TerrAscend Corp. (TSND) Earnings Call Transcript & Summary

Good morning. My name is Anas, and I will be your conference operator today. At this time, I would like to welcome everyone to TerrAscend's Second Quarter 2021 Investor Call. Joining us for today's call is Jason Wild, Executive Chairman; and Keith Stauffer, Chief Financial Officer; and Ryan McWilliams, EVP, Northeast region will be available during our Q&A session. Listeners are reminded that certain matters discussed in today's conference call or answers that may be given to questions could constitute forward-looking statements that are subject to risks and uncertainties related 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, MD&A and other periodic filings and registration statements. These documents may be accessed via the SEDAR database. The company began reporting results in U.S. dollars in the first quarter of 2021. And as a result, all figures in the prepared remarks are in U.S. dollars, unless otherwise noted. Please note, this call is being recorded today, Thursday, August 19, 2021. I would now like to introduce Mr. Jason Wild. Please go ahead, Mr. Wild.

Thank you. Good morning, everybody. Thank you for joining us today. TerrAscend has established itself in a very short period of time as a leading multi-state operator within the large and rapidly growing U.S. cannabis market. Our strategy, business model, and focus have positioned us extremely well. We continue to increase our scale in our existing markets, both organically and through M&A, while also continuing to evaluate entrants into new states. Before getting into our second quarter financial results, this morning, we announced the signing of a licensing agreement with COOKIES, one of the most recognized and highest-grossing cannabis brands in the country to supply COOKIES branded products across the state of New Jersey and to bring COOKIES Corners, a store within a store concept to each of our dispensaries in New Jersey. This is exciting news and bolsters for us what was already a very attractive path forward for our business in New Jersey. Our vision for TerrAscend is to establish a leading presence in attractive states by going deep through vertical integration, great branding, high-quality products and leading execution. Our agreement with COOKIES allows us to continue down this path, enabling us to further solidify our leading position in the state, as it is expected to turn adult-use by the end of the year. Now turning to a discussion of our second quarter results. For the second quarter of '21, revenue increased 72% year-over-year and 10% sequentially. Adjusted gross margin and adjusted EBITDA margins were 61% and 41% respectively, maintaining TerrAscend's position among the best in the industry on these important financial indicators. Additionally, we continue to have one of the strongest balance sheets in the industry, especially relative to our size, with over $150 million in cash. In Pennsylvania, as we mentioned on previous calls, construction is well underway to further expand our cultivation capacity. Our latest expansion plans are to add an additional 50% of Canopy space, with the potential for a 60-plus percent increase in output at that facility. The greater increase in output relative to Canopy will be the result of converting lower-yielding hybrid greenhouse rooms to higher-yielding and higher quality indoor grow rooms. The market in Pennsylvania remains very healthy with the recent headset data pointing to 41% growth year-over-year for the period and continued sequential growth. We are investing into this growth, as we see great opportunity over a multiple-year horizon. This additional expansion is expected to be completed by year-end and will be a key driver of growth for the company in 2022. Related to this ongoing construction and expansion work, in the middle of the second quarter, we began to see cultivation yields at our facility impacted by this activity. We experienced similar challenges in 2019, during one of our last major expansions, and we were able to remediate the situation in relatively short order. Our team has been working on getting the yields back up to previous levels, while also working towards completion of the project. Our recently acquired KCR stores are performing very well, similar to our other 3 Apothecarium dispensaries in Pennsylvania. We have also made operational improvements to the acquired of stores as part of our integration efforts. While we do not break out revenue per store, KCR did materially contribute to revenue during the quarter, and growth was 10% in those 3 stores on a pro forma full quarter-over-quarter comparison. We have a total of 6 retail locations now in Pennsylvania, and we fully intend over time to go deeper with the ability to increase our store base up to the state-licensed maximum of 18 stores. Turning to New Jersey, our second store in Maplewood opened in early May. This store is built for volume with 6,500 square feet of space, 15 point-of-sale registers and express pickup location, and it is in a very densely populated region of New Jersey. We estimate that this location can do $40-plus million in revenue annually in an adult-use program. Given the limited number of dispensaries opened in the state, we expect each store and especially those like ours located in densely populated regions of the state to perform extremely well in the soon-to-be-implemented adult-use program. Also, it's