-50, plus or minus. And I apologize, what's the core driver of growth and margin in Pennsylvania has been a factor of adding capacity and leveraging the scale and the continued great performance of the cultivation team increasing grams per square foot, which has a very strong bottom line performance. So those are the 2 largest contributors to the expansion of the margins.

Congrats on the 2021 guidance.

The next question comes from Andrew Semple at Echelon Capital Markets.

Congrats on the quarter. My first question here, you're about to deliver your -- the first of your production to the New Jersey market. I imagine in head about your reaching out and building your relationships with potential customers in that state. Do you have any comments on the initial indications of demand that you're seeing for your products in that state from third party retailers?