Edited Transcript of TER.CD earnings conference call or presentation 29-May-20 12:30pm GMT

In the U.S. today, we are active in Pennsylvania, New Jersey and California, and plan to leverage these East and West Coast hubs to strategically expand where the return on investment is justified.

In Q1, we completed the tripling of our cultivation facility in Pennsylvania and have begun to see the benefits of that expansion driving our growth in the last month of the quarter, and expect to see that continuation of this growth in sales and profitability throughout the rest of this year. We are also progressing well on the build-out of our New Jersey cultivation and dispensary sites and expect to see these operationally by the end of the year. I’m also pretty excited but cautiously optimistic about New Jersey rec ballot in November, which could have a very positive impact on the growth of that market.

Since our last call, we have continued to see strong demand across our business despite the current pandemic. And we’d like to reiterate that all of our facilities and dispensaries have implemented strict protocols to protect the health and wellness of our employees, our customers and patients during this very difficult time. We have introduced in Pennsylvania a drive-through, which has been a great success and curbside pickup at almost all of our dispensaries locations. And across the company, online revenue for our retail locations have increased 4x driven by COVID. And given my background as an online retailer, this makes me particularly excited because I do believe that digital is a big part of the future of our business.

Last week, we announced a $30 million private placement that will position us with a very strong balance sheet to complete our investments in the U.S. We are propelling the growth of our business through this investment. And as you may recall, earlier this year, we strengthened our balance sheet through the Canopy loan and the concurrent repayment of the $47 million U.S. credit facility, and we have plans to complete this current fundraising as part of that overall financing strategy to support the completion of our U.S. build-out. Some of the main projects included in that is the construction of our 150,000 square foot New Jersey facility, which is scheduled for the end of this year. And we plan to open 4 new Apothecarium dispensaries across all 3 states that we’re active in, bringing the total footprint at the end of the year to 9 with added locations planned for early next year.

And lastly, before I turn the call over to Keith, I’m excited to announce that we anticipate that based on our strong success to date that our Q2 2020 net sales will be at least $45 million, representing excess of 30% sequential growth as well as ongoing expansion of our gross margins and adjusted EBITDA margins. As I continue to focus on building a world-class team, I’m very excited to have Keith as our new CFO. Keith has deep CPG experience in highly scaled global businesses and brings very strong financial acumen and rigor to the team.

And with that, I’d now like to turn it over to Keith to discuss our financial highlights for the first quarter, then we’ll open up for questions. Thank you.

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Keith Stauffer, TerrAscend Corp. – CFO [3]

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Thanks, Jason, and good morning, everyone. Before I start, I’d just like to say how excited I am to be on the TerrAscend team and really impressed with what I’ve seen so far since joining about a month ago. As a reminder, the results I will be going over today can be found in our financial statements and MD&A, and all results are in Canadian dollars.

Net sales increased 139% to $34.8 million in Q1 compared to $14.6 million same quarter a year ago. This growth was driven by our U.S. business, which delivered $30.9 million in revenue in the quarter, as Jason said, representing 89% of total company net revenue and really reflecting TerrAscend’s continued focus on this important market. The increase in revenue was driven by the operational scale-up of our U.S. footprint, which the company has strategically expanded through investments in production capacity as well as wholesale and retail sales capabilities, as Jason outlined earlier.

In Q1, gross margin before gain on fair value of biological assets was 45% compared to 10% last year. The increase in gross margin is the result of the company’s shift to higher-margin revenue opportunities in the U.S. as well as the ongoing initiatives the company has performed to rationalize its Canadian operations to the current market opportunity. And importantly, our Q1 gross margin in the U.S. before gain on fair value of biological assets was 57%. In the quarter, G&A was $14.6 million, an increase of 66% versus last year, but less than half the rate of net sales growth. The change was primarily driven by the 2019 acquisitions in the U.S. The company expects to continue to strategically invest in acquiring the talent and developing the appropriate infrastructure to ensure our continued expansion in the high-growth U.S. market while also driving operating leverage as the company’s operations continue to scale.