important to note that each of the 3 towns in New Jersey, where TerrAscend already has or will have dispensaries that they have past ordinances protecting our continued operation and enabling our dispensaries to participate in the adult-use market as well. These same towns have also banned all other cannabis establishments. Therefore, TerrAscend's dispensaries will be the exclusive cannabis establishments in all 3 of those towns. This could change in the future, but this is an extremely attractive situation for us at this time. Today, I am also excited to unveil the location of our third New Jersey dispensary, which will be in Lodi. It's in one of the best locations, if not the best, in the state right now, in my opinion. Directly off of route 17 and I-80, this location has approximately 107,000 vehicles that pass by per day. For those who are fans of the Sopranos, our location is right next to the famous Bada Bing. This new location is 5,000 square feet with ample parking space for parking as well as a drive-through. We believe that Lodi has the potential to deliver even higher revenues than our Maplewood store. By the end of this year, we will have Phillipsburg, Maplewood, and Lodi up and running in New Jersey, a 140,000 square foot cultivation and processing facility in the state is now fully operational and prepared to supply the market. While New Jersey is an extremely attractive market for us, we are seeing temporary market dynamics that we believe are related to the unique situation that exists in anticipation of the expected upcoming adult-use transition in Q4. For example, patients with a medical cannabis card are tied to a specific medical dispensary. This uniqueness in New Jersey specifically, can create a longer sales cycle to attract new patient growth to new dispensaries. Additionally, new patient growth has somewhat slowed with consumer anticipation of adult-use in the coming months. We believe that both of these dynamics are temporary and that once the state transitions to adult-use, which we expect by the end of the year, it will be a whole new ballgame. Furthermore, in anticipation of a dramatic increase in demand once adult-use goes into effect, we have made the decision to increase allocation of our own branded products to our own Apothecarium dispensaries ahead of the anticipated demand surge to ensure that our own stores are fully stocked. This decision will have an impact on our sales in the second half of this year. However, it will result in future more profitable sales and will guard against out-of-stock situations in our own dispensaries. I'm just excited about Pennsylvania and New Jersey, as I've ever been. In both high-growth and limited license states, I believe we will continue to grow and scale our business and continue to own meaningful market share. In Maryland, with the closing of the HMS acquisition earlier in the quarter, we are now focused on expanding our capacity in the state to a scale, which will enable us to be a leading branded manufacturer. Since we have taken over the business, we have implemented improved cultivation and processing techniques, grown our own high-quality strains and introduced our own brand. It's still early days for us in Maryland, but we're already very excited about the future in this highly attractive market. Turning to California, our stores experienced signs of recovery during the quarter, as commuters and tourists began to return to San Francisco. That traffic has started to come back, as an indication sales at our 5 Apothecarium dispensaries in California grew 13% sequentially in Q2. At our Berkeley location, specifically, we expect increased demand as students return to campus for the first time since that store opens in the middle of 2020. That store, in particular, should see a notable pickup in sales. We expect this to be a great location for us. In Canada, the business grew sequentially driven by top-selling flower SKUs that we've recently introduced, including Retrograde, Indigo Daze, and Secret Address. For example, Retrograde and Indigos Daze number 2 and number 4 top-selling 3.5 gram SKUs at the Ontario Cannabis Store for the quarter. Our commercial focus and product portfolio are much improved, and our cost structure is now aligned with all of the work that we did last year. We have expectations for Canada to continue to progress, both on the top line and from a profitability perspective. Subsequent to Q2, we made the decision to undertake a strategic review process to explore, review and evaluate potential alternatives for our Arise CBD business. This business has not recently represented a material part of our strategy. As a result, we will conduct this review with an eye towards focusing our efforts and resources on our core THC businesses. I would like to thank the Arise team for all of their effort, as we continue to work through this process. In closing, TerrAscend has established itself in a very short period of time as a leading multistate operator in the large and rapidly growing U.S. cannabis market. 2022 is going to be a breakout year for TerrAscend. Our licensing agreement with COOKIES, New Jersey going adult-use, expansion in Maryland, and our larger footprint in Pennsylvania will solidify TerrAscend as one of the leading and most profitable multistate operators in the U.S. I would now like to turn the call over to Keith to discuss the financial results for the quarter. Thank you.

