TerrAscend Corp. (TSND) Earnings Call Transcript & Summary

Good afternoon, everyone, and thank you for joining us at the 23rd Annual Needham Growth Conference. I'm Matt McGinley. I'm the cannabis analyst at Needham. In this session, I'm pleased to welcome Jason Ackerman. Jason is the CEO of TerrAscend for, I think, about the past year. Prior to TerrAscend, he ran FreshDirect for 18 years and has a lot of experience running omnichannel, retail and distribution businesses. We'll start with the session of Jason giving us some thoughts about the overview of TerrAscend and the industry, and then we'll transition to a fireside chat and a Q&A. If you're in the audience and you have questions, please use the chat feature, and I'll be able to read the questions from there. And with that, I'm happy to hand it off to Jason.

Great. Thanks, Matt. Yes. So as -- by way of background, I've spent the last near 20 years in the online grocery and grocery space, fresh side, having touched a lot of the full vertical integration across the business. And what's really interesting is how similar, at the end of the day, this business is in some ways where it's really about starting with a plant in nature and converting and growing that plant and converting it into a manufactured good and selling and then down to the retail side and e-commerce, I think, is an incredibly important part overall long term as well. So as I got into the space and think about this asset, some very important things to be thinking about is that, given its lack of federal permissibility, when you look at this industry, it's an enormous difference state by state. The laws, the regulation has been created very, very different, supply-demand dynamics in the marketplace and allow a market to be strong or poor. And so as we think about building on our asset base, we're very, very focused on what are the right criteria around the country and so forth. It creates a dynamic that we think creates a highest rate of return opportunity and the ability to scale our business because that's not the answer in every state. So as that lands back into our strategy as a business, we tend to focus very much on states where the license structure is limited, not infinite. In states where there's no limit to the amount of license grants, you have a bit of a gold rush and a very large mismatch with supply and demand that happened in Canada, California, Colorado, a lot of places that really kind of had way excess supply than demand and created some dynamics. And so where we tend to play our largest asset base is in the Northeast, what we call kind of the limited license medical markets, New Jersey, Pennsylvania and Maryland. What's unique about those is right now they're all medical states, not recreational. But they have some very strong characteristics about the medical program that makes it a very robust program. So usually driven by Pennsylvania, where it's now about $1 billion at retail at the medical market. They allow for very good patient conditions, anxiety and pain and PTSD and things that are really the highest use for cards. They've got a lot of good form factors that are allowed, and the municipalities have been very open to allowing the retail footprint to open up, which is very critical for that retail footprint so that you can convert people from the illicit market demand that's there regardless. You got to have the access points to convert that into sellable demand into the legal market that supports the growth overall. Interesting, you look at a place like Canada, got very oversupplied in the marketplace. I know there's a lot of hype, but it got understored in a lot of excess capacity, and that really made it a challenging market. So New Jersey, Pennsylvania, Maryland, the largest set of our assets. In Pennsylvania, we are about a 20% share as a branded manufacturer in the state distributing to all 100 dispensaries in the state. That state, we tend to be about 30% retail sales, 70% branded manufacturing. So we have very large-scale cultivation and downstream processing for branded goods that we distribute. And we've been in that state since the very beginning and have a very strong share. And it's a very, very profitable market to operate with very strong EBITDA margins. The outlook in that state is very strong. Only -- there's 180 store licenses that have been granted. So the market is going to continue to roughly double the store presence, continue to see it grow. And we also have recreation, which we believe, in the next 2 years, will continue to boost the market. And we think that's going to be a $2.5 billion, $3 billion market over the coming 4 years or so. Moving over to New Jersey, which while they just -- you may have heard that they have made it a rec state, the laws haven't been put in place. It's operating under medical. That is an earlier stage market. The med market is new. We have put in place 120,000 square foot production and cultivation facility that literally just opened up. We have license for 3 stores. And during the course of the end of the fourth quarter in 2020, we just opened up the facility. And throughout the year, we're going to continue to ramp up production and open our stores. And interesting, that market also does allow for home delivery, something near and dear to my heart. And I think that omnichannel congress is going to be a big part of that state's program. And as we think about recreational bill, general thinking is that, come the end of the summer, the laws will be in place, and we'll be able to operate under a rec environment, which is really going to accelerate the speed of the growth of that market. Moving down south, contiguously to Maryland. Maryland is a $600 million medical market. It's -- on a per population, it's smaller than Pennsylvania, but it actually has more penetration than Pennsylvania does. We recently purchased a growing cultivation relative -- a smaller size asset that we are in process of closing on and to our form of going very deep into that market to expand that as well. And so across those 3 states, we see, over the next several years, them all going rec, and we believe that, that's going to be roughly a $7 billion market quarter within that state corridor. And as a business, we are super focused on going a mile deep, not a mile wide. We believe very much in scaling places you're going and trying to be the #1 or 2 player in the places you play or don't really play. And so you're not going to see us hit every state in the country. It's not for us. It's not a state grab game. It's about a market share game where you play because we think the margins will have a much better return on that strategy. We also have some stores out in California of a Canadian presence. They're an important part of our business in terms of culture and learning. They're not a very large part of our overall scale. That's more on the East Coast. And if you just -- last thing I'd say, Matt, to add, and for those who don't know us, last year, in the fourth quarter, we lost about $5 million of EBITDA. And then we've gone from positive $5 million to positive $11 million, positive $18 million. We're going to record a very strong fourth quarter as we gave our forecast, and margins have gone from negative. The last third quarter, we reported 35% EBITDA margins, which I think put us third or fourth in the industry in terms of profitability. And so we just think there's a lot of momentum behind us in growth.