In Q1, adjusted EBITDA was a positive $4.9 million compared to negative $5.5 million last year. On a geographic basis, adjusted EBITDA from the company’s Canadian and the U.S. operations in Q1 was minus $3.3 million and positive $8.2 million, respectively. Importantly, adjusted EBITDA margin from the company’s U.S. operations was 25%.

We ended the quarter with $31.4 million in cash and equivalents, including restricted cash, compared to $8.6 million at the end of Q1 last year.

As Jason noted earlier, subsequent to the quarter end, we announced a 30 million — USD 30 million nonbrokered private placement. Based on strong investor demand, we announced this morning has been upsized to $37 million. The first tranche, which included a $20 million lead order JW Asset Management closed on May 22; and the second tranche totaling $7.1 million closed yesterday, May 28; and we’d expect to close the remaining proceeds by the end of next week.

Finally, before closing, I’d just like to say that after 1 month on the job and getting to know the team and the company’s capabilities, I’m really impressed with what I’ve seen so far. However, there is also much work to be done to continue to strengthen the company’s foundation for future growth. To that end, we have initiated a finance transformation effort which will upgrade, standardize and streamline our accounting, financial, IT and management processes and systems. This effort will be a key enabler to future sustainable and predictable growth, and I look forward to reporting our progress in future updates.

With that, I’d now like to turn the call back to the operator to open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions)

Your first question comes from Kenric Tyghe from AltaCorp Capital.

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Kenric Saen Tyghe, AltaCorp Capital Inc., Research Division – MD of Consumer & Retail and Analyst [2]

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Congrats on the quarter, very strong performance. Nice to see a positive surprise in the space. Jason, could you speak to the momentum you’re seeing in your East Coast versus West Coast operations? How to think about the progression of that momentum through the year? And if you could also then just sort of line that up with the cost discipline and cost controls we saw in quarter and how you’ll execute against that for the balance of the year as well, please?

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [3]

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Sure, Kenric. So if you look at how we’re growing right now, the largest increase in our throughput and capability was in the East Coast operations by tripling our cultivation capability and manufacturing capability. And as I said, as that came through the end of the first quarter and will be fully realized in the second quarter, that will be our largest propelling of growth into the second quarter. And given the profit margins that exist within the vertical integration operations, that will continue to put positive momentum in our overall earnings capability as that expands.

On the West Coast operations, as you know, that’s a relatively mature market. And the growth will continue to be shown through the opening of — largely through the opening of additional dispensaries, which we have in the pipeline at the moment, and we continue to work with the local governments for finding additional locations. We have a nice pipeline there and. As well as throughout the year, as you recall, we are expanding and have spent the money mostly already to expand our high-quality cannabis growth in the West Coast for our vertical as well as our Valhalla operations, we opened a new facility to expand that. So we expect to see that show up more towards the middle of the back of the year. And then, of course, New Jersey, which will then be following up behind it, which largely will be seen into the following year, which we think is a — will be a great accelerant as continued growth for our business.

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Kenric Saen Tyghe, AltaCorp Capital Inc., Research Division – MD of Consumer & Retail and Analyst [4]

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And Jason, just a quick follow-up on the East Coast or Pennsylvania specifically. Could you remind us how many dispensaries you would expect to have opening in this second quarter? And separate to that, how the performance of the Pennsylvania business, both in quarter and dependent on whatever dispensaries you’re opening in the second, how that margin performance is tracking relative to your prior comments, your level of confidence around that opportunity set? We realize it remains supply constrained and the margin profile is attractive. But any color you could provide there would be fantastic.

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [5]

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Sure. So we have 3 licensed dispensaries in the state of Pennsylvania and 3 licensed in New Jersey. So that third — second one has opened up about 6 weeks ago. And the third will be opening up sometime during this second quarter, probably towards the back end. And dispensary margin operations have been strong. And interestingly enough, as online has been a larger part of the business in COVID and COVID has continued to provide strength, we’re seeing very strong margins at our dispensary level. And we also — as you can imagine, with the scaling up of our operations in cultivation and manufacturing, that tripling has also provided some substantial scaling opportunities.

