Sundial Growers earnings release. I really admire them for calling out QoQ performance, even when it is not flattering.

You might wonder why we cover Sundial. There is not much investor or subscriber interest.

I find that you learn more about financials and repercussions from poor operations than you will from a company that is printing money.  Plus, they have pretty good disclosure and their sales have been in the top 6 Cdn cultivators.  Although, I do take issue with them dropping Harvest KGs after me pointing it out to them there could be a Biomass Swap last Q.

There has just been so much chaos in their operations. They hit the public scene straight to the NASDAQ, expanded into the UK via an acquisition of an ornamental flower business and had to just as abruptly sell it to pacify their lenders when operations started to stray from projections.  The unwinding of UK, the shuttering of their Cdn grow in the hopes or rightsizing cultivation versus sales, offered a glimpse of the carnage a large fixed production cost base would cause to Gross Margins.

There are lessons in there that we will see repeated again and again in the Canadian space.

Despite working down their debt via the sale of UK operations, they are again in technical violation of their bank debt and being granted waivers, a looming more material violation is on the near term horizon.

“Syndicated Credit Agreement ($71 million at Q end matures Aug 27, 2021): At September 30, 2020, the Company was in compliance with all financial covenants under the Syndicated Credit Agreement. Additionally, based on the Company’s most recent financial projections, management is forecasting that the Company will be in violation of the Syndicated Credit Agreement senior funded debt to EBITDA covenant at December 31, 2020.”

Much like Aurora, Organigram, Zenabis and few others, being under the heel of a secured creditor with most of the garage sale of saleable assets in the rear view mirror, it will be shareholders that will be footing the bill. From presser:

• Capital raises provided gross proceeds of $26.4 million during the quarter and $48.1 million subsequent to the end of the quarter

From MDA:

“From October 1, 2020 to November 9, 2020:

• US$2.4 million aggregate principal of Unsecured Convertible Notes was converted into common shares at a weighted average conversion price of US$0.1631 resulting in the issuance of 14.7 million common shares;
• $18.3 million aggregate principal of Secured Convertible Note was converted into common shares at a weighted average price of $0.2122 resulting in the issuance of 86.0 million common shares;
• The Company sold 121.9 million common shares under its ATM Program for gross proceeds of $46.3 million; and
• 4.8 million Unsecured Convertible Notes Warrants were exercised at a weighted average exercise price of US$0.1766 per warrant resulting in the issuance of 4.8 million common shares and gross proceeds to the Company of US$0.9 million
• 3.0 million Series A Warrants were exercised at a weighted average exercise price of US$0.1766 per warrant resulting in the issuance of 3.0 million common shares and gross proceeds to the Company of US$0.5 million.”

The couch cushions have been searched and new money from equity and resultant dilution is the only way out. 

Open up the fins and MDA and follow along.   

Income Statement Drivers and Implied Breakeven: Trend

Sales Table:

Gross Cannabis Sales (before excise tax deduction) were $15.5 million a decrease QoQ of 36%, giving back most of last Q’s gains.  $12.5 million was sold through provincial boards versus $18.1 million last Q, a -31% decrease.  Revenue from other LP’s decreased -52% to $3.0 million for the Q.  Wholesale is under pressure industry wide.  Whereas good quality saleable flower might still attract buyers, trim and extract grade flower are competing against a glut of inventory and Croptober 2020 will make that worse.

VFF and Aphria are the two LP’s that have seen decent wholesale revenue this past Q.

Net Revenue was $13 million for the Q down from $20 million over the previous Q.    

By segment

• Flower totaled $11.6 million down -28% from $16 million last Q and the lowest this year.
• Vapes totaled $3.6 million down -43% from $6.3 million last Q and the lowest this year.
• Oil totaled $0.3 million down -84% from $2.0 million last Q and the lowest this year.

The previous Q’s boost in vapes did not hold.  Sales channel pressurization versus sell through.

Net revenue per gram sold decreased by 34% to $2.67/gram as wholesale KGs sold increased 27% to 3,551 KGs yet revenue cratered 52%. Pre excise Rev per gram decreased by 2% to $5.53/gram, the declining mix of vape sales the likely culprit.  Sales per gram to LP’s fell 62% to $0.84/gram from $2.22/gram.

Income Statement Drivers and Implied Breakeven: Peer

Sundial would rank as 6^th largest LP in the above peer with sales at $13 million.  We might have to send SNDL down to the Tier 2 group.

Gross Margin: Peer and Trend:

Negative Gross margin four Q’s in a row.  Only Cronos’ five Q’s of negative GM beats Sundial.

Gross Margin decreased from negative $7.2 million to negative $17 million in the Q.  A $20 million inventory obsolescence and impairment was the driver after $10 million and $8 million impairments in each of the previous two Q’s: $38 million in impairments over three quarters.

Reversing the obsolescence would yield only an 20% GM versus the negative 134% they are sporting.

At June 30, 2020 they had projected Yield of 5,545 KGs (down from +13,000 KGs in the March 2020 Q), I imputed that they harvested 4,601 KGs. This unabsorbed capacity will be a bit of a boat anchor on GM% until they re-ramp to previous yields. (This is the issue also facing Canopy and their unabsorbed overhead). Projected yield at September 30, 2020 was 6,091 KGs.

Their revenue on wholesale was $0.84/gram versus a cash cost to produce cannabis at $1.76/gram.  Inventory has a booked cost of $1.86/gram at Q end. 