Great. So in terms of capital markets activity, in middle of December, you raised $120 million on a term loan facility. I think you got another $20 million from Canopy. And then earlier this week, you raised another $175 million in a secondary equity issuance. You did have a $130 million payment you had to make for the Pennsylvania assets, but you raised north of $300 million and you had a need for about $130 million. So philosophically, how is it -- is it important for you to build up a cash pile now for CapEx and M&A? Or sort of what will be the use of those proceeds over the next year or so?

Yes. It's in -- it's fair to say that outside of the final acquisition payment that we've made, a lot of our CapEx has been spent, and so we've got a lot of firepower for growing our current markets. But there's well $125 million, $150 million on the balance sheet right now that's earmarked towards acquisitions. And so when you look at the market today, having cash as part of a bid for things, I think, strengthens our ability to do what we want to do. As we think about acquisitions, I think a lot about concentric circles, the fill-ins of where we are and then expanding to other states. Right now, we have only 3 stores in Pennsylvania. We can license up to 15. So -- and then also in Maryland, we don't have any stores. We can get up to 4. So right now, we've got earmarked looking more closely into the end markets to acquire assets to bring in the fold in the stores. And so we wanted some firepower to take care of that and also be able to take care of opportunities in around adjacency markets. So we do have -- and it's interesting, the process. We actually went out for -- in perfect honesty, it's for about $50 million to $75 million. And it's amazing how the market has changed and literally 5 phone calls to some larger institutions, and we had a $200 million book in less than 24 hours coming up. It really kind of surprised us. So we made a pivot at the last minute to feel like that probably makes sense to take the additional capital with all the things we've got going on. It gives us a better way to execute something. So we kind of went with it. It really shows you about how fast this sector can change on a dime with the momentum of race and so forth.

It's a different world in a lot of ways versus a year ago for sure.

Yes.

The -- so let's talk about the strategic investments that Canopy has made into TerrAscend. Can you kind of frame the nature of that relationship that you have with Canopy? What are the investments they made? And how much equity would they own if there was a U.S. legalization event?

Yes. So they're just north of 20%, but it's on an as-converted basis. So Canopy Growth is a Canadian player, which is seeded by Constellation, which is a large beer -- Corona beer company listed in the United States. They're not allowed to invest in THC because of the federal permissibility laws. Canopy has made -- was an early investor in our Canadian asset in the beginning with JW Asset Management. They've put the company together and had supported the business in the phase. But as the business has pivoted to the U.S. from Canada because the U.S. opportunity was bigger, Canopy had a limited way of which they can play so they have invested in our business historically then through what we call just a synthetic convert, where they had to put it in debt to comply. So when permissibility happens, their shares -- their warrants automatically convert. The warrant money pays off the debt and it's like they did an equity deal back then, but it allows them to govern, but there's still a limit to what they can do. So we've got a great relationship with them. And Canopy has stated very vocally that their intention is to be in the United States when the governing exchanges allow them to play. But in the meantime, kind of we have a great relationship with them today.

Great. And as far as you mentioned the desire to expand in contiguous states around the Northeast, but sort of what features do you look for, be that states being contiguous, assets, management team? What do you look for in terms of your criteria for acquiring assets?

Well, there's probably 3 or 4 things we look pretty heavily towards. One is we got to see a lot of leg room to grow where, if we buy an asset, we feel like there's a lot of investment that we can make to greatly expand its capability. So as you buy and you want to buy into a fair multiple, and then you want to be able to drive that multiple significantly down by making strong assets. So when we think about Maryland, for example, we bought the asset at a great multiple of EBITDA, that's fine, but we think that the ability to greatly expand that where that asset investment we can make to expand it really, really drives down that multiple. And we also look for markets where we think it's got a lot of legs. Places like California, it's pretty mature. It's a different place. So we look for limited license. We look for growth where it's earlier stage. We like medical markets that have a chance to go rec, and we like to be a very scaled player where the structure allows us to buy in where we can continue to expand. And then it's all about people, too. We're either looking for teams or, if it's close to our very strong team in the Northeast, we'll tuck in without the team and leverage what we have.