And I believe that we’re a very effective operator. And I got to say, the team there is just knocking out of the park. They’re really a strong team, and they’re very super cost-conscious. And this expansion has given us substantial leverage in our operations.

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Kenric Saen Tyghe, AltaCorp Capital Inc., Research Division – MD of Consumer & Retail and Analyst [6]

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And just a quick final one for me, if I could. The nonbrokered private placement upsized and oversubscribed, could you speak to what flexibility that provides with respect to either current operations or opportunities perhaps outside of your current operations and geographies with that most recent capital raise?

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [7]

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Sure. So the raise is — the dollar raise, we did have a substantial oversubscription for it. So we have well over funded our capital needs, so this amount is in excess of the needs for us all the way through into next year, so — which gives us a little bit of powder. So we will continue to do and be opportunistic on — outside of our current capital plan to look to be opportunistic. So yes, at the moment, it’s not earmarked, but we’ll use our disciplines, but we’ll be opportunistic.

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Operator [8]

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The next question comes from Robert Fagan from Stifel.

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Robert Fagan, Stifel GMP Research – Equity Research Analyst of Healthcare [9]

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I’d echo congrats on the strong profitability there. Yes, so Jason, if I could ask you maybe to give us a bit of color, whatever is available, for the performance in California in this quarter. With obviously, I guess, a strong performance on the East Coast division, where — could you give you kind of like an order of magnitude of relative performance for the West Coast kind of retail operations in comparison? That would be great.

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [10]

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Sure. So the dispensary operations in the West Coast had good performance, but the level of overall growth that we’re seeing on the East Coast with the large expansion. So it’s a smaller — as we said, California as a market is more mature, so you would expect to see more mature growth rates overall in that marketplace. And so for the first quarter, that’s what you would have expected. But again, I’ll reiterate that there were no additional dispensaries opened in our channel. In the West Coast, we have a pipeline that we’re building of new retail opportunities, and we’ve been investing substantially, which most of that money has now been spent to increase — or grow and increase our manufacturing capability, which will be seeding future growth for that West Coast operation.

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Robert Fagan, Stifel GMP Research – Equity Research Analyst of Healthcare [11]

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Okay. And if I could ask another one on — shifting gears to Canada. So the — there was, I guess, a good sequential growth in Canadian revenues, but still quite a bit below the kind of quarterly run rates we saw historically. What do you think would — is the possibility to recapture some of those kind of higher sales levels in Canada, if that’s something you guys envision? And if not — or maybe, if not, what kind of growth trajectory should we expect going forward in that business?

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [12]

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Yes. Great question. So in Canada, I — sales to me are less important than profitability. And so as we kind of dissected our — where we were, it’s — my assessment overall is that we need to make sure that we’re going after profitable growth, not just growth. So through the last 4 months, we’ve done a complete top-to-top review of every product we have in the marketplace, our costing, our processes and so forth. So I have intentionally kind of pushed them back off, things that are not what I think making sense for the long term. So what I would say is that we are reseeding our portfolio in a way that will position us to have sustained supply and sustained product and sustain margins, and we’re in the middle of that. So I expect that, that overall growth, as you saw, come down, and I believe that we’ve built a foundational base largely off of that. It takes a little bit of time to work our way into the market with new SKUs that we’re launching and changing some of the profiles that I think are more logical relative to the demand in the marketplace.

So I think we’ll see those come in towards the back half of the year, but we are in a transition. As you also know, and I stated in the last call, we’ve done a substantial cost reduction in the Canadian operations, which will begin to show up soon in rightsizing that business. So I really feel that, that opportunity sits more in the back half of this year.

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Robert Fagan, Stifel GMP Research – Equity Research Analyst of Healthcare [13]

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Great. And I guess, if I can get one more in. Insofar as your U.S. kind of EBITDA margin for the quarter [at] 25%, very respectable. Could — is there some kind of indication you could give us about whether the CBD or Arise Bioscience business unit is a drag or kind of augments a little bit that profitability profile? I can imagine that is not as strong as what you have in PA, but is it — are we looking at kind of EBITDA losses there as we are in Canada here?