Thanks, Jason. Good morning, everyone. As a reminder, the results I will be going over today can be found in our financial statements and MD&A on SEDAR. In Q1, we transitioned our reporting currency to U.S. dollars, so all figures discussed this morning are in U.S. dollars, unless otherwise noted. Net sales for Q2 increased 72% year-over-year and 10% sequentially to $58.7 million. This significant year-over-year growth was driven by 2020 cultivation expansions in Pennsylvania and California, the initial ramp-up of both wholesale and retail sales in New Jersey, the continued growth and ramp-up of our 3 Apothecarium dispensaries in Pennsylvania and 2 newer locations in California as well as the acquisitions of HMS in Maryland and KCR in Pennsylvania. The 10% growth sequentially was driven by the continued ramp-up of our New Jersey business, the 2 aforementioned acquisitions, some recovery of retail in California that Jason just mentioned, and a strong quarter in Canada, all partially offset by the temporary yield declines related to our construction and expansion in Pennsylvania. Regarding net sales by channel, our branded manufacturing business was down 5% sequentially, driven by the lower PA yields, while our retail channel grew 50% sequentially, largely driven by 2 months of the KCR acquisition, but also by the 13% growth at our California stores and continued ramp-up of our New Jersey stores. Branded manufacturing with its healthier EBITDA profile represented 62% of our revenue mix for the quarter. This percentage continues to represent the highest mix in the industry and is a key pillar of our business model and strategy as a branded manufacturer first. Adjusted gross margin for Q2 was 61% compared with 65% in Q1. Note that adjusted gross margin is a non-GAAP measure, which excludes fair value of biological assets and other nonrecurring adjustments. The 400 basis points of sequential decline in adjusted gross margin was primarily driven by lower yields in PA, resulting in an unfavorable mix relative of branded manufacturing relative to retail and lower absorption of fixed costs. We have maintained our strong focus on cost control with SG&A as a percent of revenue at 25% for the quarter, a 500 basis point decline sequentially, partly due to some onetime costs in Q1, but also due to operating leverage. Overall, we remain at or near best-in-class levels of SG&A leverage in the sector and our strategy to go deep, build scale, and leverage our cost structure, teams, and capabilities remains a central focus. Q2 adjusted EBITDA was $24.3 million, representing a 41% adjusted EBITDA margin and 3x the adjusted EBITDA levels of Q2 of last year. This also represents our third consecutive quarter with EBITDA -- adjusted EBITDA margins above 40%, which continues to place us among the best in the industry with this important indicator. Net loss for the quarter was $23 million, driven by a noncash loss on fair value of warrant liability of $20 million, a noncash $8.6 million impairment related to Arise, goodwill and intangibles, and a $3 million unrealized loss on foreign exchange, primarily driven by revaluation of U.S. dollar-denominated cash in Canada related to our January equity raise. Turning to the balance sheet, we ended the quarter with a very strong cash position of $154 million. This level of cash balance is among the highest in the industry, especially relative to our size and positions us well to further invest in the business, both organically and through M&A. In Q2, we generated $3.4 million in cash from operations, while CapEx spending during the quarter was $2.5 million, leading to a slightly positive free cash flow for the quarter, our third consecutive quarter with positive free cash flow generation. Year-to-date cash from operations, perhaps a better indicator given the timing of tax payments, in particular, was almost $17 million. During the quarter, we also made some significant payments related to M&A transactions. We paid $22 million as part of the closing of HMS in Maryland, $20 million as part of the closing of KCR in Pennsylvania and $30 million as part of the final Ilera earnout payment. For the full year, we expect that our cash flow from operations will partially fund our organic expansion plans, while the cash on our balance sheet will continue to largely be used to execute on our M&A agenda. Also of note, we recently -- we received approximately $3 million of proceeds from warrant exercises in the quarter and over the course of the coming months, we expect to receive approximately $40 million of additional proceeds from warrants that will expire in January of 2022 and approximately $50 million of proceeds from warrants that expire in August of '22. Lastly, before turning the call over to questions, I want to take a few minutes to discuss our 2021 outlook. As a result of what Jason outlined in Pennsylvania and New Jersey, we are withdrawing 2021 financial guidance. This is primarily due to the temporary reduction in yields of quality flower caused by the ongoing capacity expansion in Pennsylvania. It also relates to our decision to increase our allocation of branded products to our own Apothecarium dispensaries in New Jersey in anticipation of increased demand in an adult-use environment. While more profitable in the long run, retail sales take longer to sell-through when compared to wholesale sales. When evaluating the potential of our dispensaries in an adult-use environment, we think prioritizing our retail channel in a supply-constrained market is the best path for building long-term shareholder value. For the second half of 2021, although we have withdrawn our guidance, we do expect to continue to deliver strong year-over-year growth in both revenue and adjusted EBITDA. Finally, I'm pleased to report that we are at the final stages of our work to convert from IFRS to U.S. GAAP and are advancing in our preparations to become a U.S. filer at the end of the year. This ends our prepared remarks. I'd now like to ask the operator to open the call for questions.

Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Vivien Azer with Cowen. Please go ahead.

Thank you. Good morning. Appreciating that this might be hard to answer specifically, but order of magnitude, is there a way for you guys to quantify what the yield disruption impact was to your total company revenue or U.S. revenues in the quarter?

Keith, sorry, I was on mute. Keith, you want to take a stab at that?

Yes. Hi, Vivien, good morning. That's one of the reasons, quite frankly, why we decided to withdraw the guidance is we're assessing that. But it started to occur in the middle of Q1 -- or sorry, in the middle -- in the middle of the quarter in Q2. And the team is already well in terms of getting the situation in hand, and we expect that by -- in the next couple of months, next few months, that we cycle through it and leading into 2022, we're going to be ready to go with the full expansion and looking forward to getting that new facility or new space in the facility up and running at the higher outputs.

Yes. And what I would just add to that -- Vivien, what I would just add to that is actually -- there's always a lag in terms of flower that you're growing and then obviously, by the time that it turns into revenue out in the stores. So there was actually -- there was a decent-sized impact in Q2. And even though in Q3, we've already made substantial progress, because of the lag, we will actually see more of an impact in Q3 than we did in Q2.

Thanks for that color, very helpful from a modeling perspective. Jason, not tying these 2 questions together, but can you update us on where you stand on the CEO search?

Sure. We are still actively searching for a CEO. As I mentioned in the past, we don't feel like we're -- it's a fire drill or anything like that or there's a very urgent need in the near term, but we are still conducting that search, and we look forward to being able to share the results of that in the coming months.

Your next question comes from Matt McGinley with Needham.

In Pennsylvania, if the yields declined there related to the construction disruptions and your customers source product from other suppliers and didn't seem to skip a beat, why would they come back when you're in a better in-stock position in the third and the fourth quarter, like what would change what their need to come back to you when you're in a better in-stock position given the, I guess, if they moved on in this quarter and like I said, didn't skip a beat?

Sure. I think this will be a good time to introduce Ryan McWilliams, our new EVP of the Northeast. I think you can answer that question.

Yes. Hey, Matt. Thanks, Jay. So I think one thing that we can point to is that we've seen an issue very similar to this at the tail end of 2019, as we went through the first phase of expansion in the same facility. And since we've been such a large contributor to the wholesale market, we're a known quantity, a known entity with the current patient base in Pennsylvania. I think that when we come back online, bigger and higher quality than ever, that same trend will continue like we saw following the end of 2019 and that construction project.

Yes. And a thing that I would add also is that it's really only -- the impact that we felt was on the flower side. It was not on the manufactured product side in terms of vapes and concentrates and things like that. So that's how the business is -- has continued to be strong. And we do believe -- when it comes down to amount, I think it always comes down to if you can produce high-quality products, there's no magic, if you produce high-quality products, dispensaries are going to buy those products and the customers are going to buy them as well and pull them through. So we are -- in every market, where we are, we very strongly believe that the better our products are and the higher the quality they are that they will continue to gain share or in the case of Pennsylvania to take back that share.

Okay. And on the inventory, I'm trying to reconcile the comments on not having the inventory to sell in Pennsylvania and allocating more of your own dispensaries in New Jersey with the $23 million increase you had in inventory in the quarter. And if you're having topline issues related to supply constraints, why would that inventory be building at such a high rate and I guess, moreover, like how much of that inventory build that you saw in the quarter was actually in New Jersey versus build in other states?