So in Pennsylvania, there's roughly 100 dispensaries that are open in the state right now. I think, over time, there could be up to 200. Obviously, you mentioned that you have 3 dispensaries in the state. You can potentially purchase more, but your bigger growth opportunity right now is probably in the wholesale business, which should grow nicely as the dispensary count grows in the state and patient population grows and whatnot. How do you -- or what are the opportunities to grow the cultivation footprint in the state of Pennsylvania? I think you have -- maybe you call the number, I think it's around 140,000, 150,000 square feet today. What can that be expanded to? And is that in the pipeline for investment over the next year or so to harness the growth in that state?

Yes. We had -- from progression, we had tripled it in the middle of this year that kind of sold out. We added another 30%. That harvest has hit the market middle to end of November this year eaten up in a nanosecond. So that's now 3x.

Very close to be.

Yes. Our Q4 numbers have a modest reflection of that. Q1 will be fully burned in for that, 30% on the 3x. And then we're under construction on another 30% on top of that 3x and 30%, [ wherever ] that map equals, is coming into play. That will kind of be in the middle to back half of the year. So we keep on expanding that facility. So that's kind of what we have on the horizon. And the great thing about when you keep on investing in the current facility is you've got the infrastructure in place, you don't have to add a ton of people per grow room to add. So it's very incremental as you move that kind of scale through the system, and we're preparing for the 200 stores into the marketplace.

And then, let's talk about New Jersey for a little bit. You had a cultivation expansion that was just completed. You opened up the Phillipsburg location, I think, in Thanksgiving time frame, so it's still early. But I guess, how well is that dispensary doing in the first month or so? And when will the additional dispensaries in the state open up in 2021?

Yes. So you're right. We're -- we spent a better part of 2020 building out the capabilities and just starting to see the marketplace. We've got a soft launch of that first store and the thing is doing great. One of the most exciting things is you look at the reviews in that store, which I encourage anyone to go check it out, New Jersey. It's almost all 5 stars. We've got a really good buzz, great quality. The store itself has really exceeded people's understanding of what a dispensary could be and -- versus you know that. The shop experience was that really high-end quality experience. So very well received. We're very excited about that. We've just begun pushing some product into the wholesale market as well with our first facility. We're expecting Q2 and Q3 is when store 2 and 3 have -- will open. They've been approved. So that's underway. And the Phase 2 of our cultivation, which over 120, 80,000 just came online and planted. There's a 3-month gestation cycle from when you open it until the plants can actually start hitting the marketplace. So that real expansion is more of a -- Q2 is when we'll start to see that larger part of our capacity coming in with the second and third stores. So we've really got a Q1, Q2, Q3 ramp of the market fully realized in Q4. And then we think the market just continue to push. And we have another 100-plus that we can build and construct on the same property in New Jersey, which we're thinking about when we can go from 120 to 220-plus.

So New Jersey is obviously an extremely supply-constrained market at present, but there's a lot of investment that's going into the state. I'm sure you're going to sell everything -- every last thing you can in that state for at least the next year or 2. But what are your overall thoughts on that market opening up? And how long do you think that those supply constraints could exist with the capacity that you know is coming online in the state?

I think you could have a full 5 years where you're in an environment where the growth is exceeding the thing. But there's a couple of tricks that have to happen. A state has to successfully allow, at the municipality level, stores to open. And so when you kind of think about the success of a program, towns need to let the stores open so the access is there to grow. The demand is -- has this issue. So that's going to happen. I think that takes time. Pennsylvania is 3 years into the program, 200 licenses, 3-plus years into it. They've got halfway there, right? So it's 5, 6 years that this takes to continuously build on the growth. The difference about New Jersey is Pennsylvania was med all the way through, Jersey is going rec. So you might see an acceleration, but we still need to see those stores open up to kind of really push the wholesale market. But I think what you'll find is the revenue per store, and we see that in Illinois. As stores are building out, we're seeing huge volumes in these stores because you have nowhere to go and the market had a $1 billion run rate pretty fast in the first year. So I'm kind of expecting a similar situation. So we're pretty optimistic on the stores on the -- we need to see that grow. So we've got quite a runway, in our view.

And in Maryland, you announced that you're going to buy the cultivation asset from Curaleaf but that deal is still pending, but should be able to close. What was unique about Maryland? And what investments we need to make into that facility to expand it to harness the growth of that state?