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [14]

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Well, we don’t give specific guidance on any particular asset. What I would say is that similar to Canada, the CBD business did have some profiles of products that had lower margin and some had higher margins. And we’ve rejiggered the team. We’ve got great leadership there right now. So into quarter 1, versus the previous quarters, we did have a increase in our margin structure. As, again, that top-to-top review of all of our SKUs and how we’re going to marketplace, we made some great progress in our margin profile. But I think if you’ve seen broadly across the CBD spectrum, business as a whole doesn’t have a lot of momentum relative to THC. So that business as a market as a whole is more challenged, and it’s harder to drive growth. But overall, our gross profit margins did see some improvements, and I believe that business is set up for success in the future. And just as a note, COVID has had an impact on the CBD business because a large amount of those stores are not considered essential, which will also have an impact. But I do believe that, that business has good potential, again, kind of hopefully seeing that more towards the back of the year than at the moment.

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Operator [15]

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The next question comes from George Ulybyshev from Clarus Securities.

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George Ulybyshev, Clarus Securities Inc., Research Division – Research Associate of Growth & Innovation [16]

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This is George dialing in on behalf of Noel. Congrats on a great quarter as well. Just a couple of questions here for me. Can you give us a sense of the wholesale competitive environment in Pennsylvania at the moment?

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [17]

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Yes, sure. So what I’d say is it is evolving. It is a relatively new marketplace. So the way I would characterize it is that the market started at being an undersupplied marketplace. So if you had cannabis, then you could sell cannabis, and that’s — in its typical cycle. A reminder, the one thing I love about Pennsylvania, it’s relatively imbalanced between the canopy that’s under growth and the relative growth in retail stores. So as we continue to see the retail dispensaries now hit 80 out of the 150, those dispensaries keep on opening up. And even as cultivation, which I believe I’d consider to be now close to balanced as opposed to being undersupplied, we finally reached a point where it’s a bit in balance. But we still see relatively firm pricing. Other people are also coming along with the capacity. But if you look at the 80 dispensaries going to 150 and strong patient growth in that marketplace, I believe that, that market has lots of room to grow, and that the additional capacity brought on by us and others will be — continue to be taken up by the growth in overall consumer demand. So we feel good, but I characterize it as moving from undersupplied to being healthy but competitive.

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George Ulybyshev, Clarus Securities Inc., Research Division – Research Associate of Growth & Innovation [18]

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Got it. Okay. And just the last question here. On the New Jersey front, what are the key milestones that you guys would need to reach to be able to open your first store there? And also, do you have any additional store locations identified in the state at the moment?

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [19]

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Yes. So our Phillipsburg location is under construction, and that is slated to open in the third quarter. We have signed letters of intent on one location and a second letter of intent that’s being finalized right now. So we’ve identified the locations. So we still have to go through the normal course process to see those through fruition, but we do, in my mind, have the identification of those 3 locations where we are. And New Jersey, construction is moving along nicely. During COVID, getting construction permits was a little bit challenging, so that was a bit frustrating. But we’ve got a good construction team over there, guys I’ve worked with in my previous life are on top of it. And so that’s all moving along nicely.

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Operator [20]

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The next question comes from Eric Des Lauriers from Craig-Hallum Capital Group.

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Eric Des Lauriers, Craig-Hallum Capital Group LLC, Research Division – Senior Research Analyst [21]

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I’ll offer you my congrats on the strong profitability as well. First question for me, I was wondering if you could just talk about the M&A pipeline and how JW Asset Management could sort of be — sort of a lead in for you guys. And just sort of how the deal flow from JW Asset Management could potentially be — act as an [acquisition] for you guys. Just a little bit color there would be helpful.