Gross Margin: Larger Peer Group

Sundial stays in the basement with negative 134% GM. It is hard to believe there are two worse than them.

SGA & SBC as % of Sales: Trend

G&A decreased by $0.5 million to $7.2 million and increased to 56% of sales from 38% QoQ on the sales drop. Office and salaries were the biggest contributor with a drop of $1.0 million to $1.9 million, which was countered with a $1.0 million salary increase.  Smaller expense category decreases aggregated the improvement.

Selling increased to $1.1 million from $0.5 million and increased to 9% of sales from 3% QoQ.

SBC was $3.1 million for the Q, an increase from $1.9 million last Q.

R&D was negligible again.

Depreciation was $1.5 million in non-production assets versus $1.3 million last Q.   

I moved the restructuring and asset impairment to Other Expenses to keep peer set comparable.

Total Opex was $13 million a slide from $11.4 million last Q.

Net Operating Profit before IFRS voodoo was negative $30 million versus negative $27 million last Q.

Other notable expenses include

• Restructuring charge -$1.1 million vs $2.4 million last Q and $6.2 million YTD
• Finance Income +$18 million.  Most of this is fair value increment changes due to declining share price.
• Asset impairment of $60 million on their Olds, Alberta facility which has been written down to $100 million
• Covid subsidy of $4 million. 

All in Net Comprehensive Income was negative $71 million versus negative $32 million last Q.  

SGA & SBC as % of Sales: Peer

While Selling is low compared to peers this is a function of wholesale revenue. Sundial is the second highest SGA and SBC aggregate in the peer group.

+Net Operating Profit Breakeven Peer

Sundial has a negative GM, as such I cannot calculate the breakeven sales.

EBITDA Trend and Peer

EBITDA slid to negative $4.1 million from negative $3.9 million last Q.   

And kudos to Sundial for backing out covid subsidies of $4.1 million from adj EBITDA.

Interest expense is $1.4 million.

+EBITDA:

Sundial has a negative GM, as such I cannot calculate the breakeven sales.

Balance Sheet Items of Note:

Cash

• Cash decreased modestly in the Q to $21 million. They have $26 million in A/P!! 
• From presser: Capital raises provided gross proceeds of $26.4 million during the quarter and $48.1 million subsequent to the end of the quarter
• As per preamble they are raising cash furiously to remian afloat.

• A/R increased signifcantly by $5 million to $14 million on Q sales of $13 million is wickedly high. And they are all trade A/R.  Either the last month of the Q was great and accounted for 100% of sales, or they are floating terms on wholesale.  We noted last Q there could be a Biomass Swap last Q.  This Q we cannot tell given removal of Havested KGs in MDA.

“Gas in the Tank” Trend

Plenty of inventory relative to sales even with the continued impairments.  But I don’t have a clue if it is FG or not as all Sundial discloses is Harvested Cannabis. 

“Gas in the Tank” Peer

Their inventory, which is not broken into WIP and FG, nor Oil and flower, is the lowest of the peer group.

“Waterfall” Trend

What I said last Q:

Their harvest decreased to 6,013 KGs or – 4,242 KGs QoQ.  Projected Yield at March 31, 2020 was 13,100 KGs, so they buried half the grow. 

Sales increased by +1,560 KGs.  But I cannot tell if they are notionally selling to themselves via a biomass swap. There is a 999 KGs difference between what closing inventory should be (12,096 KGs) and what they reported (13,095 KGs).  Did they purchase inventory of 999 KGs?

Inventory QoQ increased from 12,081 KGs to 13,095.

This Q:

I guess they did not like me pointing out the potential Biomass Swap last Q…  They removed Harvests this Q.  So, I have had to impute harvest and assume they did not purchase or destroy any inventory.

Using an imputed harvest figure of 4,601 KGs versus sales of 5,819 KGs, they depleted inventory by 1,218 KGs this Q.  Looks like they are getting into balance.  But at a 20% GM without the impairment this operation does not look viable at present sales levels.

That harvest trend is killing them on Gross Margin.

Waterfall Peer:

Sundial’s harvest for the Q was lowest in the group behind Tilray whom is no longer inventorying trim and OGI.

Sold vs Harvest & Sales vs Inventory

• Sundial has 2.4x Q’s of inventory to sales on hand down from 2.8X last Q.   

• A/P decreased markedly from $37 million to $26 million, which exceeds cash.  They are unlikely to be getting trade terms from many suppliers anymore.
• Current Portion of Long Term Debt increased by $63 million to $71 million as are offside on covenants.
• Derivative liability made a reappearance with convertible notes last Q and dropped by $6 million to $4 million as share price slid.
• Senior converts were paid down by $22 million and are at $48 million. Another $18 million were converted since Q end.

I cannot imagine the Secured Bank Creditors are taking kindly to the repaying of the convertible debentures ahead of their debt. I understand why Sundial is doing it as they are getting a discount on the debentures which a secured creditor would likely not give.  With an EBITDA covenant breach looming at Dec 31, 2020 I would not be surprised to see equity raised to pay down the senior secured debt.

In closing

20% GM would require sales of $40 million a Q to cover existing SGA.  This would require them to triple sales, and their present trajectory is going in reverse. 

This is not a viable business. 

New share issuance will be required to pay down debt to get the secured creditor to let go of their leg.  And even more shares will be required to pay A/P and to offset the negative cash from operations.

The preceding is the opinion of the author and is in no way intended to be a recommendation to buy or sell any security or derivative. The author has no position in Sundial nor intends to start one in the next five days.