Should I take that, Jason?

Yes.

So yes, when you peel the onion on the inventory, it's divided across a few of the areas. But in Pennsylvania, the dynamic is that a lot more of the biomass is needing to get converted to manufactured product formats, which is then a longer process and then a longer lead time to sale. So that's sort of the dynamic in Pennsylvania. And then in New Jersey, it's just like we said, we're -- we've made the choice to build the inventory ahead of time in anticipation of adult-use later in the year to make sure that our own stores are fully stocked. So those are the 2 drivers for the 2 main buildups. And I would say roughly a third and a third of each of those 2 and then there's a third of purchases that we've made in Canada to procure product and strains against the high selling SKUs that we've been -- that we talked about earlier.

Your next question comes from Kenric Tyghe with ATB Capital Markets.

Jason, I'd like to just better understand the construction and Pennsylvania-related delays. Is it a function of there are equipments and supply delays and you're actually not able to complete construction and the expansion as quickly as you could, and that contributed to the disruption? Or is it simply a case of construction is disruptive and these things happen? I'm just trying to unpack the actual construction-related angle on this. Because we have seen a number of other players referencing delays on sourcing and securing of key parts or components of their capacity expansion and the like, can you sort of speak to that, so we can better understand the construction delay, as it impacts yields in Pennsylvania?

Sure. Yes, I wouldn't describe it as a construction delay. We actually have -- we actually expanded the expansion in terms of, I believe, on the last call, we said we were going to -- we were undertaking a 30%-plus expansion of our Canopy, and it's actually going to be more like 50% and that has not been delayed. The issue that occurs often when you try to undertake a large expansion at a facility that is currently producing product, is that just the addition of the -- that construction, the sort of the excavation of the dirt outside of the facility, the extra people that might be in the facility, things like that, just that you end up introducing more issues and more potential issues into the growth. And that's exactly -- practically exactly what happened to us in Q4 of '19 when I believe we expanded our footprint at that time by 4x. We ended up having the same issues in terms of that current quarter sales. The thing is nobody was really -- I don't believe we were covered by analysts at that point, so nobody was really paying attention. And then once we got all that straightened out, it was off to the races. We believe that it will be the same case here. It's just -- we think we're going to go through another -- another couple of months of remediating some of these issues. And we've already made substantial progress, it's just that it shows up -- it's going to show up as a lag in terms of revenue. But that's really the sort of the bottom line on it. It's not that -- it's not that the construction was delayed, I would say, at least relative to what we had disclosed, it's actually ahead of plan and our production is going to go up, our output should go up even more than the 50% increase in Canopy, because we are also converting some of these hybrid greenhouse rooms into indoor rooms, which will substantially increase both the quality and the yield in those rooms.

And then if I could, just switching to sort of a combined one on guidance versus Pennsylvania and New Jersey, something -- guidance essentially predicated on, as you've discussed, the yield challenges in Pennsylvania and sort of evolving market dynamics in Jersey, could you speak to in Jersey, you've commented that you would still expect to see recreational new sales late in the year, can you just help us better understand that in context of the inventory build end market and the fact that those sales can't commence until there is -- there is sufficient inventory, my apologies, to supply the medical market. Do you actually still believe we get there in New Jersey this year? And how should we think about your positioning on the assumption that we do, it sounds like things in New Jersey are tracking well, but I'd like to just better understand the New Jersey and the context of the evolving dynamics and New Jersey in the context of the constraints on adult-use sales, only beginning once medical-use has been covered.