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [22]

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Yes. Sure. It’s a good question because one of the compelling reasons for me to join the team, honestly, is the partnership with Jason Wild and the firm. Because, as you know, JW has been a long-term investor in this space and is in the pipeline of pretty much all deals that are coming through, which, for me, it takes a lot of pressure off and making sure that — worrying about the deal flow focus on the business. So we’re seeing a ton of stuff is what I’d say. That’s what I love about the partnership. So we pretty much see everything that comes across. But at the same time, I’d say that we are not just looking to grow for growth’s sake. We are very focused and have a lot of strategic filters to our process.

And Jay and I speak about 100 times a day, so that filter is known and understood. And so we’re just — we’re focused, but the pipeline is good. And I think, as you know, it’s an interesting time. One thing to love about the space at the moment is there’s — as the musical chairs have stopped, in large part, in the markets around funding is a little tougher these days, that does present some great opportunities, which I’m pretty excited about. But we’ll maintain our disciplines.

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Eric Des Lauriers, Craig-Hallum Capital Group LLC, Research Division – Senior Research Analyst [23]

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Yes, that’s great to hear. And then just last one for me. I figure I’d try another one on PA wholesale strategy. Looking at menus online, it looks like Ilera has more SKUs in third-party dispensaries than any other brands. Are there any market share numbers that you guys can share? And do you have any SKU expansion or SKU rationalization plans that go along with your tripling of cultivation capacity? And are you guys comfortable with your current SKUs and now it’s really about just increasing volume?

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [24]

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So market share — gosh, I’ve heard so many different numbers. I think I know what the market share numbers are, but I’m a little cautious to quote them. But I would say, as a primarily a wholesaler, so if we’re ever to quote market share, we will be focusing on the wholesale market share because, as you know, with having 3 dispensaries out of the 885 that are open right now, that — you can just say 3/80ths of the market share at retail. But on a wholesale basis, with our capacity, I would say we’re certainly above 20% share of the wholesale level, if not high, would be my estimate. And so I don’t know where we rank relative to exactly the other top players, but I’d say we’re right up there with them.

And with respect to products, listen, we’re — at the end of the day, we are in the business, plain and simple, of making customers and patients happy and satisfied. And if you’re going to do that, you can’t just have products available, you have to have great products available and the products that are evolving with the needs in the marketplace. As Pennsylvania continues to increase the counts of patients, the demographic of those patients will evolve and therefore, the taste of those patients will as well. So we have a great product development cycle. So the answer is no. We obviously have some killer SKUs that are running through the system. But make no mistake, product development is a critical part of the lifeblood of this business, and they are really great. We’ve got a great group of scientists. We meet all the time — or they meet all the time. So product development is a big part of what we continue to expect. But given the velocities that we’re moving for the facilities, we continue to see scale and efficiencies in all the stuff that we produce. And just to note that we’re not just a flower business, a large percentage of our revenue does come from manufactured products, and I believe that’s a very important continuation of our strategy.

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Eric Des Lauriers, Craig-Hallum Capital Group LLC, Research Division – Senior Research Analyst [25]

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Yes. That’s excellent. And then just one last follow-up for me on PA side of things. So it’s great to hear that you guys have completed your expansion in Q1. I’m just wondering, is that expansion fully planted? Or are you planning on kind of scaling that — the amount that’s planted throughout the year?

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [26]

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We do have the ability to further expand capacity another 15%, and we do plan on putting that in place during the course of the third quarter, which can become available into the fourth quarter of this year.

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Operator [27]

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(Operator Instructions) The next question comes from Glenn Mattson from Ladenburg Thalmann.

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Glenn George Mattson, Ladenburg Thalmann & Co. Inc., Research Division – VP of Equity Research [28]

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So just curious on — I think you guys have quoted a few different times that Ilera had 59% EBITDA margins prior to the acquisition. So I’m just curious as to what do you think those margins might look like as you scale? Like, I’m assuming they’re going to come in a bit, but just kind of a ballpark range for how we can think about it, since it’s going to become likely a large percentage of the business by the fourth quarter, even larger so.

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [29]

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Yes. So we’re not quoting margins by department at the moment. But what I would say, if you look at our 25% in contribution this month, and that largely did not fully reflect the growth of the expansion. With that $10 million flowing through the operation from quarter-to-quarter, you can kind of extrapolate on how that will play through into the numbers going forward. The East Coast vertical operations are what I would say at the upper end of the more profitable side of the business, particularly as the market maintains a generally healthy equilibrium between supply and demand. And as we continue to increase capacity, we are growing sales in excess of growing our costs in that marketplace, which not to say that will expand our margins because we’re very focused on being the highest-quality and lowest-cost producer. So to the extent that we see any price compression, we’re going to be right there. And we believe we can kind of hold our margins as we drive growth and competitiveness.

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Glenn George Mattson, Ladenburg Thalmann & Co. Inc., Research Division – VP of Equity Research [30]

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Great. And in California, I think — I’m not sure if you updated when exactly you think the Berkeley store will be open. And then — perhaps you did and I missed it. But any insight as to what the further expansion will look like as far as geographically speaking in California?

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [31]

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Yes. Berkeley actually was scheduled to be open, but COVID stopped it. So construction is done. I believe that we will be opening up Berkeley in the month of July now coming through the summer. COVID still is affecting the college towns, so we’re kind of using our judgment on that. Capitola is under construction, so that will be largely a fourth quarter opening. And the team has — since TerrAscend has been involved has been supporting the efforts with — that they’ve done to support finding additional locations with towns and applying for licenses. So they were very active. So not to announce other things, but we do have, what I call, seeds out there in the marketplace, which we are encouraged and hope to continue to be issued additional license opportunities.

In terms of focus, we are really focused on Northern California right now. California is a big place. I’m a big believer in scale, line of sight, eyes-on-prize management. So we’re very focused on generally kind of northern part of California so that we get leverage on our team’s consistency, customers, brand, marketing, delivery and so forth. So that’s really where our focus is at the moment.

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Operator [32]

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The next question comes from Peter Ferrero from Ferrero Enterprises.

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Peter Ferrero, [33]

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I just got 2 questions. Can you talk about — a little bit about Heather Molloy and what she means to TerrAscend? She was instrumental in getting the Ilera deal done. And then my second question would be, when do you think the State Flower acquisition is going to close?

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [34]

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So Heather runs business development. So biz dev is an incredibly important part of our operations today. In terms of — I think you asked — sorry, the second question was future acquisitions. Sorry could you repeat that one?

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Peter Ferrero, [35]

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With State Flower, that was supposed to have closed…

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [36]

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State Flower.

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Peter Ferrero, [37]

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And I believe — yes. Do you know when that will close?

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [38]

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So the general — it’s now in our numbers, and there is an earn-out payment based upon the year’s revenue post expansion. So we’ve been funding and have finished funding, and they’ll be opening soon the further expansion. So I believe that will close officially during 2021, probably the middle end of ’21. I could be wrong exactly on those dates, but I’m pretty sure that’s roughly it.

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Peter Ferrero, [39]

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And just one more quick question. Do you still like the Massachusetts market right now?

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [40]

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Not during COVID. But yes, it’s interesting that marketplace. I think it has some — there’s definitely strong demand. There’s a lot of players. I said if we could find the right entrance into that marketplace with enough scale, I do. I wish you can get more than 3 dispensaries into that marketplace. But I think there are some good margin dynamics. The state has been a little bit rough at getting locations up and running. But I do believe if you can find the right positioning there, there is good money to be made, and there is a good — there is good consumer demand. So I would say, yes, but cautious, but it’s got to be exactly the right spot. It’s not just being there for the sake of being there.

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Operator [41]

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There are no further questions at this time. You may proceed.

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Jason Ackerman, TerrAscend Corp. – Executive Chairman & CEO [42]

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Okay. So if there’s no questions, I just want to thank all of you for covering us and for listening. And that’s it, we look forward to speaking to all of you the next quarter, hopefully, with even better results. Have a good weekend. Bye.

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Operator [43]

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Ladies and gentlemen, this concludes your conference call for today. And we thank you for participating, and we ask that you please disconnect your lines.