Sure. I mean that is -- that's actually one of -- the reason that we've been building inventory in Jersey is because we think that once adult-use kicks in that it's going to be a completely -- New Jersey is going to be a completely different market and we think that we are going to have demand for pretty much for everything that we currently have an inventory that's ready to go and whatever we're going to be producing on a run rate basis once adult-use kicks in. In the meantime, the dynamics are not great from -- in terms of -- as a medical market, they -- as we mentioned earlier, new patient growth in the state has -- the growth has slowed down because everybody is just waiting for adult-use, I mean, you wouldn't believe how many calls our dispensaries get per day from people asking if we already have adult-use in place and if they can come to the store. So we think that there's just sort of been a little bit of a natural lull in terms of new patient growth. And then New Jersey has its own unique dynamic, where when you sign up for a card, you choose a specific dispensary to be your main dispensary. And that just results in a little bit of a longer sales cycle for our dispensaries under medical, because there are several other established dispensaries that have been around for a while and people were already signed up with them. All of that being said, we think that things are going to be completely -- and it's completely different come adult-use, and that demand is going to be -- is going to be more than what we can potentially supply. And that's the reason that we made this decision to move towards having our brands be almost exclusively sold through our own stores. We don't want to have any stock-outs in our stores. We want them to be some of the best supplied stores in the state, and we think that these can be some of the best revenue-generating and profit-generating stores in the country. So while that serves to sort of from a timing perspective, move sales from the second half of this year into, say, the first and second quarter of next year, just because the book on retail sales, the patient has to buy the product from your store to book a wholesale sale, all you have to have is a dispensary buys your products and put it out on the shelf. So it's really -- to us, it's more of a timing issue than anything else. But remember, when you sell it through your own retail store, you're getting the full retail price, as opposed to the wholesale price that you would sell it to another dispensary for us. So we just believe that those will be higher quality revenues and we are -- we're willing to wait to be able to realize those higher quality -- higher revenues and higher quality revenues. Additionally, now that we have the COOKIES agreement signed, that additionally bolsters our confidence that we're going to be able to sell everything and then some that we can produce. We are actually planning on a significant capacity -- starting to work on a significant capacity increase in New Jersey in the coming months.

Your next question comes from Eric Des Lauriers with Craig-Hallum.

All right. Great. So I'm not sure if this one is best for Jason or Ryan, but the Ilera team was obviously a key area of strength for TerrAscend and with Greg now moving on, how does that impact the grow teams in the Northeast? Was his departure a factor in those Pennsylvania yield declines? And how does that maybe impact your outlook for New Jersey or Maryland?

Sure. I think I will let -- I think I'd like to let Ryan answer that question.

Yes. Yes. So to the question about how does it affect the yield declines, I think that the remaining team that we have in place, specifically, our SVP of Operations, Jason Morris, who's already been responsible for the New Jersey location to date, and that's been such a successful production facility. Now, his reach has broadened to cover the entire Northeast, so I only expect upside from there having this promotion for Jason and expanded responsibility for the region.

Okay. Great. And then just focusing on Pennsylvania, specifically, obviously a key market for many MSOs here and I understand that the yield decline sort of impacted your participation in the wholesale market for this quarter, but just any commentary on the competitive dynamics unfolding in Pennsylvania, whether you're seeing stiffer competition as it relates to quality or pricing, if you could kind of just give any comments on what you're seeing on the competitive dynamics of the wholesale market in Pennsylvania, that would be great.

Yes, sure. Yes, I got it. So from a wholesale perspective, there's really been not too much change at all from a wholesale pricing perspective. On the retail side, we've certainly seen as any maturing retail industry or any state that's a little bit further advanced in Pennsylvania, as we've seen some more competition in terms of promotional activity and discounting. But really, we -- not as much as I would have personally expected to see this far into the program, so we're very pleased with the continued demand that's out there. And even as this additional capacity comes on from ourselves and others operating within the state, I think there's still plenty of demand to go around.

Your next question comes from Pablo Zuanic with Cantor.

Can you just give us a reminder, in the case of Pennsylvania business, how much, say, back in the fourth quarter 2020, first quarter '21, how much is really coming from greenhouse and how much indoor, right? Because what we are hearing is that there's significant pressure on the lower end, flower of the market, mainstream, what's coming from greenhouse and that indoor of course, is doing well because it's premium. Just give us a reminder of where you were in terms of mix. I understand you're building capacity in indoor, but just a reminder of where you were in terms of mix back in the fourth quarter and first.

Ryan?

Yes. So Pablo, from a product perspective, the majority of what we're -- what we have been historically harvesting from the greenhouse has gone towards the extracted products. So we've had the indoor expansion included on there, which has been the primary driver of our higher-quality flower sales and flower availability since that first phase of the construction project was complete back in Q1 of 2020. From a square footage perspective, it's more in the range of probably 20% greenhouse to 80% indoor or something along those lines, give or take.